What can investors do with a fully invested portfolio?
Many investors have a dilemma right now.
Although they agree that now is a good time to buy stocks due to very attractive market valuations, they cannot buy more as they are already fully invested. Meanwhile, some investors are sitting in losing positions, which are psychologically difficult to sell because it would mean cutting losses and losing hope for a recovery.
Instead of maintaining the status quo or simply selling stocks for cash, investors facing these issues may choose to shift some of their positions to other stocks which may rise faster when the bull market returns.
Blue chip stocks that are part of the PSEi typically drive markets higher during rallies as these stocks are prioritized by large institutional investors. The main reason institutional investors like them is because of their liquidity, which makes them easier to buy and sell, even for those with large portfolios. It’s only when blue chip, large-cap stocks get expensive that institutional investors rotate and buy second-tier, less-liquid stocks or smaller-cap stocks.
As such, investors who hold second-tier or small-cap stocks can trade them first for larger-cap index names that also trade at attractive valuations.
Another reason investors should consider switching to larger cap index names is that most of them pay cash dividends. Currently, the average dividend yield of index stocks is around 2-3%. These dividends provide investors with passive income, making it easier for them to wait for market sentiment to improve and the bull market to return.
Investors can also choose to convert some of their stocks into bonds. There are growing signs that the US will soon enter a recession, which should bring inflation down and convince the Fed to finally pause and even cut interest rates.
Although interest rates may rise further in the short term, Philippine bond yields are already very high compared to their historical averages. In fact, the 10-year bond rate is now at 7.6%, which is only 40 basis points from its peak of 8% in 2018, when inflation was also high.
In my view, the risk of interest rates remaining permanently above their current level is very minimal. Assuming that the historical average spread of 170 basis points between the 10-year bond rate and the inflation rate is maintained, inflation would have to remain above 5.9% for 10-year bond rates to exceed its current level.
That seems unlikely given central banks’ relentless approach to keeping inflation from skyrocketing and signs that they are succeeding. For example, in the United States, the inflation rate has already peaked and is expected to fall to 4.2% next year from 8.1% this year. Meanwhile, in the Philippines, the inflation rate is expected to drop to 4.1% next year and 3.2% the following year.
Additionally, bonds perform better than stocks in times of economic weakness, as the resulting decline in consumption leads to lower inflation and lower interest rates. Lower inflation and lower interest rates automatically drive bond prices higher, which benefits investors who bought bonds when yields were higher. The same cannot be said for stocks, as corporate earnings are also likely to decline when the economy weakens.
The only caveat to this strategy is that investors need a large sum of money to buy bonds directly. However, those with less money can still participate indirectly in the performance of bonds by buying mutual funds or mutual funds that invest in bonds.
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