Putting the pieces together...

It's Still August

George Slezak is one of my favorite market commentators. George thinks August is a perfect time to be out of the market which will resume real activity after Labor Day. Meanwhile enjoy the summer.

My hedged portfolio is up marginally but dollar meaningfully on very low volatility since the week after Independence Day. That despite several atypical inter-asset moves: one when seemingly everything went down and in another quite the opposite happened.

If you have read the earlier comments and seen the graphics, we are now at a similar point as on 5 August in Reverse Point Waves. There is a 4 point larger degree under the last market high with five wave progressions of several levels into the last up leg. In "short", it looks bad for SP500. These moves can extend and make marginal new highs, but they are distribution moves. "You want to buy? Have we got a deal for you."

I'll be back in two weeks.

Further Portfolio Hedge Considerations

There have been few changes made in the portfolio I discussed in detail on July 1, 2006 : http://twocents.blogs.com/weblog/2006/07/the_low_volatil.html But I have changed my way of thinking about it.

The Low Volatility fund category consists of HSGFX, VWIAX/VWINX, DODBX, FAIRX, and SGENX with the first two being 2/3 of the category total and the last three totaling 1/3. What I have done recently is to separate out from the low volatility portfolio the  portion of DODBX and VWIAX/VWINX which consists of bonds and add that portion to the bond category which also contains VWALX, HSTRX, and PSAFX.

The High Volatility Niche category of stock funds contains nearly equal amounts of VGHCX (health), VGSIX (REITS), VGENX (energy), VGPMX (metals), and TAVFX (deep value). VSTCX (small caps) was sold because of increasing evidence that small caps are over-valued and will be more vulnerable relatively than they have been since 1999.

I have three funds to hedge some of the inherently (HSGFX) unhedged risk: BEARX (short + gold), RYVNX (200% short small caps), and RYTPX  (200% short SP 500 index).

I had also held long term, paid-for (unleveraged) gold outside this portfolio but have decided to include it with the hedge category. Gold is not always a good hedge but it usually (but not in May/June 2006) does not correlate highly with the other categories.

Then I have money market cash.

Only very minor changes were made in the total holdings. But when I make these reasonable changes from one category to another to more accurately reflect what the holdings really are doing for the portfolio, I come up with these percentages:

1. Core low volatility ex-bonds           32.8%

2. High Volatility niche funds              10.9%

3. Bonds + bond part of Core                25.1%

4. Hedges + gold                                        18.6%

5. Money Market cash                             12.6%

     Total                                                         100.0%

I could get even more accurate by subtracting fully-hedged HSGFX from the Core, and I could remove VGENX, VGSIX, and VGPMX from Niche and add to the Hedge + Gold category. Also I could explain that RYTPX and RYVNX are 200% short which also increases the Hedge + Gold category's effectiveness.

The real point, however, was to convince myself, and hopefully you, that I have created a true fairly simple, low volatility, low cost hedge fund containing a lot of usually non-correlated liquid funds.

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A legitimate question to ask is what do you get by hedging everything? Although the fund was not fully in effect at Janaury 1, 2006, it has been evolving for three years. It is up 5% on the year and up 40% since September 1, 2003. The concept is to be long with quality stock and bond pickers and short the average indexes; to hold some cash; and to hold categories which are usually uncorrelated. Long the good and short the bad or just the average was the original concept  of a hedge fund. Volatility is reduced, as it was for me in May and June.  Vanguard's Prime Money Market Fund is up 2.74% so far this year while I am up 5%. But using the same principles I am up 12.6% compounded annually since September 1, 2003 when I first adopted this approach (although not the complete current lineup). For someone approaching or already  in retirement this is not a bad result.

Please see the Low Volatility post of July and others related to it for more details on the individual funds and some studies done on this approach. With limited funds or limited desire to spend time on it, one could probably do nearly as well using only HSGFX 60%, HSTRX 20%, and a decent money market fund 20%.

Secondary High Forming?

An EL is what xxxxx called an xxxxxxx. It is the low of the last bar up after an advance into new high ground that had several long white up bars. There are 3 or 4 of them in this chart and 2 of them have really played out classically by rejecting price each time it passes through the horizontal line from the EL.

Yesterday the 3 month constant forward "perpetual" SP futures matched the January 11 high and closed below the EL of that high January 11 bar. another rejection. Also yesterday's bar exceeded the June 2 high setting up a 1,2,3,4 Reverse Point Wave (RPW) UNDER the May high. This is a fantastic bearish setup for a continuation of the bear move off the top. At the same time the leg from the black 3 to the black 4 of the RPW is itself a smaller degree 1,2,3,4,5 point RPW. Odd numbered points (5,7,9,etc) are reversal points...so the shorter term implies reversal down and the larger degree suggests resumption or continuation of the down move.

One method of targeting says 1188 for Sept or December SP futures. rule of 7's says 1222.3, 1193.6, 1145.7, 1049.9. If we have seen waves A and B (Ellliott) of a three wave correction, a 1.618 extension beyond A to C would carry to 946.9. My guess is 1146 for September/October unless panic ensues.

Most sentiment watchers are missing the fact that a "range shifting" is taking place in most sentiment measures. For the past few years the 2CS (5 day sum of daily VXO times CBOE p/c ratio) has been topping out, even in secondary highs, with 2CS well under 60 and often even under 50. In the previous bear market it was commonplace for 2CS to top out in the mid 60's. And that's what is happening now, and it implies we are making the transition to a real bear market, just as the opposite range shifting occured at bottoms in the summer of 2003.

Understanding sentiment changes at secondary highs and lows, after long runs in a trend direction, is of immense importance for intelligent asset allocation.

Getting tired at point 5 of Larger Degree 4?