Following the old saw that "What goes up must come down" - and vice versa - advisors who employ a strategy of buying cheap like it when market sectors decline.By the same token, some economic-minded advisors are continually on the lookout for market laggards in the expectation that the next swing might trend upward. Top performers over the recent past are the likely suspects for future price declines, say experts.
A look at mutual fund leaders might suggest that investments in international small cap funds or emerging markets would be areas of concern, due to a number of simmering crises in various parts of the world. But the heretofore-superior performance of either sector is not enough to send advisors fleeing the class.
"There have been substantial profits in the class, and we believe that returns will revert to the historical mean," said Harold R. Evensky, CFP and principal of Evensky, Brown & Katz, in Coral Gables, Fla. "We've underweighted emerging markets, but we still believe in the potential for the Pacific Rim, and kept our allocations there."
Sectors that have soared include natural resources and real estate. But barring an Armageddon-like event, the lofty prices aren't scaring everyone out just yet.
Evensky, who has fully allocated 20 percent of clients' portfolios to the tactical "satellites," has lightened up on natural resources. "We got into commodities early and made some money," he said. "But with pressures building in North Korea and the Middle East, prices in the sector reflect a mini-Armageddon and we don't want to get greedy."
"I did a Morningstar search looking for anything that's fundamentally ugly or overpriced, and can't find anything," he continued. "Everything is rich right now, but not too rich."
Residential real estate prices might fit the description of a "bubble." "Houses are sitting on the market here for over a year," says Stephen Barnes, a CFP and CFA at Barnes Investment Advisory, in Phoenix. "Anyone wanting to get out at the peak needed to have moved six months ago."
Interest-sensitive sectors like banking or fixed income might pose a challenge with rates rising. But some predict that the past increases have been sufficient, and that the new chairman of the Federal Reserve, Ben Bernanke, might stay at these levels for a while. "We expect the yield curve to look more normal," said Barnes. "And rate increases are close to done, and we expect they might even drift down a bit from here."
Potential trouble spots
An area of concern in the broader markets is the leverage in hedge funds and the newly created products using credit derivatives. Because these investments are less transparent and less understood, the scope of concern is difficult to quantify. Their market is limited among advisors to individuals, because of the difficulties in understanding the true level of risk.
"Credit derivatives represent one area that could be a ticking time bomb," said Barnes. "But I'd be happy if someone called 'Fire!' and they all headed to the exit, because it might open up some buying opportunities."
The amount of money invested in hedge funds and the unknown levels of leverage could be a sinkhole waiting to happen. But as the industry moves to greater transparency, new investors could provide a firm floor under values. "If we had more confidence in alternative investments, we'd be heavy into them," said Evensky.
Currently, some asset classes represent firm ground for advisors. "We are reasonably comfortable with our allocations to a plain-vanilla, high-quality laddered bond portfolio," said Evensky. "The risk there is gaining a real return, though, not asset price fluctuation."
Non-U.S. dollar bonds also represent an area of firmness. "One story in which we have the most confidence is in the potential for the U.S. dollar to stay weak," explained Barnes. "We have a meaningful position in foreign bonds to hedge our allocations to the U.S. fixed income class."
Markets are still watching Fed chair Bernanke for clues about any change of heart.
"The new Fed chair is still finding his sea legs on how to communicate with the markets," said Barnes. "But I don't see any indication that he'll face something like [former Fed chair Alan] Greenspan did with the 1987 crash just 10 months into his tenure."
Advisors say that with nothing overextended or cheap, the markets seem amazingly stable given all the political chaos right now, and that that might open up some buying opportunities later on.
On the other hand, said Barnes, "We're not going to get rich in the financial markets right now."
