By Elizabeth O’Brien in Barron’s, featuring Brian Spinelli, CFP®, AIF®, Co-Chief Investment Officer
The bull market may be nearing a peak after a stellar two-year run. Rebalancing into these areas could help you avoid losses.
The stock market’s string of record highs offers investors a good opportunity to rebalance their portfolios before year end—or even before the election.
The bull market just celebrated its second birthday, and it has been an exceptional run, with a nearly 60% gain. But some analysts warn that the market is ripe for a pullback. “History says that investors need to be prepared for a possible setback in the coming 12 months,” wrote Sam Stovall, chief investment strategist at CFRA, in a recent research note.
Following the 11 bull markets since World War II that celebrated a second birthday, the average 12-month return was 2%, Stovall noted. What’s more, stocks aren’t cheap, with a price/earnings ratio of 25 times trailing earnings, a “concerning” valuation, he said.
The conditions may warrant some rebalancing. That’s the practice of selling some winners and using the proceeds to buy relative laggards to bring your portfolio back to its target allocation. After all, an overly concentrated portfolio is more vulnerable to downturns than a diversified portfolio.
Sometimes, small tweaks are all that’s needed. Say your target mix is 60% stock and 40% bonds, but the big run-up in stocks has shifted it to 70%/30%. In that case, you’d pare some stock and buy bonds. If you own, for example, an exchange-traded fund like SPDR S&P 500 (ticker: SPY), you might sell a little and put it into the iShares Core U.S. Aggregate Bond ETF (AGG), which covers the U.S. bond market.
Alternatively, you could shift some of your equity portfolio into less dominant areas. Market breadth has improved in recent months, so the divide between winners and losers within the S&P 500 index isn’t as stark. For a long time, a handful of tech stocks carried the market, but now sectors like financials and industrials are participating. Small-caps are also in the action, rallying on the expectations that the Federal Reserve can keep inflation under control while continuing to cut interest rates.
One option within equities could be to swap some U.S. exposure for international. Stocks in Europe, Asia, and other foreign markets trade at discounts to the U.S.; while that has long been the case, international markets historically have outperformed at times when U.S. stocks have wobbled.
The Vanguard Total International Stock ETF (VXUS), for instance, covers both developed and emerging non-U. S. markets. It yields 2.8%, well above the S&P 500, and has returned 10.7% this year. It’s also a way to get exposure to some of the hottest themes in investing, including artificial intelligence and GLP-1 weight-loss drugs through top holdings Taiwan Semiconductor Manufacturing and Novo Nordisk .
Trimming your winners is easier said than done. “People don’t want to leave something hot to go into something not as hot,” says Brian Spinelli, co-chief investment officer of advisory firm Halbert Hargrove in Scottsdale, Ariz. “It’s like exercising—you gotta do it even if you hate it.”
It may also be a good time to build up some cash for next year’s living expenses, and there are ways to do it without triggering capital gains. If you have appreciated securities in a tax-deferred individual retirement account, you could leave the cash in a money-market fund within the account so you won’t owe capital-gains taxes on the sale. While yields have come down a bit, they’re still healthy: The Vanguard Federal Money Market fund, for instance, yields 4.8%.
One wrinkle: Retirees who are subject to required minimum distributions must withdraw some money from their tax-preferred accounts each year and pay income tax on it. Keep that in mind before you sell anything so you don’t wind up paying additional capital-gains taxes.
Markets have been relatively calm, making it a good time for retirees to raise some cash, Spinelli says. Volatility could very well increase as we get closer to the Nov. 5 election. While the outcome of presidential elections rarely influences the long-term performance of the stock market, there could be short-term volatility. This is especially true if the winner isn’t settled on election night, leaving markets on edge.
