Time to Reduce Equity Exposure . . .

All this week, I have been discussing why I thought we may be coming to an end of the cyclical bull market that began in March 2009: Listen to Ritholtz Sees “Major Cyclical Correction” from Tuesday morning, and watch this and this from Thursday.

I have cut back on some major holdings, and raised our cash levels to 25% in the asset allocation model I manage. I removed half of our energy positions, eliminated our emerging markets exposure. The biggest move was cutting S&P500 exposure by 50%. A handful of clients who had outsized Apple exposure saw those positions reduced by a third. We maintain a heavy bias in long portfolios in health care and in consumer staples. I have no desire to reduce treasuries or munis, which will become a safe harbor if and when things get choppy. (I have NOT added inverse ETFs, but that is something I may consider in the future).

Note that these portfolio moves have nothing to do with the upcoming elections or the fiscal cliff. I agree with what Michael Belkin said at the Big Picture conference: “People should forget the Fiscal Cliff, this market is all about the Earnings cliff.”

In terms of future recession probabilities, I now place us at 60% over the next 18 months. In other words, we are more likely to see a normal cyclical recession before Spring 2014 than not.

I don’t imagine we go straight down from here; There will be sell offs and rallies, pre and post elections. There will be some data points that suggest things aren’t so bad, and then some that are awful. It is not a black and white situation. I do believe the low volatility we have seen may very well become a thing of the past, and the VIX is becoming a definitive Buy.

One last point: This is NOT a batten down the hatches, go-to-100%-cash, looking for a 50-60% crash type of expectation. (We, um, already had that one). Instead, this is looking like a regular earnings and revenue shortfall driven recession, with equity markets at risk for a 20-30% correction.


Investing is an art form that requires probabalistic decision-making using imperfect information about an inherently unknowable future. We work with less than a century of price action, when ideally we should have 1,000 years of market data to analyze. We never know the ideal time to enter and exit positions, but we can at least strive for an objective process using known metrics (earnings growth, valuation, price trends, etc.).

Hence, why we make gradual and infrequent moves, highly cognizant of the possibility we will be wrong.



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