I manage Oxriver Capital, a market-timing hedge fund that began trading in October 2013. The fund uses quantitative signals to time U.S. equity markets. The fund aims to give investors broad diversification while avoiding corrections in large-cap stocks. Macroeconomic trends are good, but the economy tends to be a lagging, not a leading, indicator of the stock market. Nevertheless, the fund believes that there is a good chance that the virtuous circle of an improving economy will feed back into good earnings and rising valuations.
We have participated in the stock market rally that ended 2013. Coming into the New Year, the stock market seems like a good but far from guaranteed bet. There is about a 45 percent chance that by mid-year 2014 the S&P 500 (NYSEARCA:SPY), (NYSEARCA:IVV) and (NYSEARCA:VOO) will close above 2000. There is a 50 percent chance that the S&P 500 index will be above 1950 and a 50 percent chance that it will close below 1950. At the same time, the fund believes there is a one in three chance that the S&P could close lower than its year end 2013 levels by the end of June 2014. There is one in nine chance that the stock market will be in a 10 percent correction by mid-year from its year-end close.
These are good odds, but we know investors tend to flee the market when they experience a 10 percent or more reversal. For this reason, many investors missed the 170 percent rally in stocks since 2009. Thus, investors should think how they would react to both losses and gains when reallocating their portfolio in the New Year. Our risk management model indicates that to reduce the chance of a drawdown, the fund should hold some cash as well as a long position on stocks coming into the New Year. Our research shows that investors can significantly grow wealth relative to the stock market if they benefit from our proprietary market signals and risk management. Many of those gains come from avoiding much of the reversals in the stock market.
The fund believes earnings will support rising valuations, but if earnings fall short in early 2014 the rally will stall. Other known and unknown unknowns could derail the rally. Another debt ceiling vote looms early in 2014. The October 2013 debate led to T-bills maturing in November 2014 to have risk haircuts. Even a small federal default, a very low probability event, could have a very negative impact on stock prices. The run on the money market funds in 2009 is a cautionary tale of how investors react to a surprise in which a miniscule loss to very safe assets (money funds) can feed a panic. If banks are exposed to rising interest rates, poor risk management could spill into the non-financial sector. Debt costs will likely increase in 2014 as the Fed stimulus is taken away, but we believe this will not be enough to eat into other drivers leading into rising earnings and valuations.
The fund's opinions and positions are subject to change without notice as more data become available. There are number of other warnings at our website that should be headed. Accredited investors which want to know more about the fund's strategy and returns should also read the warnings in the investors' presentation and the private placement memorandum.
Disclosure: I am long SPY.
Business relationship disclosure: I manage Oxriver Capital.