Time to Comb Through Your Holdings

 | Apr 15, 2013 | 4:00 PM EDT
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The talk around Chez Melvin this weekend started about baseball and stocks -- and, as with everyone else who watches markets, it ended with a focus on the slaughter in gold, silver, oil and other commodities amid some fairly breathtaking declines. The commodity traders in my social-network feeds were all concerned, of course, and had resorted to drinking heavily under the kitchen table by end of the Orioles-Yankees game Sunday night. The metals were the worst, with global concerns again focused on economic weakness and a dimming potential for growth and inflation.

The materials and mining stocks have been tipping this move for months now. Miners, iron-ore companies, steel and other basic-materials stocks have been tumbling all year, and that weakness is now spilling over into the commodities themselves. Many of my friends spent a good part of the weekend trying to read whatever big macroeconomic picture is being painted by the data. As usual, I abstained here, as I am not smart enough to figure all that out -- and I am not even sure this would be a profitable exercise, even if I were able to properly read the leaves.

I do have one thought as all this unfolds. Whatever happens as a result of the high volatility in commodities, I want to be positioned to take advantage of whatever emerges from the rubble. I do not make market calls, but I have been known to throw caution flags, and I am doing so now. With commodity positions tumbling precipitously, it is time to worry about margin calls and fund redemptions that lead to selling in the stock market. If fund managers can't raise money from their disastrous commodity positions, they will eventually turn to their stock portfolio as a source of liquidity.

The commodity tumble is a red flag by itself, but I'm seeing even further evidence that it might pay to exercise prudence right now. There's a lot of borrowed money in the stock market at the moment -- and, as stocks have recovered from the 2009 lows, risk-tasking and leverage have risen as well. Margin debt on the NYSE is back to levels not seen since June 2007. Hedge-fund-borrowing figures haven't been this high since 2004, according to a recent Morgan Stanley report. For the borrower, the combination of falling asset prices and rising debt levels is a recipe for disaster, and we could see liquidation-type selling as a result.

I would avoid any of the widely held stocks right now -- and, if I had gains in some of the high-flyers most loved by the hedge funds, I would sell them. Stocks like Facebook (FB), Apple (AAPL) and AIG (AIG) could find the exits crowded if their hedge-fund owners need to raise cash. The large real estate investment trusts remain over-owned and overvalued on assets, and earnings and could quickly become a liquidity source for funds facing margin calls. It is time to sit down and go through your portfolio and do a stock-by-stock evaluation. If a stock is over-owned by institutions, or has reached the upper limits of valuation levels, it is a good time to consider selling.

I do not think it is time to go to cash or get net short -- but, then again, I never do. I am not going to bail out on a stock like ArcelorMittal (MT) because of market movement. It is far too cheap and, if anything, I would buy more of this large integrated-steel company. If Nabors (NBR) gets cheaper in a broad-based margin-driven recline, I will be a buyer. I am not going to bail out on my core cheap positions, no matter what the stock market does in the short to intermediate term. Being prudent means getting out of overvalued and over-owned stocks when risk levels are high. Panicking into cash, regardless of valuation, is rarely a sound strategy.

It is also time to make sure your wish lists are updated. I have no idea whether we'll actually see a margin-call-fueled selloff. I think there's a risk of this, but markets do not always follow the script. If it does happen, I'll want to be ready with my list of small banks, infrastructure stocks and other companies that are currently trading a bit above my buy levels. If we see margin selling, I may get a chance to buy some at my price.

All in all, the risk level looks pretty high to me, and I think it is a good time to apply liberal doses of common sense to portfolios. It is also time to anticipate and prepare for the opportunities that a selloff will create. To a value vulture, the time to celebrate is when prices are declining and are offering us a chance to accumulate assets at favorable and even ridiculous prices.

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volatility is quite low here, and we could see some downsides here in the short term. ...



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