Time to Read: 5 Minutes
After March delivered a historical drop in the stock market and ended the longest bull market on record, BWM rebalanced portfolios to move from an underweight position in stocks to an equal weight, taking advantage of attractive valuations and extreme pessimism. Yesterday, we rebalanced again for very similar reasons, but on the other side of the trade: This time, we cut equity exposure. After stocks’ huge rally from the bottom and price appreciation after the March rebalance, our portfolios had moved into overweight territory. Here we take a closer look at the reasoning behind our rebalancing decisions.
Heeding a critical rule: Beware the crowd at extremes
One of our primary rules of tactical investing is, “beware the crowd at extremes.” Looking at Ned Davis Research’s Daily Trading Sentiment, shown below, we see the indicator has moved from extreme pessimism in March—the point at which we added equity exposure—to squarely within the excessive optimism range as of this week, an environment which has historically been a headwind for stock returns.
Benefiting from a tech-driven recovery
The market recovery from the COVID-19-induced decline has been unprecedented. It took the S&P 500 Index just six months to return to a new high—according to NDR, this is the fastest such turnaround on record and 17 months quicker than the second-fastest recovery (the rebound after the 1987 crash). The recovery’s composition has left some asking if the rally is sustainable. At the crux of the issue is the worry that most of the gains are attributable to the “FANMAG” stocks (Facebook, Apple, Netflix, Microsoft, Amazon and Google’s parent company Alphabet), while the average stock is still well below its level on February 19, as shown below.
When we increased our equity weightings in March, we did so primarily through technology-related exposure due to the sector’s solid balance sheets and lesser sensitivity to the widespread “shelter in place” orders. At the time, we did not foresee that this segment would be among the best places to invest over the coming months. In fact, if you look at the tech-heavy Nasdaq 100 performance relative to the broader S&P 500, the recent move eclipsed the bubble-like outperformance witnessed during the late 1990s dot-com era, as shown below.
Looking ahead: Maintaining dry powder ahead of potential risks
We believe there are plenty of potential risks on the horizon, including the looming election, ongoing pandemic and increasing social unrest. As such, we believe it makes sense to keep some powder dry and our portfolios in line with benchmark allocations. We recently moved back to equal weight by selling some of the same technology-related equity investments purchased in March.
While we don’t think it make sense to get too defensive right now, we believe investors with outsized concentrations in some of the high-flying Nasdaq tech stocks might want to review their allocations and consider taking profits for potential reallocation into other, more value-oriented areas of the market at the right time.