Stephen A. Rossi, BridgeTower Media Newswires
Well, it finally happened! The Dow Jones Industrial Average fell from an all-time high of 26,616.71 on Jan. 26 to 23,360.29, on an intra-day basis, on Feb. 9 - a correction of over 12 percent and well in excess of the typical 10 percent market pullback that most consider to be normal, healthy and expected.
Aside from fears of inflation and a more aggressive Fed, just about all of the financial metrics in the U.S. suggest that stocks are headed higher. However, if you're one of those people who are still concerned about lofty valuations, a black swan event or some other geopolitical mishap, here are six things you might consider to ease your market anxiety.
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Rebalance your portfolio
As stock prices have moved higher and bond prices have moved lower over the past several years, most investors' overall asset allocations have drifted away from their strategic targets. In other words, if your portfolio was strategically set to have a 60 percent weighting in stocks and a 40 percent weighting in bonds, it's quite likely that market movements have pushed these weightings closer to a 65/35 or even 70/30 mix of stocks to bonds. Since forward price-to-earnings multiples in the equity market are still well above their historic medians in most cases, consider selling some stock and buying some bonds (i.e. selling high and buying low), to restore your portfolio's strategic asset allocation and claim some of your equity market gains.
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Move money from U.S. to international equities
The rest of the world seems to be behind us in the current economic expansion, and lower equity valuations outside the U.S. certainly reflect it. Central banks around the world continue to deploy all the tools the U.S. did to emerge from its economic malaise - deficit spending, cutting interest rates, quantitative easing, etc. - and they're likely to continue doing so until they get the same favorable result that the U.S. equity market did. In this environment, and as the Bank of England seems to be one of the few central banks that is actually removing stimulus from the system by raising rates, why not take advantage of other countries' relative position in this economic cycle by decreasing U.S. stock exposure and increasing equity exposure in areas like Japan, Europe (broadly speaking) and the emerging markets instead?
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Be selective about small/ midsize stock exposure
Though many believe that recent tax and regulatory reform will be a boon for small and midsized businesses in the U.S., a risk-reward trade-off generally exists, such that small/midsized companies are riskier than larger-sized companies, all else being equal. If your goal is to reduce this type of risk, perhaps shifting funds from U.S. small/ midsized companies to U.S. large-sized companies is appropriate. Based on valuation and/ or the international market's relative position in the current economic cycle, it may also make sense to shift from U.S. small/ mid to international small/mid or, further, to shift from U.S. small/mid to international large-sized company stocks as well.
Shorten up bond maturities
The U.S. has obviously been in a rising interest rate environment of late and it generally holds that, as rates go up, bond prices come down. It's also generally true that, for a given increase in interest rates, bonds with longer maturities tend to come down in price more than bonds with shorter maturities; this is referred to as interest rate risk. That said, perhaps U.S. bond maturities could be shortened to no more than 7 to 10 years, as opposed to bonds that might mature in 20 or 30 years, to control this type of risk.
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Lighten up on U.S. high-yield bonds
High-yield bonds are generally issued by companies of lower credit quality. As an asset class, they can exhibit price movements that are more correlated to equity investments than to safer, more conventional bond investments and, over the past several years, they've been one of the best performing fixed-income asset classes out there. That also means that, as prices have been driven up, yields have been driven down, such that the incremental return that you can earn above a riskless asset, like a U.S. Treasury bond, has contracted. In this context, why not capture gains and reduce the equity-like characteristics of your portfolio by selling some of your high-yield bonds and investing the proceeds more conservatively?
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Consider adding (inflation-protected) U.S. Treasury bonds
If you're worried about market volatility and the adverse impact that any further correction in U.S. stocks could have on your portfolio, a negatively correlated asset like a U.S. Treasury bond may be the answer. Being negatively correlated simply means that when U.S. stocks go down, U.S. Treasury bonds typically go up, effectively offering the investor a degree of downside protection for his or her overall portfolio. Given a choice between a plain vanilla Treasury bond and an inflation-protected Treasury bond, the Treasury Inflation-Protected Security (TIP) may be the better way to go, since the market has priced them to assume a 2 percent average annual rate of inflation over the next 10 years, even though, historically, inflation has run at 2.5-to-3 percent per annum. To the extent that average annual inflation exceeds 2 percent over this time period, the TIP will provide a higher inflation-adjusted, or real, rate of return.
Before acting on any of these items, one should consider speaking with a qualified wealth manager. This individual will make it a point to understand your goals, investment horizon, tolerance for risk, tax situation, charitable intentions and the framework of your overall estate plan. It's possible that your wealth adviser will agree with some of the suggestions made herein. For these folks, and particularly at this stage of the current economic expansion, being proactive and implementing these portfolio adjustments may be a way to spend more time enjoying meaningful, regenerative sleep and less time counting sheep.
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Stephen A. Rossi is senior vice president and senior equity strategist at Canandaigua National Bank & Trust.
Published: Mon, Mar 12, 2018
