Updated from 7:04 a.m. ESTThe stock market's big up-and-down swings of late might have daytraders and professional investors buzzing. For the majority of investors, however, the recent gyrations should be viewed simply as noise, with little bearing on a longer-term allocation strategy. Consider a recent period, in which the Dow Jones Industrial Average rose or fell by more than 80 points five times in eight sessions, just to end up about 30 points higher than where it started. Professional traders love this kind of market because it plays into strategies that profit from volatility itself. The average investor should pay far less attention, financial advisers say. Neither the market correction, which took the Nasdaq Composite, the S&P 500, Dow Industrials and most other indices down for the year, nor the recent rally should profoundly alter your asset-allocation strategy. It's far wiser to stay steady and follow the consensus of market strategists, who may quibble about sectors but generally agree that the right mix of stocks, bonds and cash depends much more on an investor's age than what the market is doing at the moment. Even for pros, the cross currents are hard to gauge. On one hand, Thursday's snapback could mark the beginning of a market bottom. On the other hand, bullish sentiment was dropping in a recent, influential survey. (Never mind that a drop in bullishness is good for the market, say contrarian pros.) Now may be a good time to buy on dips, according to Charles Blood, global market strategist at Brown Brothers Harriman. The investment bank is currently about 70% invested in equities, 25% in bonds and about 5% in cash, he said. But remember, conventional wisdom suggests that investors roughly split a portfolio into 60% equities and 40% fixed-income investments. Blood said there will be a pullback from his firm's high equity weighting, but said it won't be a sudden, drastic shift. "I have been thinking that as stocks move higher, it would be time to at least bring equity numbers down to a more standard level," he said. "The recent dip was a buyable dip, but recent big returns are behind us. We don't want to get swept up in the notion that we can do as well as we have done." The wisdom of a well-allocated portfolio was amply demonstrated recently when bond prices rallied on questions about the strength of the economic recovery, with yields on the 10-year note returning to levels not seen since last July. The weekly Wall Street survey by Chartcraft.com bolstered Blood's outlook: Its Investors Intelligence report for the week ending March 19 showed a 13% drop in respondents who called themselves bulls, mirrored by a rise in the number expecting a market correction. Even without a major correction, Blood's view that the biggest gains of the market are behind us has support from Merrill Lynch, which is in the process of revising its sector weightings and starting to make some defensive moves.
According to a recent research report on allocation, Merrill remains overweight in consumer staples because they perform well in decelerating profit cycles and are seen as the most undervalued sector in the brokerage's dividend discount model. While the report recommended reducing positions in financial services, industrial stocks and materials, with an eye to a flattening yield curve, it also suggested increasing holdings in defensive sectors such as health care, utilities and energy. Merrill pulled back from technology and consumer discretionary stocks, calling tech "a bubble sector." "As we have repeatedly emphasized, even the biggest of bulls are forecasting that the profits cycle will decelerate in 2004," the report said. "We have gradually shifted our sector weights to better reflect a late-cycle environment (i.e., moving sectors such as energy and materials upward in our sector ranks), but now feel that it may be more appropriate to make our recommendations even more conservative." That's music to the ears of Mitchell Freedman, a financial planner in Sherman Oaks, Calif., who counts many members of the entertainment industry among his clients. He tells them to look for value, make an investment plan and stick with it. Most individual investors need to see results before investing. That often leaves them behind the maximum upside and prone to sell near the maximum downside, Blood says. After all, the strong performance of the major indices in 2003 swept many investors back into the stock market. The Dow Jones Industrial Average rose more than 28%, the S&P 500 had a total return of 26.38% and the Nasdaq Composite gained 48.8%. "I think the financial services industry thrives on people buying and selling; they don't make money by people sitting and holding tight," Freedman said. "Since they make their money on transactions, it's no wonder that they do encourage people to try to pick the times to buy and the times to sell. I think applying one method over a long period of time will produce reasonable gains, provided the methodologies aren't faulty in and of themselves."
Doug Altabef, senior managing director at Matrix Asset Advisors in New York, which manages $800 million, said he will stick with his standing equity allocation -- about 60% -- in part because of modest expectations for this year. "If you think individual investors are throwing money down a sinkhole because equity fund inflows are still strong, because you think we are on the verge of another March 2000, I would disagree," he said. "We're going to stay fully invested in equities, as requested by our clients. We're not market-timers, we're not moving in and out of equities and going into cash. We would do it if we thought people could do it well on a sustained basis, but we haven't seen that. It wasn't always pleasant, but we've done well staying in the markets." Jack Ablin, chief investment officer at Harris Trust and Savings Bank in Chicago, remains overweight in equities, but he used part of his allocation from fixed income to move into commodities last month. "We think that the supply/demand dynamic is still pretty powerful and will continue to be pretty valuable," he said. "As long as Treasury bill yields are below the rate of inflation, that's a favorable backdrop for commodities." Many smaller investors will have trouble getting into commodities unless they look at the Pimco Commodity Real Return funds or Refco's S&P Managed Futures Index Fund, though most investment professionals also say there's little reason to move quickly when considering one's own allocations. With a dedicated investment plan, individuals don't have to try and mimic their counterparts at big investment banks and larger funds. "You've got to be willing to give something up on the upside in order to protect your profits on the downside," Freedman says. Most importantly, smaller investors need to look at their own goals and tolerance for risk, rather than seek crystal-ball insights into market behavior, said Peng Chen, director of research at Ibbotson Associates. "If you believe that the stock market is going to underperform not just this week but over the long term, you may want to consider changing your focus," he said. "If there's a fundamental belief that equities won't do so well, there's reason to change your allocations, but it shouldn't be based on this week's market performance."