Legacy Funds

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Don’t Try to Pick a Top in this Market

OK, now that I have your undivided attention, let’s get to work, we have a top to try to pick. What, did you think I was going to let you down? I will let you be the judge of that. Besides it wouldn’t be any fun if we didn’t at least give it a shot or two or three — but, and that is a very big BUT, only if we manage our risk while doing so.

So what do we have so far. The SPY still hasn’t filled its gap from Oct 6 of last year at 106 to 108, but is getting closer almost by the day. Again, no guarantee it will do so but it has come too far for too long (or depending on who you ask too fast) to just ignore it and tank here — though it is always a possibility. If that target is met then possibly after a brief pullback the SPX makes a run for 1100 to 1120 which coincides with the 50% retracement I have covered in previous posts. That will likely be it, but never any guarantees. This is why we will have scenarios along with predetermined risk points to get out before we even take a position. As always I will be lazy and let the charts do most of the talking for me — and if you don’t speak chart, then stick around here long enough and you will surprise yourself when even a traffic light starts to resemble candlesticks and moving averages. Let’s check the SPX on a weekly with the 50% retracement:

spx

You can see the 50% retracement at around 1120, and the 89 week moving average which corresponds roughly to the 20 month moving average. Many resistance levels above. OK, let’s see how the dollar is holding onto $76 support:

usd

It is hanging for dear life, but $76 should be good support, and odds are the bottom for now, which means we are very close to the top on SPX — 1080 to 1120. Now a lower risk way to position short is to wait until the SPX breaks the uptrend line from the March bottom. You won’t catch the top (yeah I know you won’t have bragging rights, but the risk doesn’t make it worthwhile) but you will have a better risk profile and avoid most of the decline:

spxd

If nothing else, this is not a time to be complacent in the market. Keep your eye on the uptrend line.

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September 17, 2009 Posted by | Legacy Funds | , , | 2 Comments

Market Signs

The market is always giving hints to those that are astute students of history.  What has the market been trying to tell us lately?  The biggest sign has been the correlation of traditionally uncorrelated assets.  There has been an unusually high correlation between global equity market indices and commodities.  Surprisingly this has also included gold.  During the rally from March and the correction over the past few weeks, most asset classes — US equities, international equities, commodities including oil and gold, real estate, and many others — have moved in tandem both on the upside and downside in all time frames.  The moves have been inverse the US dollar.   The charts are currently placing high odds on a correction in these asset classes and a rally in the dollar.  Technically, the odds are that the S&P will correct to 810 to 820 area over the next month or so.  At that point careful analysis will be crucial along with risk management to cover shorts and position long for a potential rally to the 1000 or so area.  At that point bullishness will be at high levels and raising the odds for a drop to retest and most likely new lows on the S&P and commodities along with a rally in the dollar, later this year or early next year.  Sounds like I just let you peek into a crystal ball?  Not so fast.  Although this analysis is based on numerous charts, models, cycles, pattern recognition, number crunching, macroeconomic factors, and the list goes on, a change in certain variables will change sometimes drastically the future roadmap.  That is where risk management comes in place — one plays the mathematical odds but is prepared to quickly cut losses when the variables change.  For example, fibonacci calculations (Fibonacci was a brilliant Italian mathematician) are used to determine the retracement for the S&P in the following weekly chart which shows although we have had a great rally off the low, the S&P hasn’t even retraced 38% of the decline:

sc

That is where we place odds that even though the S&P is correcting now possibly down to 810, we are likely to rally to 1015 or so afterwards.  We can zoom into a daily chart using the last high and March low to see likelihoods of targets for this pullback, and this is how we get around 810:

sc

Then we see that if 810 fails, our last line of support is about 780 after which a retest of the lows at a minimum would almost be a given.  Let’s not worry about that for now but manage our trades and risk in accordance to the highest probability set-ups.  Remember this is for informational purposes only and not a recommendation to buy or sell any securities.

July 9, 2009 Posted by | Legacy Funds | , , | 11 Comments

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