Portable Alpha Daily

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Monday, August 28, 2006

Use This Week to Adjust Your Strategy

With very little trading volume throughout the week, the markets ended mostly lower Friday, and down for the week, thanks in part to a slightly disappointing speech by Federal Reserve Chairman Ben Bernanke. Investors were hoping for dovish commentary regarding inflation and the weakening economy to balance out hawkish comments made by another Fed official earlier in the week. Unfortunately, Big Ben wasn’t in the mood to play market maker just yet.

A rally in oil and natural gas prices, which will likely lose traction today with news of a weakening Ernesto, facilitated a decline in blue chip stocks. The Dow Jones Industrial Average fell 20.41, or 0.18%, to 11,284.05. The S&P 500 index slipped 0.97, or 0.08%, to 1,295.09, while the NASDAQ composite rose 3.18, or 0.15%, to 2,140.29. Bond prices increased, with the 10-Year Treasury yield falling to 4.79%. The U.S. dollar was mixed against foreign currencies and gold prices rose.

The surplus of economic reports released this week will hopefully induce an increase in trading volume and activity, although that’s probably wishful thinking. Most of the heavy-hitters are enjoying their last week of vacation and as such we should expect more of the same this week.

Augusts’ consumer confidence index will be released on Tuesday with an expected drop from 106.5 to 103.5. This report, coupled with the release of the minutes from the most recent Federal Reserve meeting might be enough to initiate an intra-day rally.

Wednesday’s markets will be driven by the revised second-quarter real GDP, with investors expecting an annualized rate of 2.9% as opposed to the original 2.5% rate.

Thursday and Friday are the most important days with Personal Income, Employment and Manufacturing reports released. Investors are expecting a continuation of July’s reports which indicated slowing momentum and volatility in payroll growth.

Boooorrring. There really isn’t any other word to describe the last two weeks of August. Even if we see spectacular economic releases this week, there aren’t many in Wall Street to interpret them. That’ll have to wait until next week. Investors, in my opinion, should continue tweaking both their long-term and actively managed asset allocation strategies, setting themselves up for the rest of the year. Basically that means adjusting any overly-exposed sectors and trying to establish as neutral a bias as possible. That way, when the markets begin to gain traction, either positively or negatively, you’re in a position to either minimize losses or maximize gains. Flexibility is the name of the game for now, and any investor stuck in the mud is going to get buried.

I’m still conservatively bullish; in fact my macro model continues to strengthen, despite the relatively bland week and a weakening in my short-term indicators. The VIX is up over the last week, but the VXN is down. I’m expecting my indicators to remain mixed throughout the week which supports my asset allocation recommendation of between 50% and 75% equities for the alpha-generating portion of the overall investment portfolio.

In terms of alpha generation, the NYSE 100 (NYC), S&P 100 (OEF) and S&P 500 (IVV) are the best major market indexes at the moment. Large Cap Value (JKF) remains the strongest style-box investment while Energy (IYE), Real Estate (IYR), Natural Resources (IGE), Utilities (IDU), Software (IGV), Technology (IYW), Healthcare (IYH), Telecommunication (IYZ) and Non-Cyclicals (IYK) are the alpha-generating sectors.

Like I said earlier, I don’t think this week is necessarily ideal in terms of buying opportunities. The markets are too indecisive at the moment and buying into a prediction could spell disaster. But that’s not to say that this week is a waste, as it is an ideal time to develop a strategy for the rest of the year. Let’s say the markets rally, that the Fed turns dovish and that a soft-landing remains a possibility. Start isolating areas of your long-term portfolio that would benefit from a rally. You would probably want to reduce your treasury exposure and allocate into a broad-based index. You would also want to isolate a few sectors that are generating alpha. In terms of the actively managed portion of your portfolio, start putting together a watch-list of a dozen or so stocks and funds. Then, when the markets start moving, put them in play.

Conversely, if it looks like the markets are going to remain either range-bound or turn bearish, begin to reduce your market exposure and over-weight defensively, which basically means cash or bonds at the moment. The best thing that you can do now is have a plan and be ready to move once September rolls around.


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