It’s Ugly Out There

Wow. What a week. Like the market all of my core health indicators got hammered. They are now all deep in negative territory. I’ll let the chart speak for itself.

One thing of note is that my market risk indicator is now signalling. This changes the volatility hedged portfolio to 50% long and 50% hedged with mid term volatility (an ETF/ETN like VXZ) or dynamic volatility (XVZ).

For official tracking purposes I use XVZ, but the instrument is thinly traded so it introduces problems in actual portfolio management. First is that thin trading means it is difficult to fill large trades at a good “market” price. Second is that in a swiftly declining market the bid may as much as 20% below the market so you’ll have difficulty getting out of the position (or rebalancing) when pure panic has set in. As a result, I personally use mid term volatility like VXZ instead of dynamic volatility. But, since the back test has been done with XVZ I’ll continue to use it for official tracking purposes… for now. At some point I’ll reevaluate and decide if VXZ should be used instead. As always, you need to pick a hedging instrument that you understand and fits your personal risk tolerance.

With the signal from my market risk indicator it changes the hedge for the Long / Short portfolio from a short of the S&P 500 Index (or the ETF SH) to mid term volatility (VXZ). So the new Long / Short portfolio allocation is now 50% long high beta stocks and 50% hedged with VXZ (or a similar instrument).

From a Dow Theory perspective we’re at a critical point. If the Dow Jones Industrial Average (DJIA) closes below 15666 we’ll be officially in a long term bear market. I’ll write more about that if/when it happens.