Col 158 - Market Update - 2
And it just keeps getting crazier, doesn’t it?
It’s highly unusual of me to issue two back-to-back market updates, but its also highly unusual for the TSX to drop more than 10% in one day!
I mentioned in my last piece that I would love to see another 10% drop before we rebalanced back in. Not that I’d love to see a 10% drop at all, but for everyone who has been so patient with me having a defensive outlook over the last few years, you certainly deserve some rebalancing opportunity.
I’m not revealing my cards at this point, but I will give you a bit of a head up into why we rebalance MORE aggressive during a correction.
Let’s say, for argument’s sake, that there is a portfolio worth $750,000. It’s been invested in 60% equities, 20% in fixed income, and 20% in GICS/Daily interest, to protect income for five years (4% withdrawn per year x 5 years). This scenario would reflect what you might call an “average” portfolio for someone is taking income.
Over the past two weeks, the equities section of the portfolio has dropped significantly. Here’s the numbers from the morning of March 11, 2020
Over what has been roughly the last three weeks, the Toronto Stock Exchange (Canadian Markets) has dropped by 19.4%
The Down Jones Industrial Average (American Markets) is down by 23.3% since their peak.
When we look at these charts again over the past five years, in Canada we’ve just taken ourselves back to the turn of the 2018-2019 calendar year. Or maybe, if you consider that in itself is a trough, then we’re back to the values from summer 2016, so not even quite 4 years.
Looking again at the Americans with the same perspective, they’re back to fall 2017, so not even a full three years.
You guys want to talk about volatility? Anyone notice that in the 6 minutes between screen shots for the DOW, the markets moved by a quarter percent? Craziness.
Why are these historical market charts important to us? Because for income producing portfolios, we normally set the Value At Risk (the most loss a person can comfortably handle during a downturn) to 10%.
And if we consider that our sample portfolio above has 60% in equities, and our equities just dropped by somewhere in the neighborhood of 20%, wouldn’t that mean a 12% loss?
Just about, but not quite. Because we still have the fixed income portion of the portfolio, which has been invested very defensively. Year to date, the holding we use the most often for this position is UP 1.9%, and our GICs and daily interest, if we assume around a 2.5% annual rate of return, will be up about 0.8% by now.
Doing some quick math, our sample ‘income’ portfolio is overall at around 11.5% right now. But let’s look what’s happened to the individual pieces:
Equities – was 60% of portfolio, now is at 54% of portfolio
Fixed income – was at 20% of portfolio, is now at 23% of portfolio
GICs / DISA – was at 20% of portfolio, is now at 23% of portfolio
Isn’t that disappointing? We’re talking about a really major market correction, and a potential global pandemic, and the most we would think of rebalancing is 6% of the overall portfolio (move 6% from fixed income to equities)?
Maybe. But how it affects the long-term results is actually really cool.
Consider that a recovery is eventual. At some point in time, things will go back to the way they were.
Math fact: If you lose 11.5% of your portfolio, you have to gain MORE than 11.5% just to break even. Because you’re starting at a lower spot. So, for our $750,000 example, a loss of 11.5% brings us down to $663,750. To get back to $750,000, we’re going to need a 13.0% recovery.
AND, because our fixed income portion of our portfolio will probably be limited to 4% per year, and our GICs are just going to keep doing their thing at 2.5% per year, equities actually need to recover 19.5% for us to achieve that 13.0% recovery.
Wait a second… you said that we had to earn MORE in the recovery just to break even. So how come your math is showing a 20% drop in equities, but then we only need 19.5% for our recovery?
Oh right! That’s because we rebalanced when things were down, and topped-up our equities. The same principal holds true when you rebalance down when markets are really high, like we have been doing. In that case however, it’s limiting the amount the portfolio falls, even if it sacrifices a bit of the gain.
In this case, it’s riding equities back up the recovery, even if it means there might be a bit further to drop first.
If we had done nothing, and kept our new updated asset allocation of 54%/23%/23%, then we would have needed a 21% recovery in the equities market to break even.
So what’s the 1.5% (the difference between needing 19.5% and 21%) worth to a $750,000 portfolio invested 60% in equities? $6,750.
Advice worth paying for? I’d like to think so.
Not only are corrections a normal and natural part of a healthy market, for anyone looking for superior performance without adding additional volatility to their portfolio, corrections are necessary
Meagan S. Balaneski, CFP, R.F.P, CLU, CIM
Manulife Securities Incorporated
The opinions expressed are those of Meagan S. Balaneski, and may not necessarily reflect the views of Manulife Securities Incorporated
Meagan S. Balaneski can be reached at firstname.lastname@example.org