Dear Mr. Market:

2013 has truly been a year of political headlines and deadlines. We’ve been yanked around with market threatening troubles ranging from the fiscal cliff, to sequestration, to the government shutdown, to the debt ceiling etc.

All the while the market continues to defy odds which further exasperates any rationally thinking mind.

The irony of recent headlines and the overall market environment is that it’s easy to make a convincing case that they’ll either go down this last quarter of 2013 or that they’ll finish strong and continue their banner-like year. Depending on who you follow you’ll end up being bullish, bearish, or completely confused! This article will be short and sweet but at the end of it all you’ll know exactly where we stand and what we believe most investors should be doing. 

First off let’s talk about the massive elephant in the room…Yes…it’s that government that is sitting over there in the corner. As always we intentionally avoid fueling or ticking off any of our readers with political commentary. It’s not that we’re trying to be neutral or political chameleons, it’s rather that being irate, pounding the table, or pointing a finger at a situation we can’t control doesn’t make you a better investor; if anything it actually makes you a worse one. All the political horn locking right now is fantastic for talk radio and Nielsen media ratings but siding with Democrats or Republicans does nothing for your “investing” mind nor does it help you in making better strategic decisions. Turn off your television and tune into this article right now.

No “Septaper” or Octaper for that matter!

We correctly decided to add to positions following August’s market pullback. Even though the “odds” of September being the worst month in stock market history was amplified with fears of the Fed finally beginning to taper, we didn’t buy the hype or trust that the printing press would stop. Eventually we’ll have to face the music and the current asset purchases of $85 billion per month will stop but we firmly believe that the Fed will not blow us up this last quarter.  Employment numbers (and the overall economy) are still anemic and the Fed will not taper without there being some material improvement here.

When the Fed eventually tapers, inflation will follow but allow us to tell you to ignore that headline ahead of time. With increased inflation will come a rising stock market. (later in this article we’ll tell you what areas that will likely be in too) Lastly…you can also ignore any “taper talk” for October. That’s right…the next headline that says “Octaper” is one you can save time and not read. We believe the government shutdown basically mutes any taper talk in October so let’s move on to what you should be doing with your money.

Bonds = Dead Money

Let’s first reiterate that at no time do we believe you completely abandon an asset class. Anyone that does will eventually be wrong and possibly in a devastating way. It’s no secret that bonds stink this year but let’s remind you that a horrible year in bonds is still far better than one in stocks. You also should be reminded that not all sectors within the bond asset class are the same. Don’t ignore the coupons that come with your bond investments. In other words, investments in high yield, for example, have actually mitigated some of the downward pressure on bond prices. We believe it makes sense to take on some credit risk on shorter-term bonds with holdings like JNK (SPDR Barclays Capital High Yield Bond ETF).

On the whole, however, bonds are a losing proposition for anyone looking out further than five years. You need to hold some percentage of them to act as a volatility buffer but you obviously can’t expect the 7% returns that most have been accustomed to receiving over the past few decades. We’ve said this before but death in the bond market is different than it is in the stock market. It will silently put you to sleep like carbon monoxide. We recommend reducing your normal exposure by at least 10% and reallocating to more opportune asset classes. Where might those be?

Europe and Emerging Markets

Europe is beginning to turn the corner. Don’t get us wrong here…Europe still has plenty of work to do and nobody is out of the woods yet. That being said, we believe there is more opportunity and possible value overseas than there might be domestically. Taking this to another level is our major call for the back half of this year…Emerging Markets. Read it again here:  We believe Emerging Markets will outperform the U.S. stock market over the next 12-18 months. Trying to predict further or make any other grandiose statements is futile but for some background on this call you can quickly look to our previous article on this.  While the “smart money” herd and the bulk of investing world was writing about how horrible Emerging Markets were doing, we began buying more of them in August. By the way, over the past three months Emerging Markets have been up +6.98% versus the S&P 500 at +1.13%. As of this writing the past 30 days continue to show outperformance by 250 basis points even with the increased volatility.

Don’t let headlines connecting the end of quantitative easing (QE) to an impending currency crisis in Emerging Markets. Sure…there will be headwinds but if you’re a smart investor right now you or your financial advisor should have already increased your relative equity exposure to Emerging Markets. Just because they were down huge in the first six months of the year does nothing to predict how they finish a year…

Alternative Investments

What else has performed poorly that warrants you to ignore what the herd is doing? We have to chuckle with how many hypocritical financial advisors there are out there doling out stale or emotionally driven advice. When the @#%& hits the fan they tell you to “stay the course”. Very few advisors explain or remind anyone why they sold you on investing into an underperforming asset class. If you keep pressing them enough they basically will cave in and sell it to only go chase the next hot area!?! Isn’t a good financial advisor supposed to protect you from making this type of emotional and short-sighted mistake?

The perfect example of this is Managed Futures. There are a ton of variations and investment options available in the “Alternative” asset space but here is one that many advisors were barking about three years ago. They explained that managed futures provide a buffer and hedge so that when the stock market goes down you actually have something that has good odds of going up (i.e. inversely correlated).

That makes perfect sense, right? Explain to us why the bulk of these silver tonged advisors have now sold most of their exposure to Managed Futures?!? Well folks…the stock market us up huge and managed futures are down now. Like any investor that abides to a plan driven by windy gusts and shiny objects, those types of strategies change instantly. If the whole idea is to “buy low and sell high” you simply need to get exposure to those things that are now low. We won’t spell this out too much further but if you are selling managed futures to go out and buy stocks near all-time highs…you’re doing the exact opposite.

Now you know where we recommend weighting your portfolio over the next few months. As always, please turn off your television and give your neighbor, advisor, or colleague “the hand” if they bait you into a political or headline driven investment decision.

Lastly…if we do get some form of drastic stock market pullback due to news of a debt ceiling or another “horrific headline”…BUY STOCKS. There are several talking heads speaking of a possible 30% decline in the next few weeks or before year-end. It’s not that we’ll be celebrating if this occurs but rest assured we’ll be shopping like mad! It’s not safe and “business as usual” out there…It never is.

If there is one thing we will say over the next 75 days though it’s this:

The bounce that comes off of market corrections in this last quarter could be substantial so if you’re cash heavy right now we recommend buying on dips.

If you want details or more specifics on how to incorporate some of the investment themes discussed in this article contact us anytime. Most investors and even professionals have no idea where to go right now so we’re glad to share exactly what we’re thinking and doing.