dow-jones-sell

If you were to ask me at the beginning of the year whether I’d accept a 11% return on my overall stock portfolio I would emphatically say, “HELL YES!”.  Thanks to fantastic first quarter earnings, the Dow Jones is up 11% and the S&P 500 is up around 9%.  Unsurprisingly, my own 401K and stock investments are up around 11% overall as well and I’m sure the same returns have blessed many of you.

It seems like so long ago when the markets plunged due to the tsunami/earthquake in Japan, and even longer ago when the US markets experienced a 10% “flash crash” drop in May, 2010. Right now, everything is hunky dory according to the markets, and you can’t go anywhere without hearing some pundit say how bullish s/he is.

THINGS I WORRY ABOUT

I am an optimist at heart, but I’ve also been burned many times before.  After over 10 years of saving and investing, if I can grow my overall net worth by 10% per annum, I’m happy. Therefore, whenever a particular portion of my net worth has risen by 10% or more, I start re-evaluating because history has shown that growing anything over a 10% clip consistently is not sustainable.

Look at Bernie Madoff as an example. His claim to fame was 10% steady YoY returns for decades and people poured $50 billion into his company for him to manage. We’d be fools to think that stocks never go down and everything is perfect right now.

* Now that May has arrived, the majority of companies have already reported their first quarter earnings. The markets have now digested these results and no longer have a strong catalyst to go higher. The markets are now vulnerable to negative events.

* 2012 US state budgets have to be hammered home by the end of June. The closer we get to see how bad the shortfall is, the more jittery the markets will become as people talk about raising taxes further and cutting state stimulus programs. Alarm bells will start sounding off again in municipal bond land, and people will likely sell munis and stocks at the margin.

* The end of May and early June is the start of summer travel season. Volumes will be lower than usual and volatility may therefore be higher than usual.  I personally plan to go to Hawaii end of May and blow my tax refund and don’t want to bother having too much exposure to the markets.

* There’s a self-fulfilling prophecy that if everybody starts taking some profits in May, it will happen and the markets will go lower. The best time to sell in May is when the markets have ramped after 1Q earnings, not when the markets have sold off and are week.  In other words, now is a precarious time.

* Oil prices will likely continue trending higher as summer and winter are cyclical highs for energy consumption. Consumers will more acutely feel the pain at the pump, and will therefore at the margin start spending less, or slow down their consumption. Spending accounts for 2/3rds of GDP.

* The EuroZone debt issues have not gone away. The markets certainly have put them on the back burner of things to worry about, but we haven’t had Spain or Portugal come entirely clean yet.

* The uprising in North Africa and the Middle East hasn’t suddenly disappeared either. We don’t know exactly what’s going on there because the government and media keep us in the dark. Things are likely much worse than we know.

* Now that Osama Bin Laden has been killed by US special forces, I fear a wave of retaliation as hundreds of new Osamas rise up to take his place and avenge his death.  The more the media highlights Americans jumping for joy and chanting “USA, USA, USA” to the world, the more fuel is added to a terrorist’s fire for revenge.

* The average S&P 500 earnings estimate for 2011 is around US$94. With the S&P 500 at 1,370, the market is trading at around 14.8X. Market earnings are expected to grow by 17.8%, 13.2% in 2012, and 10.2% in 2013. As such, a 15X multiple seems pretty fully valued to me.

BRINGING EXPOSURE DOWN

As a result of the above concerns, coupled with a 11% return YTD, I’ve drastically brought my exposure down from 100% equities to 50% equities. The other 50% is in a stable value fund that has a guaranteed yield of 2.1%. In other words, if my equity performance stays at 11% until year-end, my overall portfolio  return will be 11.55%. I probably should just sell everything and lock in my 11% gains, but that would be too conservative since I have a full 30% of my net worth in cash and CDs earning around 4%.

Who knows for sure what the markets will do from May till the end of the year. We may return another 10% from here, and never have another pull back again. If this is the case, my stock portfolio would be up 16%, underperforming the broader markets by 5%.  Am I OK with this?  Yes, I am absolutely OK with being up “only” 16%. If the markets are up 21% in 2011, it’ll also mean the job market is on fire (good for compensation and other employment opportunities), rents are going up (good for rental property owners), and property prices are also going up (good for property owners).

What I’ve learned time and time again is that you can’t lose, if you lock in a gain. You just have to understand what returns you are happy with.   If I can consistently grow my overall net worth by 10%+ a year, I’m happy.  You might scoff at such a low hurdle, but it gets harder and harder to reach the more you accumulate because you become risk adverse. Growing a $5 million net worth by $500,000 for example, is different from growing a $500,000 net worth by $50,000 because you focus more on capital preservation the more you accumulate.

Readers, what are your thoughts about the markets now? Are you buying at these levels (Dow 12,850, S&P 500 1370) or a seller like me?

Have you ever heard of someone on the internet ever lose money in the markets before?  Have you ever confused brains with a bull market?

Note: I firmly believe asset allocation is the most important thing. I can’t pick stocks worth crap, and I’m not an investment professional. My rebalancing is based on my own decisions and comfort levels. Please make your own decisions.

Yakezie Note: The editorial calendar is open for Member Articles and guest posts.  Members, feel free to upload directly on the site, and guest posts and Challenger posts can be e-mailed to theyakezie AT gmail DOT com.

Regards,

Sam