Many investors with a patriotic spirit have enjoyed positive returns on U.S. stocks during the past three years. In 2014, the S&P 500 index of large U.S. companies gained 11.39 percent, following gains of 29.6 percent and 13.29 percent the prior two years.
Clearly, the nation’s economy has come roaring back from the 2008 recession.
As a result of these returns, many investors’ portfolios now have a significantly larger share of their total value invested in U.S. stocks. As a result, they may be overexposed to the risk of a possible decline in value this year.
While it’s always tempting for investors to “ride the winners,” that's not the safest strategy over the long term. That’s because of the cyclical nature of the financial markets, as well as the national and global economies. Recessions and downturns occur from time to time, and maintaining a balanced portfolio of assets is one of the ways to address those risks.
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So, now is a good time for investors to sit down with their financial advisers and take a look at how to position their portfolios for the coming year. In many cases, that will mean shifting those gains in U.S. stocks to international and emerging market equities and alternative assets.
There are several reasons why rebalancing your portfolio makes a great deal of sense this year. First of all, the Federal Reserve is expected to consider raising interest rates at some point this year, as there is less need for a monetary policy to stimulate the U.S. economy. An increase in rates could adversely affect the equities market. It could also have a negative impact on fixed-income securities like corporate bonds.
But that’s just one factor to consider. Monetary policies are also changing in Europe, Japan, China and some emerging markets, as central banks take action to stimulate their sluggish economies. Those steps may create opportunities for investors to increase their allocations to global equities, which have been underperformers in recent years. The European economy is where the U.S. economy was several years ago and stock markets are predictive economic indicators, perhaps making European stocks an opportunistic investment.
Market volatility is another trend that creates both challenges and opportunities for U.S. investors. Already this year, there have been substantial swings in the price of oil, which affects the shares of multinational energy companies, and impacts the economies of countries that rely heavily on exports or imports of fossil fuels.
A stronger U.S. dollar, compared with other leading currencies, as well as varying central bank monetary policies, may also increase market volatility in the coming months.
While some investors concerned about volatility may increase their allocations to “safe” but low-return investments like T-Bills or money market funds, others may opt for a different approach.
But greater turbulence in global markets can also create new opportunities for some types of alternative investments. For instance, qualified investors who understand the risks may decide to shift a portion of their portfolios into hedge funds or other types of actively managed funds that seek “alpha,” or above average risk-adjusted returns.
These types of hedging strategies seek to exploit relative differences in value in sectors like global equities or currencies. Historically, they have tended to perform better during periods of higher volatility, and underperform when the financial markets and global economies are moving in the same general direction.
Returning to the U.S. market, it seems likely that the nation’s economy will stay on track this year. Consumers generally feel confident about the future, which could have a positive impact on companies in the automotive, durable goods and housing sectors. So, there’s no reason to abandon the U.S. stock market in 2015. Just be careful not to put all your funds in an asset class that’s currently over-performing.
It is important to stay focused on your long-term investment goals, and consider rebalancing your portfolio so you are well positioned for both the risks and opportunities in the year ahead.
Andrew Menachem, CIMA, is a Wealth Advisor at the Menachem Wealth Management Group at Morgan Stanley in Aventura. Views expressed are those of the author, not necessarily Morgan Stanley, and are not a solicitation to buy or sell any security. The strategies and/or investments referenced may not be suitable for all investors. Follow Menachem on Twitter @AMenachemMS