The Risk Of De-Risking The Equity Portfolio

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Includes: CRF, DDM, DIA, DOG, DXD, EEH, EPS, EQL, FEX, FWDD, HUSV, IVV, IWL, IWM, JHML, JKD, OTPIX, PPLC, PPSC, PSQ, QID-OLD, QLD, QQEW, QQQ, QQQE, QQXT, RSP, RWL, RWM, RYARX, RYRSX, SBUS, SCAP, SCHX, SDOW, SDS, SFLA, SH, SMLL, SPDN, SPLX, SPSM, SPUU, SPXE, SPXL, SPXN, SPXS, SPXT, SPXU-OLD, SPXV, SPY, SQQQ, SRTY, SSO, SYE, TNA, TQQQ, TWM, TZA, UDOW, UDPIX, UPRO, URTY, USSD, USWD, UWM, VFINX, VOO, VTWO, VV
by: David I. Templeton, CFA

The unique aspect of the current U.S. equity market has been the market's desire to move higher without any significant pullback. As the below chart shows, the last correction (double-digit decline) occurred in early 2016 and culminated with a 13.3% decline ending February 11, 2016. Since the February correction, two other pullbacks of around 5% occurred around June 2016 and November 2016.

So far this year investors have not faced even a 3% pullback. This lack of volatility and over 17% S&P 500 return since the election seems to have investors more interested in preparing for the inevitable correction. As the above chart does show, 5% to mid-teen corrections are not that uncommon and are a fairly normal occurrence in bull markets. In fact multiple pullbacks occur in most years, yet 2017 is proving to be the exception, although three or so months are left in the year.

If pullbacks are the norm, then it may seem reasonable to de-risk one's equity portfolio. In a recent research report from Goldman Sachs, it highlights the return generated in equities in the lead up to past recessions.

The recession factor is is an important economic consideration as we do not believe a recession occurs within at least the next year or so. And we would note though, the economy is not the market. The Goldman Sachs report notes however:

"Although the current economic recovery is of advanced age, the fundamentals suggest 'age is just a number.' Not only have 94% of countries experienced positive growth, but growth is accelerating in 61% of them. We think investors who question the sustainability of the recovery and equity returns risk premature withdrawal from the market. Historically, the two years prior to a recession have averaged an annualized ~15% return. We prefer to deploy a durable risk management framework, and remain invested."

At HORAN we concur with utilizing a risk management strategy that is not simply reducing equity exposure. Market timing is a difficult endeavor. Our clients have benefited from our use of alternative investments in their accounts in an effort to de-risk a portion of their overall portfolio.