Put Your Retirement Portfolio In 'Market Neutral' Part 2

 |  Includes: SPY
by: Fiver Capital

In the first installment of this series, I suggested retirees consider a market neutral strategy to reap the benefits of dividend growth investing while managing downside volatility. Before moving on, I’d like to review my assumptions in support of this action. 1) We are in a secular bear market with several years left to run. 2) Bonds are headed for a bear market of their own. 3) The retiree is happy with the size of his/her portfolio and can live off the 3-4% yield generated (remember, the income stream will grow over time).

If you believe we're in a new bull market and headed for all-time highs, it will be hard for you to execute this strategy with conviction. And even if you're with me in the bear camp, the last assumption will likely cause problems. After all, the average retiree’s portfolio is dramatically under-funded and living off a 3-4% yield would require a multi-million dollar nest egg. I understand that most folks need at least some growth beyond the income stream. For the under-funded investor, I propose the following options for generating capital gains.

1) Wait

This one's simple. There will come a time when it makes sense to flip from a fully hedged position to long only but the S&P 500 will be much lower offering price to earnings multiples in the single digits and the gains made during the next bull market will more than make up for slight underperformance in the mean time. Timing the exact bottom is not as important as surviving the next major downleg. In the mean time, enjoy your sleep-at-night portfolio and have fun spending your inflation-protected income.

2) Stock Picking

In future articles, I'll be seeking out the best global dividend stocks in a variety of sectors. If we pick the right stocks and enter at reasonable valuations, we have the potential of beating the s&p 500 for a marginal gain. Of course there's also the possibility of a marginal loss but it would pale in comparison to a portfolio which goes unhedged during a return of the bear.

3) Market Timing

For the adventurous investor interested in scoring risk-managed capital gains as the bear market progresses, you’ll have to employ a market timing strategy. Since my goal was to make this strategy practical for everyone, I suggest keeping it simple with moving averages. Using a weekly chart of the S&P 500, plot 15 and 40-week moving averages. See below for an example.

[click to enlarge]

Click to enlarge

Notice how the market is typically ready to run higher when the 15-week (red) moving average crosses up through the 40-week (blue). This occurred in June 2009 and again in October 2010. In both instances, this would’ve been a good time to sell a quarter to a half of your short position and profit from the upside. Incidentally, now would be a good time to return to a fully hedged stance as the moving averages have crossed to the downside and the index has broken its trendline from the 2009 bottom. Ideally we never take profit on our longs, we simply trim our short position near intermediate term bottoms.

Benefiting from a market timing approach is always going to be as much art as science however I strongly believe that anyone can do it. The alternatives are not pretty. Take a look at the chart above again and decide if you're emotionally prepared for another plunge like we saw in the 2008 bloodbath. Be honest with yourself. If the answer is no, you should either be out of the market altogether or seriously committed to taking matters into your own hands. The latter starts with a plan. So what's yours?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.