Mid-year Portfolio Review

With the second quarter ending last week and the Fourth of July holiday past, now is a great time to reassess your investment portfolio.

2013 started with a bang in equities.

• The S&P 500 rose more than 14 percent into May, and then retraced 3 percent to current levels. Not a bad six months.
• The NIKKEI took off like a rocket ship on “Abenomics” and has returned more than 31 percent, year to date.
• Gold and commodities have faced a tough road, starting in April, on accelerated selling and concerns over slowing demand in China.
• Treasury yields and mortgage rates have jumped over the past couple of months.

Needless to say, there has been a lot of volatility across the investment space.

Much of these price fluctuations have been driven by central bank commentary, monetary policy changes, and participant expectations—a constant tug of war. With interest rates trending sideways until recently and nowhere to go but up in the future, the 30-year bull bond market seemingly ended April, 29, 2013, according to PIMCO’s Bill Gross. (Note: bond yields are inversely related to the price, as yields rise the price falls or visa versa).

Rising rates will prove to upset traditional portfolio allocations and, negatively or positively, influence the pricing of many other risk assets.

No one has all of the answers, neither can they predict the future or create an impenetrable portfolio that always goes up. If someone tells you otherwise, you should run the other direction, and fast.

This reaffirms the value of basing portfolio decisions on a long-term thesis and adjusting with conditions. Whether you are working with professional adviser or individually managing your portfolio, it is important to reassess what has and hasn’t worked so far this year and formulate the best path moving forward.

Many participants attempt to time the market or make large moves in and out of assets, which has historically proven to be a loser’s game.

It is advisable to frame a macro thesis that guides your portfolio and dollar-cost average into various classes based on such. Adding incremental amounts of capital to your portfolio across a longer horizon ensures that you are buying more (or less) of an asset when it is relatively cheaper (or more expensive), but doesn’t impact the larger picture goals.

Even if you bought in at the previous peak of equities on October 9, 2007, and held the position until recently, you would have returned about 16.5 percent. Emotional driven investors exited on the way down or near the bottom and re-entered closer to the recent peak earlier this year, missing an enormous return possibility, as displayed in the charts below.

Some of the many threats that exist to investors going into the second half of the year, and beyond, include:

• Global demographic shifts and monetization of sovereign debt
• Federal Reserve taper: effect on equity, debt, commodity, alternative, and housing markets
• U.S. fiscal policies, Obamacare, and regulatory risks: effect on employment, sales growth, capital investments, etc.
• Japanese volatility and the yet-to-be-seen impact of “Abenomics”
• Euro crisis: high levels of debt, social unrest, unemployment and a slow recovery
• China: growing pains in both social and economic policies necessary to evolve with the current demand (somewhat similar to U.S. growing pains through the 20th Century)
• Unrest and corruption in developing markets
• Shale gas impact on energy markets and various supply chains
• Technology, resource scarcity, and sustainable design effect on employment, housing, transportation, food, communication, politics, etc.
• Changing asset correlations

As a whole, the S&P 500’s forward price to earnings ratio (13.9x) remains below its long-term average (14.9x) and corporate earnings are at all-time highs. Investors should position themselves to capture economic recovery through specific industries’ or countries’ growth potential, while defending as best they can against rising rates and the underlying systemic risks, based on their long-term goals and risk profiles.

It is a constant battle to not let emotions or intraday noise drive portfolio decisions, but investing is an ongoing process and self-reflection is a necessary component of growth. Plus, the recent evolution of financial instruments (ETF, ETN, MLPs, etc.) has created many opportunities previously unavailable to retail investors.

If nothing else is gained from this introspection, you will at least be more prepared for evaluating the rapidly evolving market landscape.

 

This article was originally featured in the Bellingham Business Journal.

[Photo: fs999/Flickr; Graph: JP Morgan Insights, 3Q Market Review]