Over the past week most of our indicators rose, however, our measures of market quality slipped enough that we’re changing our portfolio allocations. In both of our Long/Cash portfolios we’ll now be 60% long and 40% cash. Our Hedged portfolio will be 80% long and 20% short. We’re long stocks that we believe will out perform the market in an uptrend. Our hedge is a simple short of the S&P 500 Index (or SH). Please be aware that this isn’t a prediction of a market top or even a correction. Our measures of market quality tend to be longer term in nature and often lead our other indicators by several weeks or even months. So this is simply a recognition that enough of the underlying indicators that we follow are falling that we feel it prudent to raise a bit of cash and become more cautious. Our goal is not to track every move in the general stock market, rather we want to participate in strong rallies and avoid catastrophic
Over the past week most of our core market health indicators improved. Our measures of the economy are still negative, but improving slowly. Our measures of risk showed some weakness that signals investors are getting a bit more concerned about the market. However, we believe that this is a normal condition when the market stalls rather than an indication of substantially lower prices. Our measures of market quality, trend, and strength jumped substantially this week. It is interesting that our measures of trend followed quality and strength in going positive especially since the rally out of the November lows has trended so strongly. It is an indication of how odd this rally has been from a underlying technical perspective. The positive changes in market trend is causing a change in our core portfolio allocations. Our Long / Cash strategies are now 80% long and 20% cash. Our Hedged portfolio is now 90% long and 10% short (using a simple short of the S&P 500 Index — or the ETF
Our core market health indicators saw improvement in everything except our measures of the economy. We’re increasing exposure in our core portfolios today. Our Long / Cash portfolios will now be 60% long. Our hedged portfolio will be 80% long and 20% short. The short is a simple short of the S&P 500 Index (or SH). Below are charts showing where we added exposure (green lines) and raised cash or added hedges (yellow and red lines). The core long / cash portfolio has had limited exposure that has varied from 20% long to 100% long. The hedged portfolio (Long / Short Hedge) Has had a bit more exposure to the long side, but carried a fairly significant hedge during the last part of this rally. This was due to our core market health indicators remaining mostly negative during the move from 1550 to 1650.
Our core market health indicators deteriorated enough this week that we’re raising cash in our Long/Cash portfolios. They are both now 80% cash and 20% long. Our hedged portfolio is now 60% long (stocks we believe will outperform the market in an uptrend) and 40% short the S&P 500 Index (either short SPY or buy SH). Our measures of the economy slipped from -7 to -8. The economy measures continue to disappoint us as they just can’t seem to get a footing. They went negative near the first of December, got all the way down to -10 (our worst reading), moved back up to -3 at the beginning of February then turned over again. This indicator usually has a pretty good lead time at both bottoms and tops so the fact that it has kept a portion of our portfolios under invested for almost three months gives us concern. Our measures of risk dropped a bit this week to +5. There still isn’t much concern from market participants about a
We’re adding exposure to our portfolios today. Our measures of market quality improved enough to cause this change. On February 22nd, our indicators reacted to the weakness in price and fear of market participants that a correction had started. This caused us to raise cash and add more shorts in our portfolios. This added some protection just in case the sell off accelerated, but also left us with some exposure to the market if it rallied. As you know, our portfolios are designed to participate in up trends, but also protect us from any unrecoverable declines. This was an example of getting cautious that in hindsight was unnecessary, however in our opinion prudent. We don’t mind paying for insurance when the market is uncertain. Our portfolios still participated in almost half the gain of the recent rally, which is enough for us during any period of market uncertainty. We’re now adding more long stock exposure on the expectation of higher prices. Both of our Long/Cash portfolios now have allocations of
Just a quick note about our current portfolio positions. Our core market health indicators have deteriorated further throughout the week. They’ve fallen enough that we’re raising cash in our Long / Cash portfolios and adding hedges to our Hedged portfolio. Our Long/Cash portfolios are both now 40% long and 60% cash. Our Hedged portfolio is now 70% long and 30% hedged with a simple short of the S&P 500 Index. The ETF SH is an easy way to short SPX if you don’t want to short SPY. The long portion of our portfolio still remains the stocks we believe will outperform the market over the long term. However, we’ve trimmed some positions based on their future prospects and used that cash to purchase the hedge. Note: charts added on 2/24/13
Our Market Risk Indicator finally made it back to a positive reading this week. As we’ve noted in our weekly market comments, our core market health indicators have been fighting against market risk. While the market health indicators were strengthening over the past month our Market Risk Indicator stayed stubbornly negative. With the clearing of our risk indicator we move from an aggressively hedged position to a 90% long position with a 10% short position. The longs are stocks that we believe will outperform the market and the short is a simple short of the S&P 500 Index. An ETF that can be used is SH. As always, we can’t see the future so we allocate our portfolios based on the probabilities created by the history of our indicators. The current condition of our indicators suggests that the market should move higher over the intermediate term. Once again, not a prediction, merely a situation where the odds favor higher prices. The current hedge ratio is .11. The green lines in
We tightened our hedges in our Long / Short hedged portfolio today. Some of our longs were getting away from their hedge so we brought them closer together. As I’ve noted on Twitter @DownsideHedge, our core market health indicators are strengthening this week, but our market risk indicator refuses to come in line. That leaves us aggressively hedged even though we’re seeing underlying health in the market. A further rally (and resolution of the budget negotiations in Washington) will most likely improve both our core health indicators and our market risk indicator. As a result, good news that is accompanied by a rally will most likely move us from aggressively hedged to a large long exposure all at the same time. Nevertheless, we’ll continue to follow our discipline and wait for a signal before making any portfolio adjustments.
Our Market Risk Indicator closed the week in negative territory. This signal caused us to aggressively hedge our portfolio. We’re effectively 50% Long and 50% short, but our shorts consist of instruments that will benefit from increased volatility in the market. Some examples are puts against our long positions or mid term volatility like VIXM or VXZ. A lesser alternative would be an actively managed bear fund similar to HDGE. The long portion of our portfolio continues to be stocks that we believe will outperform the general market over the long run. This move in the portfolio is not a prediction of lower prices in the market. Rather, it reflects enough increased risk that we want to insure our portfolio. As we’ve noted before, our Market Risk Indicator has many false signals that are usually short in duration. If this signal is false we expect to take a small loss which we consider paying for insurance. If the signal proves to be correct we expect to make money as volatility
Our Long/Short Hedge strategy is now 100% net long. The break out above 1422 in the S&P 500 Index brought with it strength in enough of our indicators to get us fully invested on the long side of the market. Our long portfolio consists of stocks that we want to own over the long run. The current situation in our indicators has occurred several times over the past 12 years. Almost all of these instances were followed by multi-week (or month) rallies. We did have one occurrence in May of 2006 that was reversed one week later to an aggressively hedged position and resulted in a whip saw. Here are some examples of where we were 100% exposed to the market after coming out of a correction. July 2003, December 2005, May 2009, November 2010, and January 2012. We can’t see the future so we don’t know if this will be a good signal, but we follow where the market leads. On the chart above the green lines indicate adding