As human beings we hedge all of the time. Even though I live in one of the sunniest cities in the world, I usually have a jacket ready, just in case. When I go fishing, I take along my bottom fishing tackle just in case the surface fish do not bite. When I go holiday shopping I keep the tags, just in case I have to take everything back.
In the market, a hedge can be constructed from many types of financial instruments including stocks, exchange-traded funds, insurance, forward contracts, swaps, options, many types of over-the-counter and derivative products, and futures contracts.
This has been yet another bad year for the hedge fund industry. One of my clients sent me an article that listed the average hedge fund return of 6.2% year-to-date in 2013.
How could this be a bad year for hedge funds when the market has had one of its best years ever? It makes me wonder how the hedge funds will fare during a bad year in the market.
With the market up over 26% in 2013, how can the average hedge fund be up only 6.2%?
Here is the answer to that question: The cost of hedging has been very high this year.
A $200 vacation can become $300 real quick if you do too much hedging. You can insure your luggage, trip cancellation, rental car, etc. A whole life insurance policy does not come cheap.
Neither does a big position in an underperforming asset.
I have pointed out many times in the past year, the wide range of returns from the various asset classes. From small cap U.S. stocks which are up over 38% year-to-date, to gold which is down 26%, and of course everything in between.
With just one month left to go in 2013, a 50/50 bond/stock portfolio year-to-date is up 6.5%. Just about in line with the average hedge fund!
In 2012, the market was up 11.8%, but a 50/50 fund was only up 5.9%.
But, in 2008 a 50/50 fund bought you a big chunk of protection! With the stock market down 38.5% and the bond market up 32.1%, the net was just a 3.2% overall loss.
Of course you would have been up 32.1% had you been 100% in the bond market that year. But only a 3.2% loss would have sure been more palatable than a 38.5% drubbing being 100% in stocks!
A 50/50 stock bond portfolio since January 1, 2008 is up a grand total of 6.37%. A 100% stock portfolio is up 22.9%. A 100% bond portfolio is up 36.4%.
Being 100% invested in the BEST performing asset class each year since January 1, 2008 however, would be up an astonishing 259%!
Modern Portfolio Theory (MPT)? Indeed! I am not buying it. Nor am I saying that is possible to always be in the best performing asset class each and every year.
But, if we can tilt our portfolios towards the best performing asset class each year, we are going to greatly improve our performance over time.
With a new year just around the corner, here is where I currently stand on the stock vs. bond debate.
I have been 100% in stocks throughout 2013. Here is why.
Every day, I rank 45 different classes from a short-term, intermediate term, long-term, performance basis. I also include a good dose of technical analysis.
When I go back and look at my rankings at the beginning of the year, U.S. small cap stocks of all flavors (growth, value, and dividend) were at the top of the leaderboard. They have been at the top all year long.
In fact, the top ten asset classes have been U.S. stocks of shapes and sizes all year long!
No emerging markets. Emerging markets are down double digits so far this.
No commodities. Commodities have had a terrible year.
No precious metals. Precious metals are down over 25% year to date.
No fixed income. The U.S. long bond (TLT) is also down double digits this year.
And lastly, no inverse exchange traded funds! Being SHORT the market in 2013 has been the WORST place to be. Yet, I watch one pundit after another on a daily basis telling me to get out the market. The bears have been wrong for almost five years now!
All the way up from S&P 500 reading of 666 in March of 2009 to a current reading of around 1600. THE BEARS HAVE BEEN WRONG.
I have owned U.S. stocks with a heavy weighting towards small and mid-caps since the beginning of the year. That has helped to propel my client’s portfolios to some very hefty returns in 2013.
As you can tell, I am not a practitioner of Modern Portfolio Theory (MPT). Nor am I an asset allocator. I don’t believe in hedging just to be hedging. There has to be a better way.
While asset allocators will be busy rebalancing portfolios towards bonds and away from stock in the coming weeks, I will instead be going where my asset class rankings tell me to go.
With just one month left in 2013, here is where I currently have the asset classes ranked:
Data from Best Stocks Now! app
The asset classes are ranked along with 3,700 other investments (mostly individual stocks), but are isolated when compared against each other.
This is still an environment that favors U. S. Stocks! This trend has been in place for over one year. This trend will eventually end, but for now the above eight asset classes are still the BEST place to be.
Nobody knows how long this trend will stay in place, but it ain’t over til’ it’s over!
All we can do is take it a day at a time, an asset class at a time, a sector at a time, a mutual fund at a time, and stock at a time.
It is just as important to know the worst asset classes at any given point in time! Here is your current list:
Data from Best Stocks Now! app
These same trends have also been in place all year long. Gold was one of the worst places to be at the start of the year and it still is. I have had no exposure to gold and have avoided a 25% loss by avoiding this asset class.
Being short the market is still one of the worst places to be.
What about being a contrarian at this point in time? Let’s let the asset classes rankings tell us when it is time to move. That is always much better than trying to guess.
Bonds and interest rate sensitive instruments are also still terrible places to be invested.
It will change at some point in time. Everything in the market is cyclical. Bonds were the best place to be in 2008. Gold has had some huge years.
My app ranks these asset classes daily. My daily radio show goes over any significant changes when they occur, and my weekly newsletter strives to keep investors in the right asset classes and out of the wrong ones.
It is up to you. You can allocate your assets all over the place or you can focus in the Best Asset Classes Now.
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