You may want to position your portfolios or at least re-balance. Markets go up, markets go down. When the market is net flat, or indifferent it should make you worry. Then you should change your view of investments. So far this year stocks' best rallies were timed rallies.
As of the end of the second week in June, stocks have given up all their gains for the year for the second time. In other words, if you invested in stocks in the beginning of the year and held on you wouldn't have made anything and further risked getting taken if there were to be an ensuing sell-off.
There shouldn't be a ruthless correction but investors should be prepared to take advantage of opportunities as well as reposition for the Summer months. Summer is usually a testy time for markets with no real direction or advancement.
Looking at investments like a puzzle is one way to understand portfolio positioning. The S&P 500 year-to-date has returned 0.4% with a risk factor of 21.66% (standard deviation). Inflation-indexed bonds on the other hand have returned 5.36% year-to-date with a risk factor of only 5%. Granted this is just a snapshot of the current situation, it still shows how deficient stocks have been.
Doing the math, investors shouldn't invest more than 30% in risky stocks given the current situation. This is based on portfolio optimization given two assets, one risk-free and one risky: inflation-indexed bonds and stocks in this case.
Understand that stocks have been resilient despite known weaknesses. Stocks have also proven to be relatively strong during rallies but the markets are approaching a decision day that is kind of mind-blowing. At the end of this month QE2 will expire leaving the Fed little leeway to buoy markets as it has been doing. What's more, the debt load has reached its limit and without government action the U.S. may default on its inability to pay bonds.
All of this is already understood in the markets however there will be no other option than for there to be a major move. Finally, the Fed has been known to throw curve balls and surprise the markets pleasantly during these ultimatums.
What this means for the investor is that he or she should position the portfolio to expect the inevitable; which is rising interest rates and falling stock prices. The investor should also give slack for the possibility (with a hand-written expected probability) of a surprise event.
The recommendation based on the math is to position the portfolio with 30% stock funds, 70% inflation-indexed bonds, with a hand-written probability of a surprise event being 0-10%. My personal hand-written probability is more like 50% of a surprise event which would make my stock allocation go to 45% and the bond allocation 55%. If you think the chances of a surprise event are 75%, the stock allocation goes to 53% and the bond allocation goes to 47%. If you wish to position the portfolio expecting a surprise as opposed to the inevitable, then your stock allocation should be 60% with a bond allocation of 40%.
Furthermore, if you really want to position yourself without bearing 100% risk you need to consider going long and short to neutralize your risk and expose yourself in a timely fashion. Consider shorting the S&P 500 while simultaneously going long the cubes NASDAQ. Be sure that both sides of the spread trade are equal. You can make one side larger than the other depending on your bias at any given time.
As of the end of the second week in June, stocks have given up all their gains for the year for the second time. In other words, if you invested in stocks in the beginning of the year and held on you wouldn't have made anything and further risked getting taken if there were to be an ensuing sell-off.
There shouldn't be a ruthless correction but investors should be prepared to take advantage of opportunities as well as reposition for the Summer months. Summer is usually a testy time for markets with no real direction or advancement.
Looking at investments like a puzzle is one way to understand portfolio positioning. The S&P 500 year-to-date has returned 0.4% with a risk factor of 21.66% (standard deviation). Inflation-indexed bonds on the other hand have returned 5.36% year-to-date with a risk factor of only 5%. Granted this is just a snapshot of the current situation, it still shows how deficient stocks have been.
Doing the math, investors shouldn't invest more than 30% in risky stocks given the current situation. This is based on portfolio optimization given two assets, one risk-free and one risky: inflation-indexed bonds and stocks in this case.
Understand that stocks have been resilient despite known weaknesses. Stocks have also proven to be relatively strong during rallies but the markets are approaching a decision day that is kind of mind-blowing. At the end of this month QE2 will expire leaving the Fed little leeway to buoy markets as it has been doing. What's more, the debt load has reached its limit and without government action the U.S. may default on its inability to pay bonds.
All of this is already understood in the markets however there will be no other option than for there to be a major move. Finally, the Fed has been known to throw curve balls and surprise the markets pleasantly during these ultimatums.
What this means for the investor is that he or she should position the portfolio to expect the inevitable; which is rising interest rates and falling stock prices. The investor should also give slack for the possibility (with a hand-written expected probability) of a surprise event.
The recommendation based on the math is to position the portfolio with 30% stock funds, 70% inflation-indexed bonds, with a hand-written probability of a surprise event being 0-10%. My personal hand-written probability is more like 50% of a surprise event which would make my stock allocation go to 45% and the bond allocation 55%. If you think the chances of a surprise event are 75%, the stock allocation goes to 53% and the bond allocation goes to 47%. If you wish to position the portfolio expecting a surprise as opposed to the inevitable, then your stock allocation should be 60% with a bond allocation of 40%.
Furthermore, if you really want to position yourself without bearing 100% risk you need to consider going long and short to neutralize your risk and expose yourself in a timely fashion. Consider shorting the S&P 500 while simultaneously going long the cubes NASDAQ. Be sure that both sides of the spread trade are equal. You can make one side larger than the other depending on your bias at any given time.
