Kass: Updating the Model Portfolio

In late April, I initiated my model portfolio. The portfolio is 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.

Successful investing is anticipating the anticipation of others. As discussed in the body of today's update, this morning's aggressive moves look beyond the current stock market vigor and the immediate strength of corporate profit cycle and more toward a confluence of factors that could lead to disappointing profit and economic growth next year.

Today represents another major change in our model portfolio, with a further increase in the cash component of the portfolio from 43% to 54%. I am further reducing both recommended equity (to 41%) and credit exposure (5%) after a huge run in both asset classes.

Over the balance of this year, I expect to further reduce the portfolio's recommended investment positions and raise cash weightings if there are (1) renewed signs that my baseline expectation of a double-dip in the economy is rising in probability; and (2) we witness a dissipation in the strong price momentum that has characterized the U.S. stock market over the past several months.

It's Different This Time

"Before all else, be armed."

-- Niccolo Machiavelli

In the last several recessions, aggregate economic activity moved quickly back to peak levels. My view remains that it will be different this time -- just as the 2002-2006 cycle was unique in financial history. The enormity of the monetary and fiscal stimulation required to stabilize the U.S. economy speaks volumes to the depth of our economic woes and to where we might have been headed without government intervention. Those required policy efforts will have a long tail. Moreover, unbridled debt creation will no longer catalyze growth in a world where banks are reluctant to lend, the securitization markets are broken and the shadow banking system is nearly extinct.