While many investors believe that passing this milestone puts markets in bull territory, it remains possible that we are seeing a bear market rally—a period of strong gains that occurs in the middle of a bear market (after a 20%+ drawdown, before a new all-time high). Until markets reach a new all-time high, it's impossible to know whether the bear market through—the ultimate low of the market cycle—is behind us.
With this in mind, we recommend investors continue to exercise caution. We favor high-quality bonds over stocks. In our view, this is also an environment where structured investments can be attractive, offering a way to manage short-term risks while staying engaged for medium-term opportunities.
In addition, such moments provide an opportunity for investors to review their long-term strategies:
Investors should consider rebalancing portfolios. Investors should check to see if their asset allocation has drifted from long-term targets and rebalance their portfolio accordingly so that it remains well-positioned for a potential inflection in markets. Asset allocation drift is pro-cyclical, which means that portfolios tend to become more heavily-weighted to recent winners, while asset classes that have underperformed recently make up a shrinking share of the portfolio. For example, US large-cap growth stocks underperformed the S&P 500 by 11% last year. Without rebalancing, this would have led to a smaller-than-intended portfolio allocation to this part of the market, reducing exposure to these stocks' outperformance so far in 2023.
Fund spending from more liquid assets. With both US stocks and bonds down about 10% from their last all-time high, this remains a poor time to raise cash for spending. We therefore recommend investors consider spending down liquid assets (cash, savings accounts, and high-quality bonds), without replenishing these reserves until this bear market is over. This “dynamic refilling” strategy can allow the rest of an investor’s assets to remain fully invested and positioned for a recovery. During a bull market, we generally recommend setting aside resources to fund 3–5 years of portfolio withdrawals, because this has historically been the time needed for most diversified, balanced portfolios to fully recover from bear market losses and set a new all-time high.
Add durable income to portfolios. Although cash and short-term bond yields are more attractive after the recent interest rate hikes, inflation is still eating away at the purchasing power of safe assets, and we expect interest rates to fall from here. The best strategy is to lock in yields as rates peak, and put excess cash to work in your long-term investment portfolio, where it has a greater opportunity to outgrow inflation.
So, we advise investors against assuming that the recent upswing in equities can gain momentum. Instead, we view this as a good time to consider rebalancing portfolios and reviewing long-term wealth plans.
Main contributors - Solita Marcelli, Justin Waring, Christopher Swann, Jon Gordon
Content is a product of the Chief Investment Office (CIO).
Original report - Reviewing portfolios as US stocks flirt with bull market, 9 June 2023.