Seeking Alpha
Long only, momentum
Profile| Send Message| ()  

Last month's 16-day Federal Government shutdown ended on Oct. 17, by funding the Treasury Department to reopen the Government through Jan. 15, by effectively suspending the debt ceiling through Feb. 7, and by forming a budget committee for talks over broader budget issues. The budget-debt issues, however, were not resolved yet, simply they were postponed for three months.

The focus of this article is to help investors by viewing an illustration of my portfolio management with a dual portfolio with two key controls - The Asset-Allocation (or A-A) Decision, and The Cash-To-Capital (or C/C) Ratio. The C/C Ratio is a near-term control in one to three weeks, and the A-A Decision is a short-term control in one to three months. The current targets of the C/C Ratio and the A-A Decision are a 25% and a 50-50, respectively. The threshold of the A-A Decision is 3%, meaning that under the current target, a 50-50, the asset allocation between equities and bonds (including cash) allows to vary in a range between a 53-47 and a 47-53.

How do these two controls get a target? They are determined based primarily on various macro-data such as business cycles and monetary policies of central banks (led by the Federal Reserve) in the globe. A supplemental source is various signals from the TANER System such as the TANER Momentum, the Market Stress Index, and the RED, and the RED Spread. Any rigid matrix to extract a target number is not pursued because it would be improper.

Table 1: The S&P 5oo Index, The C/C Ratio, & The MSI

S&P 500

CASH TO CAPITAL

MSI

DATE

INDEX

% ch

Cum % ch

RATIO

% ch

9/18/2013

1,725.52

22.1

42.9

9/20/2013

1,709.91

-0.91%

-0.91%

17.6

-22.67%

42.9

9/23/2013

1,701.84

-0.47%

-1.38%

16.5

-6.45%

42.9

9/24/2013

1,697.42

-0.26%

-1.64%

11.5

-35.71%

42.9

9/25/2013

1,692.77

-0.27%

-1.92%

11.9

3.42%

42.9

9/26/2013

1,698.67

0.35%

-1.57%

12.3

3.31%

42.9

9/27/2013

1,691.75

-0.41%

-1.98%

11.7

-5.00%

35.7

9/30/2013

1,681.56

-0.60%

-2.58%

11.2

-4.37%

35.7

10/1/2013

1,695.00

0.80%

-1.78%

13.9

21.51%

42.9

10/2/2013

1,693.87

-0.07%

-1.85%

15.6

11.53%

35.7

10/3/2013

1,678.66

-0.90%

-2.75%

17.5

11.48%

35.7

10/4/2013

1,690.50

0.70%

-2.05%

19.1

8.74%

35.7

10/7/2013

1,676.12

-0.85%

-2.90%

18.8

-1.58%

28.6

10/8/2013

1,655.45

-1.24%

-4.15%

17.9

-4.90%

35.7

10/9/2013

1,656.96

0.09%

-4.05%

15.2

-16.31%

42.9

10/10/2013

1,692.56

2.13%

-1.93%

24.1

45.29%

42.9

10/11/2013

1,703.20

0.63%

-1.30%

21.8

-10.02%

42.9

10/14/2013

1,710.14

0.41%

-0.90%

22.5

3.16%

35.7

10/15/2013

1,698.06

-0.71%

-1.60%

23.1

2.63%

42.9

10/16/2013

1,721.54

1.37%

-0.23%

25.5

9.88%

42.9

10/17/2013

1,733.15

0.67%

0.44%

27.5

7.55%

42.9

10/18/2013

1,744.60

0.66%

1.10%

29.2

6.00%

28.6

10/21/2013

1,744.66

0.00%

1.10%

26.7

-8.94%

28.6

10/22/2013

1,754.67

0.57%

1.68%

24.6

-8.19%

28.6

10/23/2013

1,746.38

-0.47%

1.20%

25.8

4.76%

35.7

10/24/2013

1,752.07

0.33%

1.53%

24.6

-4.76%

28.6

10/25/2013

1,759.77

0.44%

1.97%

26.8

8.56%

28.6

10/28/2013

1,762.11

0.13%

2.10%

26.8

0.00%

28.6

10/29/2013

1,771.95

0.56%

2.66%

26.7

-0.37%

28.6

10/30/2013

1,763.31

-0.49%

2.17%

26.2

-1.89%

28.6

10/31/2013

1,756.54

-0.38%

1.78%

23.0

-13.01%

28.6

11/1/2013

1,761.64

0.29%

2.07%

21.8

-5.36%

21.4

11/4/2013

1,767.93

0.36%

2.43%

22.2

0.00%

21.4

11/5/2013

1,762.97

-0.28%

2.15%

15.9

0.00%

21.4

Note: The percent change formula: 200*(B-A)/(B+A)

As shown in Table 1, starting Sept. 18 (when the S&P 500-Stock Index had an all-time high) until Oct. 17, the Market Stress Index (MSI) had been steady within a tight range between 35.7 and 42.9. The only exceptional data point was 28.6 on Oct. 7. That range was a bit higher but much lower than those for the last political events such as a 53.1 for the tax deal (12/31/2012), a 59.2 for the debt-ceiling (1/23/2013), and a 46.7 for the stopgap bill (3/27/2013).

Since Oct. 18 the C/C Ratio has been at 28.6. Markets have been very calm recently. The C/C Ratio had been constantly increased toward a target ratio, 25%. Note that the C/C Ratio rose modestly until Oct. 9, and then jumped to 24.1% when markets soared with signs of a thaw in Washington's budget stalemate on Oct. 10. The S&P 500 hit a record high at 1,771.95 on Oct. 29. So was my portfolio. The C/C ratio stood at 26.7. The cumulative change column in the Table 1 indicates that on Nov. 5 S&P 500 was 1762.97 which was 2.1% higher than 1725.52 on Sept. 18, a last record high, and it was just 0.6% below a new all-time high 1771.95 on Oct. 29.

Many Investors were largely confident throughout the latest fiscal showdown, clearly demonstrating the lack of appetite of selling. This kind of investors' resolve in the face of major political events is relatively new phenomenon. As a consequence, markets were firm during Oct. 1 through Oct. 16, with only a couple of dips: a 0.9% on 10/3, a 0.85% on 10/7, and a 1.28% on 10/8, as highlighted on Table 1. One of the positive factors for markets to push the S&P 500 up further since Oct. 17 was investors' expectations that the Fed's reducing their 85-billion-a-month bond-buying program would be delayed into the next year due to weak economic data, caused by the past shutdown.

The A-A Decision and the C/C Ratio are mutually constrained each other. In a near term (in a couple of weeks), however, the C/C Ratio is somewhat free to maneuver to take an advantage when any security is mis-priced, disregarding a target of the A-A Decision (for example, a 50-50 or a 60-40). On the other hand, in a short term (in a couple of months), the A-A Decision would dictate by rebalancing toward a target allocation, leaving the C/C Ratio disrupted temporarily.

In fact, the two controls would not move too far away from their targets because a dual (two-tier) portfolio has a second-tier portfolio which currently has a13% of total capital. The second-tier trading portfolio trades equities, bonds, and cash daily to narrow a gap between the targets and the actual standings. As shown in Table 2, the A-A Decision and the C/C Ratio has been constantly changed to reflect market trends and volatility.

Table 2: The A-A Decision, The C/C Ratio, & The S&P 5oo

A-A DECISION

C/C

S&P 500

DATE

STOCKS

BONDS

RATIO

INDEX

9/18/2013

69%

31%

22.1

1,725.52

9/20/2013

65%

35%

17.6

1,709.91

9/23/2013

65%

35%

16.5

1,701.84

9/24/2013

65%

35%

11.5

1,697.42

9/25/2013

65%

35%

11.9

1,692.77

9/26/2013

65%

35%

12.3

1,698.67

9/27/2013

63%

37%

11.7

1,691.75

9/30/2013

63%

37%

11.2

1,681.56

10/1/2013

63%

38%

13.9

1,695.00

10/2/2013

60%

40%

15.6

1,693.87

10/3/2013

59%

41%

17.5

1,678.66

10/4/2013

57%

43%

19.1

1,690.50

10/7/2013

57%

43%

18.8

1,676.12

10/8/2013

57%

43%

17.9

1,655.45

10/9/2013

58%

42%

15.2

1,656.96

10/10/2013

53%

47%

24.1

1,692.56

10/11/2013

54%

46%

21.8

1,703.20

10/14/2013

53%

47%

22.5

1,710.14

10/15/2013

53%

47%

23.1

1,698.06

10/16/2013

52%

48%

25.5

1,721.54

10/17/2013

50%

50%

27.5

1,733.15

10/18/2013

49%

51%

29.2

1,744.60

10/21/2013

49%

51%

26.7

1,744.66

10/22/2013

49%

51%

24.6

1,754.67

10/23/2013

47%

53%

25.8

1,746.38

10/24/2013

50%

50%

24.6

1,752.07

10/25/2013

49%

51%

26.8

1,759.77

10/28/2013

49%

51%

26.8

1,762.11

10/29/2013

50%

50%

26.7

1,771.95

10/30/2013

50%

50%

26.2

1,763.31

10/31/2013

51%

49%

23.0

1,756.54

11/1/2013

51%

49%

21.8

1,761.64

11/4/2013

51%

49%

22.2

1,767.93

11/5/2013

56%

44%

15.9

1,762.97

In a couple of weeks, rebalancing or taking profits (or losses) is constrained by the direction of the C/C Ratio. The current target of the A-A Decision for the first-tier portfolio (an 87% of capital) is a 50-50, including cash in bonds. If allocation changes from a 50-50 to a 45-55 due to a spike in equity markets, rebalancing is needed and is made. On the other hand, if the allocation changes to a 55-45 due to a drop in equity markets, rebalancing cannot be made because of the C/C Ratio constraint, even though it is required. In a couple of months, the actual asset allocation would be rebalanced to fit the target.

For about six months markets would wiggle, following further negotiations on the fiscal issues. However, they would trend in a steady upward movement in a couple of years because industrial corporate earnings are likely to continue to be strong. They would because the industrial companies can cut costs due mainly to a lower price of energy. Another reason is exports are expected to rise because the global economy is getting better. Also, the U.S. technology industry led by Google (GOOG) and Apple (AAPL) keeps a solid global leadership position so that earnings of tech companies are expected to be higher. As a result, current bull markets are likely to continue until 2015

What should investors do? First, check the soundness of portfolios and asset allocations. Second, build cash whenever possible. There are two points that are crucial this time. One is that short-term bonds are more vulnerable than loner-term bonds. Also shy away from illiquid mutual funds or their exchange traded mutual funds (ETFs), and stick to liquid large mutual funds and ETFs. The other is that it is important to have a proper ETF (or Mutual Fund) allocation, given an asset allocation.

The major holdings in my long-term portfolio are Vanguard mutual funds. My current mutual fund allocation is shown in Table 3 with corresponding ETFs.

Table 3: The Mutual Fund Allocation (Nov. 4, 2013)

Vanguard Mutual Fund

ETF

NAME

SYMBOL

ALLOCATION

VTI

Total Stock Market Index Admiral Shares

VTSAX

12.7%

VXF

Extended Market Index Admiral Shares

VEXAX

22.9%

VTV

Value Index Admiral Shares

VVIAX

15.5%

BND

Total Bond Market Index Admiral Shares

VBTLX

18.7%

TIP

Inflation Protection Securities Admiral Shares

VAPSX

22.9%

VEU

FTSE All-World ex-US Index Admiral Shares

VFWAX

7.3%

TOTAL

100.0%

Holding mutual funds in a same family has three advantages, compared with holding their twin ETFs: First exchanges between mutual funds are free and convenient. Second, mutual fund exchanges are made at closing so that any rush trading during a session, turned out to be a wrong move, can be avoided. Third, it is observable that mutual funds are less volatile and usually a bit better priced than their counterpart ETFs. The reason is that most holders of mutual funds are long-term investors.

The equity market has held pretty well, and that trend is expected to continue until the end of this year. As a result, in November the R-R Decision changed to a 55-45 from a 50-50, and the C/C Ratio reduced to a 15% from a 25%. If a budget compromise would not be concluded by Dec. 13, the C/C/ Ratio would be lifted up to a 25%.

If there would be no sign to resolve the fiscal impasse by the end of this year, the C/C Ratio would be raised to a 35% to take an opportunity from a last-minute panic selloff. If the U.S. defaults, unfortunately, a 35% cash holding surely minimizes the damage from that event. Will the unthinkable really happen? The chance would be fairly low, but cannot be completely ruled out.

Source: A Dual-Portfolio Strategy With 2 Controls Has Worked Out. Can It Weather Any Looming Storm?