Why It Would Be Foolish to Sell Your Stocks

Justin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The market has pulled back from its recent highs, and investors have begun to talk about bubbles in several asset classes. Long-term investors should stay focused on the key trends that can move markets, as opposed to scary headlines and political commentary. Two crucial facts make investing in U.S. stocks a compelling opportunity for patient, long-term investors: demographics and the performance of bonds.

The Bull Market in Bonds has Ended?

David Rosenberg, Chief Economist & Strategist with Gluskin Sheff, has been particularly accurate regarding the direction of U.S. Treasury yields and inflation during his entire career -- and he recently said that the bond bull market has ended.

This comes after Rosenberg correctly forecast a continuation of the bull market since 2009, while several prominent “experts” called for rising inflation and a collapse in bond prices. The end of the bond bull market doesn’t mean hyperinflation, which would be bad for stocks, but rather a gradual increase in rates. Rosenberg expects very modest movements upward in the long end of the Treasury curve -- nothing catastrophic, but enough to suppress the returns of fixed income assets. If he is accurate, this makes the relative return expectations for stocks all the more appealing.

Rosenberg recommends financial stocks during such a scenario. Banks will see increasing earnings from rising net interest margins, and life insurance companies will be able to sell product with higher margins. The Financial Select Sector SPDR (NYSEMKT: XLF) is one of the most popular ways to gain diversified exposure to the financial space. Its weighting includes 47% banks, 26% insurance, 12% REITS, 12% diversified financial companies, and 3% other.

The big boys in the insurance space will likely do well, but one concern is the large amount of buys from analysts in regards to Allstate, Metlife, Prudential Financial, Travelers, and Hartford Financial. It is much harder to outperform when expectations are already high.

Instead, an investor may favor Torchmark (NYSE: TMK) which has a lower percentage of buys than most of its life insurance peers. Torchmark is the low-cost provider of insurance to niche areas such as military, seniors and other relatively underserved groups.

The company has grown book value at a 9% compound annual growth rate, or CAGR, over the last decade, and its current price-to-book ratio of 1.4 is in-line with the industry average. Torchmark has also grown dividends at a five-year CAGR of 11.9%, the highest among life insurance companies with a market capitalization greater than $5 billion.

Demographic Destiny

For long-term investors, there are few things more important than demographics. One of the more important demographic stats is the ratio of people aged 35-49 relative to those aged 20-34.

Ned Davis Research has extensively studied the topic, and found that a rising ratio is good for the economy and stock prices. Per capita spending is higher for those in the 35-49 age group, as are their contributions to retirement goals. And increasing retirement contributions boosts demand for stocks.

The fact that baby boomers were hitting this key age segment was a big factor for the Great Bull Market from 1982-2000. For the U.S., this ratio is set to trough in 2015 and then increase for more than a decade. It should be noted that these forecasts are extremely accurate, as the births occurred 20-40 years ago.

The favorable demographics for stocks also apply to housing.  The homeownership rate moves up significantly for the 35-49 age group.  According to Ned Davis Research, the home ownership rate will increase by about 90 basis points from 66.7% to 67.6%. This doesn’t sound like much, but combined with other demographic tailwinds such as increasing families with stock ownership it could fuel a long sustainable rise in housing related equities.  Home Depot certainly isn’t cheap with a price-to-earnings ratio of 24. There may be some consolidation and pullbacks following such a strong move, but the demographic forces will likely lead to a decade of strong earnings growth.

What about international opportunities? Japan just went through a severe decline in this demographic ratio, which served as a headwind to a 25-year bear market. This ratio is set to rise through 2020, though, and it may be the cause for a new secular bull market in equities. iShares MSCI Japan Index (NYSEMKT: EWJ) is one of the more popular options available. The fund has deep liquidity and offers diversified exposure to more than 300 Japanese companies.

Japan has been front and center with its current monetary and fiscal stimulus. The country has witnessed an 80% surge in the stock market, only to see it immediately crash 20%. Investors should expect significant volatility in the near term if investing in Japan.

Those concerned with currency movements may find the Wisdom Tree Japan Hedged Equity Fund (NYSEMKT: DXJ) a better alternative, as it attempts to offer equity exposure while simultaneously hedging currency risk. Three big markets where the demographics are set to become a headwind include China, the United Kingdom, and Germany.

The Foolish Bottom Line

The stock market doesn’t move in straight lines, and sentiment will ebb and flow. Next to the valuation of the stock market, (which is reasonable in the context of low inflation) the performance of alternative asset classes and demographic forces might be two of the most important factors for long-term performance. The U.S. stock market is positioned to do very well if bond returns turn negative and demographic forces take root.

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Justin Carley has no position in any stocks mentioned. The Motley Fool recommends Home Depot. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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