“Because of me.” Time
The stock market is on track to log a highly unusual year, and for that reason it’s a good time to revisit some key investment lessons.
People expect individual stocks, and the broad market itself, to rise and fall. Most of the time they do. But measured in one respect, stocks overall this year have gone entirely in one direction: up.
There have been down days in 2017, of course, and even down weeks. What’s unusual is that the Standard & Poor’s 500 index and some other broadly diversified baskets of stocks have spent the entire year on higher ground. At no point so far in 2017 have their values slipped below where they closed on Dec. 30, the latest trading day of 2016. The S&P 500 was up more than 15 percent for the year to date through Nov. 21.
It’s rare for the stock market to deliver such a smooth ride. Historically, the market has faltered about once every four years on average. The downdrafts can be nasty, like the 37 percent tumble in 2008.
“There have been only 10 prior years where the (S&P 500) went the entire year without trading into negative territory,” noted Bespoke Investment Group in a recent commentary. Barring a market crash over the waning weeks of 2017, the index will spend all of 2017 in positive territory.
The danger here is that such consistency can breed investor complacency, if not overconfidence. Selloffs from time to time reinforce the notion that stocks are risky. They help to deflate speculative bubbles, bring investor expectations down to earth, allow new dollars to come in at cheaper prices and boost dividend yields.
One way to guard against stock-market overconfidence is to rebalance or adjust your portfolio occasionally. The idea here is to take some profits off the table and reinvest the proceeds in assets that haven’t fared so well. It’s a natural buy-low, sell-high discipline for making sure that your overall portfolio allocation is appropriate for the amount of risk you’re willing to take.
Suppose your long-term goal is to have 60 percent of your portfolio in stocks and 40 percent in bonds. If the lengthy stock-market rally has pushed your ratio to 65-35, it might be time to sell a portion of your stocks and reinvest the proceeds in bonds, to get the mix back to 60-40.
Another option is to rebalance not based on portfolio movements but according to the calendar. Some investors do their tweaking at year-end, for example.
Rebalancing makes most sense in Individual Retirement Accounts, workplace 401(k) plans and other tax-sheltered accounts so that you don’t incur taxable gains along the way. It also means relinquishing some profits when the market is on a roll.
But without rebalancing, your portfolio will become increasingly stock-heavy — and risky — over time, with heavier concentrations in the hottest assets. Most people prefer their portfolios to become less aggressive over time, as they get older.
One argument against rebalancing right now is that the stock market tends to follow up consistently higher years with at least one more year of solid gains. As for those 10 prior years when the stock market traded entirely in positive territory, it also gained ground in nine subsequent years, according to Bespoke. The lone exception was a stumble in 1977 after a consistently up year in 1976.
Timing retirement withdrawals
Given that the stock market has delivered such a smooth ride lately, it can be easy to forget that sharp downdrafts can decimate a portfolio. While younger investors have time to bounce back, people who begin withdrawing money from a retirement portfolio during bear markets can incur significant damage, from which it can be hard to recover.
This was a topic covered by the American College in a survey of more than 1,200 relatively affluent people in or nearing retirement. The results showed that many investors don’t understand the dangers of making large withdrawals when stock prices are dropping. Only 34 percent of respondents knew that a large investment setback at the start of retirement, when withdrawals typically start, has a bigger impact on a portfolio’s sustainability than similar-sized losses several years before or after retirement begins.
Now isn’t one of those times when big losses appear threatening. But they can materialize at any time, and people nearing retirement should keep that in mind.
Predicting market crashes
Most people, including experts, can’t forecast when the next bear market will arrive, just like most didn’t prognosticate that the current upswing would begin in March 2009. But there are some indicators to watch, if you want to try.
One observation, from Jim Allworth of RBC Wealth Management, is to beware recessionary downturns in the economy. But because recessions can take many months to identify, usually in hindsight, Allworth suggests looking for signs of a credit squeeze — periods when loans become much more costly and difficult to obtain. Credit squeezes often trigger, or at least accompany, recessions.
In this regard, the gap between short- and long-term interest rates has been a reliable guide, Allworth wrote in a recent commentary. Since World War II, whenever the gap between 90-day Treasury bills and 10-year Treasury notes has narrowed to less than 30 basis points (0.3 of a percentage point), the economy has weakened significantly.
“All such recessions since the war were preceded by such a tightening,” he wrote.
Usually, the gap narrows because short-term rates are climbing quickly, but that’s not the case currently. With the gap around 115 basis points (1.15 of a percentage point), the economy isn’t near a credit crunch. In fact, interest-rate differentials are in a range where further stock-market gains are possible, if not probable, Allworth added.
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