The Labor Department had some good news for February -- 235,000 new jobs, and unemployment down to 4.7%. This caps a nearly 8-year bull rally in the stock market, and a surge of nearly 10% since last November's elections. Over the past four quarters, 71% of companies in the S&P 500 have reported quarterly earnings that beat expectations.
Although everyone is happy about the good performance, many are also worried. When is a correction coming? What can I do to take advantage of the growth, but also prepare in the event of a pullback?
The good news is that the market is already settling down from the initial euphoric highs, and moving towards more modest long-term growth. From the election to Inauguration Day, the Dow Jones Industrial Average jumped 8.2%. Since then, the DJIA has continued to move up, but at a more sedate 2.3%.
There is still room for growth. The strong and improving global economy plus above-average cash holdings held by investors supports the opinion that stocks can go even higher.¹ Consumer optimism is also high. This is important, since consumer spending drives two-thirds of the economy.² In other words, we are on a roll.
Whether the market can take advantage of the positive numbers depends a lot on the order in which President Trump implements his campaign promises. The post-election enthusiasm of the market was driven by Trump's promises of tax cuts, corporate and financial deregulation, repatriated earnings and fiscal stimulus. These moves could potentially increase earnings and drive the market to new highs. Instead, since the Inauguration he has led with protectionist trade policies, anti-immigration legislation, border taxes, and nationalism, which tend to be economic drags.
However, Trump recently indicated that in the next two to three weeks, he plans to introduce a plan to reduce corporate and individual taxes. He also signed executive orders to possibly roll back Dodd-Frank banking regulations, and the requirement that financial advisors act as fiduciaries.
At this time of uncertainty, investors do not want to miss out on potential future growth, but would also like to protect themselves from a possible correction. The sectors that could benefit the most from economic growth include industrials, financials, energy, technology, and non-essential consumer goods. It also makes sense to put some money into defensive strategies, such as companies that pay out strong and consistent dividends. These companies tend to support strong dividends no matter what is happening to their stock price.
This would be an excellent time to rebalance your portfolio. U.S. large companies have done well in the last few months, and U.S. small cap value has leaped 35% in the last year.³ Even if you started with a balanced, diversified portfolio, it is probably now overweighted in those asset allocations. By rebalancing, you are locking in the highs, and buying other asset classes that are currently a bargain. It is a disciplined way to "buy low and sell high".
This is also a good time to review your bond investments. The Federal Reserve Bank is likely to raise interest rates this week, and may raise interest rates further before the end of the year. When interest rates go up, bond values go down. The bonds that will be most affected are long-maturity bonds that have maturities of 10, 15 years or more. If you have these in your portfolio, you may want to shift to bonds that have shorter maturities of one to three years. These short-maturity bonds still provide downside protection during a market dip, but are the least affected by increasing interest rates.
Do not let politics divert you from your long-term plan. Successful investors tend to stick to their plan no matter what is happening with the market. The market will always have volatility in the short-term, but your retirement can last 25 to 30 years. Current swings in the market may have little consequence even a few years down the road.
¹ Wall Street Journal 3/11/2017
² Kiplinger Feb 2017
³ Bloomberg 1/31/2017
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