There are very few absolutes when it comes to the timing of investment shifts, and that is because timing the market has proven to be a very inexact science. Yet, today, I am saying it is time to lighten up on some risk in

portfolios

. How do these statements reconcile?

The reason is that sometimes timing is just rebalancing and many investors’ exposure to the stock market has grown larger over the past couple of years. Along with this increased exposure to stocks, the market has become more expensive, which historically means there is greater risk in investing in the stock market today than in most periods.

Combine a higher weight in stocks and a higher risk in stocks and you have a situation that likely requires some change. It is something that I am taking action on this month with my clients.

There are many ways to measure the valuation of stocks. One of my favourites is the Shiller price-to-equity (P/E) ratio. It has been tracked against the

S&P 500

going back to the 1870s. Since that time, the average or mean

P/E ratio

has been 17.28. Essentially, the higher the number, the more expensive the market is; if it’s lower, the market is less expensive.

One of the benefits of the Shiller ratio is that it is based on average inflation-adjusted earnings from the previous 10 years, rather than a snapshot or 12-month forward P/E ratio. This gives a longer timeline and tends to minimize short-term large changes in earnings.

Today, the Shiller ratio is a bit less than 40. The only time it was more than 40 was in 1999 and 2000. It peaked at 44 in December 2019.

Why does this ratio matter for your stock returns? If we compare 40 years of the Shiller P/E ratio and the subsequent 10-year annualized return on the S&P 500, it shows that if the ratio is 32 or higher when you buy, then the likelihood is that the 10-year return ahead will be in the range of minus five per cent to six per cent. If you bought the S&P 500 when the ratio was 20, the likely 10-year returns would be in the five per cent to 15 per cent range.

Remember, history repeats itself, but never in the same way. Keeping that in mind, what happened in the period from 1997 to 2002, a little before and after the Shiller P/E ratio peaked?

The S&P 500 was fantastic from 1997 to 1999 and terrible from 2000 to 2002. The Shiller P/E ratio peaked in December 1999, but it was already at 29 in January 1997, which was pretty high. The market had three great years after that. This timing thing is inexact. However, it is hard to doubt that a very high P/E ratio increases investment risk.

If history did repeat itself, the story of 1997 to 2002 would have been to sell stocks at the end of 1999 and

buy bonds

, both solid corporate bonds and

10-year U.S. Treasuries

(although real estate also did well).

But if you had done this trade one year early at the beginning of 1999, you would have missed out on a 20.89 per cent return in stocks and probably would have lost money in bonds and Treasuries, too. This highlights how difficult it is to time the market and why you don’t want to make absolute shifts from one sector to another. There is simply no certainty.

So, why am I taking some risk off the table?

We are rebalancing. A client who might be 40 per cent to 60 per cent in stocks is likely close to the latter level this month. We definitely want to bring that client back to at least 50 per cent when we look at the current market and valuations.

What do we do with the 10 per cent? I am looking at a few investments. One is a broad exposure to old-fashioned bonds. A second is a tax-efficient income strategy using options income, with minimal exposure to stock markets. The third is an investment in a specialized two-year note that pays 10 per cent with monthly income and is completely uncorrelated to stock markets.

One of the lessons from my years of investing is that if you are trying to lower your stock weighting, make sure you don’t move the cash into something that may not look like a stock, but will still move in the same direction as the markets. I believe I am achieving that with these investments.

As you can see, there is no abandonment of stocks, just a rebalancing.

Now might be a good time for you to consider this as well.

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Ted Rechtshaffen, MBA, CFP, CIM, is president, portfolio manager and financial planner at TriDelta Private Wealth, a boutique wealth management firm focusing on investment counselling and high-net-worth financial planning. You can contact him through www.tridelta.ca.

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