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Market Turbulence: Not Fun, But Not Unforeseen – Having a Plan

October 17, 2018
by Jack Reynolds

After a wild ride in U.S. equity markets during the week of October 8th, let us remind ourselves that it was not unforeseen, and that it is likely to reoccur.  We can’t stop the turbulence, but we can plan for it.

I have written two articles in the last year to provoke my readers’ thinking about how to address the highly valued U.S. equity markets: Volatility – Opportunity or Cause for Concern?, May 15, 2018, and earlier Asset Values Are Stretched – What to Do About it?, November 15, 2018.

It was also instructive to see an article in the Wall Street Journal of Monday October 8, 2018, just before U.S. equity markets hit an air pocket, “U.S. Stock Near a Pressure Point,” by Michael Wursthorn and Sam Goldfarb, whose prescient opening paragraph was:

“Yields on long-term U.S. government debt moved abruptly higher last week, calling into question the durability of the more than nine-year-old bull market for stocks.”[i]

Nonetheless, it will not surprise you that I do not advocate dumping one’s equities and employing a pall mall rush to cash and/or Treasury securities. I am not an adherent of such tactical asset allocation for two reasons:

  • The likelihood of making both exit and reentry decisions correctly is low. Missteps in either exit and reentry can be costly.
  • The tax consequences of tactical asset allocation for private investors can be significant.

At the risk of reprising my own earlier remarks, here is what I do recommend:

  1. Be mindful of the degree to which valuations are stretched, to avoid unpleasant surprises.
  2. Have enough cash, plus assured sources of liquidity (e.g., expiring Treasuries), to cover a year’s spending, including:
    a. taxes (income, gift, real estate, etc.),
    b. current pledges and anticipated charitable commitments,
    c. capital expenditures (e.g., education or acquisition of non-investment assets)
    d. life style maintenance, and
    e. alternative assets capital calls, without reliance on distributions, which could
    be temporarily impaired.
  3. Review your long-term asset allocation targets. Be sure that they are suitable for your current and likely future circumstances. Consider doing that with a trained and experienced professional.
  4. Rebalance back to long-term asset allocation targets at least semiannually, reducing exposures that are above target and adding to exposures that are below target. There may be frictional considerations that inhibit your rebalancing, such as tax factors, age and health.
  5. When feasible (from the point of view of taxation and regulatory supervision of “insiders”) reduce outsized single asset exposure(s).

Managing asset volatility is a part of managing various risks in your overall financial/investment strategy. The steps outlined here, and in my prior articles (see links above), can assist you during market disruptions.

[i] “U.S. Stock Near a Pressure Point,” Wall Street Journal, by Michael Wursthorn and Sam Goldfarb, October 8, 2018, at p. B-1. Or see online Surging Yields Raise Threat of Tipping Point for Stocks Oct. 7, 2018 8:00 a.m. ET