Resources/Weekly Insights

Volume 12, Edition 33 | November 27 - December 1, 2023

Rebalancing: It Pays to be Opportunistic

Doug Walters, CFA

The holy grail for most investors is to effectively “sell high and buy low.” This week, as we continue our series on our guiding principles, we will discuss how rebalancing can assist in this noble endeavor.

Contributed by Doug Walters, David Lemire, Max Berkovich, Eh Ka Paw

The holy grail for most investors is to effectively “sell high and buy low.” This week, as we continue our series on our guiding principles, we will discuss how rebalancing can assist in this noble endeavor. We prefer the “Opportunistic” version of rebalancing, which the evidence shows is a better tool to capitalize on the ups and downs of the market systematically.

Rebalancing comes in many forms, most of which add value. The most common is calendar-based rebalancing. Here, an investment manager will rebalance the entire portfolio back to its targets at set points throughout the year, often quarterly. If you have a 401K with your employer, you will likely see this option in there (use it!).

There’s a Better Way

But there is a better, more sophisticated, and nuanced way to rebalance, called “Opportunistic Rebalancing.” We put this method to work on our managed strategies. What makes it different? Rather than rebalance blindly based on the calendar, you rebalance strategically based on market moves. In our case, we look weekly for individual securities that have moved too far (we generally use 20%) and buy or sell them to bring them back in line. We don’t rebalance the whole portfolio, just the outliers.

For example, let’s say US large-cap stocks rally and are now 20% too high versus your target. You would sell US large-cap back to target and then buy whatever securities fell the most. Systematically selling high and buying low! And just because you are looking often does not mean you are trading often. If everything is in line, no trade occurs.

A Pandemic Example

Why is this an advantage? It may already be obvious, but a good test case was the pandemic. In the span of less than two months in the Spring of 2020, the S&P 500 fell more than 20% and then rose more than 20%. Perhaps a calendar-based rebalancing would have been lucky and captured the bottom, but it would have been just that… luck. With opportunistic rebalancing, cheap equities would have almost certainly been purchased near the bottom.

Quantifying the Advantage

How much better is opportunistic rebalancing? A study in the Journal of Financial Planning¹ puts the number at about 29bps. That may not sound like much, but over 30 years on a $1 million portfolio (earning 6%) that is nearly $500,000. Small wins like this amount to big dollars over an investing career. Each one of our guiding principles is designed to deliver one of the small wins. Together, they add up to a potent recipe for long-term investing success.

Previous articles on our guiding principles can be found here:

Guiding Overview: Unveiling the Evidence
Patience: The Foundation of Investing Success
Diversification: Winning Even if It Doesn’t Feel Like It
Factors: Systematically Advantage Your Portfolio
Rebalancing: It Pays to be Opportunistic
Expenses (upcoming)
Taxes (upcoming)
Behavior (upcoming)

1. “Opportunistic Rebalancing: A New Paradigm for Wealth Managers”, Gobind Daryanani CFP^®, Ph.D, Journal of Financial Planning, January 2008

9.1%

Gain for the Russell 3000 in November

Stocks rallied in November, with bond market returns positive as well.

Headline of the Week

Santa Claus Came to Town Early

The holidays seem to be coming earlier and earlier each year, and this year is no exception. ChatGPT says the “Santa Claus” rally typically doesn’t start until the last week of December. This year, it didn’t even wait for Black Friday or even Halloween.

Rather than a calendar event starting the rally, it appears that a yield threshold popped the cork. The 10-Year Treasury briefly touched 5%, which enticed many to attempt to lock in higher rates. The resulting decline in yields (recently at 4.2%) flipped the script for the stock markets, and the Santa sightings were on.

For those fortunate to have hung their stockings early, they were filled with lots of nice treats in November. One of the bigger gifts was from US equity markets, with the Russell 3000 posting an over 9% gain on the month. The international present was ever so slightly smaller. And even bond markets chipped in with a near 5% gain. While mega-cap tech helped, when we unpacked the US present, mid-cap growth led the way. And while value still lagged (a bit), small-cap also delivered some early holiday cheer.

We are grateful for these early gifts, and we hope the Fed delivers something nice at its next meeting (continued pause in rate hikes). However, we don’t want to get too greedy and expect a rate cut gift next year (unless it’s needed to facilitate that greatest gift of all – the soft landing).

The Week Ahead

After a phenomenal November for stocks and bonds, the first week of December will bring a jobs report. Markets are awaiting a Goldilocks report on Friday to keep the party going.

All work and no play…

The non-farm payroll report on Friday isn’t the only jobs-related data out. ADP Employment, Challenger job cuts report, and a job openings and labor turnover report (JOLTS) precede it.

Being too strong or weak is not good; matching consensus estimates of 175,000 jobs added to the economy in November would be nice.
October added 150,000 jobs, so a significant revision to that report would also be unwelcomed.
The unemployment rate of 3.9% is expected to hold, but the most important number should be wage growth.
Wages continuing to accelerate is a cause for concern, as it tends to fuel further inflation.
The previous JOLTS report indicated an elevated job openings level of 9.55 million, tightening that a bit should be a positive for the battle versus inflation.
Keeping an eye on Friday’s University of Michigan Consumer Sentiment Index is also important.

Tuning the noise out!

Australian and Canadian central banks have rate decisions next week. The European Union and Japan have yet another revision to their Gross Domestic Products (GDP), and trade data from China should all be just noise.

Inflation is cooling globally, making further hikes unnecessary in significant economies.
Bank of Canada is expected to maintain its benchmark rate at 5% as the economy has been at a standstill for three months, and inflation is cooling.
Reserve Bank of Australia lifted rates at its last meeting to a 12-year high of 4.35% after no hikes for five straight months.
Australia’s economy grew slightly but ahead of expectations, making a hike unlikely.
India is also due for a rate decision and is highly unlikely to move from 6.5% despite challenging inflation numbers caused by erratic food prices.
The final revisions to 3^rd Quarter GDPs shouldn’t mean much, but a big positive revision would be big news.
Japan’s GDP shrank in the 3^rd quarter, so the revision would need to be quite large to bring the number into the positive.

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