Over the past week most of my core measures of market health improved. Most notably is that my measures of risk went positive. This changes the portfolio allocations as follows: Long / Cash portfolio: 20% long and 80% cash Long / Short Hedged portfolio: 60% long high beta stocks and 40% short the S&P 500 Index (or the ETF SH) Volatility Hedged portfolio: 100% long (from 10/9/15) Another thing of note this week is that the Bullish Percent Index (BPSPX) is back above 60%. This reduces the risk of a steep or waterfall type decline. Here’s a post that explains the risk associated with poor breadth in the market.
As I mentioned on Tuesday, my market risk indicator cleared during the week and the positive readings have held throughout the week. However, my core market health indicators are all still below zero. This changes the portfolio allocations as follows. Long / Cash portfolio: 100% cash Long / Short Hedged portfolio: 50% long stocks I believe will outperform in and uptrend and 50% short the S&P 500 Index Volatility Hedged portfolio: 100% long As was the case in mid August the core indicators don’t like the current market internals, but the perception of risk is low. You’ll need to assess your own needs and risk tolerance to decide how much of a hedge (if any) you leave on your portfolio. If you’d rather use an ETF for the long portion of your portfolio here are some ideas on how to find one. Look at the comments too as a reader found several ETFs that met the high beta criteria. At the end of August I wrote a post explaining why
With the sell off this morning I’m taking the opportunity provided by a spike in volatility to take some profit from the hedge and soften it in the Long / Short Hedged portfolio. I’m taking all profit from the hedge and buying new long positions with it. In addition, I’m selling 1/3 of the aggressive hedge (mid term put options, VXZ, or XVZ) and buying a short of the S&P 500 Index (or using SH). Usually, the longs in the portfolio have dropped enough that the new allocations are fairly close to a 50% long and 50% hedged position after a rebalance. But due to the large increase in volatility without much price damage in the market since 8/21/15 (when my market risk indicator signaled) the new allocations have a slightly smaller hedge than is normal after a rebalance. The new allocations for the Long / Short portfolio are as follows. 53% Long stocks that I believe will outperform in an uptrend (high beta stocks) 15% Short the S&P 500
Just a quick note about the portfolio allocations and the current market health indicator readings. All of my core health indicator categories rose this week, but they’re still mired in negative territory. In addition, my market risk indicator is still signaling. As a result, the core portfolios remain aggressively hedged with an instrument that benefits from higher volatility (mid term put options, mid term volatility — VXZ, dynamic volatility — XVZ, etc.). I’ll do an in depth post with my thoughts on the market later today that will highlight VXZ. Here’s a preview chart. Notice that the S&P 500 Index (SPX) has retraced it’s decline from last Friday’s close, but VXZ is still up 15% from Friday’s close. Volatility begets volatility…which is why mid term volatility makes a good hedge during fast moving markets.
My market risk indicator is warning today. That changes the portfolio allocations of the Long / Short portfolio and the Volatility Hedged portfolio to 50% long high beta stocks and 50% aggressively hedged. An aggressive hedge is a vehicle that benefits from higher volatility such as put options, or volatility ETF/ETNs like VXZ or XVZ. Please note that XVZ is thinly traded so limit orders (and likely several small purchases) would be prudent. Use your own discretion in which product you use…and as always never buy a product you don’t understand. If you’re using put options our portfolio allocations indicate that you should fully cover your portfolio at or near the money. Use your own discretion in term structure, but be aware that I look to mid term (4 to 7 months) puts first. If you’re uncomfortable with volatility or put options an actively managed bear fund like HDGE is a short option to use as a hedge. It will likely offer more protection than a simple short of the
Over the past week my measures of market health bounced around with some gaining and others falling. Most notably, measures of market quality fell below zero. This changes the core portfolio allocations to the following. Long/Cash portfolio: 100% cash. Long/Short portfolio 50% long stocks that I believe will outperform in and uptrend — 50% short the S&P 500 Index (using SH or a short of SPY). My market risk indicator is still reluctant to warn. The two least sensitive components have flat lined over the past several weeks. They have been moving slightly just above or below zero. The most sensitive components are are compressing in a range well above zero. This leaves the volatility hedged portfolio 100% long. Basically, the market is on dangerous underpinnings, but price hasn’t broken down. My market risk indicator is telling us that market participants are waiting for a price break before getting concerned. The indexes are painting patterns that can be either accumulation or distribution. They are best characterized as trendless. A great
My core market health indicators weren’t impressed by this week’s rally. All of them fell in the face of a rising S&P 500 Index (SPX). This isn’t an encouraging trend. During the month of July as the market traded sideways in a 5% range my core indicator categories have broken down one after another. This week my measures of market strength fell below zero which is changing the allocations in the core portfolios. The new allocations are as follows. Long / Cash portfolio: 20% L0ng and 80% Cash Long / Short portfolio: 60% Long and 40% Short the S&P 500 Index Below is a chart with the portfolio changes over the past year. Green is adding exposure / reducing a hedge. Yellow represents adding a hedge or raising cash. Red represents a market risk warning where I use an aggressive hedge (with put options or a product that benefits from rising volatility). Fortunately price hasn’t broken yet and as a result market participants are comfortable keeping core measures of risk
Over the past week most of my core market health indicators fell. Most notable is my measures of the economy which have gone negative. As a result, the core portfolios are adding a larger hedge or raising cash. Below are the current core portfolio allocations. Long / Cash: Long 40% – Cash 60% Long / Short: Long 70% – Short the S&P 500 Index 30% My market risk indicator currently has two of four indicators warning, but the other two a long way away from a signal. It appears that people aren’t too concerned about the current dip. In the absence of any risk event (i.e. Greece, Ebola, etc.) my risk indicator generally won’t signal without serious price deterioration. As a result, the Volatility Hedge stays long during “normal” consolidation periods. It is currently 100% long and I expect it to stay that way unless we see a steeper decline ensue. Below is a chart with changes to the core portfolio allocations over the past year. Green lines represent adding
We end this week in a critical situation. My core indicators were all damaged during the high volatility moves both up and down this week. Core measures of risk and trend have now gone negative. The measures of the economy are close to going negative and market quality and strength aren’t far behind. As a result the core portfolios are raising cash and or adding a hedge. The new core allocations are as follows. Long / Cash: 60% Long and 40% Cash Long / Short: 80% Long stocks I believe will out perform in an uptrend — 20% short the S&P 500 Index (SPX) My market risk indicator hasn’t signaled yet so the volatility hedge will remain 100% Long. So, what’s an investor to do? Follow the core portfolios or the volatility hedged portfolio? The answer lies in your risk tolerance. The volatility hedged portfolio is designed to ride out most dips in the market and only hedge when the odds for a steep decline rise. The core portfolios are
Over the past week all of my core market health indicators have strengthened except for market risk. My measures of the economy strengthened enough to move slightly above zero. This means we’ll be adding exposure to the core portfolios. The new allocations will be as follows: Volatility Hedged portfolio: 100% long (since 10/24/14) Long / Cash portfolios: 100% long Long / Short portfolio: 100 long Here’s a chart with changes to the core portfolios over the past 18 months. Green is adding long exposure, yellow raising cash or adding hedges, red represents an aggressive hedge using an instrument that benefits from rising volatility. One thing of note is that my core indicators (which are intermediate term in nature) are currently at odds with some of the short term indicators I watch. For example, Trade Followers momentum from Twitter is currently issuing a consolidation warning. This indicates that even though we’re adding exposure the market may chop around or dip before it can move higher. Another thing of concern is that