It's already shaping up to be a summer of discontent for investors, so it's time to manage your expectations. To a global investor, there are conflicting signals everywhere: Although the U.S. economy continues to chug along like a tugboat, the "fiscal cliff" of massive tax increases and budget cuts still looms at the end of the year. Then there is the euro zone opera with the fat lady singing in Greece, Spain and elsewhere.
Do you stay out of all stocks and cower in bonds? What about the possibility of rising inflation in the United States and recession in Europe? How do you avoid the "tail risk" of multiple sour scenarios unfolding the way they did last August?
While it's hard to predict the cumulative effect of political and financial uncertainty, you can adjust your attitude accordingly so that you deal with what will come. Here are some new approaches:
1. Earnings Expectations Aren't Worth Worrying About
Wall Street has always been in the business of selling expectations, not managing them. So when a Facebook comes along and disappoints, why should we be surprised?
Millions get sucked into this roulette game all the time. Will earnings hit or miss analysts' estimates? If you're a long-term investor and not a trader, earnings estimates shouldn't matter - if that stock is worth holding long-term. Maybe you should ignore earnings estimates from analysts altogether.
Over the last three years, according to Fortune magazine, an average of 74 percent of companies in the S&P 500 beat estimates. In the first quarter of this year, though, the median two-day gains after earnings reports was zero. So the general impact of earnings surprises on the market has been nil lately. A more important indicator for me is the company's dividend. Did it raise or lower it? Companies that share earnings in the form of dividends typically have more downside protection and provide more income for you over time if you're a patient shareholder.
2. Stop Chasing Facebooks
With any new stock, your expectations should be low, not high. Start-ups have tremendous business risk. And if expectations are high, their capacity to disappoint is even higher.
You shouldn't pin your hopes on one stock anyway. Charles Wheelan, a University of Chicago economist who wrote the recent book "10-1/2 Things No Commencement Speaker Ever Said," advocates investing in diversified index funds that cover global stock and bond markets. "Don't try to be great" is one piece of his advice. It is unlikely you are going to hit a home run with one stock or fund. Consider emerging markets, dividend-paying stocks, real-estate investment trusts and a variety of bonds.
3. Jumping Off the Fiscal Cliff
This is the scariest of all the doomsday scenarios because it assumes Congress will do nothing early next year to avert the mother of all personal-income tax increases and more than $600 billion in federal budget cuts.
The Congressional Budget Office estimates that inaction will plunge the United States into recession again, contracting the economy into a negative growth rate ranging from 1.3 to 2.3 percent. Considering that Congress went through this charade last year and has known about this "taxmageddon" prospect since last August, it seems unlikely that they will plunge markets into despair again and trigger another downgrade of U.S. debt.
If you're incredibly pessimistic, then buy gold and U.S. Treasury bonds. The political impetus, though, is for some reasonable election-year compromise that won't deep-six the economy and markets again, so it's too early to hit the panic button.
4. Raise Your Own Expectations.
Finally, some good news. Want to buy a house? The great housing recession may have bottomed out as both sales and prices rose in April while mortgage rates remain low. It's too soon to tell if this trend has legs, but you can still find some bargains.
Although there's always a limit to how much your portfolio can appreciate given constrained market conditions, there's no limit on how much you can learn. So invest in your human capital. Learn a language. Take a cooking class. Update your job skills.
This could be a great summer if you focus inward and discover how to grow your mind instead of worrying about the scorched-earth politics of pervasive pessimism. Dampen your expectations for financial markets, but raise them for yourself and your family. There's no downside there.
