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dialing down the temperature

4/23/2014

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I made the call.

That's right : I rebalanced my portfolio yet again. But unlike many of the "sponsored" guests of CNBC, Bloomberg, Fox Business, etc., I am rebalancing for the purpose of balance itself. Recognizing the dramatic rise in large cap equities since the bottom-fishing days of 2009, a near three-fold return is more than enough for me. With any such acceleration in any financial sector, whether we are measuring public securities, national GDP, or employment data, there really is such a thing as "too much." Those that are holding out for just that extra drop of gas may end up getting derailed later, a fate that I have no intention of wishing on myself, and more importantly, to my family and clients.

Consider this excellent article by frequent CNBC contributor Michael Santoli, in which he juxtaposes current market conditions with the tape of 2005. In particular, he noted that large-cap equity indices absorbed hefty gains following a bounce from the bursting of the internet bubble, and 2005 was marked by indecisiveness. Further expounding matters was Google's astronomic rise of over 400% against its IPO, which occurred only a few short months ago in August of 2004. This led "The Economist" to headline an article entitled, "The Echo of a Boom?," which mirrors bearish sentiment currently expressed by alternative media sources and select offerings from the mainstream.

But the similarities don't end at mere conjecture : by Memorial Day weekend in 2005, overheated tech stocks fell by as much as 12% while the broad market remained relatively stable. So far this year, the tech-centered NASDAQ is the clear laggard amongst the major indices, with its fortunes changing abruptly in the first week of March. Tellingly, its chart pattern is dramatically different from the S&P or the Dow, displaying an aggressive broadening wedge, a rare formation with bearish implications.   

Another parallel is the action taken by the Federal Reserve. In 2005, the Fed was reigning in easy-money stimulus that it had administered following the market breakdown near the turn of the century. Then chairman Alan Greenspan signaled his intent to retire, leaving Ben Bernanke to carefully oversee the rate-lifting process. The connection with Bernanke's decision to exit front and center after negotiating the wake of the 2008 crisis is perhaps more than coincidental. 

While the comparisons are eerie, there's no guarantee that moving forward, the equities market will resemble what occurred since 2005, when the S&P and Dow Jones would both go on to hit record highs before utterly collapsing one year later. On the flipside, there's also no guarantee that the equities won't resemble  what happened after 2005.   

One of the key differences between then and now is that the S&P 500, while certainly flat for most of 2005, maintained a consistently upward trajectory. In fact, after the lull of the first quarter, the index accelerated in a respectable manner, closing December at an average point level of 1,248. Contrast that with this year's price action : the market veritably tanked at the opener, setting off superstitious concerns of the January Effect.

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This discrepancy in market dynamics leads me to believe that large-cap equities are petering off, shedding momentum as professional traders desperately attempt to hold the fort. Perhaps they will be successful, and we may even see new records this year, such as clearing the 1,900 point threshold. Nevertheless, the underlying fundamentals are, in my opinion, bearish and for reasons stated earlier, I see little need for exposing myself to great risk for marginal gains.

Ultimately, we'll see how this plays out but there are times that call for careful prudence. This may be one of them.

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