Breadth, Momentum, and Asset Allocation Around Retirement

Most lazy, low-cost, broadly diversified ETF investors are momentum investors in disguise.

That’s right, a cap-weighted ETF (such as VTI or VOO) uses the momentum factor. Since it is cap-weighted, the better a stock does, the more of it you own. The worse it does, the less you own. This is the “self-cleaning function” that The Simple Path to Wealth describes. Momentum means cap-weighted.

Breadth is a new concept that can apply this self-cleaning function to our asset allocation around retirement. We all must de-risk at some point.

Let’s use Breadth and Momentum to try and predict the future. It will be fun to see how wrong I am.

What is Breadth?

Breadth tries to quantify total market risk by deciding how important it is whether most stocks are going up or down. The bull market has legs as more stock prices participate in a rally. Whereas once most stock prices start turning down, you might wonder how much longer the rally’s teeth will get.

As a novice on breadth, I’m placing it along the momentum factor spectrum. Since all factors are interrelated, you get mostly subjective once you start talking about combining factors. And if you combine all of the factors, you should get the average results of the market. But since we have seen US Large Cap Growth crush all alternatives for an extraordinarily long time (seriously, it might be the best example of momentum we ever see), momentum should be interesting to lazier factor-based, mostly total market-based investors.

Breadth interacts with momentum strategies. Should it be used as an exit screen or a sign that the US will continue its unexpectedly long recent history of dominant increasing stock prices?

Breadth and Momentum Investors in Disguise

I am a lazy momentum investor in disguise (because I have a factor-based yet largely Cap-Weighted portfolio). Momentum uses breadth as an excuse to bail on buy-and-hold.

What about those of us who are considering de-risking or going conservative around the time of expected retirement?

I’m not traditionally a market timer, but I am looking for a good time to adjust my asset allocation because retirement. At some point, we must move from an accumulation portfolio to a de-accumulation one.

And, like most, I traded in a traditional 60/40 portfolio for something much more aggressive. Equity lust in the last 20 years is obvious in the retrospeciscope. Remember, bond yields were catastrophic for a 4% Safe Withdrawal Rate just a short time ago. And there is no alternative to holding a higher asset allocation than old-timers since they had high bond yields and falling bond prices (which push up bond yields). From inflation in the ’70s to the boom times of the ’90s and the dot com crash, and the lost decade of the oughts and the Immaculate Seven, it is always the right time to invest in the US stock market via lazy ETFs. How about that for momentum???

Our parent’s generation had high bond yields and falling prices, and we had TINA. TINA, there is no alternative that requires a more aggressive asset allocation.

The Effect of Recent Market Conditions

Since we all got hurt in 2022 (stocks and bonds are the biggest loser), many resilient reasons exist to de-risk your portfolio. Some of us in retirement want to de-risk a little. Some a few years out also want to go conservative since five years before retirement, you suffer from retirement date risk, and you have sequence of return risk for the five years after.

If you sell stocks to buy bonds, when should you do that with respect to market prices and understanding both retirement date risk and sequence of returns risk? Sometimes you just have to grit your teeth and do it. Other times you can consider the effect of recent market conditions. Breadth even.

Cash flows into bonds are logically high right now. Stocks are up a bit, and bond prices have stabilized and have a yield to support a 4% Safe Withdrawal Rate.

I know some people are adjusting their asset allocation. Now is good enough; we are back up from recent market lows, and bonds have attractive yields again.

Personally, I am still TINA since I have an 8% Variable interest loan against my equities. A hurdle rate of 8% requires equities (and probably leverage and smacks of market timing, given that I’m up almost 20% this year), but if my hurdle rate were 4%, I’d go 60/40 all over again. I’m highly aggressive right now because I’m riding the momentum of the last eight months and am a lazy cap-weighted low-cost buy-and-hold three or for broad-spectrum ETFs. And nothing has worked better for the last 20 years. When will it be time for other factors to shine? I still own them, too.

Since I’m leveraging my existing ETF portfolio to pay for a new home purchase partially, I’m looking for any reason to sell right now. I’d love to get a little more conservative asset allocation and/or take some leverage off the table. When you are 120/-20, you either believe in momentum (or market timing) or still have some human capital to burn (which is why I’m coast-FI).

Since I’m a momentum investor in disguise, when is it time to get off the momentum train? Or, not as drastic as all that, is it time to de-risk

Equal Weight S&P 500

Since I’m fully invested in equities, and a lazy momentum investor, the easiest way to know if a rally has legs (via a crystal ball) is the momentum of the breadth. Or just breadth since it is a new concept for me.

Let’s look quickly at the equal weight vs the cap-weighted S&P indexes (RSP vs SPY). In the last year and a half (including the poor market performance in 2022), RSP is down by 6.5%, while SPY is down by 4.5%. Interestingly enough, year to date, these numbers are up 7% vs up 16%.

The difference is the outperformance of large-cap growth for the last several years and also in the last several months (the so-called Immaculate 7). Since we are momentum investors in secret, we participate in the growth (then they get cut in half) and the growth without worrying about buying or selling. The Immaculate 7 have had a pretty good rebound that continues the US vs. Non-US domination for perhaps a statistically significant period of time.

More on Momentum

Just as an aside, this dual momentum strategy combines absolute (trend following) and relative (cross-sectional) momentum. Then they use breadth for “crash protection” or as tail risk defense.

So, trend following lets you know if you should be in equities or cash-equvalents, and relative strength momentum decides which equities to select—and breadth momentum screens for when to abandon ship back to safety again. Interesting enough, and it backtests well, but so does everything else.

Since market breadth indicators analyze the number of stocks advancing relative to those that are declining in a given index, they are more often than not used to determine when you should sell (if the price supports selling) When resetting your asset allocation before retirement, momentum is also important. The only basic rule is don’t sell stocks when they are at all-time lows.

Some Breadth Indicators include:

Advance-Decline Index: calculates a running total of the difference between the number of advancing and declining stocks.
New Highs-Lows Index: The new highs-lows indicator compares stocks making 52-week highs to stocks making 52-week lows.
S&P 500 200-Day Index: what percentage of stocks in the S&P 500 are trading above their 200-day moving average.

Certain breadth indicators also incorporate volume. They will look at whether a stock is advancing or declining in price and the volume of those moves. This is because price moves on larger volumes are considered to be more significant than price moves on lower volumes.

Using Momentum and Breadth to Find Your Retirement Asset Allocation

When more stocks advance than decline, it suggests bullish market sentiment and confirms a broad market uptrend. Conversely, many declining securities confirm bearish momentum and a downside move in the stock index.

Chartists consider breadth indicators as poor timing signals and say you have to correlate with the price. Since the price contains all the information you need, always confirm everything with the price. Breadth alone provides false signals, suggesting trend reversals that don’t materialize.

I want to rebalance my retirement portfolio at the optimal time. Since I’m a lazy investor, I might as well think about those factors that correlate and respond well to momentum, like breadth.

I’m not a market timer (or maybe I’m just not a very good market timer). Instead, think about trimming at the edges of your portfolio, making changes, or at least give some consideration to your timing.

In accumulation and deep into de-accumulation, you rebalance like clockwork. But at some point, you must de-risk. You face both retirement and sequence of returns risk, a toxic ten-year retirement reallocation window. Given the effect of recent market conditions, both momentum and breadth may light the way.