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The Kass Model Portfolio -- Updated!

This blog post originally appeared on RealMoney Silver on June 15 at 7:10 a.m. EDT.

In late April, I established the Kass Model Portfolio, intended to reflect the general construction of a model long-only portfolio with a six- to twelve-month investment horizon. My hypothetical portfolio depicts positioning relative to S&P 500 industry benchmarks and weightings.

As promised, today's opening missive updates a major change in the portfolio -- a near-doubling in the cash component of the portfolio from 15% to 29%. I am also reducing credit -- which has had a very strong rally in price -- from a 20% weighting down to a still-high 15%.

I view the investment mosaic as a scalene triangle (though in its complexity it is more like a quadrilateral pyramid!), with the angles of that triangle representing fundamentals (substantially the highest weighting), valuation (second-most-important weighting) and sentiment (the least important weighting).

Four factors suggest that the U.S. equity market is now vulnerable to a decline of 5% to 10%.

  • The scope and duration of the recent market advance seem to have discounted a second-half production boom.
  • An uneven and shallow economic recovery that could double-dip in early 2010, coincident with higher interest rates and a hike in individual tax rates, is becoming more likely.
  • We're seeing some early signs of emerging technical deterioration.
  • Bullish sentiment is rising.

In conclusion, above-average cash positions should now be held in light of a possible market correction and in order to have excess reserves to capitalize on opportunities available in a volatile trading environment.

S&P Weighting Recommended Weighting Rationale for Weighting
Technology 18% 10% Business spending will remain subdued and sector is now overowned
Financials 13% 10% Widespread income and low valuations relative to normalized earnings offset consumer loan loss cycle
Energy 13% 7% Fairly priced relative to commodity price and sector is now overowned
Health Care 13% 5% Government intervention threatens pricing
Consumer Staples 12% 5% Exposed to generic trade-down
Industrials 10% 5% Shallow and uneven economic recovery remains a headwind
Consumer Discretionary 9% 6% The consumer is still levered and vulnerable
Materials 4% 2% Shallow and uneven economic recovery remains a headwind
Utilities 4% 2% Exposed to a further spike in interest rates
Telecom 4% 4% Secular prospects remain superior
Total equities 100% 56%
Credit 0% 15% Opportunistic
Total exposure 100% 71%
Cash 0% 29%

Finally, I have included a shopping list of individual stock candidates (by sector) that could be considered in the aforementioned Kass Model Portfolio.

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