Hi all,

Sorry about not being more diligent with the frequency of posts.  I am wondering if there is a way for people to be notified when I do update.  Any blog geeks out there? :)


Anyway, I think we are witnessing the manifestation of the market being short stocks (relatie to where there long term position should be) and getting worried that they are going to miss out.  There is no doubt that stocks are cheap RELATIVE to bonds.  The problem is that the bonds are being propped up, so I think that is what has intelligent investors worried.

Now, you could say "Short the bonds!" and that is a reasonable strategy but not without risks if there is a geopolitical problem.  Perhaps shorting corporate bonds is safer and more direct.  I would look to the high yield sector which is looking a bit precarious with a lot of good news priced in.  HYG and JNK are the candidates there.  They are yielding in the low 6% range.  I am watching the spread between 10 year government bonds at 1.6% and high GRADE corporate (Aaa) @ 3.4% and then high YIELD  at 6.2% or so.  So the spread govt to HY is around 4.6% which is tight and gets back to my point that a lot of good news is priced in.  I don't have a historical chart handy, but I think high yield would look more attractive around 7% over the govt bonds and we have seen much higher numbers than that.  I do not believe we have been much tighter than 4.6.  Some of this is due to the fact that as rates get low, the spread come in on a proportionate level, but I believe there should be some absolute numbers in investing and we are getting very close.  Putting in a more mathematical way, the default rate does not have to be that high to wipe out the spread between high grade and high yield.  Making up some numbers here, but I don't think they are far off:

Amount lost on default 40%
% of portfolio defaulting 5%, that is a 2% loss on the portfolio.

Currently, I have about 9% of my portfolio in high yield and I will be taking that amount down, probably about half of that amount.  I probably should go all the way to ZERO, but zero seems so final...

So, I still come back to stocks looking cheap but I am more convinced of that on a relative basis rather than absolute.  I do think there is some upside as the market gets more invested but I think given the gorilla in the room that is the high degree of monetization, I prefer to invest with some protection.  Thankfully, call options are cheap IMHO and so I am buying some call options out to October (SPY Oct 150,155 currently).  These are speculative in nature (because the time value goes away) and so I will be trying to operate a bit quicker than is my usual style.