Sunday, July 29, 2007

Defensive Strategy Update

Perhaps I'm better at thinking about defense when I'm no longer invested defensively.

This week I discovered a great defensive pairing right under my nose: The Currency Harvest fund (DBV) and long-term US Treasuries (TLT). It's preferable to have defensive funds whose movements aren't correlated day-today, and it's ideal if they are actually anti-correlated. Since it was launched last year, DBV has been about as anti-correlated with TLT as one could possibly hope for.
As the above chart shows, one could have purchased the DBV+TLT pair at almost any time in the last 10 months without suffering any significant short-term loss. Each one of the "D"s on TLT's chart is a dividend payment which amounts to a 5% annual yield, so the average gain of the pairing is 10% (16% DBV with 4% TLT dividends) in less than one year.

At this point I'm not sure exactly why they are anti-correlated, since DBV doesn't place any bets on the U.S. dollar or U.S. bonds. It may simply be that any time global investors move out of U.S. bonds, they move in to bonds in other high-yielding countries - and vice-versa. Whatever the reason for this relationship, the DBV+TLT pairing will be the core of my next defensive position.

Wednesday, July 25, 2007

CSD is disappointing

It was fun while it lasted, but CSD is no longer beating the market. In fact, since June 19 it has actually underperformed the S&P 500 by 2%. I'm officially removing CSD from my portfolios.

There are two lessons here: (1) don't trust any individual stock fund for defense, and (2) don't rely on a specialty fund for long-term gains based on a few months of outperformance.

Friday, July 20, 2007

Gold and BEARX

It's officially defensive-fund season, and this has me thinking about the Prudent Bear fund (BEARX) again. Part of the strategy used by BEARX is to invest in gold-mining and related companies, since gold usually increases in value during economic downturns. These long positions are part of the reason that BEARX has actually been able to go up in value during slow market rallies.

Carl Swenlin on his Decision Point website points out that gold has been on a huge bull run since 2001, and may be poised to crash in the not so distant future. That run-up in gold has obviously helped BEARX over the last few years, and if Mr. Swenlin is right about the upcoming gold crash, then BEARX's ability to rise during bull markets may be coming to an end.

All in all, these concerns are enough to keep me out of BEARX. For the time being, I no longer recommend BEARX as a defensive fund.

Fame and fortune - actually just fame.

Yesterday I made a little news on the Motley Fool investment website. (fool.com) I was winning a summer stock-picking contest with over 1000 people participating, and the Fools featured me and my modest blog that I'm keeping on their site.

Saturday, July 14, 2007

Correction over - going defensive

The S&P 500 has closed at an all-time high of 1552, ending a strange little correction that began in early June. My indicators tell me that the market is vulnerable to a correction now, so I've changed my market stance to "defensive."

Back-testing returns

Leveraged 2x funds have been available for about a year now (June 2006), so it's time to back-test my current method to see how well it's worked. The market was at the bottom of a correction in June '06, a time to buy 2x leveraged funds. The S&P and investor sentiment both returned to their trend lines in November, which was a signal to change back to defensive funds.

The next correction began in February of this year, as indicated by the dip below the November price of ~1400. That was the second signal to buy 2x funds. By May the market had returned to its upper trend line, signaling a return to defensive funds.

The most recent correction followed quickly in June, dipping below the May price level of 1505 and returning (intra day) to the market's upper trend line on July 13.

The following table shows the returns using the most conservative 2x fund, SSO:

DateBuySellCumulative
Return
Buy and
hold S&P
June 16 '06SSO-0%0%
October 26 '06SHYSSO20%10%
March 2 '07SSO
SHY22%10%
April 25 '07CSD+DBVSSO40%19%
June 7, '07SSOCSD+DBV45%19%
July 13CSD+DBVSSO56%24%