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Friday Commentary

February 19, 2010

note: the follow up post on identifying mean-reverting vs trending markets will be put up early next week–stay tuned!

Tonight the fed raised the discount rate in what is the first domestic sign that the easy money days are finally coming to an end. China is well on its way down clearly signalling its intentions of cooling things off with the recent policy moves. FXI the big China ETF is now BELOW its 200 day moving average—to me that is a real sign that the bubble in China may have finally run its course. If that is the case, then this is terrible for commodities and US multi-nationals and overall very bad for the world economy which has become dependent on their  growth. The big banks have been big borrowers at the window speculating all over the world making free money, you can bet that this will scare some capital back home to the good old US dollar. It is a virtual guarantee that this money has found a home in commodities and speculative stocks. Take a look around you at the markets that have gone up the most, especially with the least fundamentals because these will be very vulnerable at some point quite soon. It is not yet a time to short the market on a long-term basis, but I feel that time may happen some time in 2010. Some additional technical signs are anectdotal–speculative fervor seems to be waning-STEC for example is one high-flyer during the rally that has just rolled over and died. Some signs are more quantitative: The US dollar (pointed out in late January on this blog) is above its 200-day moving average an gaining strength. The Russell 2000 is now leading the S&P500 which is not healthy historically. Other signs are fundamental: i) it seems that the banks are now under pressure from the government to potentially limit risk-taking, ii) the discount rate has been raised, iii) they are now starting to come under the microscope for sovereign loans/swaps, iv) they already are technically insolvent and hold massive sovereign liabilities in addition to bad mortgages to US consumers, and poor credit card books. 

These opinions led me to do some research on how to best take advantage of the situation. My all-time  best discretionary  results have flowed from theory matched with confirmation. Relative strength and long-term technical trends are a sure sign that the market is backing you up on whatever crazy ideas you might have. Tonight I reviewed Market Rewind’s Rotation Model which I have to confess is my new favorite toy and has kept me up really late putting it through the paces ( a couple posts will be posted soon to show you how to best utilize this model) It allows you to put in any ten stocks, ETFs or asset classes into a portfolio and uses a highly-refined algorithm to rank then from strongest to weakest. You can also see a backtest of how this model performed over a 3-year period. Considering it is a long only model, the results are extraordinary through this highly difficult period. This is the kind of model that is absolutely critical to validate your fundamental views/opinions BEFORE making trades. The advantage to the REWIND algorithm is that it adapts a lot faster than most standard models, and this allows you to catch moves a lot quicker.

It is also the kind of model that is critical to stabilizing your portfolio and ensuring long-term success—-as many readers know, I am biased against an overly short-term focus because of all the pitfalls involved in succeeding. I am not aware of anyone who has been financially demolished using a multi-asset rotation model. Furthermore, the returns and risk-adjusted returns are nothing to sneeze at and rival good swing trading models. When you consider commissions, slippage, and taxes, the rotation model is the clear winner. So note to traders: if you haven’t been winning consistently for years, this is your bedrock–everything else is risk capital that must be budgeted wisely to ensure you don’t wipe yourself out.  Currently the top positions in my own multi-asset class portfolio were Canadian Real Estate (XRE.TO)–igloos are going for high prices these days!, the US Dollar (UUP), and Cash (SHY).  The short positions I put into the model to create a complete dynamic timing approach were not in the top 3 indicating that it is premature to go full bear.

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