Positioning.

So far this week we have tried to lay out both the positive and negative case for equities as we head into the fall.  What I hope has been shown is that we are currently in a data environment where for every bad headline you can point equally to something that is a positive.   Fundamentals can be construed as supportive and valuation parameters are not stretched.   Never-the-less I think that stock prices are vulnerable to a short term correction.  I will try to lay out my concerns and explain what we have done in client portfolios.

Let's get this out first.  I have no idea where the markets are headed in any time frame.  Here at Lumen Capital Management, LLC we use a weight of the evidence approach that applies probabilities to different market scenarios.  These scenarios and strategies come from our playbook.  The playbook is situational analysis based on historical market results.  We study money flows along with the disciplines of fundamental and valuation analysis to see how markets have responded to similar historical events. It gives us different scenarios regarding market activity. We use it to formulate our game plan. The game plan is a tactical and a strategic allocation of assets based on what the playbook tells us has historically occurred. It is then further refined to the specific risk/reward parameters of our clients.  Here then is what we are seeing.

Markets are tuned into Federal Reserve Chairman Ben Bernanke's speech at an economic symposium tomorrow at Jackson Hole, Wyoming.  It is from this perch a few years ago that Bernanke launched the first round of quantitative easing of fiscal policy and stock markets rallied.  There is hope that he might launch a similar policy tomorrow.  While I think most market participants have by this point discounted what he will say, I believe the speech will more likely set the tone of the economic debate for the rest of the year than actually provide any concrete measures tomorrow.  What I mean by that is that any indication from Bernanke that the Fed is on the sidelines and will likely not do much till the end of the year could set a negative tone for investors.   An indication on his part for example that the Federal Reserve is ready to immediately step in on any further signs of economic weakness would likely set a more positive tone going forward.   I think on balance that Bernanke's speech will be more negative than market participants currently want and that could get us started off on the wrong foot when the world returns from summer next Tuesday.

Investors are more complacent right now than they were a few months ago, we can see this in investor sentiment numbers.  Stocks are also overbought in almost every time frame we follow.  The percentage of stocks trading above their 50 and 200 day moving averages has entered over bought territory that has often signaled a correction.  On top of this we are now in the middle of statistically the worst seasonal period of the year.  September is the worst trading month and the late August to mid-October period in most years brings up heightened trading volatility and often a correction of some sort.  Finally there is the election.  While I think the markets as a whole are agnostic about who wins in the long run, the next few months have the potential to be unsettling for investors.  This is particularly true if the election remains tight.  

As we mentioned yesterday stocks are not expensive on a valuation basis but they are not as cheap as they were back in the early summer.  On top of that one has to factor in the nearly 10% rise in prices off of the June lows and we should expect that there will be some investors anxious to lock in profits.

In general we have been pretty fully invested for most clients until recently.  The definition of fully invested for us of course varies among our investment strategies, is tailored to our individual client's investment criteria and is dependent on how long we've had client assets.  For example some of our  new clients who have come on board in the last six months have not been fully invested as the timing of when we received their assets and market conditions did not warrant so far that kind of posturing.  On the other side of that coin some of our accounts in some of our more aggressive strategies spent most of the summer with cash positions under 5%.  

In the past several weeks, reflecting rising market conditions and these concerns, we have raised our cash positions so now all things being equal we have between 10-15% cash in most client accounts.  Again that is a general statement and subject to what we said in the previous paragraph.  To reflect what we have been doing, we lowered both our short and intermediate indicators down one notch to NET MARKET NEUTRAL back on August 8th, 2012.  You can go here for a definition of that term.   We have the defensive pages of the playbook handy and stand prepared to implement them should market conditions warrant.

I will summarize our thinking this way.  So far 2012 has been a pretty good year for investors.  The market is showing classic symptoms of being tired.  I have no idea whether that means stocks will go up or down in the near future but the weight of the evidence is suggestive of a market that could have a correction ahead of it.  In my mind therefore it is prudent to raise some cash and to be prepared to raise more should the need arise.  If markets zoom higher from here then we will still be along for the ride.   If we do get that corrective phase then hopefully we will have some cash to redeploy at more attractive prices and the position should help blunt any move lower.

In any event, the next few months promise to be a bit more interesting that what we've seen over the summer.  Strap on those seat belts because it could be a bit more of a bumpy ride in the next few months.

*Long ETFs related to the S&P 500 in client and personal accounts.