In one of my recent columns, I noted that investment analysis has gotten far trickier over the last few years.

We have entered a period of “administrative markets,” in which equity returns are affected as much by government policies as they are by economic growth and corporate profits.

In the last few years, we’ve seen large-scale bailouts; trillions in fiscal stimulus; massive quantitative easing; nearly seven years of zero short-term rates; heavy-handed regulation; and sharply higher taxes on income, dividends, and capital gains.

Our corporate tax rate is the highest in the developed world, driving even iconic American companies like Burger King to move their headquarters to Canada.

These policies distort markets… and lately equity investors have been paying the price.

A Shot Across the Bow

The S&P 500 recently plunged more than 10% in four days.

Don’t shrug this off. According to Bianco Research, this has happened only eight other times in the last 80 years.

Yes, the markets took a significant bounce. But I still view this as a shot across the bow, a warning.

Here’s what makes the smart money nervous right now…

In the past, when the economy (and the stock market) went into the tank, the traditional policy response was to stimulate the economy with lower interest rates and deficit spending.

But interest rates are already at zero. And under the Obama administration, the national debt has soared from $7.4 trillion to $18.4 trillion.

What’s next? Are we moving to negative interest rates (like Europe), creating a situation in which you have to pay to leave your money in the bank and even more stupendous deficits? That policy prescription didn’t work well for Greece.

Don’t put me in the gloom-and-doom camp. I’m not a pessimist. But I’m no Pollyanna either.

I consider myself a skeptical realist who looks at both the positives and negatives. Despite the many government policy missteps over the last decade, there are factors to appreciate as well.

For instance, the U.S. economy posted a much bigger rebound in growth during the spring than previously reported… (The Commerce Department adjusted the annual expansion rate in the April-June quarter sharply higher to 3.7%.)

Plunging energy prices are a huge plus for everyone outside the oil and gas industry…

Inflation is negligible…

Housing is roaring back…

Unemployment is falling…

The dollar is strong… And the outlook for corporate profits is improving…

Three Essential Steps

Given the mixed outlook, what should you do with your portfolio now? Start with these three essential steps:

1. Check your asset allocation. The roaring bull market of the last six and a half years has almost certainly increased – and perhaps more than doubled – your exposure to equities. If it’s now larger than you’re comfortable with, pare back to the point at which you’ll be able to sleep at night.

   How much in stocks is enough (or too much)? Investment great Benjamin Graham used to say that no one should have more than 80% of their portfolio in stocks – or less than 20%. Look at your age, time horizon, and risk tolerance, and adjust accordingly.

2. Move those trailing stops. Make sure they are no more than 25% below your holdings’ recent highs. And if you’re using “mental stops” – no actual stop orders entered – be sure to maintain your sell discipline when your stocks trade through your predetermined price.
3. Adopt a late-stage bull market strategy. That doesn’t mean move to cash. (This bull market could last five more weeks, five more months, or five more years.)

   History shows that as a bull market ages, the safest and best-performing stocks tend to be recession-resistant, mega-cap value stocks, preferably ones with growing dividends. (Those dividends both support your shares and provide income during the bad times.)

All this government meddling with the market makes this a challenging time for investors. We can only wait and see what policymakers dream up next, whether it’s higher rates or QE4 or something entirely new.

Investment legend John Templeton used to point out that no matter how strange things look, economic and market cycles are all essentially the same.

He famously noted that “this time is different” is the most expensive phrase in the annals of investing. That statement is generally true.

But check your history. When was the last time the national debt was bigger than our GDP and the Fed held rates at zero for nearly seven years?

This time really is different. Govern your portfolio accordingly.

Good investing,

Alex Green
Chief Investment Strategist, The Oxford Club