Cool It, Bulls!

Now could be a good time to take some equity money off the table.

Summary: Many investors have run with the market bulls, but now could be a good time to leave the herd or at least take a well-earned breather. Investment strategists are suggesting that investors in equities take some profits.
Key take-out: Lock-in equity gains, and take some bond losses for tax benefits, so you’re in a strong position for whatever curve balls are served up in 2014.
Key beneficiaries: General investors. Category: Investment portfolio construction.

Smitten by US equities? Wells Fargo Private Bank’s deputy chief investment officer Ronald Florance finds today’s unanimous bullishness a bit disconcerting, and is advising his clients to take profits and rebalance their portfolios accordingly.

To be clear, Wells Fargo’s team is not underweight the stockmarket. Florance estimates the S&P will appreciate somewhere between 5% and 7% from current levels, even as markets continue to get batted about by political uncertainty, the tapering of the Federal Reserve’s monetary stimulus and a slowing economy due to deeper government spending cuts. A conventional take, in other words.

But folks should take profits in their equity allocation, and losses to offset the tax liability, Florance says, so investors can reposition for the uncertainty ahead. Simply, “If you were properly invested in the stockmarket at the beginning of the year, today you are overinvested,” Florance says. It’s simple algebra because as your stock portfolio appreciates it will make up an ever increasing percentage of your portfolio. “And there’s nothing wrong with taking a profit to rebalance to previous levels,” he says.

Four years ago, money managers were advising that their clients stuff an inordinate amount of money under the mattress, in a desperate attempt to preserve their nest eggs. During the summer of 2009, Wells Fargo’s clients had 17% of their portfolios in cash. That number now stands at about 7%, the vast majority of which has been rebalanced to equities, now 39% of overall assets.
Graph for Cool It, Bulls!

“What’s interesting is we went from a place of extreme fear to one that will gradually shift to a place of extreme greed,” Florance says. We’re not there yet but the folks at Wells Fargo are already grappling with their clients’ excessive expectations. Some of them seem to believe that the 20%-plus returns of late will continue into perpetuity, he says, while others have even complained about their 10% gains this year. “We’re trying to dial down clients who are expecting 15% to 20% returns in a diversified stock portfolio, which is totally unrealistic,” Florance says, who believes the S&P is fairly valued at 15.5 times next year’s estimate.

Florance’s more inquisitive clients have begun to question him about recent losses in their bond portfolios. In one instance, a client was concerned that a rising interest rate environment would erode the stable cash flow he had come to expect from bonds. He didn’t want to lose any money and came to the table saying, ‘I know interest rates are going to go up and that’s bad for bonds.’ Florance quietly agreed until the client said, ‘Just move everything out of the bond market and put it in the stock market.’ Florance was horrified.

“Instead of looking at an asset class through the eyes of prejudice,” Florance says, “we needed to identify what the goals and concerns were.” For this particular client, it was about instructing him that by holding a diversified portfolio of shorter duration bonds, as opposed to a strategy of hold-to-maturity, it would help minimise the risk. “His immediate focus – that that interest rates are going to go up – was actually a pretty prudent outlook, but his reaction – to get rid of all of his bonds – was wrong,” says Florance.

Lock-in equity gains, while also judiciously taking bond losses for tax benefits, so you’re in a strong position for whatever political, fiscal and monetary curve balls are served up in 2014.


This article was first published by Barron's, and is reproduced with permission.