Saturday, February 14, 2009

This Hodar guy is nuts!

I know what some of my readers are wondering: Is my GRZZX investment a good idea, or am I completely crazy? Nobody can be 100% certain of what the market is going to do, so I've never used language on this blog that specifically recommends any investment to anyone. I just report on where I'm putting my money and then I let time be judge. However, I'm going to break two rules for the first time by (1) suggesting some strategies for readers and (2) talking about investment strategies that I'm not actually using.

I realize that some folks are anxious about making the wrong investment at the wrong time, such as staying in/getting into stocks before another crash, or conversely following my lead and buying GRZZX right before a huge rally. First of all, remember that any money you've lost in this bear market is water under the bridge, and the worst attitude to have right now is "I've got to get it all back!!!" You'll make better decisions if you put the past behind you and focus on what's coming. My advice to anyone losing sleep over the stock market - if he doesn't trust my market-timing skills - is to hedge or diversify.

Hedge

Any investor who prefers to own stocks in individual companies, but is afraid of a general stock market crash, can balance his stock positions by buying a similar amount of a bear fund like GRZZX or SH, which moves in the opposite direction of the market. This way a portfolio is shielded against a crash, and will only gain or lose money depending on how well the individual stocks perform relative to the market. The downside of this method, as with any hedge, is that it won't necessarily benefit from a rally, because the bear fund loses in that case. Keep in mind that general stock funds like SPY or index mutual funds can't be hedged with GRZZX or SH, because the price motions will just cancel out, meaning you might as well be in cash.

Diversify

My whole strategy is based on not diversifying, so I may not be the best person to pontificate about it. Nonetheless, I do have a few suggestions that might be useful. My definition of diversifying goes well beyond owning a group of stocks; rather, it makes sense to dip into a wide range of investment types in order to minimize the risk from any one part of the economy. Fortunately there are some ETFs and mutual funds out there that make it extraordinarily easy to invest in a broad range of assets from around the world.

In the table below I've assembled a portfolio that I think achieves the maximum diversification with the minimum number of funds.

AgeVT
World Stocks
BND
U.S. Bonds
BWX
Non-US Bonds
RYMFX
Futures
3060%20%10%10%
4050%30%10%10%
5040%40%10%10%
6030%50%10%10%
Retired20%60%10%10%

  • VT: Vanguard Total World Stock ETF. This exchange-traded fund (ETF) owns stocks from all of the major economic zones of the world. The breakdown is as follows: 47% in North America, 27% in Europe, 15% in the Pacific region, and 10% in emerging markets. All told, this represents roughly 80% of the world's stocks in one fund. (I will remind readers that I predict VT is poised to fall along with every other stock fund; that's why I'm in GRZZX right now. The above portfolio is for those who don't want to time the stock market.)
  • BND: Vanguard Total Bond Market ETF (U.S.). This ETF owns treasuries and other government debt, corporate bonds, and municipal bonds. It's got it all.
  • BWX: International Treasury Bond SPDR. This ETF owns treasury bonds from foreign countries. It's a good hedge against inflation of the dollar, but it will be more volatile than the U.S. bond fund.
  • RYMFX: Rydex Managed Futures Fund. This is the only mutual fund in the group, the only hedged fund I recommend, and the only one that uses derivatives. It tracks a wide range of investments, including agricultural commodities, energy commodities (oil), precious metals (gold), major world currencies, and US treasury bonds. The fund places bets either for or against each one of these commodities based on recent price trends, meaning it aims to go up in price whether commodity prices are rising or falling. Because of the phenominal diversification, one or two mistakes in divining price trends won't devastate the returns.
The following chart demonstrates why I like the idea of including a wacky fund like RYMFX in a diversified portfolio:

In the last two years, U.S. stocks (SPY), foreign first-world stocks (EFA) and emerging markets (EEM) have all collapsed, bonds (BND) have been characteristically flat, and oil (OIL) has been a gut-wrenching roller coaster ride - yet RYMFX ended up ahead of all of them. Here's a close-up of the chart without OIL, showing the relatively steady performance of RYMFX that has resulted in a 15% gain in 24 months.

There will obviously be occasional hiccups for this fund as there are with any investment, but its lack of correlation with other investments and its broad diversification make it too compelling for me not to include it. If the derivatives market runs into trouble, then this fund could really suffer, which is why I would never recommend letting it be more than 10% of your portfolio.

I will finish by reiterating that I have no plans to purchase any of these investments myself, because I'm convinced that I can do better by riding the next leg of the bear market with GRZZX.

8 comments:

Jen said...

OK - Here's a question borne of much ignorance. What do you recommend to hedge against inflation? I've read a little online and people are recommending diversification in "real" assets, such as real-estate, commodities, etc... If we have a great credit-rating and if we could secure a low-interest loan on a rental property, is that something you think is reasonable? Obviously, I'm anticipating future dollars won't be worth as much as today's. Might we also get some sort of tax break out of the stimulus package? I realize almost nobody knows what's in the package - just wondering if you've heard anything regarding real-estate.

Jody said...

Inflation and real estate are both outside of my primary field of study, which is timing the stock market, but I'll share some thoughts here.

It depends on what kind of inflation you're anticipating. If the US dollar is going to suffer inflation while other currencies remain relatively stable, then the best bet is to send your dollars overseas: Buy foreign stocks instead of US stocks, foreign bonds instead of domestic, and foreign real estate instead of American.

On the other hand, if you anticipate inflation all over the globe, then the general strategy I recommend is to not hold money. All other things being equal, real estate would probably be a good bet, but I have no idea when or at what level prices are finally going to stabilize and turn around. However, if you're thinking of renting out for the long haul, then this may be a great time to start. Banks are reluctant to lend money right now, so the pool of potential renters is probably growing.

I've also thought about a worst-case scenario that would not be so good for landlords. If the economic downturn becomes sufficiently severe, renters may be forced to change their living standards and put up with more roommates to save money. That means fewer apartments rented for the same number of renters, and more empty rentals.

Gold is one of the first things people talk about for hedging inflation, but one has to be careful here because it's difficult to predict the emotionally-driven price swings. I would advise any new gold investors to buy in small quantities over many months. The gold ETF [symbol: GLD] actually owns real slabs of gold, so I think it would be the easiest way to start.

wooderson316 said...

There is a lot of good research that shows that gold is not an inflation hedge. That is to say the price movement of gold has no correlation to what inflation is, positive or negative. Gold is, however, correlated with uncertainty.

Oil appears to be a much better hedge for inflation.

TIPS are of course the best inflation hedge and right now it is amazingly cheap to buy this hedge. Inflation has to average below 0.5% over the next 10 years for TIPS to be a bad investment.

Tim said...

Jody Excellent Post...

On behalf of myself and others I have referred to the page, I would like to thank you for your time and analysis that you put into this blog.

Any Treasury Inflation Protected securities (TIPS) funds that you recommend? Thanks

jeff said...

Jody,

With the recent further declines in the markets, I am curious whether your indicators are more or less pessimistic about a possible market turn than they were a month ago. In other words, is that elusive market bottom falling farther and farther down?

Thanks....jeff

Jody said...

Jeff,

Yesterday's decline only slightly reduced the optimism. In addition, everywhere I look today I see people predicting that we're at the bottom, including discussions on fool.com, B.I.G.'s blog and others. I realize that these don't constitute a quantitative assessment of sentiment, but they are consistent with the numbers. This means we are not at the bottom.

Anonymous said...

Hi Jody.. a little off topic I guess, but I am baffled as to why people are dumping GE's stock. Seems very cheap now.. but then again it also did a few dollars ago. I can understand that all stocks are in a downward trend right now, but this company has seemed to have gotten beaten up a lot more than other industrials.

wooderson316 said...

To Anonymous:

Fear makes people act for self preservation. In response to a stimulus, the emotional centers of the brain are always activated prior to the logic and reason centers. In some cases the logic and reason portions of the brain are not activated or simply can not overcome the fear response.

Behavioral finance, and it supports technical analysis in spades.