The Risk Manager Report - October 17, 2012October 17, 2012 @ 12:48 PM EST
The first step to successful investing is to identify the Market's "Big Picture" Environment in terms of risk versus reward. This is critical to success over the long term because different "environments" require different strategies. For example, in Bull Markets the objective is to maximize returns, while success in Bear Market Environments demands an emphasis on capital preservation. By reviewing the Environment every single week, we are assured that we will remain "in-tune" with conditions and not be surprised by environment changes.
At the center of our risk management work are our Exposure Models (see below). The models detail the current conditions for the Trend and Momentum of the Market and help guide us to the proper exposure to market risk.
Executive Summary For October 17, 2012
Stocks have come roaring back this week after selling off all last week. Sentiment surrounding Spain has improved dramatically due to the liklihood that Madrid will seek a line of credit from the EU/ECB in the near future. Ratings agency Moody's confirmed that Spain's credit rating would stay above junk on Wednesday, which gave stocks an additional boost. Besides Spain, improving economic data here in the U.S. has also lifted sentiment as Housing Starts & Building Permits, the NAHB Homebuilder Confidence Index, September Retail Sales, Industrial Capacity & Utilization, and CPI all posted better-than-expected figures. The S&P 500 has surged up to the 1460 area, where it will face a critical test of resistance. The bears still have some ammunition given the murky-at-best earnings picture thus far. Wednesday's afternoon action and Thursday's follow up should give us a decent idea of where stocks are headed in the short-term.
Risk Management Models Summary
Our disciplined approach to managing risk is designed to keep our Portfolios "in-line" with the major trends of the market. We strive to keep portfolios mostly invested during Positive Environments and to Reduce Exposure to Market Risk during Bear Markets and severe corrections.
We focus on our two proprietary Risk Management System Models. Both systems are robust market models incorporating the entire spectrum of market indicators. In short, our disciplined systems act as our primary guide to exposure to market risk. (For more details on each risk management system, see model summary below)
Current Readings - Risk Management Systems
Graduated Risk Management System
Recommended Exposure to Market Risk (Short-Term): 80.00%
Long-Term "Big Picture" Trend Management System
Current Signal: Moderately Positive
Graduated Exposure System (Intermediate Term Time Frame)
The Graduated Exposure Risk Management System is our guide to determining the appropriate exposure to market risk.
The system is a "Model of Models" comprised of of 10 independent Models. Each model includes has proved successful in its own right and gives separate buy and sell signals, which effects a percentage of our exposure to the market. Our Trend models (Short-Term Trend, Intermediate Term Trend, Trend & Breadth Confirm, and Sentiment) control a total 40% of our exposure. The 3 Momentum Models and 3 Environment Models each control 10% of the portfolio's exposure to market risk. The model's "Recommended Exposure to Market Risk" reading (at the bottom of the Model) acts as our longer-term guide to exposure to market risk.
Long-Term "Big Picture" Trend System
Designed for Long Term Investors who do not wish to make a lot of adjustments to their holdings (i.e. 1 to 2 adjustments per year), our "Big Picture" Trend System focuses on the overall Environment of the market. The goal is to identify the "Major Trend" of the market and keep portfolios on the "right side" of the market's current cycle. The Model includes hundreds of indicators (both long term and short term) in the areas of "the tape," monetary conditions, investor sentiment, economics, valuation, overbought/oversold conditions, and industry leadership.
When the Environment is rated as "positive" (about 32% of the time) our studies have shown that the S&P has advanced at a rate of +38.4% annually. However, when a negative environment exists (about 20% of the time) the S&P loses almost -21% per year. The Model recently switched to a "Buy" signal on July 6, 2012 in response to the model registering a positive condition.
"Big Picture" Trend System
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