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Fighting Volatile Markets

|Includes: IGE, IWN, RWX, VEU, VNQ, Vanguard Total Stock Market ETF (VTI), VWO

How do I see the week ahead and what is the strategy for ITA investors?  While not trying to frighten anyone, I am approaching this next week with great caution for two reasons. 

1. The "Super Committee" is deadlocked and unless this changes over the next few days several things are likely to occur. 

  • Automatic cuts will go into effect, but not until 2013.  You might know that Congress would put off the problem as long as possible. 
  • The cuts will go into effect, but Congress, with their incredible wisdom, will vote to remove the automatic cuts they voted for in the first place.

Either of these scenarios will have a negative impact on the financial rating of the U.S. resulting in higher interest rates and a dip in our markets.  While it is unpopular, taxes need to be raised, and that includes everyone.

2. The second reason for extreme caution is the growing problem in Europe.  France is now becoming part of the problem, and they are one of the larger economies. And the problem is spreading.  It is no longer just the PIIGS, but now we are seeing problems with the FINS.  Spain gets counted twice.

What paths are available to investors considering the uncertain climate ahead?  Below are several possible suggestions.

First, hedge the portfolio.  I am beginning to purchase shares in SDS, an ultra-short ETF on the S&P 500.  Long-time ITA readers recall when we put on SDS positions in the past.  Here is how the SDS is designed to work.  If the S&P 500 goes up one point, the SDS will go down about 2 points.  It is not a perfect hedge, but it is a close approximation.  If the S&P 500 declines by 1 point, the SDS will rise approximately 2 points.  Generally, I will hedge a portfolio in the 5% to 10% range. 

The second suggestion is to kick the ITA Risk Reduction model into action.  This is not easy to do with a complex portfolio with numerous holdings.  With the Maxwell, Euclid, and Madison portfolios I've reduced the number of holdings while continuing to spread investments all over the globe.

When I looked at StockCharts this morning, VTI, IWN, IGE, VEU, VWO, VNQ, and RWX were all priced under their respective 195-Day Exponential Moving Averages (EMAs).  Investors should be in cash according to the ITARR model.  We have a few days until the end of the month at which time I will examine the situation closely.  The coming weeks are ones where closer attention needs to be give to the portfolios.