Macro Tsimmis

intelligently hedged investment

Posts Tagged ‘dog’

4Q11 Volatility Declines but to a Still-High Level

Posted by intelledgement on Mon, 23 Jan 12

The combined wisdom of all market traders and investors appears to be that risk declined last quarter, after a scary 3Q11…at least, the market was up and volatility was down…but we are not out of the woods yet. For the full story, check out “Nerve Racking: Q4 2011 Volatility Declines, But Only To Still-Elevated Levels,” published at Seeking Alpha.

Previous volatility-related articles:

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Market Volatility Spikes in 3Q11

Posted by intelledgement on Thu, 13 Oct 11

2008 initially looked a lot like 1929…but in the Great Depression, the stock market gyrated and sank for the following three years while this time around, the markets have been calm and healthy…until this last quarter, that is. For the full story, check out “Just When You Thought It Was Safe to Go Back in the Water: An Update on Market Volatility,” published on The Motley Fool website.

Previous volatility-related articles:

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BUY ProShares Short Russell 2000 (RWM)—Again

Posted by intelledgement on Fri, 26 Aug 11

We got the Bernanke bump we were expecting—the market is up today, although looks to be a more modest advance than we had expected. It would have been fine just to stay short here, but we will probably end up a bit ahead when we come back in at the close today (that is, the price we buy RWM at today will likely be a few cents less than what we got for the shares we sold on Tuesday).

We still expect that the most likely scenario is that The Powers That Be will manipulate the smoke and mirrors to mask the seriousness of our financial problems long enough to conduct an orderly U. S. election in 2012. However, the cracks in the wall—Eurozone sovereign debt issues, U.S. no jobs “recovery” and structural debt/demographic issues, BRICs growth slowdown, Middle East unrest, etcetera—are proliferating faster than the metaphorical wall paper can be applied and thus it is prudent to go short here (again) as a risk management tool to limit the potential damage if things fall apart sooner than we expect.

We are again utilizing the ProShares Short Russell 2000 ETF (RWM) as our vehicle of choice. Our logic is that a slow growth scenario is likely to negatively impact smaller companies more than large companies (although both will be hurt). This ETF is low on assets—$400 million where normally we prefer a minimum of $1 billion—but the robust average daily shares traded (up to 1.9 million) ensures adequate liquidity.

Previous index short-related posts:

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SELL ProShares Short Russell 2000 (RWM)

Posted by intelledgement on Tue, 23 Aug 11

We are cashing in our insurance here with a 4% one-week profit because with Europe essentially closed for business through the end of August, we believe the need for short protection here is outweighed by the risk of a temporary market surge in the face of the combination of no fresh bad news and (false) reassurances likely coming from Ben Bernanke at the Jackson Hole confab by the end of this week.

We expect to be back again by early September.

Previous index short-related posts:

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BUY ProShares Short Russell 2000 (RWM)

Posted by intelledgement on Tue, 16 Aug 11

We still expect that the most likely scenario is that The Powers That Be will manipulate the smoke and mirrors to mask the seriousness of our financial problems long enough to conduct an orderly U. S. election in 2012. However, the cracks in the wall—Eurozone sovereign debt issues, U.S. no jobs “recovery” and structural debt/demographic issues, BRICs growth slowdown, Middle East unrest, etcetera—are proliferating faster than the metaphorical wall paper can be applied and thus it is prudent to go short here as a risk management tool to limit the potential damage if things fall apart sooner than we expect.

This time we are using the ProShares Short Russell 2000 ETF (RWM) as our vehicle of choice. Our logic is that a slow growth scenario is likely to negatively impact smaller companies more than large companies (although both will be hurt). This ETF is low on assets—$400 million where normally we prefer a minimum of $1 billion—but the robust average daily shares traded (1.1 million) ensures adequate liquidity.

Previous index short-related posts:

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SELL ProShares Short S&P 500 (SH)

Posted by intelledgement on Fri, 12 Aug 11

We are cashing in our short “insurance” here at a profit. We still believe it prudent to be short, and we are planning to short the Russell 2000 instead of the S&P 500 because we feel the cyclical growth slowdown that is occurring is likely to hurt smaller companies more than larger ones. However, we may wait a few days to see how the latest European can-kicking effort goes; if the market believes there is a good chance it will “succeed,” then we may have an opportunity to get in at a significantly lower price.

Previous SH-related posts:

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Another Boring Quarter of Below-Average Volatility…or Was It?

Posted by intelledgement on Mon, 11 Jul 11

The Intelledgement Macro Strategy Investment Portfolio is managed, obviously, using a macro-analysis approach. We look (primarily) at economic, political, social, and environmental factors to assess the likelihood of various potential events—e.g., Middle East conflict affecting oil supply, real estate bubble burst in China affecting oil demand, a sovereign debt default in Europe affecting all sorts of things, etcetera—and position the portfolio to avert the most likely bad consequences, if not actually benefit thereby.

So saying, generally speaking, we have little use for so-called “technical analysis”—methods of predicting stock price movements by analyzing historical data. Not to say that hedge funds that follow mechanistic, mathematical-based trading schema cannot be profitable…there are plenty that are. (Although most of those focus on sundry arbitrage opportunities that take systematic advantage of inefficiencies in the market such as the yen carry trade—and not, technically speaking, genuine technical analysis.)

Be that as it may, we do track one technical indicator here: market volatility. We do that because it’s a reasonably reliable gauge of perceived risk levels. Roughly 73% of the time, when volatility in the S&P 500 goes up—when the average annual daily change in the price of the index (up or down) is greater than it was in the prior year—market performance for that year declines compared to the prior year.

And based on volatility levels, the perception of risk has been remarkably low for the past two years, and is continuing to decline. The second quarter of 2011 marked another non-event, volatility-wise. Market volatility declined, quarter-over-quarter, from slightly below average in 1Q11 (daily change of ±0.58%) to notably below average (±0.54%)—from inception in 1957 to now (30 Jun 11), the all-time daily average change in the S&P 500 index has averaged ±0.62%. In fact, for the first time since the 2008 crash, volatility for the trailing twelve months (±0.59%) has dipped below the all-time average.

Volatility hit an all-time high in Q4 2008—breaking the record set in 1929 (by the DJIA)—with mind-boggling peak average daily change of ±3.27%. (That’s a whopping 427% above the average.) For 2008 overall, it was a record ±1.71%, or 176% above average. But since then, it has been dropping steadily: ±1.19% in 2009 (92% higher than average) and ±0.74% last year (19% above average). Now, through the first half of 2011, volatility is ±0.56% (10% below average). The following chart tracks the annual average daily volatility for the S&P 500 index from 1950 to 2011. (Note that while the index was implemented in 1957, in order to get the most meaningful/largest feasible data set, we include retrospective data back to 1950.)

The following chart shows the quarterly fluctuations in volatility levels for the S&P 500 (red line) from a year before the crash—the fourth quarter of 2007—to the present, compared to volatility measurements of the Dow Jones Industrial Average (blue line) from a year before the 1929 crash. (We use Dow volatility data for the 1929 crash because the S&P 500 was not around back then.) Also shown in the chart is the average daily volatility level for the S&P 500 (±0.62%, as mentioned previously).

Of course, the fourth quarter of 1929 was just the beginning of an extended period of market decline that persisted for years. Consistent with our research into the relationship of market volatility and performance, volatility levels in the 1930s continued to surge well above normal. Thus, it is encouraging that the trendlines have been diverging for the past two years.

But even if the volatility levels for this past quarter were boring, the macro situation was anything but. With the USA failing to come convincingly out of recession, now involved in three wars, and no solution to structural entitlements obligations or the growing national debt in sight, with the BRIC countries apparently slowing their growth rates, with Europe barely having dodged one sovereign debt bullet with Greece and facing several more (Portugual, Ireland, Italy, and Spain, at least), with unrest in the Middle East spreading…well, in the Intelledgement Macro Strategy Investment Portfolio, we are currently short the dollar and the S&P 500 index, and contemplating adding more short positions. A couple of years’ worth of denial on the part of the market as to how serious things are does not—in our view—obviate the need for investors to maintain some insurance against a sudden and severe downturn, should some bad combination of these various exigencies come to fruition.

Previous volatility-related articles:

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BUY ProShares Short S&P 500 (SH)

Posted by intelledgement on Thu, 16 Jun 11

We expect the exigencies of the election cycle in the USA and the need to limit damage to the banks in Europe will drive another round of can-kicking-down-the-road—raising the debt limit and “rescuing” Greece, respectively—that will temporarily buoy up the markets. However, the options for wallpapering over the cracks in the structure of the system are fewer and weaker than ever, and it is inevitable that investors will eventually cotton on to the seriousness of our situation…and possible that that may happen sooner rather than later. Thus it is prudent to go short here as a risk management tool to limit the potential damage if things fall apart sooner than we expect.

We are going with the Proshares Short S&P 500 (SH) ETF, which seeks daily investment results, before fees and expenses, that correspond to the inverse (opposite) of the daily performance of the S&P500® Index.”

Previous SH-related posts:

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Judging by Market Volatility, All is Well

Posted by intelledgement on Mon, 11 Apr 11

The first quarter of 2011 marked another non-event, volatility-wise. Market volatility did tick up, quarter-over-quarter, from the extraordinarily low 4Q10 reading—the lowest level of volatility in three-and-a-half years—but remained 6% below average. For six of the last seven quarters now, the S&P 500 index has experienced an average daily change of close to the all-time (since inception in 1957) average daily change of ±0.62%.

Volatility hit an all-time high in Q4 2008—breaking the record set in 1929—with mind-boggling peak average daily change of ±3.27%. (That’s a whopping 427% above the average.) For 2008 overall, it was a record ±1.71%, or 176% above average. But since then, it has been dropping steadily: ±1.19% in 2009 (92% higher than average) and ±0.74% last year (19% above average). The following chart tracks the annual average daily volatility for the S&P 500 index from 1950 to 2011. (Note that while the index was implemented in 1957, in order to get the most meaningful/largest feasible data set, we include retrospective data back to 1950.)

We track market volatility because it’s a reasonably reliable gauge of risk levels. Roughly 73% of the time, when volatility in the S&P 500 goes up—when the average annual daily change in the price of the index (up or down) is greater than it was in the prior year—market performance for that year declines compared to the prior year. And when volatility declines year over year, market performance improves 55% of the time.

The following chart shows the quarterly fluctuations in volatility levels for the S&P 500 (red line) from a year before the crash—the fourth quarter of 2007—to the present, compared to volatility measurements of the Dow Jones Industrial Average (blue line) from a year before the 1929 crash. (We use Dow volatility data for the 1929 crash because the S&P 500 was not around back then.) Also shown in the chart is the average daily volatility level for the S&P 500 (±0.62%)

Of course, the fourth quarter of 1929 was just the beginning of an extended period of market decline that persisted for years. Consistent with our research into the relationship of market volatility and performance, volatility levels in the 1930s continued to surge well above normal. Thus, it is encouraging that the trendlines have been diverging for the past two years.

Having said that, it’s important to keep in mind that volatility is not a leading indicator; black swan events engender volatility, not the other way around. Should Italy or Spain default, should Iran attack or be attacked by another country, should rising sea temperatures set off a major extinction event—or any equivalent event occur—then all bets are off.

But for what it’s worth, the current consensus of U.S. investors continues to be that the worst is behind us, and that risk levels going forward are no longer elevated.

Previous volatility-related articles:

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4Q10 Intelledgement Macro Strategy Investment Portfolio Report

Posted by intelledgement on Fri, 14 Jan 11

Summary of Intelledgement’s model macro strategy model investment portfolio performance as of 31 December 2010:

Position Bought Shares Paid Cost Now Value Change YTD ROI CAGR
FXI 29 Dec-06 243 37.15 9,035.45 43.09 11,113.05 0.97% 3.29% 22.99% 5.30%
IFN 29-Dec-06 196 45.90 9,004.40 35.11 10,919.16 7.82% 21.11% 21.26% 4.93%
DBA 13-Mar-08 235 42.50 9,995.50 32.35 7,708.00 17.69% 24.05% -22.89% -8.86%
EWZ 3-Aug-09 165 60.39 9,972.35 77.40 13,614.94 3.75% 3.74% 36.53% 24.71%
GLD 21-May-10 95 115.22 10,953.90 138.72 13,183.34 8.45% 29.27% 20.35% 35.27%
SLV 21-May-10 636 17.29 11,004.44 30.18 19,227.55 41.52% 82.47% 74.73% 148.42%
UDN 21-Oct-10 399 27.54 10,996.46 27.10 10,812.90 n/a -1.60% -1.67% -8.30%
RSX 31-Dec-10 316 37.91 11,987.56 37.91 11,979.56 n/a 22.13% -0.07% n/a
cash 17,049.94 29,492.49
Overall 31-Dec-06 100,000.00 128,051.00 5.32% 3.96% 28.05% 6.38%
Macro HF 31-Dec-06 100,000.00 126,889.20 2.52% 8.10% 26.89% 6.13%
S&P 500 31-Dec-06 1,418.30 1,257.64 10.20% 12.78% -11.33% -2.96%

Position = security the portfolio owns
Bought = date position acquired
Shares = number of shares the portfolio owns
Paid = price per share when purchased
Cost = total paid (price per share multiplied by # shrs plus commission)
Now = price per share as of date of report
Value = what it is worth as of the date of report (price per share multiplied by # shrs plus value of dividends)
Change = on a percentage basis, change since last report (not applicable for positions new since last report)
YTD (Year-to-Date) = on a percentage basis, change since the previous year-end price
ROI (Return-on-Investment) = on a percentage basis, the performance of this security since purchase
CAGR (Compounded Annual Growth Rate) = annualized ROI for this position since purchase (to help compare apples to apples)

Notes: The benchmark for the virtual money Intelledgement Macro Strategy Investment Portfolio (IMSIP) is the Greenwich Alternative Investments Global Macro Hedge Fund Index, which historically (1988 to 2010 inclusively) provides a CAGR of around 13.8%. For comparison’s sake, we also show the S&P 500 index, which since January 1950 has produced a CAGR of around 7.4%. Note that for our portfolio’s positions, dividends are added back into the value of the pertinent security and not included in the “cash” total (this gives a more complete picture of the ROI for dividend-paying securities). Also, the “Cost” figures include a standard $8 commission and there is a 1% rate of interest on the listed cash balance. Finally, the “cash” line for the “Cost” column is reduced each quarter by a management fee (annual rate of 1% of the principal under management). More information about how the IMSIP is managed can be found here.

Transactions: OK, so much for the theory that less volatility invariably begets fewer transactions…when you are positioned for a potential apocalypse and instead everyone drinks the Fed’s Kool-Aid and starts singing kum-ba-ya, some significant maneuvers are called for.

Performance Review: Another modest gain which—for the second consecutive quarter—failed to keep pace with the market. We were up 5%, which normally is good, but we lost to the S&P 500 index (+10%) by five points. We did beat the macro hedge fund index (+3%) by two points.

Tactically, we ditched our index shorts for losses in November in the face of a second round of quantitative easing from the Fed. This $600 billion flood of money may not do much to heal the economy—in our view, it hurts us by propping up zombie too-big-to-fail financial institutions whose existence exacerbates structural problems and impedes recovery—but combined with continued low interest rates it is driving investment funds into the equities markets. Under those circumstances, being short the market may be philosophically appropriate but it sure generates a lot of red ink in a hurry. We also sold our high-grade corporate bond ETF (LQD, for a tiny loss) due to concern that QE2 will result in higher interest rates and took a short position on the dollar (UDN) due to concern QE2 will weaken the greenback.

As the year ended, we added the fourth BRIC component, Russia, to the portfolio for the first time via the Market Vectors Russia ETF (RSX). The other three BRIC ETFs overall were all up in the quarter, though all trailed the market: India (IFN, +8%), Brazil (EWZ, +4%), and China (FXI, +1%). The commodity ETFs outperformed on average, with SLV (silver) the star of the port at +42%, DBA (basket of agricultural commodities) +18%, and GLD (gold) +8%. The three index short ETFs had a tough quarter, of course: DOW (DOG) -11%, NASDAQ (PSQ) -14%, and S&P 500 (SH) -11%. Our newly acquired shot dollar fund (UDN) was down 2% in a month-and-a-half.

For 2010 overall, we trailed both both the macro hedge fund index and the S&P 500 index, +4% for us compared to +8% for the hedgies and +13% for the market. DBA was +24%, IFN +21%, EWZ +4%, and FXI +3% for the year. Although we only held them for part of the year, SLV was +75% for us and GLD was +20%.

We are now 39 points ahead of the market in terms of total return-on-investment: +28.1% for us and -11% for the S&P 500 in the four full years since the inception of the IMSIP at the end of 2006. This puts us just slightly ahead of our benchmark, the GAI Global Macro Hedge Fund Index, which is +26.9%. In terms of compounded annual growth rate, after four years IMSIP is +6.4%, the GAI hedgies are at +6.1%, and the S&P 500 is -3%.

4Q10 Reprise: Here are some topical 4Q10 links, organized by subject:

BRICs

Deep Capture

The Dollar

Eurozone

QE2

Analysis: Well our portfolio looks a bit different now (36% emerging markets, 31% commodities, 8% short the dollar, and 25% cash) than it did a quarter ago (27% emerging markets, 26% commodities, 9% bonds, 26% short the market, and 12% cash). Three months ago we were 26% short and now we are only 8% short…but that doesn’t mean we think things are looking up.

There is no arguing the fact that one thing is looking up, however: the market. Volatility—how much the market moves up or down—is a good measure of perceived risk: as investors perceive the market as more risky and uncertain and tend to sell, prices fall and volatility generally rises. But volatility has been declining sharply since the 2008 crash—as market values have risen—and in 4Q10, volatility for the S&P 500 fell below the 50-year average for the first time in over three years. Evidently, investors collectively believe that the risk of something bad happening has been reduced.

We demur.

We see giant multi-national banks that are still stuffed with toxic assets and riding for a fall, a USA real estate market with property values that are still overvalued, developed economy consumers who are still underemployed and overleveraged (especially in the USA), fast-growing emerging market economies that are by their very nature vulnerable to bubbles, and material sovereign debt risk. And, unfortunately, regardless of whether we put Republicans or Democrats in control of the government, our political leaders seem invariably intent on treating the symptoms of our illness, avoiding challenges to any entrenched elites, and hoping and praying they can muddle through with no ultimate crisis on their watch…even at the cost of leaving us with fewer resources to deal with our structural problems when we finally run out of effective delaying tactics.

Be that as it may, central banks in general are working in concert to hold down interest rates and expand liquidity in order to “stimulate” the economy. The Fed in particular is dispensing out $600 billion of financial Kool-Aid with their latest quantitative easing scheme (“QE2”), and funds are flowing into equities, driving market prices higher. Between the value distortions foisted on the market by the manipulations of the central banks and the machinations of the high frequency traders constantly threatening us with a flash crash or worse, the investing waters that appear so calm on the surface are actually quite roiled.

Conclusion: We are in the eye of the storm, and most everyone is sipping the QE2 Kool-Aid and singing Kum-Ba-Ya. Accordingly, it is time to make love, not war…but we remain prepared for both.

We now hold all long emerging market ETFs for all four BRIC nations in the portfolio: Brasil (EWX), Russia (RSX), India (IFN), and China (FXI). We believe that in a deleveraging environment, the economies that are still growing will fare far better than those that are not and we expect that non-dollar-denominated assets to do better than those tied to the greenback. Thus these emerging market long positions will be the last we will surrender if and when things get really dicey.

In the face of QE2 and the continued runup in the price of equities, we dumped our index shorts and—out of concern for possibly rising interest rates—our corporate bond fund. So far, the combination of continued slack consumer demand and Eurozone sovereign debt risk has kept the dollar strong, but against the likelihood that its decline will resume and even speedup, we added the short dollar ETF (UDN). We also still have three long commodity plays: the agriculture ETF (DBA) and precious metals ETFs for gold (GLD) and silver (SLV).

Although we are mostly long now in congruence with the prevailing love fest, we remain vigilant as to a potential turning of the tide. In times of heightened uncertainty, valuations can fluctuate wildly and the preservation of capital takes precedence over meeting any target ROI. To that end, when the phantasmic prospect of sustained economic growth sans serious deleveraging fades—that is, when the Kool-Aid runs out—we are prepared to unload our long positions, possibly excepting the precious metal funds, and short the indices again.

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