A reader sent me the following question:

Hi David, this is shall be link to your impossible dream part 2 question.

You mention in the article date May13 that we are probably at #4 part of cycle (looking back great called) Where are we in the part of the cycle? ( I would assume we are in #5) if that is the cast..why you added large 5 of your cash in this sell off? (for trading or for investing) Hope I am not asking too much since I am not a client, only long time reader whom respect your opinion.

Here’s the article he was referencing.? There is a tension between my equity management and the switching strategy I proposed in the first Impossible Dream question.? If we are in a market where we should be allocating asset to safe areas, why am I buying more equities here?

It’s a question of time horizon.? The switch model tells you what will do well for the next month.? I am playing for longer horizons.? That’s why I have my seventh portfolio rule:

Rebalance the portfolio whenever a stock gets more than 20% away from its target weight. Run a largely equal-weighted portfolio because it is genuinely difficult to tell what idea is the best. Keep about 30-40 names for diversification purposes.

My best purchases occur in bear markets.? I buy things that are safe but way out of favor, and they rocket back when the market finally turns.? That adds a lot to my alpha, which is more than the advantage of switching, historically.? That’s why I average down in bear markets, if the thesis behind the investments is still valid.

As for what phase we are in, I would say 5 or 6. Cycles aren’t neat.? In this case, we don’t have a lot of defaults, but we do have a lot of negative momentum in equities. In four months we have moved from top momentum, top valuation, to bottom momentum middling valu1ation.? That is pretty deep in the don’t buy stocks region, but it often offers the best opportunities to long only investors, if one is buying for three years, rather than one-to-six months.

So I continue to buy equities that are attractive, even in a market where bonds might be favored in the short run.? As for my clients, it is a question of investment horizon.? Short-term: bond strategy.? Long-term: equity strategy.

In general, I aim for the long term.