Do as we say, not as we do!

Now with a title like that I could be commenting on the British Parliamentary system and potentially expand upon some of the greatest hypocrisy ever seen, but this week I wanted instead to look at the recent "recovery," and try to see through some of the words and commentary beling generated by managers either encouraging us all back into the market with "the recovery well underway" or telling us this is all implausible and there is a sucker punch around the corner.

Opportunity risk is something that everyone is aware of, and the recent 34% rise in the S&P 500 further underlines the old adage of "not timing the market but time in the market." Anyone slow to react has seen a real opportunity go by (the rally has been even larger for certain sectors, e.g., Financials up 100%), and the question following such returns has to be whether this is just a reaction to over-pessimism before a period of sideways movement, the beginning of a sustained upwards trend, or as many economists are warning, a false dawn with unemployment still rising and severely denting any hopes of an early return to growth.

In order to get a general feel I have looked at the cash allocation of those funds in the Lipper U.S. Equity Large Cap Universe. This universe is large enough for a general analysis and I am using cash allocation as a proxy for confidence in the recovery, paralleling an increase in allocation with doubt about the rally and vice versa. I believe that cash allocation should be an active decision, and so in order to exclude those funds whose cash holding mandated limits might add noise, I have excluded any fund with less than a 4% cash allocation.

The chart above follows the average cash allocation of the fund universe against the level of the S&P 500 from early 2006 until today. We see that it has been steadily rising through mid-2007 despite a slightly rising market, reflecting the move towards a more defensive stance. The rapid market falls also shows, not surprisingly, a surge in cash allocation as managers opted out of the market altogether.

Interestingly, the recent rally reflects some money returning to equities but still less than the end of last year, underlining, I believe, the cautious nature of this rally and the belief that there may well be more trouble to come.

Does your allocation reflect your belief?

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