Zagging While the Market Zigs

 | Aug 15, 2011 | 10:30 AM EDT  | Comments
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SSO

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cut

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pso

For all its stomach-churning volatility, the stock market seemed to move in slow motion last week as I sat glued to my trading screens for much of the week.

By most measures, last week in the U.S. markets was unprecedented.

In terms of market breadth, last Monday's drop was the market's worst performance since before Pearl Harbor. In terms of volatility, last week was only the sixth time since 1897 that the S&P 500 swung at least 4% up or down for four straight days.

In terms of sentiment, the University of Michigan Consumer Sentiment survey on Friday recorded its third-lowest reading since the survey started in 1952. U.S. consumers haven't been this blue since Jimmy Carter was in the White House.

And yet for all the hell and the fury, the S&P 500 ended the week down only 1.63%.

At times like this, traders' rationality goes out the window and the good old fight-or-flight response kicks in.

I moved some of my client accounts 16.5% into cash on Tuesday, halving my positions in the U.S. stock market, global developed markets and emerging markets With other accounts, I bought short ETFs to hedge the accounts equity exposure to individual stock positions.

But I did the opposite with my personal portfolio.

In addition to taking a position in ProShares UltraShort S&P500 (SSO), I piled into some more risky assets.

On Friday, I saw that both Guggenheim Timber (CUT) and PowerShares Listed Private Equity (PSP) were massively oversold. I added to both of these positions in my personal portfolio.

Am I nuts? Hypocritical? Or both?

It all goes back to something as prosaic as different investment objectives.

I manage a lot of retirement portfolios. And these folks are rightfully scared when they see big drawdowns in their IRAs. They're worried sick about   another 2008. So, my primary focus for them is on the preservation of capital, even if it may impair their long-term investment returns.

In contrast, my personal tolerance for risk is higher and my time horizon is longer. When the markets zig, I can grit my teeth and zag.

Why did I choose to risk more of own my hard-earned cash on Friday?

I'm a huge believer in the long-term diversification benefits of alternative assets like timber and private equity. And last week the market offered me a chance to add to my positions in these sectors at bargain-basement prices.

I also believe in the reversion to the mean. Markets may go crazy for a while, but they go back to normal after a period of extremes. And by every objective measure that I follow, the market last week was almost psychotic.

I'm convinced that at some point the market, whether measured by advancers vs. decliners, volatility or sentiment,-will calm down.

As the late economist John Kenneth Galbraith observed: "The financial memory is very short."

And I expect that the behavior of the markets in the coming weeks will prove me right.

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