Thanks for the newsletter. Goodwork.

If one believes that the market is overbought, does it even make sense to talkaboput portfolio allocation ? What would be one’s strategy – except to hedge?

TPC, cld u pl talk abt what strategies are available for someone who faces this ddilemma: strongly feels that market is overbought but has a medium term perspective (1 – 2 years)?

In some ways I feel that cash in the better near term alternative. Either we get recovery and sentiment stays high, then interest rates will need to rise especially with the deficit (better to buy bonds) or we get a relapse in sentiment and stocks fall, which should offer better buying opportunities in the future. Neither bonds nor stocks seem to be a very good value now.

My level of uncertainty about what to do has never been higher. Even though I didn’t lose any principle, my fear of losing principle has never been higher than today.

I don’t understand the wild swings in market sentiment over the past several months. Today, it was interesting to see someone hit the sell button at the end of the day. The only reason I can see for the big run up is an expectation that GDP will be better than expected and stocks will soar tomorrow. If GDP were to come in worse than expectations I would expect a sell off after the huge rise of the last three weeks.

I would like you opinion if this makes any sense and what the risks would be.

I was looking at making on allocation of bonds as follows:

45% Long-term Muni – 13.2 year maturity – yield 4.34%
35% Long-term Treasury – 18 year avg maturity – yield 4.05%
10% Intermediate Investment Grade – 6 year maturity – yield 5.12%
10% High Yield Corporte – 6 year maturity – yield 8.71%.

The mix has a pretax yield of about 4.75% and an after tax yield of about 3.8 to 3.9% and the ups and downs in principle value seem to offset each other (since January and over the past week). I would rebalance buying more Treasuries if the risk trade continues.

I see the primary risk to bonds as a rise in inflation expectations and generally rising interest rates. Nevertheless, I am sitting on far too much cash. I think stocks have run too far too quick and I am not prepared for a major loss of capital.

I preserved all my capital by selling most of my stocks in October 2007 and moving largely into cash (so I feel lucky). I then froze as I saw the bond market crash and the stock market crash. I have played several rallys with my trading account but I have not had the confidence to commit a large amount of money to stocks or to bonds for that matter. I foolishly didn’t buy Treasuries early on for fear that inflation worries (oil spike and all) would drive the long rates up. I have never been so afraid to invest in my life. My cash is earning all of 1.3% after tax.

I have enough to retire provided I can get a return of 1% above inflation. Partially as a result I have become extremely risk averse. This has all played out so quickly and I have been far too slow.

I shake my head and just can’t believe that the crisis is over and stocks will continue to rise significantly from here or that inflation will pick up soon. I still see this crisis has having a long time to play out. I am maybe foolishly convinced that the equity markets should make a sigificant correction or sucessful retest of the lows, as has happened at the end of other major deep bear markets (1929-1933, 1973-1974, 2001-2003). I see the recovery in 1982 as being completely different since interest rates were falling quickly as the market rose and the market had bottom at single digit PE on trend earnings (close to the lowest PE this century).

I also don’t understand completely way corporate bonds continue rising, usually it is later in a recession that default rates rise.

The entire trade seem to be risk on, risk off. Diversification except Treasuries versus risk assets seem extremely difficult. (Munis are now partially a risk asset).

Personally I prefer t-bonds now over corporates. Corporates will deteriorate if the stock market relapses whereas t-bonds serve as a good anti-stock play. Corporates have had a huge run. They’re fairly valued in my opinion. T-bonds, however, I think have been unjustly trashed based on U.S. deficit fears and inflation fears. Over the long-term, both are legitimate fears, but in the near-term t-bonds have been hammered too much in my opinion.

Jenny,

Glad to be able to help. It’s nice to know that people are truly benefiting from the site. I wish I had started the site two years ago before so many portfolios got annihilated.

Corporate bonds or Treasury bonds or a mix? If a mix, how do you decide on the allocation?