'Barbell' Your Portfolio to Reduce Risk

So we have been here before..in 1999, then again at the end of 2003 and now once again. Dow at 10,000.

The prognostications of Tice, Farber, Roubini, back in March and April about Dow heading to 3,000-5,000 are no longer a very realistic scenario...although some hard core bears may disagree. Personally, I never dismiss any scenario, to me it’s just a matter of odds and probabilities. These odds and probabilities are always shifting, depending on what I see, read, hear and feel. At Dow 10,000 and with SPX approaching 1100/1150 we are near the upper end of the trading range. Although we can clearly get a breakout-fueled rally as more towels get thrown in, the risk is also increasing.

I am dealing with this risk by creating a Barbell Portfolio. It is a technique borrowed from bond managers, to create a portfolio using bonds with short term and long term duration. In simple terms, it reduces bond portfolio risk in an uncertain interest rate environment. Similarly, I am rebalancing my portfolio by adding some of the ‘safer’, lower beta healthcare stocks, while also keeping some of high beta, volatile materials, industrials, energy, and emerging markets stocks.

I think this is a sane approach given where we are and how far we come from. Here is my thought process.

If the market tanks from here, the healthcare holdings in my portfolio should outperform. Yes, they may still decline in absolute terms, but given that most of them lagged the market because of the HC reform overhang, it remains one of the least overbought sectors.

Conversely, if the market keeps going, my high octane stocks should continue do well, and hopefully outperform the market, while the resolution of the Obama's HC plan (whatever the final outcome) should drive stocks higher as well. Despite a defensive nature of this group, we may see a pretty rapid ‘catching up’ as investors bid up the shares of the best of the breed biotechs, managed care, and hospital stocks. I am not including smaller, riskier, biotechs with binary outcomes as part of this strategy, but will add them on a case by case basis to the “risky” part of the barbell.

The barbell portfolio will allow you to still participate in the market advance, while protecting you on the downside, should momentum turn. Of course, as any insurance/protection, it has it cost. Should the market move aggressively from here, the healthcare will continue to lag.

My top picks for the HC are : AET, UNH, CEPH, CELG, GILD, AMGN. Another name that I like and have a lot of confidence in is DNDN.