Seeing Opportunity in the S&P 500 Selloff

It is all over the news: 'Sentinel halts draws from their Money Market Funds/Cash Deposits'. I think the media should be a bit more specific with the headlines. Enhanced Money Market funds are not really the same. Money markets strive to maintain $1 NAV and are a bit more risk averse. It would almost tempt you in to thinking that the problem is a bit more widespread, like having a bank run.

It all goes back to placing value on those house loans that where wrapped up into securities and sold off in various forms. It should be noted that most of the headlines are related to hedge funds. The Sentinel issue is a bit more worrisome, since it is a bit closer to home than some exotic hedge fund strategy and concerns liquidity for such funds.

Secondly, it could affect the unrelated commodities markets. Sentinel holds liquidity for many pooled funds that operate in the commodities markets. As liquidity is withheld, it could remove a source of funds from the market, which have been propping up prices. This, in turn, could push down certain artificially high commodity prices. Outside of the social panic factor, we wonder if this is such a bad thing after all. It seems the market is proceeding as it should, and clearing itself of excess in all the various markets. Obviously, the same notion could be carried into the current equity markets. The sub-prime issue is spreading.

As we have noted, as long as the banking system holds up, which it should, the markets should not collapse nor should the economy fall into a huge recession. What is occurring is the shuttering of private market liquidity pools and liquidity engines. This is causing a greater reliance on the world central banks, so they are fulfilling their roll, which is to be a “Lender of Last Resort”.

How to play this current sell off and potential “correction” (decline of greater than 10% from peak) in the portfolios? If you look back at the past post of Bear Market and Correction stats, you would note that the average correction is roughly -13% and takes 4 months. We have currently sold off by -8.29% from the intraday high to intraday low Tuesday on the S&P 500. Currently, our max growth allocation holds 13% cash.

We have been moving rapidly into (HYG) high yield bond ETF. We are hoping to see this fall to around 95 before we move in again. Once the S&P 500 moves into a negative return for YTD basis, we will start to lower cash and rotate into Large Cap Stocks (IVE) & (IVW), with a bias toward growth. However, small caps have a tendency to sell off very sharply, so we may deploy capital in this direction, as well. We estimate to have lowered cash to around 7% to 10% of the portfolio. If we come close to the -10% marker, we will work a bit more in and at -13% we will be fully invested. We are eyeing our commodity holdings (DBC), as a source of funds.

Comments

[Nidhi Kadalbal:]

Agree that -10% can represent a good support point, speaking as technician. However, I prefer that the entire Credit Squeeze is rooted out before I move in into the market. Let that be at -10% or at -13% or at -15% drawdown. Or other alternative is when the fed offers to pitch in by making the liquidity available to the consumer (not just to the banks).

I think looking out for these fundamental changes is important in addition to looking at the charts as a technician.

creating-wealth.blogsp.../

2007 Aug 16 07:31 PM