Stock Market Derisked?

I was surprised as anyone to see the stock market erase its 2020 losses last week in a remarkable reversal of the COVID-19 doldrums. Certainly the trillions in Federal stimulus spending and ‘loose money’ from the Federal Reserve has a lot to do with it.

Minneapolis Federal Reserve Chief, Neel Kashkari – who had been involved in the 2008 TARP program and Fed initiatives during the Great Recession – was on CBS 60 Minutes two months ago promising unprecedented liquidity to businesses & banks to get through this year’s Great Lockdown. The Fed recently announced that they would keep interest rates near 0% until 2022.

That is some economic helping hand.

Since this is at least the third straight economic disaster (9/11, Sub-Prime Lending, & Coronavirus) that the government has spent trillions to protect businesses, shouldn’t we be valuing the stock market differently? Has the government effectively derisked stock market investing such that it warrants a bigger share of our portfolios going forward?

You might recall at the beginning of the market fall in late February, I noted that the Shiller PE Ratio was quite high compared with its historical range. Here’s where is sits now … 28.5 …

I expected that in addition to the short-term CV-19 impact, we were overdue for a correction into the 20-25 range. That might still happen, but perhaps the Fed’s fast relief over and over again have investors feeling like the stock market is an increasingly safe haven that gets special status when things go wrong?

For my part, I’m keeping my investment allocation the same. Even if Congress & the Fed wanted to keep the easy money coming, there has to be some limit to what they can do. With interest rates already at 0% and the 2020 deficit approaching $4T this year, I have to believe that limit is close. At my age and our financial position, it is more important to protect what we have than try to squeeze out extra growth by betting on the government.

What is your take on the historically high market PE ratio?

Image Credit: Pixabay

6 thoughts on “Stock Market Derisked?

  1. I think you ment to write “keep interest rates near 0% until 2022” not 2020.

    I am not sure what is going to happen, but my experience has taught me I can’t time the market and I should just keep the same course.

    Liked by 1 person

    1. Thanks for that catch – fixed it. Agree, we are playing the long-term game, too. That approach benefits from government ’stimulus’ too.

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  2. I utilize a stepped variable method for my diversification model, decreasing risk (lowering equity positions and increasing bond allocations) as the Shiller PE rises beyond the mean, and increasing risk as the PE decreases (lowering cash/bonds positions and increasing equity positions). My target equity allocation for my age would normally be in the 60%-65% range, given our current personal sequence of risk timing. And based on our unrelated baseline rental income, which essentially covers our expenses in early retirement, I am able to increase my equity risk by about 10%, and remain comfortable sleeping at night. So under normal PE ratio levels, I would be at a 70%-75% equities allocation for my age/risk tolerance. However, given our past few years of high PE levels, I gradually stepped down (reduced) our exposure to a 50/50 split for equity to bonds, based on my pre-determined triggers for lowering risk for the higher PE levels. It saved our butts during the initial COVID slide. However, as the PE began to drop (when the DOW crashed to 18k), I began to gradually rebalance (step back up) toward our current 55% equity and 45% bonds position. Subsequent market gains have been a great for us using this approach. I like the variable (but systematic) approach as it takes the emotions out of the decisions, while considering the market level risk (via PE levels). And yet rebalancing is very simple and typically captures any major market gains in small steps, while reducing risk during crazy high market periods. (I should note we are now shifting back toward 50/50 allocation, now that the market has bounced back and the PE is back above 28.)

    So far it’s weathered the storm(s) of 2020 very well for us…

    Liked by 1 person

    1. Wow – that sounds like a very smart approach & objectively accounts for market valuation. Do you track it in a spreadsheet? How often do you make adjustments (when needed, or on a specific cadence, like quarterly)?

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      1. There is a great article on Micheal Kitces’ blog about Dynamic Asset Allocations and Safe Withdrawal Rates (www.Kitces.com -I have no affiliation, but like some of his work). I use my own modified version of his theory. I typically only rebalance annually or when there is a major (+ or – 5%) swing in the market (like Covid!). There really is no need to track it in a spears sheet. I simply visualize my traditional three bucket approach (0-3 yrs, 4-8 yrs, and +9yrs) across all of my different accounts (IRA’s, 401ks, etc), so I keep it very simple to rebalance. Whatever the shilling PE is at that time, I rebalance according across all accounts. (Note: I do keep tax optimization in mind based on account type.)

        Even though we are early retired, I have not started withdrawals, but plan to use a similar approach for a safer withdrawal rate (see same article).

        Check out the article. It’s a good one and may change your approach. It did mine.

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