Restructuring and Rebalancing as of Close of June 1, 2012

It’s been some time since I tended this blog.  My apologies.

As you know, as of close of October 26, 2011 the Standard Portfolio has been, as usual, equally invested in stocks of Dow Jones 30 Industrials (DIA), long term U.S. treasury bonds (TLT), natural resources represented by gold (GLD) and money market instruments (SHY).  As of June 1, 2012, this portfolio has appreciated 1.85%, which compares to the market represented by Dow which has decreased by 0.84%.

The second portfolio, called the Trading Portfolio, has appreciated 3.23%.  This, compared to the Dow losing 0.84% is even stronger performance.  This outperformance was achieved because the portfolio was more positive on stocks, having moved into Nasdaq 100 on October 26 close.  SHY in the portfolio was substituted by QQQ, for that purpose, raising the stock commitment to 50% instead of the regular 25%.

In net effect, both portfolios have seen positive absolute results which are better than the stock market as represented by the Dow.  This is achieved with much less volatility than the market, which is an additional beneficial feature of both portfolios.

It is time to review the portfolios and the market dynamics going forward.  To say that markets have been very volatile in the period covered from last October would be an understatement.  Stocks had a huge rally which has dissipated as at this point and even drifted into a slight negative territory.  DIA, representing the Dow, as we saw, has lost net of 0.84% during this period.  Bonds were weak but picked up and had a terrific rally.  TLT, representing the long term U.S. treasury bonds, has appreciated by14.18% in this time period.  Gold started a correction and has lost 5.91% during this period, as represented by GLD.  Money market, measured by SHY, is up by 0.04%, which is typical of its steadiness.

As far as stocks are concerned the prognosis going forward does not appear good.  As of close of June 1 stocks have lost about ten per cent from their recent high.  Their correction is now experiencing the key level of their 200-day moving average.  This may act as support, at least temporarily.  It won’t be surprising to see stocks bounce for a while.  But, domestically and globallly speaking, economic conditions do not look promising for the next few months any way.

Stocks generally discount economic conditions for the next six to nine months.  Everyone thinks about stocks when talking about financial markets.  But bonds, though not as glamorous as stocks, represent about three times larger market than stocks.  Much smart money is invested in bonds and their discounting mechanism is even smarter than that of bonds.  Stocks did well for several months but, having come down by ten percent in about a month, they now indicate soft economy for the months ahead.  But bonds having gone up by similar or even greater amout, which is more substantial for them, have been indicating weak economy for a longer while.  Stocks have just awakened to the weakness in the economy prospectively.  True, bonds are “safer” and their safe haven status accounts for some of their outperformance.  But that by far is not the whole story though some say so.

Some even say that bonds are in an unsustainable bubble.  That itself is unsustainable even though bonds may consolidate or even correct prospectively.  As we have seen in the previous posts dealing with the structure of our portfolios, investment money can travel only in four continents: equities, bonds, natural resources and money markets.  These four represent the entire world of investment almost exclusively.  So, if the investment money, old or new, is moving out of stocks it has to go somewhere.  With investors seeing weak economy it won’t go to the commodities which, on the contrary, have also come down heavily because of the weak economic prospects.  Hence, bonds are the choice area left.  Gold too has a safe haven status and now seems to have turned from its recent correction.  Of course the ultimate safe haven is money market instruments and most typically the three-month U.S. treasury bills.  Remember 2008 when global economy was about to collapse, everything came down as investors piled up in T-bills even though they returned zero per cent in interest.  But such total panic is very rare.

Europe does not look good.  At best we can look forward to the proverbial can being effectively kicked down even further for the next few months.  Austerity won’t bring down the deficits when economy is weakening and on top it is quite unpopular.  If another round of quantitative easing or stimulus is started, bonds and gold will again benefit, along with a temporary boost for stocks.

So, being invested in all four major areas of investment, both our portfolios are prudently situated.  We may not make a quick killing but we are likely to continue making good steady returns.  We will, therefore, leave the standard portfolio alone as equally invested in DIA, TLT, GLD and SHY.  We will rebalance it as of close of June 1. 2012 to bring the alotment back to equal proportions of the four asset types.  For example, we will sell some bonds in order to bring them back to 25% and buy some gold to boost it back to 25%.  New investors can simply buy 25% each of DIA, TLT, GLD and SHY as far as the Standard Portfolio is concerned.

As to the Trading Portfolio let us try something less conservative and yet prudent enough not to cross concerns safety and volatililty.  We will liquidate all four holdings.  So, sell all holdings in DIA, TLT, GLD and QQQ.  Instead, we will buy five stocks in equal proportion of 20% each.  The five stocks are Abbot Labs (ABT), Church & Dwight (CHD), Consolidated Edison (ED), Southern Company (SO) and Newmont Mining (NEM).  All five are defensive issues with very low volatility compared to stock market as a whole.  They are likely to go down less in case stocks enter a bear market.  Abbot Labs is a solid company in the health care industry.  It represents the growth area within the world of stocks.  Church & Dwight, involved in cleaning chemicals, represents the staples sector in the same area.  Con Ed and Southern Co are utilities and a bond substitute.  Newmont Mining represents natural resources, being a large gold mining company.  Besides being defensive all five have greatly outperformed the market over the last ten years.  On top they will together yield about 3.25 per cent in dividends.

Good luck in your attempts to achieve financial freedom.  Do not forget to add and maintain a solid spiritual dimension of your choice in your life.


About Ramesh

Ramesh started investing in 1974. He has explored widely and deeply in the world of investing through avid reading and actual practicing all manners of strategies. Investing can be a fascinating journey by itself pointing to diverse challenges and points of learning about life and world. I would like to share my ideas and practices with all investors who seek not just monetary success but learning experience through the art and business of personal investing. Achieving financial health and freedom is an important goal in life. I would add, however, that having a spiritual dimension in life is equally, if not more, important.
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