S&P 500 Index 1507
By Steve Blumenthal
February 6, 2013
RISK OFF
Hedge Long Equity Exposure and/or Defensively Raise Cash.
Investment Sentiment charts 2-6-13:
Chart 1. NDR Daily Trading Sentiment Composite. Excessive Optimism – RISK OFF (hedge).
Today, The Daily Trading Sentiment Composite (NDR) reached record high Excessive Optimism. Note the peaks “green boxes” and small “red arrows” on S&P 500 Index chart. The small green arrows mark points of Extreme Pessimism.
Also note the large “red” arrow pointing to the Gain/Loss/Annum of -11.3% when sentiment is 62.5 or higher (the NDR Daily Trading Sentiment Composite has been above 62.5 just 28.4% of the time from 1995 to the present).
Chart 2. NDR Crowd Sentiment Poll – Extreme Optimism – RISK OFF (hedge).
The weekly crowd sentiment remains in the Extreme Optimism (Bearish) zone. The “red” arrow points to a Gain/Loss/Annum of -9.7% when sentiment is 66 or higher (the NDR Crowd Sentiment Composite has been above 66 just 18% of the time from 1996 to the present).
Here too sentiment is in the Extreme Optimism (Bearish) zone.
Disciplined equity hedge – risk management approach
Several times each year investor emotion reaches levels of Excessive Optimism and several times each year emotions reach levels of Extreme Pessimism. A strategy idea I favor is a disciplined risk management equity (hedge) approach as it relates to the long-term equity portion of a portfolio. Initiate hedges when investor sentiment reaches Excessive Optimism and remove hedges at periods of Extreme Pessimism.
A collared option strategy which involves writing covered out of the money calls and at the same time buying out of the money puts is something to consider. It is a relatively inexpensive hedge approach. The game plan is to implement the hedge just a few times each year tied to sentiment extremes. Today is one such extreme. Then remove hedges tied to Extreme Pessimism. Go to www.cboe.com and search for “collared option strategy” to learn more. I favor selling 5% out of the money calls and buying 5% out of the money puts with maturities several months out. It is important to manage to your risk tolerances/investment objectives but at most budget spending a small percentage of your equity exposure each year.
Please note that this is absolutely not a recommendation to buy or sell any security. For discussion purposes only.
While the above focuses on risk management, click here to view commentary on the current Cyclical Bull Market trend that remains in place. January 23, 2013 Trade Signals
Click here for Deeper commentary on Risk Off trade: January 17, 2013 Trade Signals
Tactical Investments and other Trading – Alternative Strategies (important note)
I believe that there is important intelligence I can gain from our various tactical strategies. I’d like to share the following that I’m watching closely: Our CMG Managed High Yield Bond Program moved to cash this week. Our CMG Opportunistic All Asset Strategy continues to overweight to equities supporting the current cyclical bullish price trend view.
Please note: Within your portfolio construction process, I do not recommend hedges against your tactical strategy allocations as they already offer a diversifying return stream to your overall portfolio. There is no need as the strategy should be considered within the framework of your total portfolio for its return and non-correlating risk benefits. If a manager has a process with edge and a proven history to execute his trading process, then ask yourself if the strategy can make money in both up and down trending markets and monitor accordingly. Make sure the manager is sticking to his process. I believe that transparency and liquidity are mandatory. Of course, past performance cannot predict or guarantee future performance.
30/30/40
I continue to favor a broadly diversified portfolio that includes allocations to three asset categories. I believe 60/40 will underperform with historical evidence projecting a 4.37% 10-year expected return (the lowest in 14 decades). Source: Expected Returns – Research Affiliates– click here.
Low dividend yields and low bond yields are the culprits. To me, a balanced portfolio today is comprised of 30% Equity (hedged from time to time), 30% Fixed Income (tactically managed) and 40% Tactical-Trading-Alternatives. Of course, you may allocate differently based on your risk level, age, needs, time horizon, etc.
I hope you find this information helpful. I share it because I feel risk management is vital to your long-term investment success and most investors don’t realize that it is not too difficult to implement. Importantly, one must have a disciplined game plan and reliable process. It is from this prospective that I openly share my views with you.
Please feel free to forward this to a friend or have them go to http://www.cmgwealth.com/ and subscribe to our free letter at the bottom of the home page.
With warm regards,
Steve
Stephen B. Blumenthal
Founder & CEO
CMG Capital Management Group, Inc.
Philadelphia
steve@cmgwealth.com
610-989-9090 Phone
610-989-9092 Fax
A note on active hedging:
Within the long-term secular bear environment I believe we are in, I favor hedging the long-term equity portfolio exposure tied to periods of Extreme Optimism and removing those hedges tied to periods of Extreme Pessimism. As you can see in the above charts, there are just a few times each year that the market moves into “Extreme”. I like put options and covered calls against long equity exposure. Never sell “naked” put or call options. Another idea is to budget a percentage of your long equity exposure to actively put on and take off exposure to a leveraged inverse index based ETF.
I believe that we are in a period of time which favors actively hedging long equity exposure. I like putting hedges on when investors are extremely optimistic and removing hedges when investors are extremely pessimistic. The focus on the long equity portion of your portfolio is to enhance return, reduce risk and preserve capital. Go to www.cboe.com to learn more about options. All investments involve risk.
IMPORTANT DISCLOSURE INFORMATION
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk. Therefore, it should not be assumed that future performance of any specific investment or investment strategy (including the investments and/or investment strategies recommended and/or undertaken by CMG Capital Management Group, Inc (or any of its related entities-together “CMG”) will be profitable, equal any historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. No portion of the content should be construed as an offer or solicitation for the purchase or sale of any security. References to specific securities, investment programs or funds are for illustrative purposes only and are not intended to be, and should not be interpreted as recommendations to purchase or sell such securities.
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Written Disclosure Statement. CMG is an SEC registered investment adviser principally located in King of Prussia, PA. Stephen B. Blumenthal is CMG’s founder and CEO. Please note: The above views are those of CMG and its CEO, Stephen Blumenthal, and do not reflect those of any sub-advisor that CMG may engage to manage any CMG strategy. A copy of CMG’s current written disclosure statement discussing advisory services and fees is available upon request or via CMG’s internet web site at (http://www.cmgwealth.com/disclosures/advs).