The S&P 500 is up more than two and a half times since its March 2009 closing low. Many stocks are up even more. The S&P 500 has gone from being very cheap to being fully or overvalued on most historical valuation metrics. Taking some profits here seems to make sense, but how much cash should be raised and how concerned should clients be with capital gains taxes? The answer depends on a multitude of factors.
NPP feels the first factor that must be considered is a client’s positioning. After an eight-year bull market, it is easy for equity and risk exposure to move above target. All else being equal, the timing appears right for reducing risk especially if you are closer to retirement and/or have a lower to moderate risk tolerance. Those with a higher risk tolerance and no cash needs can afford to ride what may be a slightly bumpier ride going forward. On the other hand, investors, who have cash flow needs and a lower risk tolerance, are likely wise in reducing equity positions slightly to keep their portfolios’ asset allocations close to target.
The tax rate is also an important factor to consider. The federal capital gains rate is currently near the low end of its historical range, although up from the lows of the Bush Administration. Chances of a reduction look iffy at best as Congress struggles with tax reform. In addition, the state you live in also affects the calculation. Those living in states without an income tax rate face a different set of circumstances than those in states with rates close to ten percent.
The decision of when to sell a stock is difficult, especially in taxable accounts. While stocks do go up in the “long run,” what is defined as the long-run can differ. Those who bought or held the S&P 500 at the peak in 2000 had to wait about six years to get their money back, and didn’t see returns on their investment grow again until 2012. On the other hand, any investor who bought the market during this bull market has not had to wait very long to recover from pullbacks.
NPP is not overly bearish in the near-term. Most deep bear markets occur during recessions, and we do not expect one in the next twelve months. A sea of easy money has lifted stocks to elevated levels. One risk is an improving or stabilizing economy could cause quantitative tightening which could in turn cause markets to drop while the economy expands. While we are not bearish, valuation levels concern us and NPP thinks it wise to reduce equity exposure. NPP has gradually cut positions throughout the year realizing gains because we feel this is the prudent course of action even for taxable accounts. Capital gains taxes are always an important factor in any sell decision for taxable accounts. However, we don't think it's wise for them to be the only reason to hold a stock.
As always, please feel free to reach out if you would like to discuss this now or in the future.