The long running economic expansion – now the second longest on record – and the accompanying exceptional returns in the stock market have been very beneficial to all of us. As the economic expansion and accompanying bull market enters its tenth year, this happy anniversary is a good time to reflect on the merits of rebalancing diversified portfolios.
Portfolio Rebalancing in Uncertain Markets
Since the inception of our firm, we have been consistent advocates of the need to rebalance portfolios to target allocations as market conditions push portfolios significantly away from the strategic targets set for that portfolio. Looking all the way back to the beginning of the current expansion, we remember the many conversations with clients about the need to “pull the trigger” on rebalancing by selling bonds and buying stocks after the 37% loss on the S&P 500 in 2008. Nearly everyone in the investment world had been shocked by the near meltdown of financial markets in 2008 and at the end of that year, nearly all of our portfolios were below target for equities and above target for bonds due to the large stock market losses, both in the U.S. and internationally (international equities lost 43% in 2008 and real estate investment trusts were down 38%). Our rebalancing discipline paid large dividends after 2008 as the world stock markets recovered and our equity investments prospered. In an unprecedented run up for equities, there has not been a down year for the S&P 500 since 2008 and the average annual compound return on the S&P for the ten years ended August 31, 2018 (which includes the last four months of 2008) was 10.9% per year. For calendar year 2017, the S&P return was 21.8% and year-to-date through August 31, the return was 9.9%.
It is precisely all of this good news that continues to drive our rebalancing discipline today.Obviously, we are all very pleased with the returns of the last ten years, but our rebalancing discipline proceeds from the assumption that no one knows with certainty how markets will perform in the future and that the best defense against uncertain markets is to hold a diversified portfolio that is systematically rebalanced over time.Although the consensus opinion of mainstream economic forecasters is that the current expansion will continue through 2019 or 2020, or perhaps even 2021, we all are aware that economic forecasting is far from an exact science. And there are certainly some significant clouds on the horizon, including the potential impact of continuing tariff impositions, emerging market currency turmoil, rising interest rates, a flattening yield curve (a flat yield curve historically has preceded a recession), and relatively high stock valuations as compared to historical norms.
None of these clouds suggest the need for radical changes to your investment strategy. In fact, all of the data on the likely outcome of market timing (shifting your allocations based on expected future market action) argue in favor of maintaining your commitment to a balanced portfolio in the face of uncertainty. So once again with that old time religion: stay the course. Once you have established a diversified portfolio that fits your risk tolerance, stay within the confines of your overall strategic asset allocation.