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Tuesday, January 02, 2007

Time for a Hedged-Sector Strategy

To end 2006 without a single “buy” recommended sector raises all kinds of red flags for me notably that our alpha analytic is picking up on broad-market weakness. This is by no means a trend, although it could be the early stages of a much needed correction. If it is indeed the beginnings of a short-to-intermediate term reversal, adjusting allocations inside a portable alpha portfolio prior to any big swings, or even early in the trend, could put you well ahead of the curve for 2007.

With that in mind, I really suggest investors design a hedging strategy that can be quickly implemented in their portfolios. As bearish as I am for the short-term, I still believe it’s premature to allocate into inverse funds or short any equities. The one constant over the last few months is that the market has defied convention, and I’m not brazen enough to suspect our analytic is immune to the discrepancies of the current investment environment. However, investment discipline is such a fundamental component of my strategy that I cannot simply ignore the model either. As such, all I can do now is walk the line and prepare to make adjustments as quickly as possible if and when they’re needed.

This doesn’t have to be a complicated exercise in portfolio modeling. In fact, I’ve written twice about how investors can adopt long / short equity and sector strategies fairly easily using AAS. Looking at the table below, I feel that a hedged-sector strategy makes the most sense, especially since there is a large percentage of “sell” recommended sectors at this time. Obviously this ranking could change, and I wouldn’t allocate any more than 5% to a short / inverse position until we see further weakness in the market and more “sell” recommended securities.

Short-Term Technical Indicators

Investor Sentiment

Long-Term Market Model – Bearish since December 8th.

Asset Allocation – 75% long within the actively-managed, alpha producing portion of the overall portable alpha portfolio.

Beta Exposure and Portable Alpha Generation
Date = Date of AAS “Buy” or “Short/Sell” Recommendation

Top Rated Major Market Derivative – NYSE 100 (NYC 11/6/06)

Top Rated Style-Box Derivative – iShares Morningstar Large Cap Value (JKF 11/29/06)

Top Rated Sector Derivative – No “Buy” recommended sectors

Today’s Top “Buy” Recommended Stocks

RTI International Metals Inc. (RTI 10/11/06)

Veritas DGC Inc. (VTS 7/28/06)

Robbins & Myers Inc. (RBN 8/10/06)

NBTY, Inc. (NTY 12/5/06)

Volt Information Sciences, Inc. (VOL 11/6/06)

Deckers Outdoor Corp. (DECK 9/7/06)

The Ryland Group, Inc. (RYL 11/14/06)

Joy Global Inc. (JOYG 11/13/06)

Lexmark International Inc. (LXK 9/21/06)

Jo-Ann Stores Inc. (JAS 9/1/06)

Today’s Top “Sell” Recommended Stocks

CONSOL Energy Inc. (CNX 12/15/06)

Chico’s FAS Inc. (CHS 12/6/06)

Intuitive Surgical Inc. (ISRG 12/19/06)

Whole Foods Market, Inc. (WFMI 11/2/06)

Chicago Mercantile Exchange Holdings (CME 12/18/06)


  • Could you expound on what a "correction" is and why we need one? Is there a magnitude of change, from high to low, in the index that must be reached in order for a "correction" to be called? Was the May-June –8.1% high to low change, and the double bottom in June and July, a "correction" and if not, why not? If so, why do we need another one?

    By Blogger NO DooDahs, at 10:35 AM  

  • Bill,

    The industry defines a “correction” as a negative movement of an index, be it stock, bond or commodity, of at least 10%. I tend to define a correction as closer to 8%, but I don’t have a strict rule in mind. Normally they occur because investors lose faith in the economy and/or corporate earnings. We’re currently seeing evidence of that via the breakdown of market technicals as well as the bearish posture of our market model.

    I feel corrections are needed to interrupt a prolonged up-trend and allow market participants to digest the underpinnings of the market. It also allows for resistance and support levels to be more clearly established.

    I agree that a correction took place from May to June, but it was the capitulation of the up-trend that started in October 2005.

    By Blogger Justin, at 3:16 PM  

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