Finding that fine ‘rebalance’
Investors have been given a great gift over the last few months: a worldwide rally in stocks that has them on track for their best year since 2003.
Use this fortuitous market moment to your advantage, many financial advisors suggest. If you’ve been looking to make changes to your portfolio, this could be a good time.
The blue-chip Standard & Poor’s 500 index is up 12.2% in price this year, and the total return is 14% with dividends. The average foreign-stock mutual fund has gained more than 20% year to date.
This is fattening up a lot of retirement savings accounts. It also will have many people wishing they had invested more earlier in the year -- a frequent December lament.
For some investors, Wall Street’s performance has been a little too good. Conspiracy theories have cropped up on investing websites such as Minyanville, questioning whether stocks are being manipulated by hidden forces that aim to suck more money into the upswing.
Some of those suspicions have been fanned by the absence of significant pullbacks in the U.S. market since mid-July, when the current rally began. The S&P; 500 hasn’t fallen more than 1% in any session since July 13, a remarkable streak that casts an inviting aura of relative calm over the market.
Sudden late-in-the-day buying waves also have raised eyebrows among analysts who study trading minutiae.
But there is a more likely explanation for stocks’ steady climb, some Wall Street pros say: Too many big-money players stayed cautious even as the market’s backdrop improved thanks to falling oil prices, sliding long-term interest rates, a wave of corporate takeovers and other factors.
That caution has given way to an overwhelming need to get aboard the rally, says Michael Metz, investment strategist at money manager Oppenheimer Holdings in New York.
“They’re playing catch-up,” he says of hedge funds and other investors that had been sitting on the sidelines. Because hedge fund managers’ compensation depends on how well they perform, they can’t afford to stay out of a hot market, Metz notes.
Their pain, your gain.
But this euphoria could end any day. After all, the big questions of 2006 still hang over Wall Street: Is the U.S. economy heading for a soft landing? Will corporate earnings keep growing at a decent pace? What’s the Federal Reserve likely to do next with short-term interest rates -- raise them, lower them or stay on hold?
Late last week, two other risks flared anew: a suddenly sinking dollar and the potential for all-out civil war in Iraq.
Those threats should provide even more incentive for investors to review their holdings and consider “rebalancing,” which entails trimming some investments and buying more of others.
Rebalancing is the simplest way to keep the overall risk in your portfolio at an acceptable level.
If you primarily invest through a 401(k) retirement plan or similar program, that should be your starting point. Take a look at what you own and whether some of the investment options you aren’t using should be in your mix.
It may be that your money is exactly where you want it for the long haul. If so, doing nothing is a fine choice.
Here are some points to consider in a portfolio review:
* Think about scaling back the investments that have performed best in recent years, if you’ve been letting them ride.
For example, small-company stocks have been among Wall Street’s hottest sectors since 2002 -- so hot that they’ve been at the top of many financial advisors’ lists of investments to prune this year.
Smaller stocks fell sharply in the mid-May to mid-June market dive but have come roaring back. In fact, the Russell 2,000 small-stock index is up nearly 18% this year, once again beating blue-chip indexes.
If you wanted a second chance to sell high, this is it.
The same goes for real estate investment trusts, which have rocketed in this decade as commercial property values have surged.
Few financial advisors would recommend bailing out of smaller stocks or real estate issues entirely. “But don’t be a pig,” said John Augustine, chief investment strategist at Fifth Third Asset Management in Cincinnati. If those sectors have ballooned as a percentage of your portfolio, take some off the top.
* What don’t you own, or what do you own less of, than you’d like?
Most investors put U.S. big-company stocks -- those in the S&P; 500 index and the Dow Jones industrial average -- at the core of their portfolio. But because that core has been a relatively poor performer since 2003, at least until recently, it may make sense to shift more money in that direction, many market pros say.
Why? Blue chips may be bargains compared with other market sectors. “I think they represent a better value overall” than smaller stocks, said James Berliner, chief investment officer at Westmount Capital Management in Los Angeles.
Also, if the U.S. economy continues to slow, multinational companies may become more attractive for their growth prospects overseas.
A lot of people on Wall Street have had the same thought this year. Although groupthink can be dangerous in investing, it also can make for self-fulfilling prophecies, which may explain the succession of record highs in the Dow index this month.
Technology is another sector that has been dreadful for much of this decade. But that makes it appealing to Augustine, who notes that Wall Street analysts’ earnings growth expectations for the industry in the first half of 2007 have accelerated in recent weeks.
* Weigh the pros and cons of foreign stocks.
They’ve performed much better than U.S. stocks in this decade, which might make the group a candidate for paring in a portfolio rebalancing. Unless, that is, you believe that the global economic landscape favors continued healthy growth overseas and that foreign stocks ought to be a bigger share of your portfolio than they were, say, in the 1990s.
That’s the view of Michael Glowacki, head of financial advisory firm Glowacki Group in West Los Angeles. Although he is trimming most clients’ stock holdings this quarter as part of normal year-end rebalancing, the reductions are mostly coming from domestic equities rather than foreign stakes, he says.
What’s more, the dive in the dollar last week was a reminder that foreign securities offer a way to protect your purchasing power if the buck is headed for another sustained decline.
So far this year, a Bloomberg News index of European blue-chip stocks is up 14.7% in euros. But the gain is 26.9% for a U.S. investor because the strong euro translates into more dollars.
Westmount’s Berliner has been reducing clients’ stakes in domestic real estate investment trust funds and shifting the proceeds into two foreign real estate funds: Cohen & Steers International Realty and Morgan Stanley Institutional International Real Estate.
Just remember that with foreign stocks, you have to be willing to accept substantial volatility. Recall how steeply most foreign markets fell from mid-May to mid-June.
* Be realistic about bonds.
High-quality bonds, such as U.S. Treasury issues, often are the primary asset investors use for the portion of long-term money that isn’t in stocks. Bonds provide income and lend stability to a portfolio.
The problem with bonds now is that they’ve rallied along with stocks since June. That means the interest rates, or yields, that bonds pay are relatively paltry. The annualized yield on a 10-year Treasury note has fallen to 4.55% from 5.24% in June.
With long-term bond yields so low, they already appear to be anticipating that next year the Fed will cut its key short-term interest rate from the current 5.25%.
“We can’t see long-term interest rates going much further below short-term rates,” Augustine said.
If he’s right, the potential for capital gains in bonds is limited, and the outlook for bond returns isn’t very appealing.
There are exceptions. For Californians, tax-free municipal bonds offer much better net returns than Treasuries or high-quality corporate bonds.
An easy alternative for investors who take a dim view of low bond yields is to lean more toward short-term cash accounts, such as money market funds, which in many cases pay higher yields than long-term bonds. Until the Fed starts cutting rates, cash account returns are likely to hold steady.
A cash cushion also gives you a bulwark in case things go bad for stocks next year.
* Be mindful of tax issues -- but not overly mindful.
Before you buy a stock mutual fund at this time of year, check to see whether the fund is about to make its annual year-end payment of realized capital gains. If you buy before that payment is made, you’ll have an instant tax liability.
Tax concerns don’t apply if you’re investing in a 401(k) or other retirement account, of course.
If you’re considering selling an investment held in a taxable account and are reluctant to do so because you’ll owe tax, remember that the top long-term federal capital gains levy is just 15%. That shouldn’t be a reason to avoid risk-reducing portfolio changes that would help you sleep better at night.
