David:
It’s been a while since we last corresponded.??I hope you and your family are well.
Quick investment question. Given the sharp run-up in equities and stretched valuations, how are you positioning your portfolio?
This in a market that seemingly doesn’t?go down, where the risk of being cautious is missing out on big gains.
In my portfolio, I’m carrying extra cash and moving fairly aggressively into gold.?Also, on the fixed income side, I’ve been selling HY [DM: High Yield, aka “Junk”] bonds, shortening duration, and buying floating rate bank loans.
Please let me know your thoughts.
Regards
JJJ
Dear JJJ,
Good to hear from you.? It has been a long time.
Asset allocation is always a marriage between time horizon (when is the money needed for spending?) and expected returns, with some adjustment for risk.? I suspect that you are like me, and play for a longer horizon.
I’m at my lowest equity allocation in 17 years.? I am at 65% in equities.? If the market goes up another 4-5%, I am planning on peeling of 25% of that to go into high quality bonds.? Another 20% will go if the market rises 10% from here.? At present, the S&P 500 offers returns of just 3.4%/year for the next ten years unadjusted for inflation.? That’s at the 95th percentile, and reflects valuations of the dot-com bubble, should we rise that far.
The stocks that I do have are heading in three directions: safer, cyclical and foreign.? I’m at my highest level for foreign stocks, and the companies all have strong balance sheets.? A few are cyclicals, and may benefit if commodities rise.
The only thing that gives me pause regarding dropping my stock percentage is that a lot of “friends” are doing it.? That said, a lot of broad market and growth investors are making “new era” arguments.? That gives me more comfort about this.? Even if the FAANG stocks continue to do well, it does not mean that stocks as a whole will do well.? The overall productivity of risk assets is not rising.? People are looking through the rearview mirror, not the windshield, at asset returns.
I can endorse some gold, even though it does nothing.? Nothing would have been a good posture back in the dot-com bubble, or the financial crisis.? Commodities are undervalued at present.? I can also endorse long Treasuries, because I am not certain that inflation will run in this environment.? When economies are heavily indebted they tend not to inflate, except as a last resort.? (The wealthy want to protect their claims against the economy.? The Fed generally helps the wealthy.? Those on the FOMC are all wealthy.)
I also hold more cash than normal.? The three of them, gold, cash and long Treasury bonds form a good hedge together against most bad situations.
The banks are in good shape, so the coming troubles should not be as great as during the financial crisis, as long as nothing bizarre is going on in the repo markets.
That said, I would be careful about bank debt.? Be careful about the covenants on the bank debt; it is not as safe as it once was.? I don’t own any now.
Aside from that, I think you are on the right track.? The most important question is how much you have invested in risk assets.? Prudent investors should be heading lower as the market rises.? It is either not a new era, or, it is always a new era.? Build up your supply of safe assets.? That is the main idea.? Preserve capital for another day when risk assets offer better opportunities.
Thanks for writing.? If you ever make it to Charm City or Babylon, let me know, and we can have lunch together.
Sincerely,
David
Hi David,
I’m feeling antsy about my investments as well. All large market cap value stocks but my question to you. Do you consider JPM risky? I bought a lot in the $50’s and it’s now a huge position in my portfolio. I’m hesitant to sell the position because, JPM is well managed, has a good balance sheet, banks tend to do well in a rising interest rate environment and I’m only 34. Below is what I’m holding and most of it is pretty good profits. Would you sell in of this? JPM is sitting at about 28% of my portfolio now.
JPM, WFC, IBM, INTC, GLW, CSCO, DE, CMI, PG, JNJ, KO, WMT, XOM, KMI, VEA, MAS, NTR.
JPM is well run, but I don’t let single exposures get that big for me. My biggest position, aside from my home and a private equity holding is about 3% of my net worth.
Don’t be too trusting of the idea that higher short rates help a bank — that’s true for most, but not all. JPM is a unique institution, and may be mismatched in ways that you and I don’t know.
I agree it is to much but I was thinking of re balancing over time by not buying anymore JPM. So for example I’m starting to look at oil field servicing because I don’t have any exposure there and I think the market is starting to recover. Do you think, given I have at least 30 more years before I retire, that I should sell some of my position or just allow the position to get smaller as other positions grow in my portfolio?
David, when you say “peel off 25%” if the market rises another 5%, do you mean go from 65% equities to 40% equities, or do you mean 25% of 65%, which would be a reduction in equity holdings of roughly 17%? Thanks.
65% –> 40%. Thanks for asking.