Tuesday, May 30, 2006

Hussmann and Svenlin on the Stockmarket

Here is the latest from Hussmann on the stockmarket. He seems to be one of the smarter guys around with regard to market analysis. Basically, he says hedge your stock portfolio against loss at this point. This is what I have been doing (after a rebound in the Aussie markets in the last two days my investment return for May seems to be 0% exactly :)).

Why hedge rather than just selling everything and going to cash? In taxable accounts there is the capital gains tax issue. If you sell you pay the tax with 100% certainty and you especially don't want to pay the short-term rates (as they are in the US and Aus) if you can avoid it. If you hedge and you are wrong you sell the hedging instrument (or buy back shorted shares) and take a capital gains loss. Another issue is mutual funds cannot be traded intraday. In reality there can be a day or two delay in getting the transaction done. If the market moves up suddenly you lose out. Hedging positions are normally much more liquid - I hedge with shares or options on ETFs or heavily traded stocks. For big investors, individual stocks are illiquid, they hedge in the futures market which is much more liquid.

Of course you can get more aggressive and overhedge until you are net short. I am slightly net short by standard measures. Again it is a risk if you are wrong - in the long-term stocks go up and based on the law of percentages up moves are bigger than down moves - a stock can only go to zero on the downside - but can go up infinitely in theory on the upside...

Carl Svenlin has posted an article on shorter term technical trends. I think that short term bounce is likely completed for now, but a larger rebound will happen in the first half of June.

2 comments:

Anonymous said...

"Why hedge rather than just selling everything and going to cash? In taxable accounts there is the capital gains tax issue."
I just want to make sure I am following your logic properly. To protect your portfolio from a possible down turn you hedge your holdings, my guess being that you are buying puts or selling calls of an index-( qqqq or whatever else). For simplicity sake say your (long) stork portfolio is worth $1000 and you hedge and after a market decline your long position is now worth say $600 but your hedge has increased in price to $400 you are still net neutral. But don't you then have to close the hedge to realize your gains? And if you do are you then not back to where you started off subject to CGT?
I just dusted off my copy of Lawrence McMillan looks like my afternoon is going to be spent on chapter 53.
BTW welcome back Charlottesville, quaint town, and lovely Uni.

mOOm said...

Yes, if you turn out to be correct then you close the hedge and pay capital gains tax (short term) on the hedge. In theory you could then sell some of the long position at a loss and offset the capital gain - though I wouldn't advise that. Ideally make the hedge big enough so that after tax it offsets the loss on the long position. The idea here is say stocks rise 100% from the 2002 low and then you sell fearing a decline - you pay tax on the whole 100%. But stocks probably won't decline that full amount. If you are wrong you lose out on the potential gain and pay a big CGT bill. Using hedging if you are wrong you lose out on the gain but can chalk up a short-term CGT loss - seems better to me? You really have to think of a 2x2 matrix with the two possible ways the market could go and your two possible strategies.

What you don't want to do I think is chop and change your entire portfolio on a less than annual basis. You'll end up with big short-term CGT bills and missing out on market moves. My strategy is to have 100% invested mostly long-term and then trade short-term. It's what most insurance companies and many hedge funds do.