Action To Take In Your Portfolio In Today's Market

Includes: DIA, QQQ, SPY
by: Roger Nusbaum

Howard Gold from MarketWatch had an interesting article titled' Don't be a Doomsday Prepper Investor', which was about the extent to which investors have very large weightings in alternative investments (mostly precious metals) compared to equities. Some of the stats cited in the article were surprising, given that they cited accounts held by people attached to markets and that the equity market is obviously up a lot.

It is not news that many investors never came back to equities, or so we are led to believe, but people actively engaged missing out on this run is news (to me anyway).

A few years ago, alternatives were more popular in terms of blog and MSM coverage, as sentiment on a large scale wondered whether it was the "death of equities." I am a big believer in using alternatives-- or as I called them, diversifiers-- but in moderation. Back then I talked about the role of alternatives being to diversify an equity portfolio but when too much is put into alternatives, then you have a portfolio of diversifiers hedged with some equity exposure.

This is not ideal because equities are still likely to be the best performing asset class as they have always been, even if the last 12 or 13 years have been a bumpy road to nowhere. Yes, for much of that time gold went up a lot along with some other commodities. Exposure was important in that time and will be important going forward too, but in moderation. Commodities have had bursts before where they've done well for years and then do very poorly for years.

Things like long/short, absolute return and market neutral target results that are below the long term average for stocks even factoring in the last decade. Again, there is a place for these and any others, but the article is about the extent to which people have too much.

The market going up 125% in four years is a huge move and we don't get too many of those in a lifetime and chances are anyone putting 20% into gold, 20% into a long short fund and 20% into a market neutral fund well into the decline (based on blog comments a lot of people did this sort of thing) has missed what will probably be one of the biggest runs on their lifetime.

The time to think about diversifying away some (not 60%) equity exposure would be after a 100% rally, not before. Anyone following the blog back in 2007 might have noticed increased writing about these products and an increased use in the portfolio (you could search Random Roger everyone into the bunker and come up with a few posts).

I look back at the financial crisis and the way in which the market warned of trouble as my having been very lucky, as all the indicators I mentioned actually occurred within a short time of each other. I am still a believer in sector weightings greater than 20%, the slope of the yield curve and the 200 DMA but those stars will probably never align like that again.

In a related note, Barry Ritholtz's Sunday column in the Washington Post is going to be about the market at highs having left many people behind. It is a good bet that what will happen is that the people who were left behind-- like the ones with too much in alternatives-- will rotate into stocks while they are high, the next bear market will start shortly thereafter and repeat the cycle whereby people bought high and will sell low.

I have been saying all along that I believe the best course is focusing toward an equity-oriented portfolio with small exposures to a couple of alternatives and taking defensive action when the market warns of a higher than normal probability that stocks will go down a lot.