With the stock market and Bitcoin reaching all-time highs, what can possible go wrong? In offering my thoughts on 2018, I see my role in reminding investors to stress test their portfolios. Is your portfolio built of straw, sticks or brick?
First, let me allege many investors have portfolios built of straw and sticks rather than brick. How do I know this? Here’s a brief check:
- If a robust portfolio is a diversified one (the only free lunch on Wall Street), then please check whether you have rebalanced your portfolio of late. If not, odds are equities have taken on an oversized portion in your portfolio, thus making it more vulnerable than you might have intended in a downturn.
- Equities are part of the so-called risk assets in a portfolio. But what about the rest of the portfolio? Have you been chasing yield by extending duration of your fixed income portfolio? Have you accepted less creditworthy issuers? Have you been lured by the promise of higher yields by financing something in a private placement? I have news for you: without judging the merits of those investments, odds are high that the value of these investments are more correlated with risk assets than you might be aware. Read: just because the label says fixed income doesn’t mean you are diversified.
Without a doubt, equities have had an extra-ordinary run. There is the view that, without a recession, you cannot have a bear market. In our analysis, that’s true for the most part – but is “for the most part” good enough? The notable exception is the Crash of 1987 where a bear market was not accompanied by a recession. In today’s context, the buy-the-dip crowd will remind you that the ’87 crash was, well, a buying opportunity. As such, if you are an asset manager interested in keeping your job, you buy. It reminds of the 1980s where buying IBM office equipment was the sure way to keep your job, as no one would question your choice. Here’s a chart that shows the S&P 500 with the percent drawdown from any peak, with recessions shaded: