Quest For The Perfect Portfolio

A couple of thought provoking comments to consider. 

The first is from Nomadic Samuel who in a recent post on what I think is his quest to find the perfect portfolio said "When it comes to building portfolios that are prepared for every economic curveball thrown their way allocating assets in a balanced manner is crucial."

It seems like he is looking for a static allocation, save for rebalancing, a sort of set and forget, again still rebalancing. I messaged him to ask if that was the correct interpretation but haven't heard back. In his posts, he explores all sort of allocations with different assets and different weightings to these assets. 

If he is looking for the perfect static allocation, that's an approach I would not take. I don't believe a single portfolio can be prepared for every economic curveball. A lot of portfolios in these sorts of exercises put a heavy allocation to long dated US Treasuries. The last 40 years, up until earlier this year, were terrific for long bonds. I stayed away because I though the yields were way to low, carrying way too much risk and the consequence for that risk has come home to roost over the last couple of months or so. I had no idea when rates being too low would matter but I did not want to bet client money that I would be able to see that coming. 

An allocation to long bonds will likely make more sense to me at some higher yield from here. If that time ever comes, I would be reducing exposure to something to take on the bond exposure. Maybe it would come from equities or maybe alternatives or both. 

Similarly with equities, I disclosed buying SH last September over inflation concerns which had the effect of reducing equity exposure a little. Then when the S&P 500 was down 15% from it's high I sold that position as part of a plan to slowly increase equity exposure, adding a little more equity exposure on June 17th with IVV. That's not about trying to sell a top or buy the bottom, it's about needing to protect some when no one sees trouble ahead and that there's a long term benefit to buying after a large decline regardless of where the bottom is. 

Lately, more and more people are talking about large allocations to trend, aka managed futures, which we've talked about a couple of times. I think a permanent allocation of 20% or whatever to something that you're hoping is negatively correlated to stocks is a bad idea. If the S&P 500 gets down to 3100-3200, about a 35% decline from the high, and I had 20% in managed futures (it would be a higher percentage with such a big drop from here), I would take most of that off at that point. The need for negatively correlated assets is much less after a 35% decline.

The chatter these days to put 20% into trend now reminds me of back before the financial crisis, people advising 10-20% into REITs, MLPs and gold. I pounded the table on what a terrible idea that would, way too much into diversifiers. Trend is great but not with such a huge chunk of my money or my clients money, not even close.

Underlying all of this is the unyielding conviction that the S&P 500 will get to 10,000 at some point and then higher at some point. It may go to 3000 first, I have no idea, but if you still believe in American capitalism then it will get there and hopefully we're all still alive to see that. Knowing it will happen at some unknown point in the future makes it much easier to plan out what to do if this decline does get much more serious and do that planning unemotionally. Any buying you do at 3500 on the S&P 500 will be very profitable even if it goes right to 2900 before going back up.

This brings me to a quote from Wes Gray of Alpha Architect who said "short-term behavioral issues cause the vast majority of the issues for investors." Every day, people buy and sell in the stock market, some are investors (natural buyers and sellers) looking to change their portfolio and some are liquidity providers that make sure markets function (refutes the idea that for every natural buyer there is a natural seller). This happens at market tops and market bottoms and everything in between. 

Some portion of natural sellers at market bottoms, like March 6, 2009, December 24, 2018 (do you even remember that one?), March 23, 2020 and on the date when the current event bottoms are selling out of fear in desperation thinking of the short term. They are manifesting a "short-term behavioral issue" succumbing to panic which, if you still believe in American capitalism is the exact opposite of what you should do.