Leif Peterson

How to Construct a Deflation Proof Portfolio

This is a great article, and for many reasons is timely because it addresses deflation -- which will likely be the primary issue for the next 5-10 years. Right now, the US economy is truly (not essentially or effectively) a bottomless pit for which very few are broadcasting the problem. Don't worry about doom and gloom; that was passed a while ago. It's more like the second great depression is already here but is unobservable. If you had an over-the-horizon backscatter radar for the economy you would probably run.

Regarding the inverse ETFs mentioned, one must realize that due to extreme volatility in today's markets, these will sell in a heartbeat if stop loss is not set at at least -20%. However, there will come a point where an equilibrium is reached and e.g. large mutual funds won't be able to unload equities so that their price drops to zero, because they can't zero out customers retirement accounts. I truly believe you can't short a stock to zero, especially one of the ^DJIA-30. (here, I am speaking about the millions of clones who continue to contribute to mutual funds through their employer and never bother checking how things are going).

When compared with the huge losses in equities and home values since 2007 (several trillion), costs of ongoing wars, derivatives, hedge funds, greed, over-leveraging, auto industry, the bailouts are not even a blip on the radar scope. That, plus the fact that only a fraction of the bailouts will reach the consumer is all the more reason to become concerned. Don't take my word for it, start studying on how to profit in times of deflation. Currently, I am long Fidelity Treasury (short-term) Money Market (FDLXX), US Dollar Bull (UUP), Japanese Yen (FXY), Chinese Yuan (FXI), China Mobile (CHL), Exxon-Mobil(XOM), and USCOX. I believe most equities are going to crash and burn much worse in the months to come, and think UUP will explode throughout 2009 and 2010. Happy Trading!

Asset Class Correlations

The majority of correlation coefficients shown are actually not that good. When you get down to 0.2 - 0.6, the association between the pairs of variables can still be jumpy. In fact, if you showed the X-Y scatter plots for a number of these matrix elements, you would probably be surprised at how noisy, jumpy and unrelated a lot of the series are. X-Y scatter plots would likely reveal problems and cause readers to ask why you tried to correlate a lot of these pair-vectors in the first place. At values of r=0.8 (-0.8) you will truly begin to see very tight patterns and tight trending between the data being correlated. The goal is to focus on high negative correlation, and the large negative correlation between the dollar and gold is actually good, since you would want to load a portfolio with something that is going to go up, on average, when the dollar goes down. (remember, though, gold is a commodity so the price is inflated in the direction in which the speculative buyers/sellers think it will go. ). Again, the majority of the coefficients are near-zero and low (less than r=0.2 or greater than r=-0.2) and uninteresting. Last, you are probably showing Pearson correlation, which can be biased by outlier pairs. Try using Spearman correlation, which is not biased by outliers.