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.

Long Model Candidates

  • Technology: Previous selections (Apple (AAPL), Cisco (CSCO), Research In Motion (RIMM) and Oracle (ORCL)) are now fully priced and have been dropped from my buy list. Remaining are Microsoft (MSFT), Dell (DELL) and Qualcomm (QCOM).
  • Financials: I'm dropping mortgage REITs and Visa (V). Remaining are Bank of America (BAC), SunTrust (STI), Regions Financial (RF) (convertibles), Legg Mason (LM), Prudential (PRU), MetLife (MET), Hartford (HIG), PNC (PNC), State Street (STT), Berkshire Hathaway (BRK.A), Cohen & Steers (CNS), Weingarten (WRI) (convertibles), SL Green (SLG) (convertibles), Chubb (CB), Loews (L), National Financial Partners (NFP) (convertibles) and Sallie Mae (SLM).
  • Energy: Dropping extended integrated oils and several oil service companies. Remaining are Transocean (RIG), select master limited partnerships (MLPs).
  • Health Care: Select depressed HMOs -- a true contrarian play!
  • Consumer Staples: Procter & Gamble (PG), General Mills (GIS), Unilever (UN).
  • Industrials: 3M (MMM); PPG (PPG), Union Pacific (UNP).
  • Consumer Discretionary: Home Depot (HD), Lowe's (LOW), Disney (DIS), Nike (NKE), Wal-Mart (WMT), eBay (EBAY), Starbucks (SBUX).
  • Materials: Freeport-McMoRan Copper & Gold (FCX), BHP Billiton (BHP).
  • Utilities: Duke Energy (DUK), Dominion Resources (D), PG&E (PCG).
  • Telecom: Verizon (VZ), AT&T (T).
  • Credit: Select bank loans/debt, high-yield debt.

At the time of publication, Kass and/or his funds were long MSFT, DELL, RIG, BAC, STI, BRK.A, CNS, SLM,LM, WRI converts, SLG converts, Regions Financial (converts), CB, L, NFP converts, MET, PRU, HD, LOW, DIS, SBUX and FCX , although holdings can change at any time.

Doug Kass is founder and president of Seabreeze Partners Management, Inc., and the general partner and investment manager of Seabreeze Partners Short LP and Seabreeze Partners Long/Short LP.

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