9/11/2012

Use April Strength to Rebalance Your Portfolio

April is the second-best month for stocks, trailing only December in terms of average gains for the S&P 500. April also marks the end of the best six-month period for stocks.

Sam Stovall at Standard & Poor's calculates that the calendar's fourth month has produced an average monthly gain of 1.6% for the S&P 500 since 1945. Large-caps have risen 68% of the time. Jeffrey Hirsch, author of the Stock Trader's Almanac, has found only one down pre-election April since 1951.

After April, the market's batting average dips. The Dow Jones industrial average has only risen by an average of 0.4% between the start of May and the end of October. June and September have comparatively bad reputations, according to Stovall, averaging flat to slightly negative performance for the S&P 500.

Does this mean you should start looking to lock in some profits? Not unless it has been longer than 12 months since you last rebalanced your portfolio (or you own stocks you were planning on selling anyway). The second quarter of the third of year of a presidential term has historically been a good time to own stocks. The aggregate economic data points to a continuing recovery, even if it is an uneven recovery. First-quarter earnings for the S&P 500 should be 13.3% higher than they were a year ago, according to Thomson Reuters. Finally, the S&P 500 still looks fairly cheap with a forward-looking price-earnings ratio of 13.4.

Not all is rosy, however. Congress is nearing a deadline for reaching a budget with the threat of government shutdown once again looming. The Federal Reserve's program of buying Treasury bonds ("QE2") is scheduled to end in June. Gas and food prices are rising. Unrest has spread across the Middle East. The European Union could raise interest rates next week. Then there is the tragedy in Japan and the ongoing issues with the nuclear reactors.

Hirsch recommends adopting a more conservative position for the period of May through October. He suggests either moving into cash and bonds or, for more active traders, tightening stop limits and using put options.

I'm not an advocate of market timing strategies, but I strongly believe that you should rebalance your portfolio on a regular basis. As I show in the new April AAII Journal, rebalancing your portfolio once a year increases performance and lowers volatility, a win-win proposition. It is more important that you rebalance your portfolio at approximately the same time every year than fret about how stocks have historically fared during a given month.

There is a middle ground--rebalance twice a year. Research from Vanguard found that semiannual rebalancing can strike a reasonable balance between risk control and cost minimization. The key is to make changes only when allocations are 5% or more away from target (e.g., your stock holdings account for 56% of your portfolio when they should account for 50%).

Following Vanguard's strategy in combination with Hirsh's would have you considering whether rebalancing is warranted at the end of every April and every October. Doing so would allow you to reduce any excess stock allocations at the end of the best six-month period and increase them at the end of the worst six-month period, while still sticking to your long-term portfolio goals. The intent of this methodology is to adjust your stock holdings back to your long-term allocation targets, not to increase or decrease them beyond those targets.

I want to reiterate that the most important step you can take is to review your portfolio allocations and rebalance your holdings as warranted at approximately the same time every year, regardless of what month it is. The best and worst six months is a strategy you can overlay upon your rebalancing process, but only after you commit to regularly reviewing your allocations.

Your Allocation Needs Will Change Over Time

Whenever I speak about portfolio management, I always explain that allocation strategies depend on age, health and wealth. A good rule of thumb is that the sooner you need to withdraw money from your portfolio and the larger the withdrawal is relative to size of your portfolio, the more conservative your investment strategy should be.

Your allocation requirements--and your tolerance for risk--will change as you get older. What Different Conditions Will Affect My Asset Allocation? explains the major factors influencing asset allocation decisions and how they change over time.

The Week Ahead

Just three S&P 500 members will report next week. Bed, Bath & Beyond (BBBY) and Monsanto (MON) will release their results on Wednesday; Constellation Brands (STZ) is scheduled for Thursday.

The economic calendar is light as well. Tuesday will feature the March ISM services survey and the minutes from the March Federal Reserve meeting. February wholesale trade data will be published on Friday.

Potentially making up for the low number of economic releases will be public appearances by several Federal Reserve officials. Atlanta Federal Reserve Bank President Dennis Lockhart will host a conference at which Federal Reserve Chairman Ben Bernanke (Monday) and Philadelphia Federal Reserve Bank President Charles Plosser (Tuesday) will appear. Lockhart also has separate speaking engagements on Monday and Friday. Minneapolis Federal Reserve Bank President Narayana Kocherlakota will speak on Tuesday. Richmond Federal Reserve Bank President Jeffrey Lacker will speak on Thursday.

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