Tactical asset allocation in a changing market

The performance of capital markets in 2023 differs materially from what investors experienced in 2022. Throughout most of the previous year, few safe havens could be found, as most major asset classes, including stocks and bonds, suffered setbacks. That’s unusual, as historically, for example, bond markets typically provide positive returns within a diversified portfolio to help offset a downturn in stocks. However, high inflation, rising interest rates and the Russia-Ukraine war all contributed to downward pressure on both bond and stock prices. In the first half of 2023, the broad stock market rebounded significantly, due in large part to impressive performance among a select group of stocks, mainly in technology-related firms. During that time, bond markets generated only modest returns. While that represented a notable improvement over 2022’s disappointing results, the fixed income market paled in comparison to the stock market’s strong start. While recent market performance may encourage investors, they should remain prepared for a potentially volatile path forward.

“It’s important to recognize that the market environment and the underlying economy are different today from what existed prior to 2022,” says Rob Haworth, senior investment strategy director at U.S. Bank. “Given what has transpired since the beginning of 2023, investors should review their portfolios and determine if it is still appropriately allocated among major asset classes.”

Here are three situational approaches to consider in the current market environment:

1. Tactical asset allocation. If you made previous adjustments to your portfolio in reaction to 2022’s market dynamics, such as reducing your equity positions, it may be beneficial to consider modest adjustments within your portfolio now relative to your long-term target allocation. “We currently recommend investors focus on maintaining a neutral stance in their portfolio mix in terms of how assets are allocated between stocks, bonds and real assets,” says Haworth. “Beyond that, any specific tactical moves designed to capture a market opportunity within any of those asset classes requires investors to be nimble and willing to move quickly in and out of specific positions.” Such short-term tactical moves should be pursued with prudence.
2. Dollar-cost averaging. Investors often accumulate cash in their portfolios through interest, dividends, or perhaps through security or business sales proceeds. Some investors may have left cash “on the sidelines” due to concerns over 2022’s market volatility. Investing cash into higher returning asset classes such as equities is key to meeting long-term financial goals. Volatile markets can affect investors’ willingness to put lump sums to work in assets subject to fluctuation such as stocks. Dollar-cost averaging¹ is a strategy that may increase your comfort level with equity investing during volatile times. This involves investing a portion of your cash balance into the target equity portfolio through regular intervals rather than trying to invest the cash all at once (a practice called lump-sum investing). “While our research shows that lump-sum investing produced the highest average historical returns, dollar-cost averaging is a way to get money invested without experiencing the regret that would occur if markets decline immediately after investing a lump sum,” says Haworth. Regularly directing assets from cash into the target portfolio of equities and other holdings, for a period of six months to two years, may reduce the risk of a large portfolio setback in a brief period of time.
3. Rebalancing. Investors should consider regularly rebalancing² their portfolios. Asset prices can move in different directions and at different speeds, and these return variations can cause your portfolio allocations to drift from your long-term strategy. In the first half of 2023, equity markets rebounded strongly while the total return in bond markets was relatively flat. “We’ve seen a significant variation in returns among asset classes in just a six-month period,” says Haworth. As a result, your portfolio’s current structure may be misaligned with your long-term goals.

“Periodic rebalancing across asset classes with the most significant differences in return and risk, such as stocks and bonds, enhances long-term returns and is effective at managing overall portfolio risk,” notes Haworth. “We first suggest evaluating your relative stock/bond allocation and using recent performance differences to nudge your portfolio back toward its target allocation. Additionally, within an asset class such as mid-cap U.S. stocks, we suggest examining allocations where growth and value style performance has materially diverged,” he says. Notably, some growth-oriented S&P 500 sectors, such as Technology, that were hard hit in 2022 bounced back in 2023’s first six months. Even in that short period of time, you might find some of your portfolio positions out of balance. “Make sure you own what you want to own,” says Haworth. “If you have significant positions in assets that have become expensively valued, you may want to reposition those holdings as a way to help manage portfolio risk.” The table below details performance across a variety of asset classes (represented by market indices) through July 12, 2023.

YTD Period ending 7/12/2023. Source: Morningstar. Past performance is no guarantee of future results. Returns shown represent results of market indexes and are not from actual investments and are shown for ILLUSTRATIVE PURPOSES ONLY.

As you seek to properly position your portfolio, consider tactical adjustments to take advantage of specific opportunities that have emerged in today’s market. Utilize dollar-cost averaging of your available cash to put money to work systematically over time and limit the potential downside risk of a large, lump-sum investment. And rebalance your portfolio positions to align your asset mix with your goals, time horizon and risk tolerance.

Your wealth management professional can be instructive in helping you blend and select strategies to keep your portfolio on target to help meet your long-term investment plans and goals.