Rebalancing My Portfolio

Last year, utilizing dollar-cost averaging, I accumulated an equity position which amounted to 40% of my total financial assets, with the remainder in fixed income securities (90 Day Treasury Bills). Of that equity portion, 75% was originally invested in the T.Rowe Price Equity Index 500 Fund and 25% in the T.Rowe Price New Asia Fund. Due to appreciation in the equity funds and the use of some Treasury Bills to pay living expenses, the equity portion, as of yesterday, had become 56% of total financial assets. Furthermore, within the equity portion, the New Asia Fund, due to its far higher total return (71% versus 7% for the Equity Index 500 Fund), had now become 35% of the equity exposure versus the desired 25%.

At the close yesterday, I sold 29% of the equity portion to bring equity exposure back down to 40%, and sold much more New Asia Fund than Equity Index 500 Fund in order to return to the orginally intended 75%-25% breakdown.

The relevant question is WHY NOW?

As those who have read my previous postings know, I feel the key to the U.S economy and stock market is WHEN the consumer resumes historically normal spending patterns after experiencing a tremendous loss of net worth from the stock market and housing busts and the discouraging effect of high unemployment. The build-up of debt throughout the economy over several decades should require more time to reverse significantly. There has been some progress in reducing consumer debt but public debt has mushroomed. Overall, there has been little deleveraging, although lower interest rates on that debt are helpful temporarily. The U.S. economy is in the worst condition since the Great Depression, and I believe nobody really can predict with conviction when normal growth will recur. Apparently, the current Christmas selling season will not be significantly better than last year, which was in the aftermath of the Lehman collapse.

The banking system is benefiting from wide interest rate spreads and the accounting change from "mark to market" to "mark to model". However, problems remain. The recent Dubai debt problem is a high profile "canary in the coal mine" foretelling the next banking crisis -- the necessity to renegotiate several trillion dollars of commercial real estate loans during the next seveal years.

Currently, the U.S. economy is in the sweet spot of: some economic growth, very low interest rates, and tremendous operating and financial leverage. The result is above-normal profits growth. Since the stock market is a discounting mechanism, the question is how much of this has already been discounted? Based on a dividend discount model, the stock market is currently between 7% and 25% overvalued depending on whether one assumes 7% or 6% annual "normal" earnings growth. At this stage in a "normal" economic cycle, that isn't so frightening, especially given the alternative paltry returns from fixed income, which tend to force investors farther out on the risk spectrum. However, given the leverage in the system and the financial plight of the consumer, this may not be a normal economic cycle. Once federal stimulus programs are withdrawn, will the economic upturn prove sustainable?

My most trusted input, investor sentiment, has not yet reached the extreme bullishness characteristic of a top.

As I have discussed previously, Fibonacci numbers are considered by some to mirror reality, although there are many detractors from this concept. Whether true or not, so many traders are believers that one must pay attention to the fact that the stock market during the last few days has retraced half of the entire bear market from the high of 1565 in the S&P 500 Index to the low of 666.

Please forgive the length of this posting. I haven't written one for roughly a half year because, until now, I didn't think there was any action to be taken. In my opinion, this rebalancing is appropriate because the stock market is no longer undervalued, and the economic uncertainty is above normal.