By JACK HOUGH
Bulls say the capital markets are in a "risk rally," while cynics call it a "dash for trash." Whatever the label, assets that investors were too fearful to touch last year have lately been the market's top performers.
That has made safe havens, which have lagged behind risky assets, more attractive by comparison. Investors would be wise to swap some of their bolder bets for boring ones.
A Standard & Poor's index of "low quality" stocks based on measures like earnings stability has gained 15% this year, versus 10% for its high-quality sibling. Greek stocks have leapt 17% this year, versus 11% for world shares overall. The top gainer in the U.S. market, Sears Holdings (SHLD),
This rise of the weak is good in that it means investors feel the chances of another financial crisis are shrinking, says Peter Tuz, president of Chase Investment Counsel, an asset manager based in Charlottesville, Va. That optimism has pushed all stocks higher this year; the Dow Jones Industrials surged 8.1% in the first quarter, not counting dividends their best start since 1998.
But it is a good time for investors to make sure their portfolios aren't too heavily weighted in areas that have run up sharply, says Mr. Tuz. For example, economically sensitive stocks have raced ahead of the market. Within the S&P 500, financials are up 21% this year and technology 22%, while consumer-discretionary stocks, such as Netflix (NFLX)
Stodgier shares have trailed. Utilities are down 3%; telecommunication stocks have barely budged; and consumer-staples producers such as Kellogg (K)
To be sure, boring stocks could keep on lagging behind risky ones if the pace of the economic recovery in the U.S. continues to strengthen. But that doesn't mean it is wise to bet everything on growth.
John Canally, a strategist at LPL Financial, a platform for independent brokers, says he has been reducing risk in his model portfolios for several weeks. "We've seen a summer swoon in the stock market each of the past two years," he says. "Given the speed of the recent run-up, it wouldn't surprise me if we see another one."
Mr. Canally also recommends moving money from stocks to bonds, from overseas to the U.S., and from high-volatility stocks to steadier ones.
To add bond exposure while avoiding the riskiest issues, investors can buy a fund that focuses on corporate bonds but avoids "junk," like iShares iBoxx Investment Grade Corporate Bond (LQD)
For less-volatile stocks, there are "low beta" funds. Beta is a measure of past trading volatility. Stocks with low betas are expected, based on their history, to rise less than the market during rallies but also fall less during downturns.
True to form, the Russell 1000 Low Beta (LBTA)
Laif Meidell, manager of the AdvisorShares Meidell Tactical Advantage (MATH)
Consider the 10-year Treasury note. It yielded less than 2% at the start of the year. As investors left Treasurys for riskier fare this year, Treasury prices fell and their yields rose. The 10-year peaked at around 2.4% earlier this month. But as share prices broadly fell this past week, investors returned to Treasurys, and the 10-year yield fell back to 2.2%.
Mr. Meidell has been reducing risk in part by shifting money from emerging markets, which are up 13% year-to-date, according to the MSCI Emerging Markets index, to large-company stocks in the U.S.
Mr. Tuz of Chase Investment Counsel recommends shares of companies with a history of limited trading volatility, but also steady growth, like Kraft (KFT),
The key with portfolio rebalancing, he says, is to avoid replacing an overly risky portfolio with an overly defensive one. As the risk rally has amply demonstrated, after all, too much caution is a risk in itself.—Jack Hough is a columnist at SmartMoney.com. Email: email@example.com