For several reasons, retirees are being forced to assume greater portfolio risk. Historically low-interest rates have the double impact of raising bond prices and reduced income. So, investors must seek riskier alternatives, either in lower quality (junk) bonds or looking to real estate or more stocks for income. Most company’s stocks are paying higher dividends than their bonds today. And the Federal Reserve just announced that they’re encouraging inflation.
While many investors and advisors utilize questionnaires or ‘risk scores’ to identify a target portfolio allocation (such as 60% or 70% stock), there is a better way. Target allocations often require systematic withdrawals, where every holding in the portfolio is pared slightly for each income distribution. This creates the ultimate short-term risk for each investment.
By separating investments based on time frames, you can practically eliminate short-term market risks to next month’s income and allow your remaining investments adequate time to generate attractive returns.
For example, Integras Partners employs multiple strategies for increasing timeframes. The first 18-30 months of distributions are set aside in their low-risk Liquid Asset portfolio. The next layer is an Income Strategy seeking higher yields across bonds, stocks, and real estate. Recent volatility has fostered tactical opportunities in Structured Notes, as well.
These early layers permit the rest of the portfolio to seek attractive longer-term gains in more aggressive strategies, which are now insulated from short-term volatility risk.
Given the abrupt halt to the US and global economies, it appeared inconceivable back in March that the stock market would have recovered all its losses – and an unbelievable 10% gain by August. Yet here we are.
While delighted with this performance, we have real concerns around current market dynamics and just how high trees can grow. Our homebound lifestyle has made technology, communications, and consumer discretionary sectors far and away the leaders of this rebound. We expect this trend to continue as this group has advanced 30% for the year, whilethe rest of the market is down. As money continues coming into the market (more on that below) – these sectors are attracting a great majority. We believe there will ultimately be a major shift towards the most disaffected areas of the market once we can envision the economy fully reopened – whenever that may be.
While the thesis of working and shopping from home that drove these sectors is still valid, the forces truly driving prices are momentum and the dearth of other places to get positive short-term gains. With interest rates near zero, high bond prices and the Fed signaling it wants inflation, alternative places to invest look less compelling. So, the concentrated advance of these sectors is likely to continue.
Until It Doesn’t.
While the economy is in fact recovering, itcould be two years for corporate earnings to match 2019 levels, let alone justify today’s stock prices. We have stated before that valuations themselves are a terrible timing tool, but history shows that when we reach 22x expected future earnings, trouble looms.
Furthermore, September is historically the most volatile month of the year, and coupled with the election, we are vulnerable to some form correction in the next few months which, if it occurs, we expect will be short and shallow.
Given these observations, we are positioning to take some gains off the table and utilize a hedge that appreciates with increased market volatility. We expect to maintain this position for only a few months and will continue monitoring market dynamics.
We could very well be wrong: similar conditions have happened before, even at current levels, and markets continued to rally. But with Main Street reality very different than Wall Street reality, we believe a little defense at this time is warranted.