A Road Less Certain

Sticking with the road theme, although it is hard to see there is a hiking path in this picture which gets you from Hellnar to Arnastapi in the Iceland countryside.

I had a thought at the gym yesterday as I tried to not get flung off the stairmaster about transitioning from defensive positioning to a more invested position as the market transitions from bear to bull.

Fair warning, this is fuzzy stuff.

Over the years I have touched on the idea of having exposure to more volatility early in a cycle and then as the cycle (or theme) matures, reducing volatility in whatever way makes sense to you.

A simplified example might be owning an oil sands name for your energy exposure then moving to an integrated oil company then to a sector ETF. At some point you will need to go back to the oil sands stock (or whatever you might think of as increasing volatility) as the next bull begins.

There are obvious issues with timing and so on but the big macro is that the time to take on more volatility is toward the start of a bull market and have less at the end or in a bear market.

As is obvious, the stock market is now down a lot and even if it seems too early to increase net exposure it might be time to start thinking about increasing the volatility of the existing exposure. For clarity, if someone has 80% stocks and 20% cash and that 80% has a beta of 0.85, they would keep the same 80/20 but maybe increase the beta to 1.05--just as an example.

Generally speaking this is not something I am likely to do a lot of but if there is a panic somewhere in the market, excluding financials, I would probably take action. Obviously panic is in the eye of the beholder.

I say excluding financials as that sector is at the center of this bear market and similar to tech back in 2001 it makes sense to expect more declines because it is very likely there will be more bad news to come. Unfortunately most of the financials with no fundamental link to the crisis would likely also go down in this context.

One area that seems ripe for a near term panic might be energy. I'm not sure what price would make for a panic but if I think it happens I'll post about it. If it does happen in a way I think I can read I would sell some or all of the ETF I am using for some of my energy exposure and add one or two names in its place (names are chosen but do not want to front run my clients).

The idea behind any of this is that anyone who took some defensive action at some point needs to get less defensive. Keeping the same cash level but increasing the volatility is one way to ease back on to the path of being fully invested.

It doesn't take too many trades to change the volatility characteristic of a portfolio so anyone exploring this concept should keep that in mind.

To be crystal clear I have no plans for meaningful changes until the SPX goes above its 200 DMA.