In the past, I have referred to a variety of Al Thomas’s articles, since he happens to be one of the few who calls it as he sees it, no matter who he may offend in the process. I like this kind of thinking and appreciated his recent piece titled “Cash is a Position,” a topic which I have addressed on many occasions. Let’s listen in:

Cash Is A Position

You may not like what I said. You will wish you did when it comes to retirement time.

I have been singing a similar song for a long time in preparation for exactly the times we are in right now. Markets go down a lot faster than they go up and, given the bursting of the bubble economy along with the fact that our domestic Trend Tracking Index (TTI) now clearly sits in bear market territory, 100% cash (money market) should be your position. The only exception would be, if you have taken measures to hedge your portfolio such as we did.

My latest No Load Fund/ETF Tracker has been posted at:

http://www.successful-investment.com/newsletter-archive.php

Being on the sidelines or in hedged positions was the place to be as the bulls got slaughtered this week.

Our Trend Tracking Index (TTI) for domestic funds/ETFs broke decisively below its trend line (red) by -1.66% thereby confirming the current bear market trend.



The international index dropped as well and now remains -9.55% below its own trend line, keeping us on the sidelines.



For more details, and the latest market commentary, as well as the updated No load Fund/ETF StatSheet, please see the above link.

With the markets having more or less aimlessly meandered for most of this year, I have tried to focus on the many details of trend tracking, which has prompted some newsletter subscribers to write for clarification.

One reader had this to say:

Many thanks for sharing your thoughts and for the wonderful service.

When the sell signal materializes for the domestic TTI, why can we not interpret it as a buy signal for SH or SDS or other short ETFs? If you have a TTI for short ETFs, will it not show a buy signal?

Many thanks for your clarification.

You are correct. If you look at section 11 of last week’s StatSheet, you’ll see that this is in fact the idea. We try to take advantage of the short side, if the domestic TTI has broken below its long-term trend line and the Short Fund Composite (SFC) has broken above its own line. As of last week, that had not been the case. The graph in section 11 also illustrates the most recent short Buy cycle, which ended up being a whip-saw signal.

In my advisor practice, we did not participate in that short Buy. I have to caution you that this is one area where it pays to be late for the party.

Personally, I want to make sure that a bear market has in fact established itself before jumping on the band wagon. If you are more aggressive than I am, you can allocate a small portion of your portfolio to bear funds/ETFs, but you need to work with a sell stop just as you would on the long side.

Another reader had this question regarding the hedging of his portfolio:

As I understand this, if I have a diversified equity portfolio of about $200,000 I should buy $200,000 of SH? How should the foreign funds be hedged, when necessary?

Yes, for a widely diversified domestic equity portfolio, you could hedge $200k with $200k of SH or, alternatively with $100k of SDS. They key here is to test your hedging thoughts by running various scenarios to see how the hedge would have worked.

For example, in my advisor practice, before deciding on the hedge I ended up using, I tested various market environments for different time periods. Here are some of the ones that I examined:

From 3/28/08 to 4/25/08 when the S&P; 500 gained 6.31%
From 5/30/08 to 6/20/08 when the S&P; 500 lost 5.86%
YTD to 6/20/08 where the S&P; 500 lost 10.22%

That would be a bare minimum. I actually went further and tested every year this century along with major up trends as well as the bear market. Testing is what will give you some idea as to the validity of your hedge. While I don’t know how your situation will work out, I can guarantee you that you’ll be surprised by the results.

I have not done any recent work in the international markets, since they’ve been in a sell mode as of 11/13/07. However, if you look at the bear market section 11 of my StatSheet, you’ll find ETFs specializing in the short end of the international arena (EFZ, EEV) as well. The key here too is to do some testing before you apply your ideas to your portfolio.

Keep in mind that there are many complex hedging strategies available; however, my preference is too keep it simple, effective and understandable.

While I don’t give much credence to wild forecasts and predictions, I read some of them nevertheless, especially when the viewpoint is presented from outside the U. S. about the U.S. Sometimes it can be interesting to see how others with (hopefully) unbiased opinions interpret our domestic market and economy.

The most recent and extremely outspoken observation came from the Royal Bank of Scotland (RBS) in an article titled “RBS issues global stock and credit crash alert.” Let’s listen in:

The Royal Bank of Scotland has advised clients to brace for a full-fledged crash in global stock and credit markets over the next three months as inflation paralyses the major central banks.

“A very nasty period is soon to be upon us – be prepared,” said Bob Janjuah, the bank’s credit strategist.

A report by the bank’s research team warns that the S&P; 500 index of Wall Street equities is likely to fall by more than 300 points to around 1050 by September as “all the chickens come home to roost” from the excesses of the global boom, with contagion spreading across Europe and emerging markets.

Such a slide on world bourses would amount to one of the worst bear markets over the last century.
…
“Cash is the key safe haven. This is about not losing your money, and not losing your job,” said Mr Janjuah, who became a City star after his grim warnings last year about the credit crisis proved all too accurate.

RBS expects Wall Street to rally a little further into early July before short-lived momentum from America’s fiscal boost begins to fizzle out, and the delayed effects of the oil spike inflict their damage.

“Globalisation was always going to risk putting G7 bankers into a dangerous corner at some point. We have got to that point,” he said.

US Federal Reserve and the European Central Bank both face a Hobson’s choice as workers start to lose their jobs in earnest and lenders cut off credit.

The authorities cannot respond with easy money because oil and food costs continue to push headline inflation to levels that are unsettling the markets. “The ugly spoiler is that we may need to see much lower global growth in order to get lower inflation,” he said.

“The Fed is in panic mode. The massive credibility chasms down which the Fed and maybe even the ECB will plummet when they fail to hike rates in the face of higher inflation will combine to give us a big sell-off in risky assets,” he said.

[emphasis added]

Personally, I think that such a scenario is very likely and long overdue given the status of the bubble economy; I just can’t be sure if the predicted time frame is correct. As always, my reference point has been and will be my Trend Tracking Indexes (TTIs), which have kept me on the “right” side of the market in regards to major downturns for some 20 years.

As you know, the international TTI has been in bear market mode since 11/13/07 and currently remains -8.20% below its long-term trend line. The domestic TTI ended our most recent Buy signal, and it has moved to -0.68% below its trend line.

Clients’ money is now positioned safely in U.S. Treasury money market and/or in fully hedged positions as mentioned in last Friday’s update. While we may see some more upside spikes, currently the major trend is down.

Having a hedged portfolio position gives me now the luxury of removing the hedge quickly if the markets move back out of the neutral zone and into bullish territory, which would make me net long. If, on the other hand, the markets break down sharply, I can remove our long positions and become net short to take advantage of the downturn.

The key here is to be prepared and have a plan in place ahead of time to deal with the uncertainties of the market place, which avoids frustration associated with last minute scrambling and decision making.

In regards to my recent post “How Many Positions Should You Have,” one reader had this question:

How should we view our “Portfolio” when we have several accounts (i.e. 401K, IRA, Broker, etc)?

Should all be considered one portfolio or separate? Would a single 8% position equal 8% of the total of all accounts or would it be for a single account? This question is related to the total number of positions and position size.

While there is certainly not just one way to handle this, my preference is to look at each account separately. For example, if you have a $100k IRA, then you should allocate as per this portfolio value. If additionally, you have started a small Roth-IRA worth $7k and a brokerage account with $25k then look at these as separate entities. A small account may only justify being invested in 1-2 mutual funds/ETFs, while a larger one should obviously be more diversified.

Along a similar theme, reader Ralph had this question:

I am interested in a hedge for my IRA and taxable accounts. How do you determine how much to buy of a fund like SH or SDS? Would it be best to buy the hedge (fund) in the taxable account to cover both accounts? For example, I have 150,000 invested in the taxable account and 500,000 in the IRA account.

Thank you.

Again, there are many ways to approach this. Let me give you an example of how I have handled this in my advisor practice. Towards the end of the last Buy cycle, we were invested in 2 widely diversified domestic mutual funds with a total 20% portfolio allocation.

I purchased 20% of the short S&P; 500 ETF (SH) to cover those positions. You’d think that this hedge now would cancel out any gains or losses on either side. That did not happen so far.

During the past 10 days, and the drubbing in the financial markets, SH has gained more in value than the mutual funds have lost, giving us a gain of over 1% on the invested amount during that time.

Whether you use SH, or the 200% turbo version SDS on only 50% of your positions, is a matter of preference. In any event, I would treat both accounts as separate entities. As time goes on, I will comment more on hedging strategies as they apply to mutual fund/ETF investing.

Reader Gary brought up an interesting question regarding the fact that a new domestic Sell signal has been generated after just having received a Buy signal on 5/15/08. Here’s what he had to say:

Enjoy your newsletter very much. You are on the “mark” with your criticism of government “doublespeak”.

I know you are not in the “prediction” business but I would like your opinion of “Failed” signals and what they might mean to your trend tracking.

I have looked back through my records all the way back to 1991. The closest incident may be the events as they shaped up in the year 2000. Take a look at the chart below (double click to enlarge):



This is our domestic Trend Tracking Index (TTI) and the topping formation (on the left), which occurred during the blow-off period starting in April of 2000. Notice that we subsequently went through 3 very short-term whip-saw signals (the buys are the blue arrows) before the bear trend was confirmed, and we finally exited to 100% cash on 10/13/2000.

As you can see, while in the bear market, we experienced another whip-saw, this one lasting about 3 months (from 3/7/02 to 6/12/02), which turned out to be the precursor of the bottom of the bear market and the subsequent turnaround, which moved us back into equities on 4/29/2003.

While this past history is certainly not conclusive, I believe that a short-term Buy signal is a sign of uncertainly and could possibly be considered a blow-off until the real major trend settles in. In today’s market environment, that would translate into bullish rally attempts before a bear market establishes itself.

Since we won’t know for sure how this current scenario will play out, you simply need to follow the trends even if it means a whip-saw or two. The ultimate goal here is not to go down with the bear, which you need to avoid at all costs, especially if the future holds anything like past represented in the above chart.