The average investor has completely missed the 100%+ move off of the March 2009 low. The “smart money” hedge funds have been wrongly positioned over at least the past year and a half. The pessimism is again reaching high levels. This is in the face of a domestic economy that, although certainly not going gangbusters, is showing slow signs of improvement and actually recovering in certain areas in very similar ways to other economies that have been recipients of a banking crisis carpet bomb. Don’t kid yourself, we have much more work to do to get out of this recovery and recent economic indicators including today’s release of 1.5% GDP growth have been less than rosy. But the wall of worry and overt pessimism acts as kindle to stock price appreciation when the news becomes less bad. Companies continue to print healthy earnings (albeit mainly by cutting costs) and are very reasonably valued. Furthermore, the Fed has got the stock market’s back. No matter if you agree with it or not, Bernanke will do his best to prop up equity prices.
On the other hand, if Ray Dalio of Bridgewater is even close to correct with his call of a 30% chance of a “really bad shock from Europe”, than this is no longer considered a tail risk. A shock over there would certainly de-rail our feeble recovery and punish stocks across the globe in an incalculable manner. We feel that it is insane to hold any direct European exposure. Add to the list of uncertainty would be all the issues that even the casual reader of markets can now regurgitate: the coming fiscal cliff, U.S. tax policy, health care laws, housing and Chinese growth, the U.S. economies ability to stand on its own without the aid of the stimulus cruthes, all of which makes us cautious.
It’s certainly no time to be a hero. Clients and readers of our updates know that we manage client accounts based on a set of portfolio constraints. The portfolio constraints provide a range of investment that can take place in the four asset classes that we consider—equities, fixed income, commodities and cash. The client’s risk profile will determine his or her specific portfolio constraint. So, based on one’s own risk profile, we favor a positioning in equities that is towards the very low end of the investment range, below underweight exposure to Europe, a healthy dose of gold, fixed income exposure at the top of one’s investment range, low cash amounts and continued market reinvestment (to take advantage of any downswings). We think that fixed income investing should be a tactical overweight for the next year. Eventually this investment will be a total disaster, but we feel strongly about the enhanced exposure in certain bonds so as to clip some higher coupons during this slow growth period (we’ll expand on our rationale on the blog in the coming days/weeks). Above all, patience is needed to endure the extreme volatility that is bound to occur based on the news flow out of Europe and our own economic news which will continue to be choppy.