With the markets having slipped into bear territory, some readers are looking ahead towards the point when a new Buy signal is being generated. Reader Ron had the following question:

Thank you for your excellent blog and services.

Or do you actually buy the entire 50% domestic when you see the next buy signal?

While this is not an exact science, here’s how I approach it. The first issue is that we don’t know yet whether the domestic or the international Trend Tracking Index (TTI) will signal a Buy first. So you need to stay flexible and not go by the fixed assumption that you want to invest 50% international and 50% domestic—you need to let the market trends tell you what to do.

Lets’ say the domestic TTI signals a Buy first. Using your above numbers, I would allocate 1/3 of portfolio value ($33k) to that area. If the market continues to rise and your positions gain some 5% in value, I would add another 1/3 to that market and so on until you’re fully invested.

If, however, after you have committed the first 1/3 to the domestic market, the international TTI signals a Buy, then I would allocate 1/3 ($33k) to that arena as well, which will result in our portfolio being invested 66%. You can now sit back and watch which positions gain in value and add to those until you are 100% invested.

Alternatively, if you are more aggressive, you could also divvy up the remaining 1/3 in various sector and country funds, which will get you to a fully invested position much sooner.

Again, it all depends on your risk tolerance and your objectives.

With the major indexes having jumped of a cliff this past week and into bear market territory, questionable (or even downright stupid) advice as to how to handle the current environment has made front page news. Two such stories were featured online, with the first one titled “Set It And Forget It.” Here are some highlights:

When the Dow rockets 300 points or the stocks of retailers, say, get decimated, I devour the news. After all, I work at a financial-news company. But here’s my admission: I’m a buy-and-hold investor, and a lazy one at that. My employer prohibits us news folks to trade equities on a short-term basis anyway, but even if it didn’t, I’d still buy and hold.

Those three requirements? A well-diversified investment plan, invested in low-cost index funds, with a long-term outlook.

It’s obvious that this author has either no clue what a bear market looks like (or the effect it can have) or her assets are so small that the outcome of a bull or bear scenario is inconsequential.

From the thousands of readers I have emailed with since the last bear market, there hasn’t been one who considers Buy and Hold and the subsequent devastation of assets a viable strategy.

Here’s another news story titled “Now’s the time to buy and hold:”

Investors may be seeing the “peak of negativity” in the markets these days, and that’s exactly why buy-and-hold types should be on the lookout for opportunities, T. Rowe Price’s chief investment officer said on Friday.

“Sentiment is so negative right now that you can’t help but make money in some of these companies if you take a three-year, buy-and-hold horizon,” Brian Rogers told attendees of the Morningstar Investment Conference. He expects it will take the next couple of years for the market to recover.
…
“Buying into stress is usually a good thing to do. And if you look for where there’s the most stress right now, you go to the financial sector,” he said. There are also opportunities to invest in the higher-quality end of fixed-income markets, including mortgages, he added.

Sure, you should not expect a different tune from a mutual fund, whose sole survival depends on you staying fully invested. “Buying into stress” is no different than buying on dips, which may work in bull markets but is an absolute no-no in bear markets.

Who is to say that this is all the stress the financial sector will experience? From my viewpoint, this market slide is only in the beginning stages (my guess), and those trying to be a hero by buying early will have their heads handed to them on a silver platter.

Even if this turns out to be the bottom, I’d rather wait for confirmation to the upside than taking a gamble and becoming another bear market casualty.

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.