Break out the champagne—that is, if you have any left after the year that Wall Street has had.
With Federal Reserve interest rate hikes looming, and at the halfway point of an earnings reporting round that’s been light on revenue, U.S. stock averages still couldn’t be restrained. They hit all-time record highs last week, and the joy is spreading.
The NASDAQ Composite Index scored its first record close since 2000 when the tech-studded index joined in on fresh records for the broader S&P 500 (SPX) and the blue-chip Dow Jones Industrial Average (DJIA).
While bulls are cheering on the stock market rally, all this strength can also have unintended consequences for some portfolios. Allocations to sectors or asset types can shift during big market moves. That means now might be a good time to do a quick checkup on your portfolio allocations and ask yourself if rebalancing may be necessary.
Last week, S&P Capital IQ’s Investment Policy Committee reduced its recommended exposure to U.S. equities to a neutral 45% from the previous overweighting of 50%. The committee also increased its weighting to cash to 15%, up from the prior neutral 10% holding.
"We are trying to tell investors: don't go so far out on the risk curve. Don't get sucked into the euphoria of a market advance. Continue to monitor the valuations of the overall stock market," says Sam Stovall, managing director at S&P Capital IQ.
Currently, the price/earnings ratio of forward 12-months earnings is 18 versus the average of 16 since 2000, explained Stovall. "We are between fully priced and overpriced in our opinion. We are also approaching a typical seasonal softness for stocks."
The stock market is about to enter a traditionally seasonally weak period. Wall Street pros point to the old market adage, "Sell in May and go away," which reflects actual performance trends.
Since 1945, the S&P 500 has recorded its strongest six-month return from November 1 to April 30, posting gains of 6.9% (excluding dividends) versus an average gain of 1.2% from May through October, according to S&P Capital IQ research. A variety of potential reasons could explain this seasonal underperformance trend, from summer vacations and a lack of market interest to mutual fund “window dressing" ahead of many funds’ fiscal year-end in October.
"We don't advise the investor to go away, as the market has a tendency to right itself or recover from declines very quickly," says Stovall. He notes that history tends to show that rotation can be a better strategy than outright retreat from the market.
Historically, seasonal strength emerges in consumer staples and health care during the May- through-October period. "Since 1995, the S&P SmallCap 600 Consumer Staples and Health Care groups posted average price gains of 5.3% and 5.4%, respectively, to the S&P SmallCap 600’s average rise of 2.5%," Stovall says.
A regular schedule of portfolio rebalancing can help keep investors on track toward their long-term investment goals. "If you have one or two stocks that have outperformed the market significantly, it may affect your allocation. Do you even realize this has happened?" asks JJ Kinahan, chief strategist at TD Ameritrade. For example, an investor may have started out with an even exposure to four sectors of the S&P 500. But because two of the sectors have outperformed, the allocations are now out of whack.
"Often the reason many people get burned in big down moves is because they didn't adjust their allocation," Kinahan says.
Or, for instance, an investor may have been aiming for a 50% stocks and 50% fixed income allocation that may now be performing closer to 70% and 30%.
“You should probably be reviewing this on a quarterly basis. Review your investment goals and ask, do your allocations match?" Kinahan concludes.
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