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).
In an up trending market HDGE an actively managed bear fund, and SH an inverse of the S&P 500, tend to move together and paint similar chart patterns. HDGE, however, under performs in an up trending market. During the rally from last October’s low to early February HDGE was down roughly 30% while SH was down only about 21%. In mid February as the S&P 500 was continuing to rally, HDGE started to out perform SH. Both bear positions were still falling, however HDGE slowed it’s decline. Then at the first of April as the market began to fall both securities started to rise. The small rally into the the first of May brought the arrival of big divergence between HDGE and SH that has continued until today. This isn’t a good sign for the markets as it signals to us that market participants are separating the good stocks from the bad. It is often one of the first signs of a weakening market so we’re watching this carefully. What makes
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
Even after a 40% sell off it’s hard to keep twitter sentiment in BIDU down. Over the last couple of months as BIDU has been making new lows, it’s twitter sentiment has only had brief periods below zero. The next couple of weeks should tell us whether everyone still believes in BIDU or if they’ll finally bail. $100 is the place to watch. Does sentiment strengthen or will it capitulate? As of today, there is a little fear about this being a short term top.
It’s always a little disconcerting when the Russell 2000 doesn’t confirm an up move in the S&P 500. It tells us that risk isn’t really back on yet and that this might just be a correction of the move down from the early April high. Looking at the chart you could see RUT stalling in March and now it appears to be stalling again. We’d like to see the Russell break back above 818 on the next move up. Over the next few weeks we want to see it hold the 50 and 200 day moving averages. A break below could give us early clues that the move down from April is under way again. If it breaks the next stop for the S&P 500 is probably 1200. But hey, if we get to 1200 SPX the good news will be more QE.
The S&P 500 closed virtually unchanged today (7/30/20120), however, our Twitter Sentiment Indicator for the S&P 500 index fell sharply. The last time this happened was on 7/5/2012. The next morning the June jobs report was released which caused the market to fall for the next several days. What will tomorrow bring? Just an update on 7/31. The sentiment indicator is even lower this morning at -.33 which is where it was at the first of June when the market was making new lows and after a few weeks of intense selling. Meanwhile the market is waiting for tomorrow’s Fed statement. Is sentiment anticipating a lack of a QE3 announcement at 2:15?
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.