Retiring in the next few years? Feeling confident about how your portfolio will hold up? If you answered yes to the first question, and did not immediately answer yes to the second question, this is a good time for a little “stress test.”
If timing is everything, then you are retiring at the right time. That is, at least from the standpoint of the financial market cycle. The S&P 500 Index is near an all-time high. It has just had one of its best 10-year runs in history. If you had any part of your retirement wealth in that stock index, you have done well.
Bonds have been in an even bigger “bull market” than stocks. Theirs lasted nearly 40 years. You may remember your parents talking about when Treasury Bills yielded about 17%. That was in 1980.
Today, they also yield 17%…except that there is a decimal between the 1 and the 7! That is, 3-month T-bills yield about 1.7%. Times have changed, but the sustained decline in bond rates also translated to historically-high returns on bonds. This is because as bond rates fall, bond prices rise. That created a big add-on effect
For instance, if you owned a bond fund yielding 5%, and rates went down after you bought it, you probably earned more than 5% return. This impact of falling rates has been so consistent since the Reagan administration, investors approaching retirement could be excused for thinking things always work this way.
However, investing does not always provide this type of wind at your back. And, if you are about to convert your life from earning money to spending what you earned all of these years, it can really help to be aware of what may change the weather.
Here is a quick list of what I see today that investors should account for. The overriding issue: investor confidence and complacency is still extremely high. There are a variety of factors that alone or together could spell the end of the party for a while. That is when you will want to be more resourceful than that old 60/40 portfolio, or the asset allocation whats-a-ma-jig you own (but don’t truly understand) allows you to be. That is when risk management will matter more. In other words, a more attentive approach to reducing major loss.
Key market themes for “Pre-tirement” portfolios
Who knows how it turns out? All we know is that the more the market behaves like it did during Watergate, the more you will want to emphasize risk management. The current stock market essentially stopped going up about 21 months ago. Ironically, that is about the same number of months it took for the S&P 500 Index to lose about half of its value in 1973 and 1974. That was when Watergate went from hearings and rhetoric to something relevant to the markets.
2. The Fed
Remember when the Fed’s next move dominated the daily headlines. That was way back in…September. Fed rate cuts tend to be friendly to markets in the near-term. But later on, they are often looked at as a signal that risk was rising. We may be in the midst of such a transition.
Pick your hot-spot, any hot-spot. The globe is full of them. Yet somehow, the ultimate confidence-breaker could be something not even on the radar right now. What we do know about the global economy is that manufacturing is weak, and it spreading to the services sector. That’s the big one in today’s consumer-driven world.
The S&P 500 “earnings yield” (shown below) has been sinking since it peaked in 2011. This is similar to saying that the S&P’s price-earnings ratio is very high. It is also similar to saying that this is no time to be complacent or uncertain about the role the stock market will pay in your retirement portfolio.
5. Index mania
Indexing has become synonymous with “easy.” That is never a good sign. A herd mentality ultimately leads to a stampede on the way out. Don’t invest in what is currently popular, unless there is a more important reason you own that investment.
Consumers are leveraged, and most have not saved much for retirement. Governments and corporations (especially smaller ones) are drowning in credit. just because they learned nothing from the Financial Crisis of a decade ago, that does not mean you have to fall in line with them.
7. Near-junk bonds
About half of all bonds owned in bond mutual funds are rated BBB. That is abnormal. It means that we are one little step away from the junk bond market being flooded with former “investment grade” bonds. That will tie big investors like pension funds up in knots, more than they already are. This is a threat to your retirement in a variety of ways.
This is the last and most important of this list of 8. Because as we have seen time and again, markets are strong until they are not. And they don’t ring a bell to signal when warning signs transition to reality.
Markets are more emotionally-driven than at any time in my 33-year career. That in itself is a reason to keep your own head about you, as you make your own transition from accumulating assets to spending them.
That will likely require you to maneuver your portfolio more than you needed to in the past, as a bear market rolls through, everyone freaks out, and we set up for the next big bull market. No one knows the timing of that. But I do know that being prepared for the inevitable is always a good idea.