Kass: Updating the Model Portfolio

This blog post originally appeared on RealMoney Silver on July 27 at 8:38 a.m. EDT.

In late April, I initiated the Kass Model Portfolio, intended to represent the general construction of a long-only model portfolio with a six- to 12-month investment horizon. My hypothetical portfolio depicts an overall equity weighting and positioning relative to S&P 500 industry benchmarks and weightings.

As I did in calling for a generational bottom in early March, I am again adopting a variant and unpopular view, but this time it is a more negative call. It is important to emphasize that in my March call, I expected a resurgence of economic and investment optimism during the summer to be followed by a multiyear period of weak investment returns. Specifically, I expected a mini production boom and an asset allocation away from bonds and into stocks to be embraced and heralded by investors, who would only be disappointed again in the fall as it becomes clear that a self-sustaining economic recovery is unlikely to develop.

Today's opening missive has another major change in our model portfolio, with a further increase in the cash component of the portfolio from 29% to 43%. I am further reducing both equity and credit exposure after a huge run in both asset classes.

As I see it, the bull market argument is that we are exiting the recession just like the many that preceded the current one. Consequently, corporate profits will exceed consensus forecasts in tandem with:

1. the resumption of revenue growth (seen in three months of improvement in the leading economic indicator, signs of stabilization in housing, etc.);
2. the record fiscal stimulation;
3. an export-led Asian recovery; and
4. the operating leverage associated with productivity gains achieved through draconian cost cuts and influenced by tame wage inflation.

Besides productivity being underestimated the bulls, further argue Say's Law of Production -- that it is business that drives consumer incomes and spending. Finally, the bullish cabal argues that the high-tax health and energy bills introduced by the President have been recently set back as the blue dog democrats and the liberal leadership are already battling.