Sitting On The Fence

by: Edward Hoofnagle, CFA

Sometimes we look for solace from market advisors. One of my favorites comes from Minynanville: "Missed opportunities are made up easier than losses."

And while this viewpoint provides some consolation, the feeling of missing the lion's share of this year's bull run cannot be washed away so easily. After prematurely exiting in early 2013, some fence sitters (like me) have been waiting patiently for the correction that never came, and each successive level up adds to the annoyance of trying to be too selective in making an investment decision and in outsmarting yourself. Regrettably, once you begin to miss that upside, the psychological impact of "anchoring" starts to drag on your opinions. When one is making the psychological error of anchoring, one ignores the merits of the current level and remains fixed on that level where he or she exited the market. The anchored investor keeps thinking about how many points the market has moved "up", how many points it has moved away from their old target. It is well documented that such reasoning is flawed, and yet, it is a part of human nature. As financial advisors, we know that the most appealing strategy to counter "anchoring" is to consistently invest in small increments and take advantage of the dollar cost averaging. That's the normal advice, and it remains an effective tool.

Let's take a look at the current state of affairs to judge the risks and rewards:

On the plus side, there are positive, albeit muted bouts of good economic news - GDP seems to be pushing against the new normal of 2.2-2.5%, and inflation seems to remain in check. Industrial activity is increasing (thanks to domestic energy production), and there are signs of pent up demand in capital intensive industries. In short, the US has been described as the best of the lagging markets, so the investment thesis is that the valuations are reasonable, and that this is the least bad place to invest. And of course, the investment alternatives like commodities and fixed income are pathetic.

On the negative side, there are the constant irritants of middle-east geopolitics, rampant US government spending, uncertainty in healthcare, and the outplacement of our Federal Reserve chairman. One of my favorite keepers of anxiety is Lloyd's Wall of Worry.

Looking ahead

Fortunately, the next three to six months promise to be illuminating, if not exciting. And, in my opinion, the markets should provide ample opportunity to straighten up any asset allocation misses without entering at unattractive levels. So patience is required, and the following events might be signs of opportunities to rebalance.

First, the technical stuff:

  • Equities - if we get a 10% correction in the equity market, it would be a welcome sign to get fully invested. If we get a 15% correction, even better. The caveat - this correction should come from normal information, not a tectonic change (new taxation, global mess, etc.).
  • Yields - if the ten year UST rates move towards 3.75%, that might be a sign that normalcy could be lurking around the corner of the fixed income market. By the way, that's a huge jump from today's level. Still, even at 3.75%, mid-term yields are out of sync with the risk. I still believe that one can keep fixed income investments short term in tenor, and leave them in the "hold to maturity" category for now. The time will come to move out in duration, just not yet.
  • Inflation - if we see inflation coming above 2%, that's a great sign, as it might portend some central bank rationality. If this happens in January, buckle up! (see below). TIPS would be the normal vehicle to capture some inflation exposure, but with the dismal yields, one can evaluate alternatives such as ITIP, STIP, and GTIP). Additional assets may include SLV, GLD, OLO, USO.
  • US Dollar - continued strength in the US dollar is bullish for US equities, bearish for Gold, and counterproductive for inflation targeting of 2%. Keep an eye on the US Dollar (UUP, UDN) and on Commodities - they normally have a strong coincident factor with the US equity market. At present, the two have diverged.

Now the softer stuff:

  • Fiscal negotiations - the debt ceiling debate was a non-event. I heard it described as a great "yawn" for investors. Fair enough, but the facts remain: debt as % of GDP is 100% and the Fed balance sheet is larger than many countries' annual GDP. At times it seems like this argument falls only on deaf ears, conspiracy theorists, and/or old-timers. Still, facts remain facts, even if they are swept under the rug. A fiscal breakdown will push yields up, support GLD and depress SPY.
  • Don't ignore the Iran nuclear talks. Ignore the phone call between Obama and the new Iranian leaders. If there isn't an agreement soon, expect some volatility in the conflict-ridden zone. In the past, political tremors have favored commodities (NYSEARCA:OIL), the US Dollar (NYSEARCA:UUP) and gold (NYSEARCA:GLD).
  • Obamacare - if the implementation of the Affordable Care Act is delayed, that would be bearish for US equities (NYSEARCA:SPY). It would raise the specter of continued dysfunction. I'm not promoting the Act; rather, I would prefer to see it implemented and fixed over time. Extended delays in the implementation of Obamacare would be an indicator of potential market volatility.
  • February 2014 -Janet Yellen comes into the hot seat in the New Year. Forget the confirmation hearings - her policy is known:

I believe progress on reducing unemployment should take center stage for the FOMC, even if maintaining that progress might result in inflation slightly and temporarily exceeding 2 percent. - April 2013

Students of market history will be reminded that changes in the Federal Reserve management are usually tested by the markets in the short term. Generally speaking, one can expect the equity markets to show distress if the steadfastness of her initial policy stance comes into doubt.


If you're sitting on the fence, you're not alone! Yet, the time has arrived to do a few things to get your financial house in order:

Get comfortable with your target asset allocation, based on:

  • your personal risk tolerance
  • your personal time horizon, and
  • your expectations of future asset class performance (not past performance).

You should consult a financial advisor if the above steps seem confusing.

And, if the fence you're sitting on seems too high to jump off all at once, invest gradually each month until you bring the allocation back to your target levels. A good rule of thumb is to move in 10% intervals.

Disclosure: I am long SPY, AAPL, GLD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.