Yesterday, I received an email from my friend and first boss post college, to which I replied:
"i've been thinking hard lately about taking my model portfolio beta down from ~0.50 to 0.25 by allocating 10% to 2x inverse S&P. but the gubmint releases retail sales tomorrow at 8:30am, which if they come in near expected 0.4% month over month growth (seasonally adjusted), will still show a decent y/y figure (which is my personal favorite indicator). overall, i think i'd rather leave something on the table than get trigger happy - so will likely wait for more confirmation. when i think about potential future scenarios, i just don't see the S&P going back to 666 simply b/c i don't see liquidity getting squeezed like it was back then. also, i think the FED can buy a lot of treasuries to finance govt spending via seniorage without creating inflation pressures, especially if the proposed higher banking reserve ratios keep a permanent lid on lending / velocity of money."
The retail sales figures released this morning were not good. Down 1.2% (month/month), rather than the consensus estimate of up 0.4%. More importantly in my view, this marks the second month in a row where the year/year increase has weakened (see chart above - click it twice).
So what do I do? I go look at other indicators to confirm and I find that the employment sitch isn't any better. Everyone was talking last week about how something like 90% of the new jobs were due to census hiring. Furthermore, calculated risk shows that temp hiring (which tends to lead payrolls) has pulled back. As icing on the cake, the small business hiring that usually isn't picked up by government payroll stats during economic recoveries (which tends to cause people to call them 'jobless' when they really aren't) apparently isn't there.
Separately, and perhaps most ominous, the TED spread has begun to widen. This is particularly worrisome to me because of all the zombie commercial real estate loans out there for which the only sustenance is low LIBOR. This is b/c their interest expense charged to borrowers is most often a spread over LIBOR, which if it's low, can be covered by cash flow generated by the property.
I think the writing is on the wall now. No use in waiting for the trumpets to sound. Trade early or not at all. [feel free to insert your own favorite cliche here]. I'm going to offset the model portfolio's exposure to the stock market by allocating ~33% to the Proshares ETF that is short the S&P 500 (ticker: SH). That will take the beta down to ~0.0x [33%*(-1.0) + (1-33%)*0.5 = 0.0]. I chose the ETF that's 1x inverse of the S&P 500, rather than the version that's 2x inverse b/c I don't like leverage (long or short).
I stand by my views expressed in the email to my friend, but I think we now have confirmation. I don't think the S&P will return to 666, but rather will swing back and forth between 800-1,200 for a few years until P/E ratios (i.e. valuations) bottom out and we begin with a new secular bull market. In the meantime, I think it's worth trying to avoid some of the downswings. At the very least, decreased exposure now will reduce volatility in my account and thereby help preserve clear judgement.
My only hesitation is that I don't know anyone who is bullish on the market right now, but I'm just going to chalk that up to being a function of my friend selection. Nevertheless, when you're a contrarian investor at heart (it's intuitively appealing), it's always bothersome to find someone who agrees with you. I take solace from the fact that wall street sell-side shops are still ostensibly bullish. In any case, I want to make decisions based on intermediate-term drivers like economic stats, without regard to short-term drivers like sentiment. [UPDATE: I hope these guys are both representative of the market consensus and overly optimistic]
P.S. Looking to the bright side, if you choose not to reduce your exposure to stocks at this time and this downswing I've described actually plays out, it will provide a nice chance to convert regular IRA accounts over to Roth IRAs while minimizing the amount of income taxes triggered (which are based on the value of your account at the time of conversion).
"i've been thinking hard lately about taking my model portfolio beta down from ~0.50 to 0.25 by allocating 10% to 2x inverse S&P. but the gubmint releases retail sales tomorrow at 8:30am, which if they come in near expected 0.4% month over month growth (seasonally adjusted), will still show a decent y/y figure (which is my personal favorite indicator). overall, i think i'd rather leave something on the table than get trigger happy - so will likely wait for more confirmation. when i think about potential future scenarios, i just don't see the S&P going back to 666 simply b/c i don't see liquidity getting squeezed like it was back then. also, i think the FED can buy a lot of treasuries to finance govt spending via seniorage without creating inflation pressures, especially if the proposed higher banking reserve ratios keep a permanent lid on lending / velocity of money."
The retail sales figures released this morning were not good. Down 1.2% (month/month), rather than the consensus estimate of up 0.4%. More importantly in my view, this marks the second month in a row where the year/year increase has weakened (see chart above - click it twice).
So what do I do? I go look at other indicators to confirm and I find that the employment sitch isn't any better. Everyone was talking last week about how something like 90% of the new jobs were due to census hiring. Furthermore, calculated risk shows that temp hiring (which tends to lead payrolls) has pulled back. As icing on the cake, the small business hiring that usually isn't picked up by government payroll stats during economic recoveries (which tends to cause people to call them 'jobless' when they really aren't) apparently isn't there.
Separately, and perhaps most ominous, the TED spread has begun to widen. This is particularly worrisome to me because of all the zombie commercial real estate loans out there for which the only sustenance is low LIBOR. This is b/c their interest expense charged to borrowers is most often a spread over LIBOR, which if it's low, can be covered by cash flow generated by the property.
I think the writing is on the wall now. No use in waiting for the trumpets to sound. Trade early or not at all. [feel free to insert your own favorite cliche here]. I'm going to offset the model portfolio's exposure to the stock market by allocating ~33% to the Proshares ETF that is short the S&P 500 (ticker: SH). That will take the beta down to ~0.0x [33%*(-1.0) + (1-33%)*0.5 = 0.0]. I chose the ETF that's 1x inverse of the S&P 500, rather than the version that's 2x inverse b/c I don't like leverage (long or short).
I stand by my views expressed in the email to my friend, but I think we now have confirmation. I don't think the S&P will return to 666, but rather will swing back and forth between 800-1,200 for a few years until P/E ratios (i.e. valuations) bottom out and we begin with a new secular bull market. In the meantime, I think it's worth trying to avoid some of the downswings. At the very least, decreased exposure now will reduce volatility in my account and thereby help preserve clear judgement.
My only hesitation is that I don't know anyone who is bullish on the market right now, but I'm just going to chalk that up to being a function of my friend selection. Nevertheless, when you're a contrarian investor at heart (it's intuitively appealing), it's always bothersome to find someone who agrees with you. I take solace from the fact that wall street sell-side shops are still ostensibly bullish. In any case, I want to make decisions based on intermediate-term drivers like economic stats, without regard to short-term drivers like sentiment. [UPDATE: I hope these guys are both representative of the market consensus and overly optimistic]
P.S. Looking to the bright side, if you choose not to reduce your exposure to stocks at this time and this downswing I've described actually plays out, it will provide a nice chance to convert regular IRA accounts over to Roth IRAs while minimizing the amount of income taxes triggered (which are based on the value of your account at the time of conversion).
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