March 27, 2017

Downside risks outweigh upside rewards

The Markets Should Grow More Volatile: Investors and traders with a short-term price objective should be opportunistic but recognize that the volatility will be more difficult to navigate. So, reduce the number of trades unless you want to be sent into financial oblivion. Longer-term investors may consider buying protection, which still is historically inexpensive, by purchasing VIX calls, S&P puts or inverse ETFs.

The Markets, on Nearly Every Metric, Are Overvalued: Maintain above-average levels of cash and lower your equity commitments. Do not be sucked into the self-confident and glib business media's masquerade that every dip is a buy. It no longer may be. Reward versus risk (upside versus downside) may have turned negative, perhaps materially so.

Prepare for an Increasingly Likely Black or Orange Swan: Black swans have occurred with greater frequency over the last decade. This trend likely will continue over the next five to 10 years. As written last week (and please take all of this quite seriously going forward):

For the last year or more I have been preoccupied and concerned with the answers to three simple questions:

-     In a paperless and cloudy world, are investors and citizens as safe as the markets assume we are?

-     In a flat, networked and interconnected world, is it even possible for America to be an "oasis of prosperity" and a driver or engine of global economic growth?

-     With the G-8's geopolitical coordination at an all-time low, how slow and inept will the reaction be if the wheels do come off?

Today, I want to add four additional questions to the three above -- the answers to which concern me as an investor:

-      Remember when the big argument in favor of President Trump was that he was a dealmaker who knew how to get things done? That was when he was doing real estate deals. Now he has to deal with 535 other politically partisan legislators in Congress -- on their own real estate turf.

-      Does the administration have the depth of experience, understand the extent of the legwork and organization required for passing legislation or have a coherent idea or shared vision of what it wants to achieve and what problems it means to solve?

-      If President Trump can't easily put through a health-care package -- what does that mean for the more-difficult regulatory reforms, tax- and fiscal-policy agenda?

-      President Trump took credit for the stock market's advance since his election victory. Will he take responsibility for Tuesday's correction -- and possibly a further correction? Is it a slippery slope for an administration to use the S&P 500 as a barometer of success? And is a pro-business and anti-domestic programs (in education, the arts, etc.) agenda going to benefit those -- in the lower and middle class (largely his base) -- who have suffered the most over the last decade?

Reduce Your Portfolio's Value at Risk: Pare down volatile, high-beta stocks. Keep speculative exposure to a minimum. Reduce VAR.

Lower Your Bond Exposure: Though the domestic economic recovery is fragile, policy errors could lead to danger ahead in fixed-income markets.

Stay American: Despite calls that European and other non-U.S. markets are cheap (they are for a reason!), a growing U.S. nationalism and political risks abroad could stall European Union growth prospects. Indeed, the EU road has run out of asphalt -- Grexit and Italeave may lie ahead and many peripheral country banks are insolvent. Asia is a potential powder keg politically, militarily and financially (leveraged shadow banking issues). Stick with the transparency brought by listed companies that operate in America.

Maintain a Diversified Portfolio: Against a confusing policy and uncertain economic backdrop, individual stocks are exposed to sudden surprises. Be diversified, now more than ever.

Avoid or Minimize Trading in Commodities and Currencies: Though some prominent talking heads and newsletter writers are into this game, their poor records clearly indicate how hard the commodities and currencies terrain is to trade. There is just too much damn uncertainty.

Be Skeptical of New Paradigms: Like the phrase "animal spirits," as it could have a brief half-life.

Pay Less Attention to the Federal Reserve: Though Fed debate fills up space in our business news platforms, the Fed's role over the next few years will be greatly diminished and have little impact on the capital markets.

Do More Homework on Individual Stock Ideas, not Less! And stick with companies that have plenty of net cash and, like Blanche DuBois in "A Street Car Named Desire," don't rely on the kindness of strangers (the capital markets) to raise debt and capital.

Originally published