A variety of forces combined yesterday and pulled the major indexes off their highs.

Some kind of a correction was long overdue with the markets having enjoyed an extended run. It remains to be seen, if this is the start of something prolonged.

Judging by the low volume, it does not appear that way but, nowadays, you need to be prepared for the fact that anything is possible. We may very well enter a period in which neither wild fear is coming back into the market nor unbridled enthusiasm.

Our Trend Tracking Indexes (TTIs) retreated and are hugging their respective trend lines as follows:

Domestic TTI: +0.86%
International TTI: +8.79%
Hedge TTI: +0.27%

All buys signals remains if effect subject to our trailing stop loss points.

Reader Joe had an interesting comment in response to Saturday’s post “Beating the S&P; 500 Index with an S&P; 500 Mutual Fund.”

Here’s what he had to say:

There is a flaw in your hedge – all Ultra-Long and Inverse funds have a “daily rebalancing” problem that causes them to all trend down over long periods.

For example, if you bought SPY in early November and sold it yesterday, you broke even. However, if you held SH for the exact same period, you would have lost 10% of your money. See the charts attached.

You are better off shorting SPY as a hedge (or even better, shorting 1/2 as much of SSO since it has the same problem, but by going short you put it to your advantage – the trouble is finding shares to short, and also you can’t short in a retirement account).

I appreciate Joe’s input since it allowed me to look at other hedge scenarios I normally would not have considered. I do not advocate hedging SH vs. SPY, but since he brought it up, I decided to run the test.

As an aside, whether inverse funds do daily rebalancing or not, does not matter to me; what matters is the published closing price, which is what I work with and which is the standard used to mark all accounts to market.

There are a few things that you may have overlooked when doing your calculations. First, SH had a huge distribution in December 08, which you must have not have considered. Here’s what the matrix looks like for that time frame:




[Click on chart to enlarge]

Please note, the distribution had a major effect on the outcome during this period and is most likely not accounted for in the charts you presented.

Second, the key is the rebalancing of the hedge when it becomes lopsided. Any hedge has an optimum rebalancing percentage, but for this example, I have used 61%.

Here’s the summary for testing your hedge SH vs. SPY for the period of 11/3/08 to 6/12/09:



[Click on chart to enlarge]

As you can see, this turned out to be a winning situation and not at all what you had assumed. It’s a better outcome than what I would have expected from such a hedge combination.

Reuters reports that “Flood of ETFs promising hedge style returns.” Let’s take a look at some highlights:

Money managers are flooding the market with exchange-traded funds (ETF) and mutual funds designed to give even the smallest of investors access to hedge fund returns without all the usual restrictions or hefty fees.

Disappointing hedge fund performance last year and redemption blocks have angered big investors and created a rare opening for new offerings. Firms such as IndexIQ, WisdomTree Investments and Grail Advisors intend to take advantage of the popularity of ETFs while offering strategies that used to be exclusive to the super rich.

[Emphasis added]

Using a hedged approach to investing can offer tremendous benefits as I have been trying to explain over the last 3 months. However, in the past, most of those strategies, as represented to the average investor via Long/Short funds, have been expensive and not yielded satisfactory results.

Only time will tell if any of the above mentioned ETFs will live up to their expectations. I believe that using my SimpleHedge Strategy is a step in the right direction and, while cost effective, it is well suited for the individual investor who likes to have some means of control over his portfolio no matter what size.

I must admit that I have been having a lot of fun lately. Not the kind of fun you are probably thinking about; it was more the kind of fund that results from satisfying a curiosity as to what might happen when various scenarios are applied to an investment discipline.

Sine I published my free e-book “The SimpleHedge Strategy” back in March, a lot has happened it terms of uncovering the enormous possibilities that exist when using such an approach. Today, I will share one of those results with you, and I’m sure that it amazes you as much as it did me.

A few weeks ago, I finally received my custom made program, which quickly lets me analyze any period in history (for which data exist, of course) to see if a hedged approach using ETFs and/or no load funds would have made sense or not.

I’ve been mainly focusing on testing scenarios in this century since it offered us two devastating bear markets that have clearly demonstrated the short comings of just about all of the canned asset allocation approaches.

Since ETFs were not available for most of the period, I have substituted them with no load funds (or load waived funds). The goal was for me to see if and how my SimpleHedge approach would work when pitted against the S&P; 500 index by using an S&P; 500 no load mutual fund.

For the short side of the hedge, I selected BEARX, and on the long side I randomly picked PEOPX, both of which have data going back to 1996.

I ran the numbers to generate yearly returns, including reinvested dividends, and this is what I came up with:



I was pretty amazed when I saw those results. How is this possible? Simple. The key is NOT to buy-and-hold the hedge, but to rebalance it appropriately as described in my e-book.

Rebalancing is the key to all success when using my hedge approach since it locks in profits and minimizes losses. If you look at the numbers above, you’ll notice that the “feast or famine” type of investing so prevalent in buy-and-hold scenarios has been smoothed out. In this example, the returns are steady and while big drops are eliminated (2002/2008), so are big gains (2003).

However, as you can see, it is not necessary to have high gain years such as 2003, which are simply neutralized with the next downturn.

I am not saying that this is a scenario you should use; I am merely pointing out what can happen if you apply a hedge discipline over a period of time during which most investors and professionals lost when using the S&P; 500 as a benchmark.

I have no positions in this hedge, although I am using BEARX with other hedge combinations. I have found a number of hedges I am currently using that have produced twice the return of the above BEARX/PEOPX combination, which means that they are on par with returns that most investors only hope to get with straight long positions.

In my advisor practice, I use hedges along with outright long holdings depending on our trend tracking signals and have found this to be a great combination for most clients.

The point of all this is not to discard a hedge approach as something inferior. My work has shown that hedging can offer great upside potential with severely limited downside risk, which is what most (not all) investors are looking for.

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

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

Trading around the unchanged line made for an uneventful week.

Our Trend Tracking Index (TTI) for domestic funds/ETFs has now crossed its trend line (red) to the upside by +1.65% keeping the current buy signal intact. The effective date was 6/3/2009.



The international index has now broken above its long-term trend line by +10.93%. A Buy signal was triggered effective May 11, 2009. We are holding our positions subject to a trailing stop loss.



[Click on charts to enlarge]

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

On Wednesday, the markets did a repeat performance of Tuesday by selling off early and staging a nice rebound in the afternoon. Nothing much changed in terms of our invested positions.

Today’s hat tip goes to Mish at Global Economics for posting a video, which tries to answer the question how some of the trillions of dollars that have been spent are being accounted for.

I had to listen to it twice, because I just could not believe that so much ignorance and incompetence actually exists.

It left a bitter taste in my mouth, and I’m still wondering if anyone is really in charge or feels some sense of responsibility.

Take a look: