why not to do this

One of the earliest lessons I learned as a portfolio manager is not to raise cash. How so?

–it’s much harder to figure out whether stock A or stock B is cheap or expensive in absolute terms than it is to figure out that A is cheaper than B. This means the easiest way to beat the stock market is to keep fully invested and spend all of your time trying to find more As and eliminate any Bs

–the penalty for having a large cash balance and being wrong can be severe. One of my former work colleagues, running a high-profile value-oriented portfolio for pension clients, decided one day that the stock market was overvalued and that he would be a hero to clients by raising 40% cash. This is like professional suicide. He did it anyway. For the following two years the market went straight up. Nothing he did could offset the negative effect of that dead-weight cash. And after a short while he was so deep in the hole that he felt he couldn’t admit his mistake and reinvest the cash. It took a huge market downturn to give him an opportunity to buy in again. But all that did was more or less recoup the performance losses he had sustained by raising cash in the first place. Then he was fired.

–personally, I’m very bad at judging market tops. I’m pretty good at bottoms, I think. But I tend to think that the good times can go on longer than they actually can

why I’m doing it anyway

To be clear, I’m only selling about 10% of my portfolio, mostly paring back individual positions by that amount. That’s not enough to fundamentally change my portfolio composition–in other words, the gains/losses from this move may end up only as a rounding error in performance attribution. So it’s more security blanket than anything else.

What’s causing me to act is something I usually don’t like to talk about: performance.

performance

One of my early mentors told me he thought a good securities analyst could find a way to make a 20% yearly gain in almost any economic circumstances. In less folksy style, I’ve come to think of a good year as the market return (S&P 500) plus 5 – 8 percentage points; if the S&P 500 is up by 10%, I’d like to end up in the +15% – 20% range.

So far this year, however, my “capital flight” idea, envisioning the US today as like Mexico in the 1980s, has worked much better than I would have thought. That’s, unfortunately, because the Trump administration has been much more toxic than I could have dreamed. The result is that my portfolio is already many times ahead of my yearend relative performance target (I really dislike writing this last sentence. My experience is the minute you begin to pat yourself on the back, your performance begins to fall apart).

Still, I don’t think the epic wave I’ve been riding can go much farther. That’s probably my strongest belief right now. The only way I can see for present conditions to continue would be if we knew that Trump would be reelected. I don’t want to replace names I know with new ones that are basically the same thing. That’s just the anti-US pro-Trump bet all over again. But I don’t have a firm idea of where to go next.

Hence, 10% cash.