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Implementing a Long/Short Strategy

Most of us, I suspect, clearly see the 'big picture'... but, I wonder if we are all looking at the same big picture. We have a dichotomy ongoing in this country that may (I think,

Most of us, I suspect, clearly see the 'big picture'… but, I wonder if we are all looking at the same big picture. We have a dichotomy ongoing in this country that may (I think, 'will') result in a calamitous ending. Thanks to the Fed and a social engineering government, full-time jobs are shrinking while the rich are getting richer and the poor are getting poorer. Combining the one-two punch of Quantitative Easing and Obama-care, we have seen the stock market soar (yes, we stockholders like that) and we have seen part-time employment soar as well, replacing higher incomes and full-time employment. Can this artificially derived (contrived?) economy continue indefinitely while our government racks up a trillion Dollars a year in deficits? Probably not, I suspect.

Quote worth Quoting Again

"The nine most terrifying words in the English language are: 'I'm from the government and I'm here to help.'"… Ronald Reagan

This week, I was talking with one of my friends in the money management business. He specializes in working with large 401k managers where he provides alternative investment strategies for these managers. Although his observations are certainly anecdotal, I do find them interesting.

One of the first question he asks is, "How are you investing the funds in your 401k?" Most say, "We have a number of mutual funds that we use." His next question is, "How confident are you that the market will continue to move higher?" Most say, "We have no idea." Then, he asks, "Do you believe there is a high probability that the market could dramatically sell off in a material fashion?" Almost all say, "Yes, we are afraid it will." Then, the last question, "What happens to your 401k value in a bear market?" He said the response is almost always a 'deer in the headlights' look and a very worried, "Our funds will be decimated."

Whether you are a manager of 401k funds or a manager of your own personal net worth, you have to deal with at least the possibility that the market will not be able to move forever higher and the economy will eventually have to deal with reality instead of the artificial monetary liquidity of Central Banks. Add to this volatile mixture the fact that the largest social engineering experiment in history (Obama-care) is proving to be so completely unwieldy that it cannot be implemented on time and has generated trillions of Dollars of negative unintended consequences (part-time versus full-time issues, to name just one), and we all should be hoping for the best but planning for the worst.

This is why I have my clients in a 'long/short' investment strategy and it is one that I think you should give careful consideration to. There are many ways to implement a long/short portfolio, but the objective is the same for all: Be long while the market is moving higher and be short while the market is moving lower.

Now, don't roll your eyes on that overly simplified strategy. Yes, I clearly know the devil is in how to know when to be long and when to be short. In reality, there will be very few times when such a strategy is 100% long or 100% short.

Here is my approach, but it is not the only approach:

  1. First, I have selected 25 segments of the global market that I believe gives my clients the kind of exposure that can capitalize on both foreign and domestic economic conditions. These 25 segments include indexes, commodities, sectors, interest rates, currencies, emerging markets and major sovereign countries.
  2. In each of these 25 segments, I identify the best performing stock in bullish markets.
  3. In each of these 25 segments, I have also identified the best inverse ETF to invest in when that market segment moves into a Bear trend.
  4. I use my analysis tools (Equity Analyzer) and forecasting tools (Market Forecaster and Equity Forecaster) to determine whether I want to be long or short in each market segment. I reevaluate this position each week. I am a long-term investor, one week at a time.
  5. I generally leg into each position; meaning, I do not invest a full "unit" in any one segment until I can see multiple weeks of supportive trends. Since I have 25 segments in my strategy, I will place no more than 4% of my investable funds into any one position. A "unit", therefore, is 4% in my case. Certainly, your situation could be considerably different.

Using the above broad-based ground-rules, I am able to be long or short in anyone of 25 global economic segments. My clients know that if we move into a bear market, most of my positions will be in inverse ETFs. In bull markets, they know that most of my positions will be in strong stocks and ETFs that historically perform well in bull markets.

This strategy then, becomes ambivalent to the direction of the market. If the market continues to climb ever higher, my portfolio will be mostly long, most of the time. If the market rolls over and begins a bear cycle, my portfolio will be mostly short (via inverse ETFs) most of the time.

I strongly suggest you consider a similar course of action. Whatever your thinking is about the market, the economy or geo-political situations, you should have a strategy for both bull and bear markets. We can all have opinions about whether the current Administration (or any Administration) is doing something stupid, nefarious or noble. But, at the end of the day, we all want to preserve our capital and to the best of our ability grow that capital for our future and our children's futures. Building a solid, well thought out, long/short portfolio is certainly one way to help make that happen.

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