Time to Read: 6 Minutes
Five short weeks ago, the US stock market was sitting at all-time highs—then everything changed. As the novel coronavirus began establishing a foothold in countries around the world, US stocks entered bear market territory with record-setting speed. In this article, we look at the current bear market and implications for portfolio rebalancing. We also examine key indicators and share how we have adjusted our portfolios.
Historically swift fall from recent highs
As shown below, the current bear market materialized faster than any other in history, with the Dow Jones Industrial Average declining more than 32% in just 35 days.
Source: Ned Davis Research T_202rpt.
Fortunately, the portfolios at BWM Financial came into this decline with an underweight position in stocks. In our recent article and webinar, we outlined the four-part process markets generally follow during times of high uncertainty: Oversold, rebound, retest, and Breadth Thrust. We are consistently reviewing these steps to determine when to return to a neutral exposure and when to eventually establish an overweight equity position. As part of our ongoing review, we recognized that the magnitude of the sell-off caused our underweight allocation to equities to be greater than intended. As such, we decided it was time to rebalance portfolios.
Portfolio rebalancing primer: Maintaining disciplined asset allocation
Portfolio rebalancing helps investors maintain the targeted blend of risk and reward in their portfolios. Over time, asset classes generate different returns that can impact a portfolio’s asset allocation, causing it to deviate from the original risk-return characteristics. Rebalancing—typically done to achieve desired levels of equity and fixed income exposures—is a “tried and true” method for maintaining asset allocation discipline. The process entails selling one asset and using the proceeds to buy another, with the end result being a portfolio that reflects the intended asset allocation.
Let’s say your original risk tolerance called for 70% of your money to be invested in stocks and the remainder in bonds. In our case, we were purposely underweight the 70% equity target by 5 percentage points—so your portfolio would have had a 65% equity allocation. Recent market declines, however, pushed our underweight to 10 percentage points, meaning only 60% of your money was invested in stocks. After rebalancing, you would return to the desired 65% equity allocation.
Key indicators show signs of extremes
While we don’t know exactly where the market will bottom, some indicators are signaling we’re getting close to levels that are attractive for long-term investors. First, due to the speed of the decline, sentiment has moved from the extreme optimism zone deep into the extreme pessimism zone, as shown below. Because sentiment is a contrarian indicator, such a move usually signals a reasonable short-term buying opportunity.
Second, the vast majority of markets around the world have fallen significantly. As shown below, 93.6% of global markets are within 5% of their one-year lows. The last time such a high percentage of global markets were in steep decline was during the great financial crisis.
Timing vs. long-term value
As noted above, we recently rebalanced portfolios. We believe there is long-term value at current levels, and we didn’t want to remain below our target underweight to equities. As a trigger, we had our eye on the S&P 500 December 2018 low of approximately 2,350, a level which was breached on March 18th. We acted by increasing equity weightings in our portfolios to bring us back to 5% underweight stocks in most models. We favored US technology investments across all accounts with an added small allocation to emerging markets in growth-oriented portfolios.
We will continue to watch our four-part playbook for the correct signals to return to neutral—and hopefully to an overweight position in stocks when the timing is right. For now, we believe the fastest bear market in history deserved a little old-fashioned portfolio rebalancing.
Investment advice offered through Stratos Wealth Partners, Ltd., a Registered Investment Advisor DBA BWM Financial. Investing involves substantial risk. BWM Financial and Stratos Wealth Partners (the “Firm”) do not make any guarantee or other promise as to any results that may be obtained from the Firm’s “letter”. While past performance may be analyzed in the Letter, past performance should not be considered indicative of future performance. All indices are unmanaged and cannot be invested into directly. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. No reader should make any investment decision without first consulting his or her own personal financial advisor and conducting his or her own research and due diligence.