Targeting Risk

“The best investors do not target returns; they focus first on risk.”

-Seth Klarman

 

Seth Klarman is the founder of Boston based Baupost Group. While I have never met the man, some of his risk management conclusions continue impress me from afar. He is one of the few large scale money managers who believes in tactically raising his cash position above 50%.

 

Yesterday, with the US stock market hitting my immediate term TRADE target of 1120, I raised more cash in the Asset Allocation Model. With a 68% position in US cash, I am at one of the highest cash positions that I have carried since the 2008 crash. I don’t call this being short the market. I simply call this Standing Still.

 

I’ll keep this holiday note short. This morning here is a list of some of the risk management levels that have prompted this low-risk decision:

 

1.       The US Dollar Index has put in an immediate term bottom and is starting to breakout from its intermediate term TREND line at $76.31

2.       The Yield Spread (10- 2-year yields) is trading at its widest margin EVER this morning (284 basis points) and forecasting an earlier than expected Fed hike

3.       The short end of the US Treasury curve (2-year yields) has broken out above its intermediate term TREND line of 0.89%

4.       The SP500 is immediate term overbought at 1024

5.       The Nasdaq is immediate term overbought at 2273

6.       The VIX (volatility index) is immediate term oversold at 19.13

7.       The US Financials Sector ETF (XLF) was down again yesterday and has broken it’s intermediate term TREND line of $14.69/share

8.       Most Asian stock markets have either broken their immediate term TRADE or intermediate term TREND lines in the last 3 weeks

9.       Oil, copper, and gold continue to make a series of lower-highs

 

Yesterday, I focused on Sovereign Debt defaults being a TAIL risk that is developing as opposed to abating. The Ukraine was denied an emergency loan this morning. The IMF apparently didn’t see the need to buck up into year-end.

 

For now, I’ll keep my suddenly reflating US Dollars in my pocket for the holiday season. I’m not targeting a return. I am targeting risk.

 

Enjoy the holiday break with your families and best of luck out there today,

KM

 

 

LONG ETFS

VXX - iPath S&P500 Volatility
For a TRADE we bought some protection at the market's YTD highs by buying volatility on 12/14.

EWZ - iShares Brazil As Greece and Dubai were blowing up, we took our Asset Allocation on International Equities to zero.  On 12/8 we started buying back exposure via our favorite country, Brazil, with the etf trading down on the day. We remain bullish on Brazil's commodity complex and believe the country's management of its interest rate policy has promoted stimulus.

GLD - SPDR Gold We bought back our long standing bullish position on gold on a down day on 9/14 with the threat of US centric stagflation heightening.   

CYB - WisdomTree Dreyfus Chinese Yuan The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.

TIP - iShares TIPS The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield. We believe that future inflation expectations are currently mispriced and that TIPS are a efficient way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.

 
SHORT ETFS
 
RSX – Market Vectors Russia
We shorted Russia on 12/18 after a terrible unemployment report and an intermediate term TREND view of oil’s price that’s bearish.  


EWJ - iShares JapanWhile a sweeping victory for the Democratic Party of Japan has ended over 50 years of rule by the LDP bringing some hope to voters; the new leadership  appears, if anything, to have a less developed recovery plan than their predecessors. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.

XLI - SPDR IndustrialsWe shorted Industrials again on 11/9 on the up move as the US market made a lower-high.  This is the best way for us to be short the hope of a V-shaped recovery.   

XLY - SPDR Consumer DiscretionaryWe shorted Howard Penney's view on Consumer Discretionary stocks on 10/30 and 12/2.

SHY - iShares 1-3 Year Treasury Bonds If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.