OCTOBER 17, 2010
By DAVE KANSAS
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Sean KellyBut the swift rise of the market -- the Dow is up about 10% from its Aug. 31 close -- comes against a backdrop of somewhat unsettling news. The jobless rate remains stuck just below 10% with little respite in sight. The housing market is still very weak, and is enduring further shocks as lenders' foreclosure problems keep getting worse. The political situation seems a bit chaotic. And the global recovery is uneven enough that the Federal Reserve is thinking of yet more extraordinary measures to get things rolling.
Even with those headwinds, the mood among stock investors as we near the end of October is surprisingly upbeat. Third-quarter earnings are coming in better than expected and optimism about the Fed's latest extraordinary plan -- quantitative easing part two, or QE2 -- is rampant in the stock market. We entered the dreaded September-October period in fear; we are leaving it with bliss breaking out.
Such sudden shifts in sentiment, especially with uncertainty on the rise, makes me a little queasy. Given the widespread gains, it might make sense to examine your portfolio now with an eye toward rebalancing, rather than wait for the end of the year. In so doing, you may want to pare back some of the bigger winners and salt away the gains for the coming year.
Here's where things get interesting. The big winners this year have come from several corners, and not just in the stock market. In the U.S., small-cap stocks have outperformed bigger stocks, with various small-cap indexes up 10% to 14% year-to-date. Outside the U.S., emerging markets, especially in Asia, have recorded robust gains. In other words, riskier stock investments seem to have done better than the safer, blue-chip shares.
Away from stocks, other assets also have had decent years. The Barclays Capital U.S. Government Bond index is up 9.4% year-to-date. The Barclays Capital U.S. Aggregate Bond Index is up 8.6% this year. Gold is up about 30%; oil has gained 10%; and food commodities have done well. The Dow Jones-UBS Commodity Index is at a 52-week high. The dollar had a great start to the year, but it has retreated and is down sharply against the yen and up a smidge against the euro.
The one asset class that hasn't done very well this year is cash. Interest rates for cash deposits are extremely low, reflecting the Fed's policy of record-low short-term interest rates. So, in the spirit of rebalancing, where we take from winners and add to the laggards, any portfolio trimming should get parked in cash. It feels terrible to park money in cash at these rates, but there's always something comforting about capital preservation.
In analyzing which winners to winnow, bonds have had a strong run for several years. Some believe that the bond market could be facing bubble-like trouble. Earlier this month, Mexico sold a 100-year bond with a yield of 6%, a highly unusual move that fed talk of a bubble. And corporations have gotten rock-bottom yields, too, with International Business Machines recently selling three-year bonds with a yield of 1%. All of these unusually low yields in the bond market have amplified the bubble chatter. If you've got an outsized bond position, trimming some winnings before year-end makes sense.
In the stock market, blue-chip stocks have underperformed. High-dividend-paying blue chips have grown in popularity recently, but these stocks have still trailed riskier sectors such as small caps, real-estate, transportation and Internet shares. Winnings here should be trimmed probably in the small-cap and real-estate areas first, with an eye toward maintaining (or even adding to) blue-chip positions.
Commodities, which should be less than 10% of your total portfolio, have had yet another good year. I've written critically about gold from $1,000 an ounce to $1,300 an ounce. Nothing like being wrong. Despite the gains, it's hard to see gold going lower when the euro, dollar and yen all want to be weaker.
If commodities have risen above 10% of your total portfolio, you should consider reducing the biggest gainers, which probably would include gold. But given the strong year for stocks and bonds, your commodity position may not require any slimming.
The main reason to rebalance is to keep your overall long-term strategy in place. Usually this means something simple, such as selling highflying bonds and adding to underperforming stocks. But so far this year, a lot of asset classes have done well, making the rebalancing exercise somewhat thornier.
But we live in somewhat thornier times. The Fed is preparing for QE2, which means it will essentially print more money, and central bankers are talking about a desire for more inflation. These are two things that would've been very difficult to imagine just three or four years ago. And they also are a bit contradictory.
Given the still extraordinary nature of our times, banking some winners might make the holiday season that much more enjoyable.
http://online.wsj.com/article/SB10001424052702304898004575556753777592096.html
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