So in terms of opportunities, I think the first thing to realize is that there are no really big bargains right now. The bull market has been running for five years. We've been in a low-rate environment, which has forced many investors into riskier assets. So it's hard to find absolute bargains. So what you're looking for are relative bargains.
What are they? I think that it comes down to a couple things. One, international stocks -- places like Japan -- which still look relatively inexpensive. Another international place to look: emerging markets. They come with risks, and we'll talk about those in a moment, but on a relative basis still look to be very cheap compared to developed markets. Third, energy companies -- not only offering the prospect of capital appreciation but also offering some yield, which is increasingly hard to come by in this world.
Now, those are some of the opportunities. What are the risks? I think there is a couple. The first and probably the biggest risk is the fact that things have gone so well for so long that investors are a bit complacent. You see that in the low-volatility ratings. And what that means is that if there's any type of exogenous shock -- if there's a deterioration, for example, of the situation in the Ukraine, if there's an escalation of violence there; if we see unrest in the Middle East -- those events are not currently reflected in the price of assets. In other words, investors would be surprised by those and you're likely to see some sell-off.
A second risk which I don't think is a big one but investors should be aware of is so far stocks have continued to do well because interest rates have moved lower. That helps stocks a number of ways. One, it helps valuations. Generally, valuations are higher when interest rates are lower. And second of all, it helps the profitability of companies by lowering their expenses. We don't believe rates are going to back up quickly but, if it were to happen, that would be another risk for financial markets.
Do a couple things, I think the most important of which is think about insurance policies in your portfolio. In other words, you know, this is no different than insurance policies on your house, on your car. It's something to own that will pay off if things go wrong. Now, insurance policies can take different forms. One would be some small allocation we call "safe haven assets" -- things like U.S. Treasuries or gold or currencies like the Swiss franc, which tend to rise when everything else is falling.
Another way to think about insurance is looking at options -- for example, put options on the market -- which will appreciate if stocks go down. Now, the reason I highlight that second form of insurance is right now, because volatility is low, that form of insurance is very cheap. So it's an opportunity to take advantage of that and to get that policy in your portfolio, which you might be glad you have later on.
Related by Topic: Economic Outlook , Investing for Income
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