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 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.
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
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.