By Jason Zweig | 11:30 am ET Dec. 19, 2014
Image Credit: Christophe Vorlet
Call it the “petro panic.”
As oil prices collapsed, the Dow Jones Industrial Average and the S&P 500 sank 5.1% in just seven trading days between Dec. 5 and their bottom (so far, at least) this past Tuesday.
Then Janet Yellen rode to the rescue. On Wednesday, the Federal Reserve Chairwoman indicated that interest rates would stay low for some time to come. Stocks went straight up, climbing back within 1% of their all-time highs by Thursday—when the market had its biggest one-day gain in three years.
The sharp and swift recovery shows the importance of not reacting to every blip in the market. Investors should use this year-end turmoil as a test of their own intestinal fortitude and an opportunity to re-examine their portfolios. A few gradual steps, such as tweaking your exposure to stocks, can lower your risk and raise your odds of being able to reach your goals.
Start by recognizing that the recent drop was too short and shallow to turn stocks into a bargain. At the market’s peak on Dec. 5, U.S. stocks were valued at 27.4 times their long-term, inflation-adjusted earnings, according to data from Robert Shiller, the Yale University finance professor and Nobel laureate in economics. At the bottom of the petro panic, this past Tuesday, that figure was 26 times earnings. By Friday morning, stocks were back at 27.3 times long-term earnings.
The average since 1871 is about 16 times. So stocks went from being very expensive, by historical standards, to being just a whisker less expensive than that, and then back to being very expensive again. From these levels, history suggests, returns are bound to be muted.
Not even high-yield corporate debt, or “junk” bonds, got cheap for long. Amid fears that energy companies issuing junk bonds would default, prices fell sharply and yields, or income, rose.
“December will be the first month of 2014 where high yield wasn’t overvalued,” says Martin Fridson, chief investment officer of Lehmann Livian Fridson Advisors, a money-management firm based in New York and Miami. As recently as late October, junk bonds yielded less than 6%. At their yield this week of about 7%, “you’re getting fairly paid” for the risk you are taking at this time of the economic cycle, Mr. Fridson says, “but it’s nothing sensational.”
Could the implosion in oil prices cause lasting damage to the economy? Energy companies such as Exxon Mobil have long paid robust dividends and been among the largest repurchasers of their own stock, helping drive the boom in share buybacks that has boosted the market.
Even so, energy companies have played a smaller role than you might expect. They account for 12% of the total dividends paid by the S&P 500. That’s fourth among the 10 industrial sectors that now make up the index, according to Howard Silverblatt, senior analyst at S&P Dow Jones Indices, behind technology (15%), financials (15%) and consumer staples (13%).
Energy companies have made up less than 9% of total buybacks over the past five years, or $176 billion of the $2 trillion that companies have repurchased of their own shares, says Mr. Silverblatt.
So the fall in the price of oil seems unlikely to set the market back severely and, by lowering the costs of production and transportation, could help many companies outside the energy industry.
Rather than make big, abrupt moves that could turn out to be ill-timed, you are better off using the end of the year as a pretext for taking small steps to make your portfolio cheaper, more tax-efficient and better diversified.
“One of the biggest things you can do is to give your portfolio a careful look before the end of the year to see if there are losses you can take,” says Maria Chrin, managing partner of Circle Wealth Management, a financial-advisory firm in New York that manages $1.2 billion. By selling a stock or fund for less than you paid, you can generate a loss you can use to offset gains or income, reducing your tax bill.
One logical place to start looking is your overseas holdings. Steve Condon, president of Truepoint Wealth Counsel, a financial-advisory firm in Cincinnati with $2 billion in assets, points out that many funds that invest in international stocks have lost money in 2014. The MSCI All-Country World Index of markets outside the U.S. is down about 7% this year.
If you have an underperforming international fund, especially one with annual expenses above 1%, consider selling it. You can use all the losses to offset capital gains elsewhere or to reduce your ordinary income by up to $3,000. Move the proceeds of the sale into a low-cost, well-diversified fund such as Vanguard Total International Stock Index or the iShares MSCI ACWI ex U.S. exchange-traded fund.
Meanwhile, if U.S. stocks are making you nervous, consider donating a small portion of holdings on which you have the largest unrealized capital gain. Put the donation in a charitable-gift or donor-advised fund, which enables you to “get paid twice,” says Owen Murray, director of investments at Horizon Advisors, a financial-planning and money-management firm in Houston.
You generally get to use the full market value of the donated securities as a deduction against your income, while escaping the capital-gains taxes that would otherwise be due on your profit.
And you get to reduce your exposure to stocks at the same time—a move that may well be overdue, now that the market is bumping up against record highs again.
Source: The Wall Street Journal