Friday, November 12, 2010

Changing Conditions = Changing Allocation, But With an Eye on Timing

Last week brought the mid-term elections, the highly anticipated and greatly hyped Federal Reserve QE2 meeting, and the latest look at employment. Has anything changed in our view? The answer is yes. At this point we feel that leading indicators of the economy are flashing signals that would imply a much smaller probability of a double dip recession, technical conditions in the market are quite strong, and valuation continues to putter along at a neutral level that gives it very little weight in our allocations.

With the amount of money being pumped into the system by the Fed, and the business cycle looking like it will avoid another contraction, we think there’s an increasing probability that the cyclical bull market in equities will have another leg up, bringing it closer to the upper end of the trading range that we believe we are navigating. From an allocation perspective, our latest thoughts translate to portfolios that should be at least neutrally invested, and a perhaps a hair over for those willing to take the higher than normal risks associated with this liquidity driven rally.

The only thing the team doesn’t like is the short-term overbought condition of the markets. Complacency has been building in recent weeks and it seems like we are due for a correction, which we may be in the midst of right now. At the moment our plan is to start scaling into equity positions if the S&P 500 pulls back to its 50-day moving average (currently around 1161), while keeping some in reserve in case the market breaks below that. Corrections are never fun, but in this case we are welcoming one, as it gives us a chance to align our portfolios closer with our latest thinking, and hopefully at cheaper and less complacent levels.