😎 Summer Sale Exclusive - Up to 50% off AI-powered stock picks by InvestingProCLAIM SALE

The Case for Portfolio Rebalancing Looks Compelling

Published 06/20/2024, 08:11 AM
US500
-
SPY
-
IEF
-

By nearly any measure you cite, US equities are enjoying a stellar run. Despite numerous global risks, investor sentiment for American shares is resilient. The question, as always, is when is it timely to take some of the winnings and redeploy to other asset classes?

There are countless ways to engage in opportunistic portfolio rebalancing analytics, but a good way to start is by profiling performance. For US equities, the case for tamping down expectations looks persuasive. To the extent that expected return evolves inversely with trailing performance, recent history provides a baseline for thinking about risk.

Meanwhile, the view that the bear market for bonds is over is attracting more attention. The future’s uncertain as always, of course, but one can argue that the foundation is in place for a round of portfolio rebalancing.

Consider how US stocks and Treasuries compare over the past three years, based on a set of ETFs: SPY for equities and IEF for government bonds. The divergence is a chasm.SPY-Daily Chart

As I wrote earlier this week, a multi-factor measure of the directional bias for Treasury yields suggests that the worst for the bear market in bonds has passed (see chart below). Other analysts are coming to the same conclusion. We’ve seen the peak in yields,” says Stephen Miller, an investment strategist at GSFM in Sydney. “Bonds are now back as having a deserved place in a multi-asset portfolio.”

Composite Bond Duration Risk Index-Monthly Chart

US Treasuries (IEF) are starting to show an upside bias lately. Although it’s still early for the rebound narrative, it’s plausible that we’re in the early stages of an extended rebound. If so, the odds are beginning to tip in favor of a bullish view for bonds.

IEF-Weekly Chart

Meanwhile, US stocks appear overextended. Let’s start with a rolling one-year-return profile for the S&P 500 Index. The 24% rise over the past year (through June 18) has yet to reach the extreme peaks in history, but it’s clearly at a lofty level that’s rarely experienced.

S&P 500 Rolling 1-Year Returns-Daily Data

For a clearer view of how the S&P’s current one-year change compares with decades past, the next chart reminds that a 24% increase is well above the inter-quartile range that (gray box) that marks the lion’s share of the return distribution for the past 60 years-plus.

Distribution of 1-Year % Portfolio Returns

Taking a longer-term view, it’s also clear that the trailing 10-year return for the S&P 500 is also elevated. The 10.9% annualized gain for the index is currently at the 75th percentile.Rolling 1 & 10-Yr Annualized Returns - S&P 500 Monthly Data

To be clear, you can’t make reliable near-term forecasts based on the analysis above, but you can weigh the implied odds for what may come next. But let’s not forget that the market is convinced that several factors have aligned so that US equities deserve to be favored over most other asset classes. When, or if, that sentiment bias will change is anyone’s guess.

From a calculated risk perspective, however, the odds are starting to favor rebalancing. The case is especially compelling for portfolios holding bonds that are well below target weights, a.k.a. portfolios allocated to US stocks at levels well above targets.

Latest comments

Loading next article…
Risk Disclosure: Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.
© 2007-2024 - Fusion Media Limited. All Rights Reserved.