Guest Author - Tony Daltorio
This week was quite a traumatic week for many stock market investors. The DOW Industrials, S&P 500, and Nasdaq all flirted with "official" bear market territory. The stock market is considered to be in a bear market when it declines at least 20% from its peak. The major indices are now down from 18% - 19%+ from their peaks and the DOW Industrial Average is back to the same level it was at roughly 2 years ago.
A couple of highlights this week showed the ying and yang of financial markets. General Motors stock fell to its lowest level in 53 years while the CRB Index (an index which tracks the prices of commodities) hitting an all-time high.
This past week in the stock market hopefully brought home a few points that were emphasized in prior articles. The first point is that investing in an index fund, such as an S&P 500 index, which tracks the major stock averages and holds stocks like General Motors is not a smart way for the small investor to try and make money. Over the past 10 years, the return on the S&P 500 is now negative!
The 'Buy and Hold' strategy is just a myth that Wall Street continues to push on to Main Street. It just does not work. Wall Street conveniently omits historical facts such as the following: The DOW Industrials first hit 1000 in 1966 and did not regain that level until 1982. It took more than 15 years just to break even!
The second point to emphasize for individual investors is to look at how large successful investors make their money over the long-term. In the prior article discussing the very successful college endowment funds at Harvard and Yale, we laid out how they made great returns for over two decades.
One of the ways these funds made great long-term returns on their money was to allocate a decent portion of their investment funds into commodities. One reason that the Harvard and Yale funds make such an allocation is that the two asset classes (stocks and commodities) usually go in opposite directions - the ying and yang of the financial markets.
A good example can be found in recent financial markets history. In the 70s, stocks went through a horrible bear market which lasted for more than a decade while commodities enjoyed a tremendous bull market which lasted for years. In the 80s and 90s, stocks enjoyed perhaps the greatest bull market in history while commodities were absolutely ravaged. Now in the 00s, it seems to have reversed again with US stocks going nowhere and commodities are enjoying a tremendous bull market.
The Harvard and Yale endowment funds average about a 15% allocation to commodities. Yet most individual investors have zero invested in commodities. EVERY investor should have at least a small portion of their portfolio invested in the commodity sector.
One way to participate in the commodity sector is to simply buy stocks of companies which produce commodities. The earnings of these companies will move up in sync with the prices that they receive on the commodities they sell. The stock price of these companies should follow the earnings higher. Some blue-chip examples of these type of companies would include: in the energy sector- Petrobras(PBR), in the metals sector- BHP Billiton(BHP), in the agriculture sector- Potash(POT). There are many other stocks to choose from, of course.
There is one major difference between the commodity bull market of the 70s and the current bull market. The commodities markets themselves are no longer solely the domain of the wealthy. With the advent of numerous ETFs(Exchange Traded Funds) and ETNs(Exchange Traded Notes), even the smallest investor can gain direct exposure to the commodity markets. As discussed in prior articles, ETFs and ETNs trade like stocks and can be bought and sold through any stock broker as easily as General Electric or Apple Computer.
These ETFs and ETNs come in all shapes and sizes. An investor can buy an ETF or ETN based on a commodity index which covers all the traded commodities, or an investor can buy an ETF or ETN based on a specific sector such as energy, or an investor can buy an ETF or ETN based on a specific individual commodity.
Tired of paying through the nose at the gas pump? Make up the money by purchasing an ETF based on Gasoline which will go up in value as the price of gasoline rises. Tired of paying sky-high heating bills in the winter? Make up the money by purchasing an ETF based on Natural Gas or Heating Oil which will go up in value as the commodity does. These ETFs and ETNs really are a simple, easy way for investors to diversify their portfolio and hopefully make some money.