Sell Down To Your Sleeping Point

The turmoil in the Middle East has sent oil prices soaring. If this persists for several months, its negative impact on other consumer spending would nullify the positive impact from the modest incremental stimulus package approved late last year. Since I have believed that additional fiscal stimulus has been needed to offset the restrictive effect of deleveraging, this situation could derail the fragile economic recovery.

There are two ways (or a combination of the two) to deleverage, or reduce debt relative to underlying assets and income-- 1) write off debt and reduce asset values accordingly; or 2) inflate asset values. Conservatives prefer the former; liberals the latter. When the Democrats controlled both the House and Senate, the Obama Administration could pursue the latter strategy. Now that the Republicans control the House, additional stimulus is more problematic. A student of the 1930s Depression, Bernanke is concerned that removal of stimulus prematurely could send the economy back into recession, as happened in the late Thirties.

Recent economic statistics indicate a strengthening of the economy perhaps to "escape" velocity, or an economy able to sustain normal growth without additional governmental monetary or fiscal stimulus. Convincing evidence of this would require several months of employment gains in excess of 200,000 persons a month. If that happens, then there is probably another leg up in our stock market. Otherwise, there is a likelihood of a severe stock market correction or worse.

The events in the Middle East are of great concern to me. Years later the ultimate outcome of this may be a more stable, democratic environment there. But the near term effect is uncertain, and the equity market hates uncertainty.

There is an old stock market adage, "Sell down to your sleeping point!" If you feel so uncomfortable with your long equity position that you are losing sleep, more often than not it is wise to pare down your position to the point where you can resume normal sleep. Several days ago I did just that. I reduced my equity exposure from 40% of financial assets to 30%. To put this in context, I initially took a 40% equity position in 2008, rebalanced it from 60% back to 40% in late 2009, and reduced it to 30% late last week.