Investment Update: June 1st 2012

Last month, we explained how we came to be carrying so little equity exposure, and why we were “in no hurry to redeploy this cash we’ve raised.” The events of May have validated our perspectives. We see an ongoing slowdown in the world’s economy, with continued softness in equity markets (though that can change).

Just how weak were global stock markets? This past month saw the equity markets slide 6%. It was the worst single month for the S&P500 in two years; the Dow Jones Industrial Average was unable to string two consecutive winning days in a row during the entire month! As of today, June 1st 2012, the DJIA has given up all of its gains since January 1 and is now flat year-to-date; Nasdaq is up modestly, while the S&P500 is barely above water.

This consolidation follows the 12% first quarter, and was not unexpected. With today’s weakness, the selloff has run almost 10% from the April 2nd highs. Since this rally began in March 2009, both times markets approached that magic 20% loss level, the Fed has intervened. Whether or not this will occur a third time is the primary question Fed Watchers will be pondering over the next few months.

The key will be the economic data, which has been slowing appreciably of late. Indeed, the global economy, while not yet contracting, has been struggling. Parts of Europe are already in recession (Greece is in an outright depression). China has slowed from a torrid 11% to a still strong 8% growth rate; India also is cooling albeit to 6.5%. The world’s largest economy, the United States, probably expanded at a 1.5-2% rate in Q2.

This is the backdrop in which the Fed is contemplating their next move. Our best guess is that we need to see even more economic weakness and another 10% or so downwards before the Fed has the political cover to act.

You may recall in January I lowered my US Recession probability over the next 12 months from 50% down to 30%. Today, that creeps back up to 40%. We continue to be underweight equities, overweight bonds and cash.

Anticipating that possibility of a recession, today we added a 1% position in Wal-Mart across all accounts. Since it topped out in January 2,000, Wal-Mart’s stock has gone nowhere – until now. It has finally broken out to levels not seen in a decade. WMT yields 2.4%, trades at a 20% discount to its Enterprise Value, and has a forward P/E of 12.

While the Fed may act (eventually), we prefer to keep healthy amounts of cash and bonds on hand as the economy slows and earnings top out. In addition to our core models being risk averse, our tactical portfolio (Good Harbor) were 100% Treasurys for the entire month of May. We continue to remain cautious and watchful.

-Barry Ritholtz
Ritholtz Group June 1st 2012

This post originally appeared at The Big Picture and is posted with permission.