As stock markets around the world continue their surge, investors should be doing what investors should always be doing – AVOIDING COMPLACENCY. Some healthy pessimism, along with a detective’s approach to today’s unprecedented combination of conditions (low yields/record stock prices/continuous money-printing/ubiquitous info via the web and media) are essential to combat the nervous feeling many investors have following a gain in the S&P 500 Index of 148% from its March 2009 low. It all comes down to one thing for the investors: does your investment PROCESS include a rational approach to handling runaway markets like the one we have today? Let’s face it, what we have today is not normal, it is an outlier. My approach to dealing with it:

1. Don’t try to call market tops. While our key market indicators point to a frothy stock market, this does not mean a decline is imminent. Investing is not a black/white exercise. It is always some shade of gray. Don’t fall victim to the “I am getting in the market / out of the market” syndrome. That’s the mentality the media tries to push on us, and they are not fiduciaries (and thus are NOT obligated to act in your best interests).

2. Determine what level of volatility you are prepared to take on. It is easy to be growth-oriented during 148% rallies, but the mirror image on the downside is daunting to any investor I know. This means their manager must have a plan to confront it whenever it occurs.

3. Use a flexible investing approach – incorporation of “inverse” securities to hedge a portion of a portfolio’s exposure to stocks can be a big advantage. And with interest rates threatening to move higher, one can also consider securities that hedge increases in U.S. Treasury Bond rates.

4. Practice proactive portfolio tax-management NOW. Taxable accounts likely have large gains that have not been “realized” (that is, the security has not been sold yet) and/or gains that have been taken already – either way, the threat of a large capital gains tax bill looms in 2013. That’s better than a pile of losses, but it demands special attention nonetheless. Mutual fund investors are extremely vulnerable here (more on that in a future blog post).

From a tax standpoint, it may be best to hold on to as much of your stock market exposure as prudently possible, and add a higher than normal dose of inverse securities. Why? Because as long as the market goes noticeably higher OR lower the rest of the year, something will be up and something will be down – which allows us to take some tax losses before year-end, while maintaining the level of balance we target in each strategy we manage.

As the venerable cop on the old TV drama Hill Street Blues said to his precinct each morning before sending them off to their assignments…”hey, be careful out there.”

© Sungarden Investment Research

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