As of this writing, the S&P500 is down more than 1% on a Monday after lots of political news over the weekend.
My last blog post articulated our current asset allocation percentages as of last Thursday. No changes today. Right now, our overall portfolio is flat on the day because of the other positions in our portfolios.
While the Nasdaq Managed to hit new highs recently, the other major stock indexes have not. Breadth in stocks is weak (ie. more stocks are going down than are going up), even though the popular big name stocks (Facebook, Amazon, Netflix, Google) have supported the major indexes.
Market tops have usually taken a long time to form … only becoming clear in retrospect. That is why many people say you can’t time the markets by getting out when you think the market is “high” or “over valued”. I don’t disagree with that belief, but I do believe that when stock market volatility begins to increase after a long run up, your asset allocation to stocks should decrease according to the rise in volatility of stocks relative to the other asset classes.
Traditional asset allocation models are based on a couple of assumptions that we all know are not true:
- The monthly fluctuation (volatility) in stock returns follows a Normal Distribution statistically; and
- The future correlation of an asset class to other assets will correspond to the long-term historical correlation of that asset class to other assets (i.e. When stocks go down, bond values will go up).
Most of the time, these assumptions are very useful for the purposes of modeling market behavior. However, during periods of market crisis. The “rules” go out the window because human beings are making decisions based on something besides cold, hard logic and mathematical probabilities. When fear and greed take over, models fail… unless you have a methodology that reduces risk when markets are more risky.
That’s what we do.