Asset Re-Allocation Might Make S&P Rise 20%

Even in 2008, the classic Bond/Equity portfolio still worked well. As you can see from the chart below, a very simple portfolio with only Equity (SPY: S&P 500) and bond (TLT: iShares Lehman 20+ Year Treas Bond ) diversified your risk and did much better than the market: this simple portfolio was down 16%, vs. –40% for SPY in 2008.

For example, for a $100,000 portfolio in the beginning of 2008 with 40% in TLT and 60% in SPY, the portfolio value was $60,000 in SPY and $40,000 in TLT.

In the end of 2008, with SPY was down around 40% (to simplify, I rounded up the percentage here; same for TLT) and TLT was up more than 20%. Now it is $36,000 in SPY and $48,000 in TLT with total of $84,000.

Now, in the beginning of the year, a disciplined investor needs to re-allocate his or her portfolio to back to its original allocation (40% TLT, 60% SPY), which leads to $50,400 in SPY and $33,600 in TLT.

In other words, there is a potential 40% gain for SPY in the 1st few weeks of 2009 ($50,400 / $36,000 - 100% = 40%). Though there might not be too many individual discipline investors these days, there are quite sizeable institutional investors such as pension funds, insurance funds and target-date ETFs that need to stick to their asset allocation. Typically it takes one or two weeks (sometimes even longer) for institutional investors to adjust their allocations. Even if they adjust it on a quarterly basis, instead of annually, half of 2008’s loss came from the 4th quarter, which still leads to around a 20% potential gain for SPY.

Disclose: I am long SPY.

Comments

[Roger Knights:]

This flow-of-funds analysis is a good counterpoint to the typical market-direction guesswork, which assumes that stocks are being bought (or sold) because of a deliberate immediate liking for them, rather than following an automatic formula.

I wonder if this re-allocation explains the January Effect? (But if so, then it would imply that January should be a down month if it follows an up-year and up-quarter.)

Jan 05 10:39 AM

[User 268734:]

"Even in 2008, the classic Bond/Equity portfolio still worked well. As you can see from the chart below, a very simple portfolio with only Equity (SPY: S&P 500) and bond (TLT: iShares Lehman 20+ Year Treas Bond ) diversified your risk and did much better than the market: this simple portfolio was down 16%, vs. –40% for SPY in 2008."

If this is the writer's definition of working 'well', I'm wondering what it would take to do 'badly'.

Jan 05 11:16 AM

[Smarty_Pants:]

Two items not discussed in the article but which still have impacts in the real world:

1) The article treats one's investment as a lump sum made at the beginning of last year. Most people's savings however are kept in 401k / Roth / IRA accounts where new investments are made every other week. This would tend to increase the average price in years where the market goes up and decrease it when the market is down. This could have significant impact on the year end performance measure (depending on the price changes throughout the year).

2) The large price increase in long maturity US Treasury bonds is an abberation in 2008. Consider some other types of bond funds that an investor might choose to get a bit more yield than Treasuries can return. Prices shown are at beginning of the year noted:

- - - FUND - - - - - - - SYMBOL - - - 2008 - - - - 2009 - - - LOSS

1) Pimco High Yield (PHYDX) - - - - 9.5 - - - - - 6.75 - - - 29%
2) Pimco Global (PADMX) - - - - - - 9.4 - - - - - 8.5 - - - - 9.6%
3) Pimco Muni (PMBDX) - - - - - - - 10.1 - - - - - 7.7 - - - - 24.8%

As you can see, a good many bond funds also had some hefty losses instead of healthy gains. This would significantly alter the results suggested in the article if substituted for the one bond fund that 'just happened' to have unprecented gains of 20% for the year.

Jan 05 03:13 PM

[basehitz:]

" there is a potential 40% gain for SPY in the 1st few weeks of 2009 "

Please shares some of whatever you're on.

Jan 05 03:21 PM

[Old Trader:]

User 268734,

Cut the author a bit of slack!...LOL. I know a LOT of people, some managing their own money; others relying on some sort of "adviser", who would be tickled pink to be "only" down 16% (and nope, I'm not one of 'em...down 9.6% for the year...managing my own portfolio).

Jan 05 09:42 PM