Time to Lighten Up on U.S. Stocks?

As those of you who follow my financial blogs know, I am a believer that the largest component of long-term investing results is one’s asset allocation. To maintain a proper allocation, one must periodically rebalance portfolios.

Since the beginning of the year, the S&P 500 has risen about 3.9%, which does not seem like a huge change. However, the year started off with a sizeable correction, so from its low this year, the S&P 500 is up over 14%.

And since it’s low in 2009, the S&P 500 is up over 200%, demonstrating why bailing on stocks when all seems gloomiest is exactly the wrong approach. And, I would argue, so is going all in on stocks as the markets continue to appear rosy. (That would be now.) Rebalancing forces one to sell off relative winners to buy relative losers.

If you haven’t rebalanced in a few months, it might be a good time to determine if your portfolio needs attention.

Only rarely do I change the allocation percentages of my various investment categories. Now, however, is one of those times. My sense is that U.S. stock markets are overpriced. As noted, The S&P 500 has already risen over 200% in the last seven years. That’s past. What matters is the future, and current price has everything to do with collective future expectations.

My expectations are a bit gloomy:

The bull market is already seven years old, but still propped up by expansive fiscal and monetary policy. The Fed still keeps interest rates artificially low. The U.S. Federal government stills pumps money into the economy. Its projected deficit for the year is $500 billion. Continually applied, these types of polices lead to bubbles.

Interest rates are much more likely to rise than decline (a negative to both stocks and bonds), unless a recession occurs.

Commodity prices have fallen substantially, temporarily boosting profits (consider airlines, for example). The five-year decline is likely to reverse.

The dollar has risen substantially over the last five years compared to major currencies (Euro and Yen by 30+%). This means U.S. based exports are more expensive and foreign earnings for U.S. companies have less value.

Much of the U.S. unemployment slack has been erased. This means corporations will have to pay more for talent they need. At the same time, much of the increased profit margin they have wrung out of labor costs by converting full-time positions into part-time and on call employees, outsourcing, and eliminating defined benefit pension plans and the like has already been fully reflected in earnings.

When (not if) the next recession occurs, the Fed will have fewer resources to counteract the liquidity crises that will surely occur because it has kept interest rates artificially low. Similarly, with the U.S. debt at record levels, Congress will be unlikely to approve appropriate economic relief measures.

Thus, the next recession will likely last longer and be deeper than would be the case if the U.S. economy were not starting from a position where expansionary measures are constantly in effect.

All of which says to me that U.S. stocks are riskier than usual in my portfolio. Recall that I am older and retired, which means I have fewer years to recover from any bear market and (worse) I do not have the ability to purchase more investments through savings from future earnings.

So my situation is different from yours, as may be my analysis of what to expect. But I figured I’d share my thinking and maybe learn something from everyone’s reactions.

~ Jim