Many investors have realized generous returns during the historically unprecedented decade-long bull market. The current investment climate may have lulled some in retirement or who have accumulated substantial assets into a false sense of complacency.
The volatility introduced by the coronavirus panic has raised some interesting questions for investors who previously believed their portfolio were immune to a downturn. While it’s likely that stocks will recover once the spread of the virus slows, the losses in the meantime are real and hard for many investors to accept.
To prepare for the inevitable rocky times, investors always should ask the following questions: What happens if interest rates rise or the economic expansion halts? Is my portfolio adequately structured to weather such a storm?
There are three principal risk factors on the horizon, that might warrant adjustment of your portfolio:
• Continuing trade tensions with China and the likely prospects for a long-term resolution or agreement
• The direction of the yield curve
• The risk of an economic downturn due to the coronavirus outbreak or another, unknown event to come
Reviewing existing investments in light of current economic conditions will help cushion your portfolio from unexpected or sudden market drops that are common attendant to any economic downturn.
Current economic conditions have challenged traditional econometric theory on which interest rate policy decisions, in part, are made. Unemployment has remained at the lowest level in 50 years. Yet, unlike unemployment periods in the past, no inflation has accompanied this full employment scenario, confounding economists as well as the Fed’s open market rate-setting committee.
Investors should be mindful that these novel economic conditions require a diversified asset mix. A flexible investment strategy will help diminish the risk of loss from over-extension in any one asset class or a portfolio that is unduly weighted with one class of stocks, such as momentum or the tech grouping.
Review asset mix and strategy
A decade-long boom in the market may prevent investors from realizing that an investment strategy or specific portfolio asset-weighting that worked in the past may not be optimal for the future. The S&P 500 Index, for instance, is heavily weighted with large-cap stocks. This sector is more vulnerable to a slowdown in global growth.
Investors should be aware that some investments once favored may no longer be suitable for your investment objectives, under current market conditions. If you owned bond funds during the past three years or longer, you would have benefited from the bond market rally.
Thanks to rate cuts, most bond funds provided enviable returns (bond prices rise when interest rates fall), with outsized gains during 2019.
The biggest risk for investors looking to maintain a bond component, is inflation and the prospect of interest rate hikes. A well-managed ETF or mutual bond fund can purchase maturities to maximize current yield consistent with avoiding losses to the principal or face amount of the funds bond holdings.
Trying to determine the proper mix of duration or maturities to enhance yields in a fluid interest rate environment, is a difficult task, best left to professional fund managers.
Another financial measure that should be reviewed are the price-to-earnings (P/E) ratios of your current stocks. You can check the P/E ratios of your ETFs by visiting their web sites. P/E multiples for individual stocks can be obtained from any financial publication.
If your funds P/E ratios are inordinately high relative to the market as a whole you could bring down the overall P/E by investing in other classes of equities, such as value stocks, utilities or other stocks whose multiples have not skyrocketed due to continuous price appreciation.
Add value stocks
Since they have been largely eclipsed by the FAANG tech group, as well as “momentum” stocks, value stocks may be ready for a rebound. A prudent investment strategy would examine value stocks, companies that are selling below their “intrinsic” value, as additions to your existing asset allocation.
Value has been out of favor for the past 10 years while prices of momentum stocks, such as Facebook, Amazon and Netflix, have consistently increased substantially every year. Value stocks represent a low-risk way to adjust your portfolio holdings to take advantage of evolving market conditions or investment strategies. A value stock strategy is an example of how reassessing your long-term holdings could enhance your overall returns.
Value stocks, by definition, are quality companies that have sound fundamentals, good prospects for growth and earnings power — important factors that are not reflected in the price of the stock. Many sound companies with excellent prospects for the future have low P/E ratios, relative to the overvalued tech sector.
Replacing exceptionally high multiple momentum stocks with quality value stocks that have been undervalued would allow you to participate in potential price appreciation with limited downside risk.
Reexamining your current portfolio holdings, with appropriate adjustments where warranted, will help cushion you from the vagaries of unforeseen economic events that could adversely impact the overall return of your retirement savings.