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With bulls firmly in charge, it’s time for investors to go defensive

Nick M. Do/iStockphoto

Chances are you've heard the old adage: "sell in May and go away". This year, it seems many investors have ignored the first part of this advice, but followed the second. There hasn't been a big sell-off, yet trading volume has been particularly low over the past several weeks.

Volatility has been down, too. The VIX, the industry-standard measure of the implied market volatility of the S&P 500 index, has gone 74 consecutive weeks below its long-term average. (For you number-crunchers out there, the VIX recently traded at 11.86, versus its long-term average of 20.00.)

On the fixed income side, there's been increasing interest in high-yield corporate bonds–so much so that it's become "normal" to include them in many bond portfolios.

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Perhaps most importantly, at the time I write this, bullish sentiment (as measured by the Advisors Sentiment survey) is now at 62.2 per cent, up from 58.3 per cent only a week ago. This is the fifth straight week it's been above 55 per cent, the level which usually suggests extreme caution is warranted. For some context, prior high levels were in August of 1987 (60.8 per cent), October 2007 (62.0 per cent) and December 2004 (62.9 per cent).

All this calm seems like a lot of complacency to me. It suggests many investors have forgotten about risk. Many times, the moment of significant market complacency or bullishness is the moment when the market decides to teach you a lesson.

Consider this chart, which tracks the performance of the S&P 500 index since 1995. The highlighted sections identify points in time when the market has been overbought, overvalued, and overbullish–an environment remarkably similar to right now.

To be fair, this chart can't predict the coming of a downturn or correction, when it might happen, how deep it could be, or how long it might last. What it can do is remind us of how quickly the market can turn. What this chart clearly shows is how the stock market is by nature cyclical, and how times of advancement are followed by quick turns and corrections.

When markets become very stable, investors often experience what I call "personal risk-drift." Risk begins to creep into the portfolio, sometimes in the form of an ever-increasing allocation to equities. Other times, you can see it in an increased interest in higher-risk or speculative plays, where opportunities that once seemed risky now seem normal.

I sometimes see personal risk drift outside the portfolio as well. Individuals find it very easy to borrow and to rationalize big expenditures. You can see this dynamic currently at work in the residential real estate market in many Canadian cities, for example.

Perhaps most importantly, the very definition of risk changes at times like these. Risk isn't the chance of losing money–it becomes the chance of missing out on opportunities or of waiting around while the train leaves the station.

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I think the time has come for investors to shift to defense in their portfolio. Don't "drift" into summer; instead, use this time to re-evaluate your exposure to risk. Take a look at your asset allocation, and bring it back in line with long-term objectives. Now is the time to rebalance or re-diversify.

Trim back or exit speculative investments and build up cash if you can. This is something my high-net-worth clients have been doing so recently, and I continue to believe it's a good idea. Be particularly cautious about entering new positions that aren't exceptionally undervalued globally, especially if you're doing it simply because you can't find any other compelling opportunities.

Above all, remember: complacency is one of the most dangerous scenarios for investors.

Thane Stenner is founder of Stenner Investment Partners within Richardson GMP Ltd., as well as Portfolio Manager and Director, Wealth Management. Thane is also Managing Director for TIGER 21 Canada. He is the bestselling author of ´True Wealth: an expert guide for high-net-worth individuals (and their advisors)'. ( The opinions expressed in this article are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Ltd. or its affiliates. Richardson GMP Limited, Member Canadian Investor Protection Fund.

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