April was an interesting month in the stock market as we started to see the first tiny inkling of volatility with a 3.5% pullback in the S&P 500, which was met with an enthusiastic bid that brought us right back to the highs by month end. In an article I wrote on March 28, entitled Consider Making Changes To Your Income Allocations, I posed the notion that conservative income investors with hefty gains in their positions could stand to lighten up due to the likelihood of a future pullback. I also mentioned core fixed-income positions as a lower volatility option for the proceeds to further balance out an equity heavy portfolio, but also maintain a respectable cash flow. Since then, both asset classes have posted gains, however equities have continued to outperform fixed-income. In a comparison of two widely held ETFs since March 28, the iShares Select Dividend ETF (DVY) posted a gain of 3.7% vs. the PIMCO Total Return ETF (BOND), which moved a modest 0.83%.
As of today, I am continuing with the theme I began in late March with additional sales on the dividend side of my domestic equity portfolio in light of this seasonally weak period of time. In addition I am concerned about the stretched fundamental valuations, such as the P/E and P/B ratios of the holdings within the ETFs that I own. I would also point out that from a technical perspective, many dividend equity indexes are well over 10% above their 200-day SMA, which is stretched when compared with historical norms. At the time, I suggested that an investor with the typical 50-60% equity exposure could stand to pair back to 30-40%. For my own portfolio, I am further reducing my dividend equity holdings to roughly 25-30%, or a 50% reduction from what I owned going into March.
So the change begs the question, am I adding to my core fixed income holdings? No, as of right now I'm allocating any proceeds from equity sales to either cash, short duration bonds, or interest rate volatility managed multi-sector strategies. A primary example would be a fund like the PIMCO Unconstrained Bond Fund (PFIUX). My reasoning is that I would like to maintain a degree of liquidity since corrections can occur swiftly and I don't expect holdings of this nature to be long term.
I believe it's important to point out that I'm not the least bit bearish on the long-term trend of the equity markets, nor am I attempting to call a top, or even considering shorting the stock market. On the contrary I'm quite bullish on the intermediate and longer-term trends in equities. I'm merely looking for a short-term pullback, or run-of-the-mill correction to bring my equity holdings back up to their prior levels. In addition, depending on how the credit markets react, I would also use any widening in spreads to increase my holdings in high-yield bonds for both myself as well as the clients of my firm.
I think it necessary to publish this update since I feel like conservative income investors with 70, 80, or even 90% equities could find themselves uncomfortable with the fall in value of their accounts during the next equity market correction. I am content with my current and prior decisions even though they cost me a small degree of performance, since I was able to sleep well at night knowing I wouldn't find myself between a rock and hard place in the midst of a falling market. I liken the continuation of this theme as a reduction of the risk in my portfolio, and not call for a for a change in trend. I also despise portfolio managers who make changes to their portfolio, then excuses, and finally hide from the repercussions of their decisions. I believe having that degree of respect and transparency acts as the first step in establishing trust with an audience.
Additional disclosure: Fabian Capital Management, and/or its clients may hold positions in the ETFs or mutual funds mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities.