Thursday, March 14, 2013

Reading the Tea Leaves

Anyone invested in the market since pre-March 2009 has to be ecstatic - we've recouped our losses, and then some, on the Dow, and the S&P is not far behind. The bulls think it could go even higher, and bears, well, there will always be bears.

While the economy is improving, as witnessed by the surprisingly high number for retail sales released this week and consumer sentiment on the rise, a high stock market doesn't necessarily signal strength.  We maintain that investors seeking yield cannot get it in traditionally risk-averse areas like bonds, and are being forced to increase their portfolio's risk by chasing higher-performing stocks. 

Having drunk the Black Swan Kool-aid, and forever on the lookout for what could trigger another one, I recently saw a piece on that suggests we may want to monitor margin activity, particularly as it pertains to managing risk.  After all, if you see the black swan circling, you have time to duck for cover.

According to the report published March 11, 2013, January's margin debt was the highest since January 2007, and we all know how that year ended.   Also, there is a $77.2 Billion deficit in the margin account credit balance, suggesting that meeting margin calls could be dicey.  Further, the last time there was such a significant margin deficit was in the spring of 2011, just prior to a 19% correction.

All of this suggests strong speculation in the market, fueled in part by increased confidence in the economy, but also signaling that there is a significant increase in market risk.  Should there be something that comes out of left field that induces selling, then forced liquidation of stocks to meet margin calls (since cash is not available) could cause a sell off.

Black swans don't come around all the time, but when they do, they can be deadly.  Protecting your portfolio from that kind of shock means being willing to settle for lack-luster yields in what seems like a boring bond market.  But it won't be so boring should the market suffer a correction.  At the very least, some exposure to bonds will give you a safety net, and placing the equity portion of your portfolio in relatively safer dividend-yielding stocks is a smart way to position yourself for what could be a bumpy ride. 

You can read the full report at:

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