Putting the pieces together...

TFSMX Followup
I just read the prospectus summary and learned that was was wrong about TFSMX's market neutrality approach. They apparently do NOT hedge their longs with short index positions but with short individual stock:
"Market Neutral Definition: The Fund employs a “market neutral”
strategy, which is defined by TFS Capital LLC (the “Adviser”) as a
strategy designed to generate returns that have a low correlation to the U.S. equity market. Consequently, the Adviser will actively manage the Fund’s holdings in an effort to maintain a low correlation to the movements of the U.S. equity market. The Fund does not seek to adhere to any other definition of market neutrality including, but not limited to, dollar neutrality, beta neutrality, capitalization neutrality or sector neutrality.
Techniques for Maintaining Market Neutrality: The Fund seeks
to minimize overall U.S. equity market risk by taking both long and
short positions in U.S. common stocks. The Fund will generally own
a diversified portfolio of common stocks and will maintain a short
position in a different diversified portfolio of common stocks. The
Fund will primarily invest in common stocks and, to a lesser degree, in
registered investment companies."

Six Year Fund Returns

The past may not repeat, but sometimes past results are instructive for planning. Mid 2007 saw a peak in many financial and real assets. Many markets have now returned to 2007 highs or exceeded them, so it's useful to see how some funds performed over this extremely volatile period.

During this period stock  indices plummeted and recovered as did non-Treasury bonds. Commodities and gold fell, rose greatly and fell again. Real estate crashed and rallied some. Overall it was a disinflationary period start to finish with an inflationary scare in 2011.

With the exception of Vanguard S & P 500 Index fund VFIAX, I have owned  all of these funds. I still own the others except for TFS Market Neutral TFSMX and Vanguard Wellesley Income VWIAX. All of these funds were open (accepting new accounts) in 2007 and had several classes with different minimums and annual expense ratios.

My goal in retirement has been to avoid excessive downside volatility. I had no idea the 2007-2009 bear market would be so severe, but the funds I held outperformed broad stock market index funds like VFIAX which was down almost 50% on a month end basis by February 28, 2009.  http://screencast.com/t/ZHWbzcb9

FPA Crescent Fund FPACX, a midcap  balanced fund which increases cash holdings proactively when they see trouble, was down 25%. Loomis Sayles Bond Fund (investment grade) LSBDX, MainStay Marketfield MFLDX (see below), and Vanguard Wellesley  VWIAX (40% dividend stocks/60% investment grade bonds) were down 19%, 18%, and 16% respectively. Pimco All Asset All Authority PAUIX (inflation hedge fund) and TFS Market Neutral TFSMX (short broad indices, long selected mid caps) were down 9% and 6% at end February 2009.

None of these escaped damage, but the average was down "only" 15.5% compared to 49+% for VFIAX. If one averages in one's cash and even Pimco Total Return Bond fund PTTRX which was up 11.3% at end February 2009, total portfolio value was almost exactly even for the period from mid 2007 to March 2009. Of course one could not have known in 2007 how well relatively new funds like MFLDX or TFSMX or even PAUIX would perform in a major financial crisis or that one would occur. The point of a portfolio like this it is that it had relatively low volatility in a very volatile period, in crash mode, in disinflation, and in inflation periods.

The next time this happens we will quite likely not still be in a long term bond bull market, and that could make a very big difference in these specific funds' performances. Time spreads in futures, options and other derivatives are very dependent on near and short term interest rates, as are bonds of course, and that makes hedging of all kinds more expensive. All of these funds shown here are "hedging" funds in one way or another. All of them also are discretionary as opposed to being index-mimetic.

MFLDX is a stock hedge fund in the classic sense, but even VWIAX and FPACX hedge their longs with bonds and/or cash. FPA is the home of the famous near cash fund FPNIX, and their cash is managed by FPNIX and the cash ratio to total assets varies with their stock market views.

TFSMX  differs from MFLDX in basically being short the whole market in as much size as they are long their specific picks, whereas MFLDX shorts what they see as worthless stocks against their favorite longs. They both have to be very good to have good returns. But TFSMX doesn't have to be quite as good as it is easier to short the whole market. But their overall risk is also less than MFLDX's risk. And looking at Hussman Strategic Growth Fund HSGFX we find a fund that has lost money since 2007 by doing poorly what TFSMX does well.

Unfortunately, neither MFLDX nor TFSMX is accessible to most of us at this time. MFLDX is still managed by its founders, but is now marketed by MainStay for the past few years. Original investors (lucky me) were allowed to remain and to add to positions, but new accounts are for $5,000,000 minimums. There are some other open classes of the fund which have higher annual fees and other expenses. TFSMX has closed several times to get a firm grasp on handling large inflows, and has now been closed to new accounts since 2011.

We can look, for free, for closed-end funds which do many of these same functions at CefConnect.com and for alternative funds at Morningstar.com on a trial subscription. Closed-end funds tend to be more volatile than open end mutual funds.

For the entire six year period the  funds featured here did well. http://screencast.com/t/FIPQQAFm

As already mentioned, in a bond bear market LSBDX, PTTRX, and VWIAX would not likely do as well as the others. But if we admit that we don't know what cards the future holds for markets, we might still wish to have some creative bond funds.

2CS and Stocks

The 2CS is a running five day's total of each day's CBOE combined Put/Call ratio multiplied by each day's VXO close. It's basically a measure of market fear. At the recent market low in June, the 2CS climbed up to 110 which over the years since 1996 has been fearful enough for bottoms in most bull market pullbacks, and so it was.

Now the fear level has quickly dropped into the low 50's which has marked all short term tops since the first 50 print in mid March. During extreme euphoria, as in the run up to the highs in 2007, 2CS can go quite a bit lower and price higher. But I don't see or sense marked euphoria otherwise at the moment, so my best guess now is sideways to down again, and then another rally

Gold Action

It has been a long, dreary story while gold dropped from $35 x 55 (1925) in 2011 to $35 x 34 recently. For Fibonacci and numerology folks 21/55 = 0.3818 and a good place to stop.

Gold had been getting sent to bed early at $35 x 36 month to date, but the release of Bernanke's taper remarks tonight caused buyers to buy and send gold nearly to $35 x 37. If 1260 now holds, we could see a very nice run up.

Stocks, Bonds, and K Wave

I'm settling back down to work in cool, green Minnesota after winter and spring in Mexico and Arizona. In late March I discussed the 2CS which made a low of 49 on the March 14 in that measure of bearish fear with SPX at a close of 1563. SPX made two moves down to its 50 day moving average in late March and again in late April before zooming up to a close of 1669 and nearly a double bottom in fear at 2CS 51 in late May. In a month SPX gave back all the gains from mid March, and most of it in four rough days.

http://screencast.com/t/8uDaF0zPZ

The high on Thursday (June 27) and today (July 1) was back at the 50 moving average fom underneath. At the June low the 2CS went as high as 110 which is typically enough fear to energize a rally. I suspect there is more down to do.

I was asked my opinion at SI on the Kondratieff Wave after someone posted that the wave can't yet have bottomed since US interest rates are so low. This is my take:

"Except for Treasury rates, the Kwave "winter" had all ended by 2003. The transition began in 1998/99 when Paul Krugman wrote his first "neo-depression" book and when a briiliant trader friend started buying hog futures calls as hogs fell to 1919 prices!

The Kwave is all about crude goods/commodity prices, and, in a free market, interest rates roughly parallel commodity prices trends.The FED basically took over control of interest rates ahead of the infamous 1/1/2000 computer non-snafu, kicked control up a notch after 9/11, and pumped away in 2002 and mostly ever since excepting 2005-06. Absent the FED, rates would have bottomed normally in 2002/03. This same political goose cooked from 1942-52 all the while the FED "pegged" short rates at 0.5% and the long bond rate at 2.5%. (There was a late May ZeroHedge article on this 1940's history which is worth a glance via a search engine.) Interest rates did not really break free permanently until after the severe 1957-58 recession, but most commodities had made final lows by 1949.

I think 2008-whenever (2013/14) is merely a mid-course correction in a long term Kwave commodity bull market phase much as 1987-93 was a mid-course correction in a long term stock bull market. Interest rates, IMO, are immaterial to an analysis of the Kwave at this point in history. They will catch up one of these years when the FED loses control as they did in the 50's and 60's. Of course I reserve the right to be wrong."

Despite these remarks, it's still possible that rates can fall further. Even though I had steadily shortened bond durations in my portfolio for the past several years, I have bought a small, leveraged position in EDV which is a zero coupon long Treasury bond fund. My reasoning is similar to an analysis today by John Hussman. http://hussmanfunds.com/wmc/wmc130701.htm

"The bottom line is this. Short-term interest rates will be  pegged at zero for quite a long time, because raising them even slightly would  require not just tapering, but a massive reduction in the Fed’s balance sheet. The securities that compete most closely with  default-free short-term money is default-free long-term money, which is why I  view Treasury bonds as increasingly compelling as interest rates rise,  particularly in a tepid economy with no material inflation pressures. Security  types that normally carry significant risk premiums (like stocks and corporate  bonds) have already seen all of the likely benefits of QE, and any return to  historically reasonable risk premiums is likely to batter these securities.

So while I view a reduction in the pace of the Federal  Reserve’s quantitative easing purchases as likely in the months ahead, regardless of the course of the economy, an  actual reduction in the amount of those holdings seems unlikely for years. As a result, short-term interest rates are likely to  be pegged near zero for a very long time, and the lack of yield on short-term  default-free investment options is likely to support demand for the most comparable  default-free options – namely medium and long-term Treasury debt. I don’t  believe that the same argument extends well to securities such as stocks or  corporate bonds that have traditionally been priced to reflect significant risk  premiums, and where we estimate present risk premiums to be extraordinarily  thin.

In my view, much of the recent selling has been based on the  idea that the 30-year secular bull market in bonds is over. The more relevant  issue is that there are no material upward pressures on short-rates, inflation, or  economic growth here, the difference in yield between 10-year Treasuries and  3-month Treasury bills is already greater than the long-term norm of 1.4%, and  the potential for credit shocks remains material. In that environment, I  believe the main consideration is to have the flexibility to extend durations  on spikes in yields and reduce durations when yields are depressed."