When Equity Premiums Fade

Re-balancing is a time-tested strategy of asset allocation discipline that allows investors, if nothing else, to sell some securities high and buy other asset classes lower. Of course, there are times when all assets rise, and sometime fall, in unison making the re-balancing act more of a magician’s act (once you saw it, now you don’t!). Now that the market has risen six straight years from the bottom set in March of 2009, that holds for stocks and (almost) for bonds, I am reminded of a time back in 1999, a mere 16 years ago, when thoughts of early retirement and day trading were on the minds of many a 40 something year olds. You like the way your 401(k) statement looks today I bet…but my goodness were those statements looking good back then! Of course, investors aren’t nearly as exuberant today as they were then having been bitten a few times since, but sit back and watch what happens from here. In this low interest rate era how many more times can you hear, “there is no other place for people to put their money but the stock market” before another place to put their money becomes obvious? Equity premiums rise and fall as stocks get overbought and oversold. Buying a stock today offers a lower potential rate of return than at other times in the past so more caution is warranted.

The moral of this story is to say there is more than one way to re-balance. Investors have a funny way of always trying to get out of the door at the same time. Those 40 something year olds from 1999 are now 60 year olds, still working, and not fantasizing about day trading this time, but retirement, once again, is on their minds. So pick a comfortable asset allocation for your personal situation, be it 70/30, 60/40 or something else, and re-visit your asset allocation now, rather than letting the markets take care of your re-balancing efforts for you by lopping off a large portion of your gains. While I am not predicting anything here as far as how high this rally takes stock prices (we all know what happens when one assumes, plus, you need to be invested to participate) doesn’t oil dropping from $140+ a barrel to below $47a barrel give you pause as an investor? Yes, there are plenty of glowing reports abound regarding the state of the US economy versus the rest of the world, and that’s a good thing…but…lots of debt, deflationary warning signs and, oh, here comes Greece again voting January 25th as to whether to stay with the euro. It’s always easier to buy an umbrella when the sun is shining folks.

From here, dollar cost averaging into the market from a lower equity percentage base seems to make sense. At the very least, keep a little cash nearby, be it in zero interest money markets or near zero interest CD’s, and stand near the exit. Perhaps a few investors will drop some bargains on you on the way out the door.