On reflection, it was an astounding quarter. Last year, we saw a meltdown in asset prices like no other since the great depression. No matter what the type of asset, if it involved any level of risk nobody wanted it and selling it was a painful event. This event took market prices far lower than rationale evaluations and we tried to take advantage of that by buying assets that we thought were extremely undervalued.

A year later, the trend has reversed in a shocking manner. Almost all assets had headed back up in prices at a speed that seems turbocharged. While we expected an initial rebound followed by slow growth, we have witnessed what Vinny Catalano has called a “melt up”. Money has come in from the sidelines and forced asset prices to keep ascending at a rate that seems removed from the reality of our lives. The “new normal” is a world in which a slow economy will not be buoyed by consumers spending money they don’t have to buy things they don’t need. The piggy bank (i.e. home equity withdrawals) is closed and does not appear as if it will be opening any time soon.

Even more astounding, the huge rally has been focused on all risk being rewarded the most. Low quality stocks and junk bonds have led the way, gaining more than high quality stocks and better quality debt instruments. How long can this go on and how will it end? If we knew the answer to those two questions, we could solve all your problems easily and could sit back and watch the unfortunates struggle to not stub their toes. How long can it go on? As long as people continue to pour in from the sidelines and pay little or no attention to fundamental values, the market can continue to go up. How will it end? It can end peacefully if it ends soon-markets can take a breather and allow valuations to catch up slowly to current prices. If the market continues to skyrocket, the end could be less pleasant-another meltdown seems unlikely but can’t be ruled out entirely.

How should we position portfolios moving forward? The answer is cautiously. The gains we expected to see over a period of years have come to us in  a period of months. There are some assets that appear to us to be fairly valued and there are some assets that now appear to us to be somewhat overvalued. We believe that the way forward is to overemphasize quality (which has now gone up as quickly), hold on to assets that appear to be fairly valued, and selectively take some profits in areas that are now overvalued. Couple this will a discipline that includes stop sell limits should the market begin a free fall and some hedging that reduces portfolio risk a bit at this time and you have our strategy moving forward. The game can change quickly from here and we must be ready to react to what is no longer a rally driven by fundamentals. It is a more dangerous moment now- the tail end of a huge rally in what is most likely still a secular bear market.