With the S&P 500 up 80% since March 2009 and the specter of a correction looming, financial advisers are scrambling to keep clients calm and to make key adjustments to their portfolios.
Along with the dramatic rally, advisers point to other signs that the U.S. stock market is due for a pullback.
For starters, the number of stocks in the S&P 500 that have a standard deviation of one above the 50-day moving average has steadily risen since the rally began — a “good indicator the market is overbought,” said Jeffrey D. Saut, managing director at Raymond James & Associates Inc.
Another indicator is that the average mutual fund cash position is near its historic low at about 3.6%. Meanwhile, the price-earnings ratio of the S&P 500 for the trailing 12 months is 17.6, above its three-year average of 15.2.
Advisers also worry that Greece's debt crisis could spill over and affect U.S. markets.
This time around, advisers said, they are being more proactive, from reaching out to clients to educate them about market movements to helping them prepare by re-balancing portfolios and implementing tactical-
allocation strategies.
“What caught us off guard last time was the rapidity of the decline,” Daniel H. Boyce, a registered principal with the Center for Financial Planning Inc., said during a presentation at Raymond James Financial Services Inc.'s annual conference last week. “Normally, in a bear market, there is more time to make adjustments.”
And while experts aren't predicting a 2008-like plunge — Mr. Saut estimated a correction of up to 10% — advisers still worry that a small dip could cause investors to panic and flee to cash.
“I think you will have some clients who say, ‘I knew this would happen,' and pull out of the market,” Richard G. Averitt III, chairman and chief executive of Raymond James, said in an interview at the conference. “Advisers should anticipate that even their most experienced clients will express real concern.”
For many reps, the first step is communicating with clients to educate them about market dips.
“I am telling clients that a correction is the healthiest thing for the market because it keeps the crazies out,” said Corey Vertich, a principal at Uhler & Vertich Financial Planners LLC. “The crazies think there is no more risk, and then prices go too high, and it creates a bubble.”
One challenge with this strategy, advisers said, is that clients often look at the market peak in November 2007 as the benchmark for future returns.
“Clients always think that that highest mark is theirs to keep,” said Nancy Caton, a financial adviser with $173 million in assets under management.
To address this, advisers such as Steve Johnson, an adviser with Raymond James, are working with their broker-dealers to access historical client data for the five years before the market crash to show clients a normal range of returns over many years.
“Being able to capture that history is critical to me because clients always want to just talk about what has happened since November 2007,” he said.
Unfortunately, many 401(k) plan clients don't have access to that historical data, especially if they changed record keepers, he said.
Mr. Johnson also is telling retiree clients to have more in cash instruments so they will be better-prepared for a correction. Before 2008, he would suggest one year's income worth of cash; now he suggests two to three years.
Advisers are also re-balancing client portfolios more often to keep them from becoming overweighted in equities and suffering larger losses in a correction.
For example, Mr. Johnson said, he now re-balances clients' portfolios annually.
“Before, we used to allow stocks [to] float a bit,” he said.
The Center for Financial Planning Inc., a registered investment advisory firm with $650 million in assets under management, has established a process to make sure that it can re-balance clients' portfolios more quickly in the event of a market dip. The RIA is becoming a discretionary manager so that it can make trades in all its clients' accounts at the same time, rather than having to do each one individually, Mr. Boyce said.
The firm also has implemented Tamarac Inc.'s software to allow it to re-balance clients' accounts faster, said Melissa W. Joy, a certified fund specialist and the firm's investment research manager.
Another strategy to help prepare clients for the next dip is to move more of a client's portfolio into tactical-allocation strategies, which allow managers to move in and out of different asset classes more quickly and make the holdings less correlated to the stock market.
For example, at the Center for Financial Planning, 10% to 15% of a client's equity exposure is in tactical-allocation strategies, such as non-correlated absolute-return funds, but the firm is moving that to 25% to 30% over the next 12 months, Mr. Boyce said.
Sal Flores, a Chandler, Ariz.-based adviser with $650 million in assets under management, said that he is adding alternative investments to all of his clients' portfolios.
“We are telling clients that traditionally, there have been two asset classes: stocks and bonds, but now we are adding other asset classes,” he said. “We aren't trying to hit a home run, but these can provide some consistent performance.”
Not everyone, of course, thinks that a market correction is imminent. Although geopolitical events such as the debt problems in Greece may prompt a sell-off in Europe, it shouldn't have a big impact on the U.S. economy, said David Kelly, chief market strategist at J.P. Morgan Asset Management.
“The U.S. economy seems to be improving, and the earnings season is very good,” he said. “We still think stocks are somewhat cheap.”
E-mail Jessica Toonkel Marquez at [email protected].
