Springing into Action

And we thought last week was volatile. Apparently, it was just a mild preview to this week’s fireworks in the stock market. Just in case you haven’t been paying attention, the daily S&P 500 returns so far this week are -6.6%, +4.7%, -4.4%, and +4.6% (through Thursday). Whew.

If you’ve been following along, you probably noticed that there’s been a significant shift in our outlook. After writing for weeks that we were getting more concerned, but the data was still too ambiguous to reach the necessary conviction to make a definitive call one way or the other, we now believe the market has probably entered a new bear market, and the odds of the economy slipping into another recession have grown considerably. And if you’ve noticed the blizzard of trade confirms arriving this week, you’ve also realized that we’ve sprung into action. In short, we’ve executed several transactions, starting last Friday and through the course of this week, to materially reduce risk across all of our model portfolios.

With the extreme moves in various asset classes, we’ve gone to great lengths in our trade execution to try and maximize our exit points, with mixed results. With our equity sales, we’ve had a couple that we feel pretty good about, like last Friday (since the market is still lower than it was then) and yesterday (when the S&P was up nearly 5%), and one really frustrating day (Tuesday, just after the Fed announcement and before the big end of day rally). We also had what may have been a well timed trim in two of our two hedges that have been on fire, gold and long-term Treasuries, when we sold a little of each yesterday morning right around their highs. Of course, if our bigger picture outlook is correct in that ultimately stocks are headed lower in coming weeks, then any sale around current levels will look great in hindsight.

For now, the proceeds from all of these trades have simply gone to cash. We’re fully aware that cash is currently yielding 0%, which obviously isn’t going to get anyone to their long-term return objectives. We simply view cash as an attractive place to hunker down for the time being while we patiently wait for opportunities to develop. One of the issues currently is that the obvious asset classes that we would normally turn to when getting more defensive (gold and Treasuries) have had such extreme moves higher that we’re not comfortable adding to them at current prices, since they are both very volatile in their own right.

So, as the clock winds down on a whirlwind of a week, we believe that the flurry of activity has lowered portfolio volatility by the largest degree since early 2008, which was the last time that we drastically reduced portfolio risk. There may be more changes to come, but we feel we’ve done enough this week to take a step back and take a breath. Make sure to stay tuned, though…