Time to Revisit Asset Allocation
By Michael McKeown, CFA, CPA - Chief Investment Officer
Risk taking by traders is more aggressive now than it has been in a long time. Options buying and volume traded by retail investors is at the highest level in years. Celebrities and high profile media people are tweeting about stocks more than ever.
A year ago, in March 2020, small cap stocks had a brutal selloff. Prices fell over 40% in just a month. Since then, small cap stocks have more than doubled off their lows. Nearly 50% of this gain has come in just the last 4 months. Positive vaccine news, clarity on elections, and economic re-opening hopes propelled the index higher.
No matter how we slice the data, valuations across most markets look high compared to the past. The four data series below illustrate this. Whether its cyclically adjusted earnings, price to EBITDA, price to book, or forward price to earnings, all are in the top 10% of the past 30 years.
High valuations means little in the short-run. Momentum is the most important factor for prices. Or more simply, an object in motion tends to stay in motion. Markets can often move faster and to a greater extent than statistics predict.
Most pensions, endowments, and families have an asset allocation target. That is the target mix between stocks, bonds, real estate, and other asset classes. Given the run-up in stock prices, most portfolios are above these targets.
We believe it is a prudent time to begin moving back towards the asset allocation targets. This will ensure the financial plan stays in line with the intended risk levels. It also allows for future rebalancing. This may mean moving back into stocks if prices were to pause or fall. Or this could be future trimming if markets trend up.
The sentiment has certainly shifted from negative in March 2020 to positive today. We wrote about this in the depths of the pandemic and what investors needed to be thinking about then.
Now, there is plenty of positive news as the economy looks robust in 2021. More stimulus, the vaccine roll out, and pent up demand from households gives a strong backdrop.
Regardless of the outlook, investors should have a North Star that guides their own target asset allocation. Basing this on a comprehensive financial plan combined with an investment process increases the likelihood of financial success.
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