I’m sure this is a question many of you have. The market has had a good run so far this year, with the S&P 500 gaining 17.3% on a total-return basis through Wednesday’s close, despite a long list of worries. Then there is the old adage of “sell in May and go away.” But, Mr. Market remains in a chipper mood as is evident by the new record closes continually being set by the Dow Jones industrial average and the S&P 500.
So, should you stay or should you go? The answer is yes.
If the above response seems to have all the clarity of a response one would expect from a politician, allow me to elaborate. The current environment does not offer any good alternatives from an allocation standpoint. Cash is earning next to nothing in absolute terms and costs you wealth on an inflation-adjusted basis. Yields on the benchmark U.S. Treasury closed Wednesday at 1.94%. Even gold is no longer glittering from an investment standpoint.
Relative to bonds, stocks remain cheap. The earnings yield on the S&P 500 is 5.8% as of Wednesday’s close, a significant premium to the current yield on bonds. One could argue that stocks are no longer cheap, but bonds are expensive too. On a valuation basis, by switching from stocks to bonds, you would simply be exchanging one not-so-cheap asset for an expensive asset. Cash not only loses out to inflation, but also incurs opportunity costs.
One of those opportunity costs is the chance that stocks will be priced higher in six months than they are now. Though the period of May through October is referred to as the “worst six months,” the S&P 500 still boasts an average gain of 1.2% since 1945, according to Sam Stovall at S&P Capital IQ. It is also helpful to consider what your potential loss might actually be. To throw out some numbers for the sake of discussion, let’s assume a summer correction hits and stocks pull back 10%. If the current momentum lifts the market another four percentage points between now and its late spring/summer peak, the actual decline from today will be a little more than 6%. Though nobody likes to see their portfolio decline in value, a 6% pullback is well within the range of normal fluctuations and should not be any cause to sell or worry. Keep in mind that this is just an example. When I asked my Magic 8 Ball if the market’s returns will be better or worse than what I just typed, its response was “As I see it, yes.”
It’s not just my Magic 8 Ball that is giving a lack of clarity. Jack Schannep of the TheDowTheory.com Newsletter sent out an alert last week saying the Dow Jones transportation average’s break to new record highs warranted an “in the clear” signal. He further added, “As an ‘old bold pilot’ the implication of rising above the clouds and being ‘in the clear’ is favorable, but not necessarily a permanent situation—there are usually other clouds, and some may rise into your flight path.”
Confusing? Yes. Uncertain? Yes. But, if correctly forecasting where stocks are headed was easy, the long-term returns on stocks would not be 9.98%; rather they would be much lower. Over time, stock investors get compensated for incurring risk.
Maintaining long-term allocations which includes bonds and cash still makes sense from an overall portfolio allocation standpoint.
Source: American Association of Individual Investors
The information contained in this article does not constitute a recommendation, solicitation, or offer by D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.
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