Legacy Funds

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Is technical analysis similar to reading tea leaves?

Many proponents of buy and hold investing will try to degrade the usefulness of technical analysis.  They will find all sorts of reasons it can’t possibly work or even wrongly state that technical analysis tries to predict the future.  To be effective, all technical analysis does is build on technical indicators that for the most part will be based on price and volume.  These are the market’s footsteps.  On a chart it will provide a visual of where that security has traded.  Will that tell you what is going to happen in the future, yes and no.  What kind of answer is that, ok, let me explain.  Many times if a trend has been in place on a certain time frame, it will continue until it doesn’t.  OK, still not being very clear, but bear with me.  If the trend continues, you would be positioned to hold on and continue riding the trend.  If however that trend changes, you have a line in the sand, actually preferably on a chart where you will take your profit or cut your loss and possibly even play the other direction.  The more indicators that provide confirmation of direction, the stronger the signal.  Take for example the financial situation of a person that is late on a payment for a small bill.  This alone wouldn’t indicate financial hardship nor predict the future but it is a concern.  Well, what if a few weeks later that person is late on paying their utility bills.  This would start to raise some flags.  If this person ends up being late on their mortgage, then it is a pretty good bet this person is eduring financial hardship.  The market gives the same signals as the financial hardship example.  The more technical indicators provide a signal in the same direction, the stronger the confirmation for that direction.

May 25, 2009 Posted by | Legacy Funds | | Leave a comment

Long term indicators delineating bull and bear markets

Sometimes distinguishing between a bull or bear market is as easy as a quick glance at a long term chart.  A very straightforward moving average is an 80 week moving average (roughly corresponds to a 20 month moving average).  You can go to stockcharts.com and plot this yourself using their free service.  Basically for starters, you want to plot an 80 week moving average for the S&P 500.  It would look something like this:

SPX 80wma

Can it be that simple, or was this just a coincidence?  OK, let’s try the last bear market to see if it would have saved you from most of the downside and managed to get you back in to participate close to the start of the bull market that followed:

SPX 80wma 00-03

Feel free to experiment with other time periods on your own.  Let’s try 1998-2001:

sp 80wma 98-01

Hopefully by now you are starting to get convinced that something this straightforward can help reveal the long term picture.  There is no forecasting involved, just simply following the market.  Obviously, there are times when getting out and getting back in is going to result in lagging the security if it continues to rise, but that is a small price to pay to avoid the large declines.   For example, in this chart covering 1990-93, you do avoid the drop but may have to get re-invested at a slightly higher price.

SPX 80wma 90-93

Anyway, hopefully by now you are getting the picture(!) and can see that technical analysis does not have to be overly complicated.  Here is a chart going all the way back to the early 1980’s, again same thing:

.SPX 80wma 1980s

Obviously, for better trading results, one can continue to decrease the time frame to get better precision.

Shorter time frames will be covered in future blogs.

May 17, 2009 Posted by | Legacy Funds | , | Leave a comment

How Did Things Get so Bad?

If I stated that we have been teaching generations of MBA students economic garbage, I would probably be taken out to the shed and shot.  For better or worse, my background being in mathematics and computer science, I have been spared, but at the same time I end up stepping on the toes of those that were not.  So in the interest of self-preservation and getting tired of trying to show them the “light”, I am going to shield myself behind John Mauldin and quote from his weekly e-newsletter titled “Back to the Future Recession“.  He started by telling the story of how Rob Arnott recalls standing in front of 200 academics — professors in schools that teach economics and asking them, “How many of you believe in the efficient market hypothesis?” Something like two or three raised their hands. “How many of you teach it?” All of them raised their hands.  So John Mauldin continues:

We have been teaching generations of MBA students economic garbage [Thank you John for saying it for me.  Further down, John continues]…. poor Harry Markowitz’s Modern Portfolio Theory got so twisted beyond recognition. I remember being with Harry Markowitz. I gave a speech at a big hedge fund conference about five years ago, talking about why Modern Portfolio Theory was not going to work. The next year it was the 50th anniversary of Modern Portfolio Theory, and they brought Harry out to speak. He of course talked about why it was. I remember meeting him in the hall of this big hotel. And I asked him a couple of questions; I forget what they were because he so staggered me with, “Oh, you missed the whole concept of correlation and assets. Correlations change.”

And he started drawing quadratic equations in the air. But because I was standing in front of him, he was drawing them backwards so I could see them. I mean, this guy is absolutely brilliant. But he’s right, you should have a diversified portfolio of noncorrelated assets; but as John was showing yesterday, correlations in a crisis all go to one.

What money managers did was to create models that said, “If you do this, diversify your portfolio like this, and here are all your noncorrelated asset classes — see what happens? You get long-term positive results.”

And they would project that into the future. But they didn’t project crises, when correlations go to one. Modern financial theory only works in models if you assume a few things that are patently not true in the real world. So we trained a generation of managers and investors that they should buy 60% stocks and 40% bonds. Yet for the last 40 years, bonds have outperformed stocks. Where was that in the model?

Well, we can go back to the 19th century and see it. But we created a trend from 1944 to 2000 that said we were going up, and we trained a generation to believe they could model, and they did it. They modeled garbage, and now we’ve wiped out a generation of retirement income. I could go on and on, but it’s nonsense.

John Mauldin does go on, and makes for interesting reading, and those curious are encouraged to read further.  However, what needs to be learned from this is the importance of correlations.  Correlations change and worse in a crisis they all go to one.  That is what happens in the real world, and that is what must be modeled in the academic world.  So relying on a diversified portfolio of non-correlated assets does not guarantee long-term positive results unless those assets remain non-correlated especially at times of crisis, when we so desperately need the non-correlation.  Bonds are not necessarily that asset class either, as I suspect that is the next asset class to blow up — can only hope we have some time left on the clock yet before that happens.  The only asset class, if you can give me the privilege of even calling it that, which is not going to correlate by definition is an inverse.  Hence, we deduce that in order to be fully diversified both in the academic and the real world, we must allocate across multiple asset classes both long and just as importantly short.


May 9, 2009 Posted by | Legacy Funds | , , , | Leave a comment

ETF Panels

This past Thursday I was a panelist at the 5th Annual ETF Global Awards & Dinner Workshop in NYC.  It was a highly-charged event; and while witnessing first hand the whiff of innovation that was in the air, one can easily forget the carnage we have been through in both the market and the economy for over a year.  My panel was “How and When to Use Leveraged ETFs and Options” and ended up sharing a lot of similarity to my panel at the Inside ETF Conference in Boca Raton back in January titled “All About Shorting and Hedging” — a topic you will soon learn is near and dear to me (and helped keep the money I manage from participating in last year and this year’s carnage, but I digress).  At both events, the questions and concerns were the performance of the double inverse ETFs and why they deviate from their benchmark on anything longer than a daily basis.  Very simply, they are only designed to match the benchmark on a daily basis.  There have been discussions by the providers in putting out some ETFs with a longer rebalancing period, but is that really what one wants?  Let’s take for example a quarterly rebalancing for a triple leveraged financial ETF.  Let’s hypothetically (or don’t we just wish it was hypothetical) assume that the financial sector dropped 33% in a quarter, then your triple leveraged ETF is now worth zero.   These are very powerful tools that give us the “ability” to make money in down markets.  However, no different than trading in general, actually even more crucial when using these tools, one must have the skill and knowledge to profit.  When it comes to the double inverse ETFs let alone the triple leveraged, not understanding the mathematics behind inverse compounding and the volatility path the ETF takes can result in losses, sometimes significant, even if one was right on the direction.   Making profits in the market is never easy, except maybe on some rare occasion.  Many times though, that only serves to get one to become complacent just in time for the market to take the profit back and then some.

May 2, 2009 Posted by | Legacy Funds | , | Leave a comment