I surprised myself recently — FB friends may have seen a note to that effect. What surprised me is that I am significantly more conservative in my investing profile that I thought I was. Ask around and my guess is that the people who know me best (Although not Jan when I asked. After this long, she knows me better than I know myself it seems…) would say that I am a risk-taker. In many ways I think that they are right — I’ve started companies, invested in start-ups, eaten from street vendors all over Asia, and do any number of things that a typical Type A personality might do, but when it comes to investing for retirement I’m a complete stick in the mud.
The following charts come from E*Trade Brokerage’s Risk Analyzer function. You can click on them to get a larger size chart.
1 Month Chart as of June 14, 2009
3 Month Chart as of June 14, 2009 
YTD Chart as of June 14, 2009
1 Year Chart as of June 14, 2009 
3 Year Chart as of June 14, 2009
When I first looked at one of these charts, it happened to be the YTD chart. My initial reaction was “Wow, I’m getting my hat handed to me compared to the S&P 500 and the Russell 2000.” But when I started to look at what was actually happening, it became apparent that my risk appetite was what was driving the difference. If I went to the 1-Year chart compared to the YTD Chart, the performance results switched places, and if I went to the 3-Month chart the difference became even larger (The 1-Month chart has me beating the S&P, but there’s too much noise in only a month’s worth of data, particularly with current levels of volatility.). What is absolutely apparent, however, is that according to E*Trade (Well, Riskmetrics, who runs this particular service.) my portfolio is significantly lower risk than either the S&P or the Russell.
I was floored at this, because in my portfolio now I include names like the ProShares UltraShort 20+ Year Treasury (TBT) and Linn Energy (LINE). I have had a significant commodities position since about 2007 through Freeport-McMoran Copper & Gold Inc. (FCX), the Fidelity Select Gold (FSAGX) mutual fund, and various oil stocks, including over the years British Petroleum (BP), Conoco Phillips (COP), PetroChina (PTR), and Pengrowth (PGH). These, I was sure, were pumping up my beta and making my portfolio generate a higher return and well as a higher risk profile.
Wrong! Obviously my beta is nowhere near where I thought it was (And thankfully so…). So what’s going on? I’d like to make sure that I can keep these long-term trend lines and alpha compared to the S&P, but for the last 3 months I’m underperforming by a huge margin.
It comes down to two things: First, I don’t like risk that I can’t measure. For that reason I went from almost 100% equities in late September to about 50% equities before the first big drop in early October. I stayed there until late February-early March, when I went back to about 75% equities until late early April, when I started going back to cash and dropped to about 60% equities, which is where I am now. I did this because the biggest driver for me in investing is a macroeconomic focus over 12-18 months, and right now I can’t get the macro-economic picture to agree with the stock market. The US government has spent or committed to spending somewhere between 2.5 and 3.5 trillion dollars. To put that in perspective, let’s say you’re a world-class auctioneer and can count 1 to 10 in 1 second. If you counted for 7,925 years you would just get to 2.5 trillion, and that’s without toilet breaks… That has certainly propped up the market, but like a cripple leaning on a crutch, unless the source of the problem is addressed the problem doesn’t get better. And in the case of this analogy, it must be noted that the crutch is borrowed and must be returned at some point in the future.
This $2.5 trillion figure is interesting as well because it also happens to be about how much money the US government raised in taxes for the 2008 tax year and give or take a $100 billion or so is also about how much they plan on getting this year. What is more telling is how US government debt is growing. — and let’s not forget those “off-balance-sheet” debts over at the Fed. To think anything other than that this is ultimately US government debt is just ridiculous. In the end, the investors in US Treasuries, such as China, the Gulf Oil States, and other net creditor nations, have to make a decision that their money is generating a return that will at least counterbalance the risk of investing in those securities. At some point we’ll reach that final dollar that breaks the proverbial camel’s back and those investors will flee. Scarily, this will not be an orderly, long-term trend, but in most probability will be a catastrophic “singularity” type occurrence after which the history books will refer to something other than “Pax Americana” when referring to the era.
I just can’t make the numbers work between this worldview and the current stock market performance.
The second thing is that I *do* have a risk appetite that is higher than most people if we structure that statement to only be valid for the stocks in which I invest, not my entire portfolio including cash. I have no idea what my beta is over the last two years (I’m way too lazy to go back and calculate all that.), but for the stocks I have now, my beta is around 1.2, meaning that over time my portfolio should move at a rate of 1.2x the S%P 500. In other words, if the S&P 500 moves 1 percent, my portfolio should theoretically move 1.2%, and if the market moves 10%, I should move 12%. However, if my cash position is also included in the calculation of my overall portfolio return, it works as a stabilizer. My inherently conservative Scandinavian soul sleeps better at night right now with cash in the bank, some gold and oil stocks as proxies for not directly holding more foreign currency, and some some yen-denominated assets here in Japan to complete the balanced picture.
In the end I, like most other people, have lost money in the stock market over the past three years. What frightens me is that I don’t see the next three years being better than this one, so I’ll sleep with that cash a bit longer. Get me back to 750 in the S&P or around 7000 in the Dow and I’ll be back to 100% equities for at least a while. At S&P 850/Dow 8000 I’ll probably get to 80% equities. Failing that I’ll stick around 40% cash and the rest in companies with strong balance sheets and fat dividends.
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So, it’s July 10 and I’m up to around 70% equities, although most are hedged toward conservative plays in medicine and value-oriented stocks such as Walmart.
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And now it’s January 1, 2010. A good year all around. :-) This is from our E*Trade account. For some reason Fidelity is not allowing access to performance reports right now, so I’ll have to add those later.
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