Following stock market rallies, what's next for your portfolio?
Your equity portfolio has hit an all-time high, congratulations. As we start the third quarter of 2016, Wall Street and individual investors, alike, are deciding if celebration or trepidation is in store for the rest of the year.
Over the first six months of 2016 we had several major events - oil touched $26 a barrel, U.S. 10-year Treasury notes reached an all-time low yield of 1.36 percent, Britain left the European Union and most recently all-time highs in U.S. equity markets.
Looking back at the major downturns, if you sold your equity portfolio in February when the market was fearful of a hawkish Fed, lower prices in oil and slowing growth in China you would have missed out on an 18 percent rally. If you sold your equity portfolio after Brexit, you would have missed out on an 8.25 percent rally.
Staying invested through market cycles is an important lesson, albeit sometimes costlier than a college semester in finance.
If you want to maintain equity growth but need current income, look to large dividend-paying sectors of the S&P 500, such as telecommunications, utilities, energy and consumer staples. Companies in these sectors generally have higher dividend-paying names than the overall S&P 500 (currently paying a 2.12 percent dividend yield).
If the thought of a market pullback makes your stomach churn, look for investments in the corporate bond market. The U.S. 10-year Treasury yield is at 1.56 percent, so make sure to find bond investments you would be comfortable holding to maturity.
Hedeker Weath is currently building out portfolios of individual investments in corporate bonds versus bond mutual funds. The choice of investment vehicle for bonds is very important. Building out corporate bond portfolios allows us to capitalize on the bonds' roll-down effect and avoid potentially adverse selection in the mutual fund as redemptions pickup. We should, however, consider ourselves lucky to have a cuspy 1.56 percent yield on our 10-year U.S. Treasury note, as there is $13 trillion of sovereign debt trading with negative yields.
Where do we go from here?
The current earnings season is off to an unexpectedly strong start. Many blue chip companies were either in line or better than analyst expectations. U.S. data is improving, as shown by recent strong reports in jobs and retail sales. Chinese GDP came in better than expected and the U.S. dollar's appreciation currently appears to be on hold as the likelihood of Fed fund increases is being priced out of 2016.
We are in a period of improving data but not good enough for the Fed to aggressively increase interest rates. This lukewarm economy gives risk assets protection to muddle higher as major central banks continue to apply stimulus. Historically low yields across the globe continue to attract foreign capital to U.S. markets. Foreign capital seeking safe havens and yield creates a buying floor under U.S. equities and lends to shallower dips on pullbacks.
As we look forward, as markets always do, the 130 earnings-per-share target for the S&P 500 is finding footing. Applying a 17X multiplier to our EPS target and we have a price target of 2,210 and a little bit more room to the upside. Balancing a complacent VIX (Chicago Board Options Exchange Volatility Index) at 13 with some headroom higher, we are cautiously invested in large balance sheet companies with strong dividend yields and attractively priced bonds.
• Michael McClain, CFA, is portfolio manager with Lincolnshire-based Hedeker Wealth. He can be reached at info@HedekerWealth.com.