We saw continuing improvement in our core market indicators this week allowing us to add exposure to the market in our Long / Cash hedge strategy. We are now 60% long and 40% cash. Most of our measures of market strength, trend, and risk are positive, while most of our measures of the economy and quality are lagging. This is the point during strong bear market rallies where we often see whip saws. During the 2000 to 2002 bear market this level of exposure was often associated with a market peak within a few weeks. However, during normal up trends this level of exposure generally signals a continuation of the up trend. In the chart above green lines are adding exposure and yellow lines are raising cash.
Our core market indicators continued to improve this week allowing us to increase our long exposure and reduce our hedge. We are currently 70% long and 30% short. The increase was fairly rapid as it appears more market participants are joining this rally. The long portion of the portfolio consists of stocks we want to own due to many factors including; individual company growth prospects, value, and beta. Our current short is simply a short of the S&P 500 Index. The current hedge ratio is .43. The green lines on the chart above represent us adding longs to our portfolio and reducing shorts. The yellow lines represent increasing short positions and decreasing our portfolio of long stocks. The red line represents aggressive hedging with instruments like puts, volatility, or actively managed short funds.
Our internal indicators of core market strength improved enough today to allow us to add more exposure to the market. We are now 40% long and 60% cash. In the following weeks we’ll continue to add exposure if our core market indicators continue to rise. We’ll raise cash if market conditions deteriorate. On the chart below our purchases of additional longs are represented by the green lines. The yellow lines represent selling stock and raising cash.
Our core indicators improved enough today to remove a portion of our hedges. We added exposure by removing some of our hedge and using the money to add to our long portfolio. We are now 60% long and 40% short (using a short of the S&P 500 Index). The current hedge ratio is .67. Several of our core indicators are lagging so it’ll probably be more than a couple of weeks before we add additional exposure. But as always, we’ll keep you updated with any changes. The green lines on the chart below represent us adding exposure to the long portion of our portfolio. The yellow lines represent adding hedges. The red line represents aggressive hedging.
Our core indicators strengthened enough today to increase our exposure to the market to 20%. We’re 80% cash and 20% long in our Long/Cash strategy. We’re dipping our toes in the water as the underlying strength in the market could propel the market higher. The yellow lines on the chart represent raising cash and the green lines on the chart represent buying stocks (by lowering our cash position).
Today it was reported that Knight Capital had a problem with their trading and market making algorithms which caused the NYSE to review the trades of 148 stocks earlier in the day. Their review concluded that trades in six stocks would be canceled if they fell outside of a 30% band (either high or low from the day’s open). Bottom line, a machine ran amok. Days like today make us feel glad we hedge. Just as we did on May 6th, 2010…the flash crash. We didn’t see any problems in the market and in fact our hedging strategy was adding exposure. We got 60% exposed (80% long and 20% short) on 4/5/2010. It looked to us according to all our core indicators that this was a rally that might stick. Then during the week of of April 26th 2010 our market risk indicator flashed. It closed the week with a Market Risk Warning so on Monday the 3rd our portfolio was fully hedged. The first few days of the week
It’s fun to compare market conditions in the past to current conditions. Unfortunately, it usually isn’t very informative. Since 2000 there have been three instances where our position was changed from a Market Risk Warning (where we’re hedged with something that contains volatility) to a fully hedged position (using a short of the S&P 500). Usually, enough of our core market indicators have turned positive that we come out of a market risk warning into a moderately hedged position. The first instance was on 6/2/2000 where we tried to add exposure and got whip sawed all the way to 9/5/2000 where we were 60% exposed. Then added hedges every week until we got another Market Risk Warning on 9/25/2000. The second instance occurred on 6/6/2005 where we slowly added exposure while the market moved sideways and were 60% exposed when our market risk indicator flashed a warning on 8/22/2005. The last instance happened on 8/21/2006 where we quickly added exposure and were 80% exposed by 10/9/2006 allowing us
Our market risk indicator flashed this week, however, we always use a weekly close to generate a signal. The strength on Thursday and Friday reversed the signal early this week so we end the week without a risk warning. This means we didn’t add any aggressive hedges today. Instead, we’re following our core hedging strategy indicators leaving us 100% cash in our Long/Cash strategy and 100% hedged with a short of the S&P 500 in our Long/Short strategy. Some of our core indicators are getting close to going positive that could give us some exposure to the market at the end of next week if the trend continues.
On 7/13/2012 our Long / Short hedging strategy moved from aggressively hedged (using put options, or an actively managed short fund like HDGE, or midterm volatility like VIXM or VXZ) to a full hedge using a short of the S&P 500 index. We’re still long 50% of the portfolio with stocks that we believe will out perform in an up trending market and short 50% using the S&P 500 index. When we’re in this position our expectation is that we’ll make money if the market moves higher (our long stocks should out perform). We expect to lose a little money if the market moves sideways or down…but that’s the price of insurance. The current hedge ratio is 1. On the chart below the green lines get wider as we add exposure. The yellow lines get wider as we remove exposure by adding hedges. The red line indicates an aggressive hedge.
On 5/11/2012 our Long / Cash portfolio moved from 40% long stocks and 60% cash to 100% cash. On the chart below the green lines get wider as we add exposure to the markets. The yellow lines get wider as we take exposure off.