Tactical Shift in Portfolios: Reducing Cash

This week, I made several changes in the Core Asset Allocation model, adding several new names and increasing our exposure to equities. And, we did that by reducing our cash position significantly, rather than selling bonds.

Recall back on August 1, we sold emerging markets, technology and small cap positions. There were a variety of reasons why, detailed in There’s Something Happening Here.

Since then, I have been patiently waiting for an opportunity to redeploy that capital. The trader in me wanted to get long for a quick pop (9/15), but . . . there is a huge difference between managing people’s retirement money, and swinging cash around for short term P&L.

I insist on something beyond a mere gut feel (i.e., blink-like recognition). I need some hard data to confirm that the buys are a high probability trade, and by last Friday, we received it. Monday’s whackage gave us the opportunity to put money to work after a 2% drop. So we legged into a few positions Tuesday (and the rest of the week); Josh discusses our buys here on Oct 18th.

There were three major factors that went into this decision. The first is simply based on seasonality. November and December are the best months of the year, and kick off the best half of the year for market gains (October-April). If you want to stay in cash, statistically that is the worst time to do so.

The second factor was sentiment. Short interest was at record highs. By our measures, too many investors were bearish, and too many hedge fund managers were caught leaning the wrong way. (The counter argument was mutual fund managers cash levels are low, but they seem to be a non-factor lately).

The last reason is market history. The 11.4% gain we saw for the S&P500 in only 5 trading sessions was unusual to say the least. Since 1950, there have been only 16 occasions when we saw “buying panics” like that. There was 1 loss (2001) 2 break-evens (‘01 and ‘02) and the rest saw healthy gains. (Source: Laszlo Birinyi)

Thus, we have redeployed into Technology, and added Berkshire Hathaway and Visa for our managed accounts. More aggressive accounts purchased Small Cap Growth index as well.

An important caveat: Note that this does not reflect a shift in my economic expectations, and we still believe a recession is more likely than most economists expect. Nor does it change our longer term secular market view, which remain negative. Before all is said and done, i expect maroets will go lower than where they are right now.

However, this is merely a recognition that markets can and do run on factors beyond the fundamental: Sentiment, liquidity, seasonality and internals suggest to us that cash will be an under-performing asset class for the next quarter or two.

Hence, we are reducing our cash exposure, and making selective tactical buys, raising our equity position significantly from 50% to 75-80%.