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The Ultimate Toolbox For Reducing Market Risks

Last update on: Jun 18 2020

The mistake most investors make is to try to predict the future and then set their portfolios to capitalize on that prediction. Unfortunately, the financial world is not predictable, even in relatively normal times. It is even less predictable when economic calculations must be meshed with considerations of war, terrorism, and the after-effects of the late-1990s boom.

One thing I’ve learned is that a crisis ends in a way almost no one expected. For example, I don’t recall anyone who forecast that the Russian debt implosion and the failure of hedge fund Long-Term Capital Management in 1998 would be followed by another leg of the boom.

Our strategy is to try to identify potential risks and decide how we want to deal with them. We can avoid certain assets. Or we can own risky investments but offset their potential risks with other assets. Another risk control measure is our pre-selected sell signals. With these, we buy an investment but decide in advance to sell if the investment falls below a certain price. That limits our risk of loss if the investment does poorly. All of these steps, plus careful selection of mutual fund managers, give us a margin of safety with the potential for solid returns. This strategy served us well through the bear market and will build capital in the next phase of the investment cycle.

Sector Portfolio

Much of the Managed Portfolio has been in money market funds since our equity fund sell signals were triggered in late January and early February. That position served us well, as the world stock markets continued a steady decline. The rest of the Managed Portfolio – real estate investment trusts, international bonds, high yield bonds, corporate bonds, and small international stocks – essentially held their values

It is time to come out of the shelter and try to earn some capital gains.

The U.S. stock markets have fallen so far and so steadily – and gloom is so deep – that I they are ready to rally. I expect the rally to be as broad-based as the decline.

To protect ourselves from the many uncertainties out there, I’m advising a balanced position. It will reap us gains if I’m right about a turn in the stock markets but protect our capital or even earn gains if another surprise pops out of either the economic or geopolitical closets.

I recommend adding a broad-based stock fund, ideally a growth stock fund. The Nasdaq has been the strongest index this year and will surge the most in any rally. My choice is TCW Galileo Select Equity, a great bull market fund. To get the lowest fees buy the I shares (ticker: TGCEX: $25,000 minimum). For a lower minimum or to buy through an NTF program, buy the N shares (TGCNX: $2,000 minimum).

The concentrated portfolio of high-quality growth stocks picked by manager Glen Bickerstaff should exceed the market indexes in any rally. I’m going to give the fund some room for market volatility but still am setting a sell signal as listed on page 10.

If you want to stick with one fund family, purchase a growth fund or index fund. Vanguard investors, for example, should buy Index 500 or Index Growth. Other recommended funds at the major families are on page 11.

I’m also adding two of the hedge funds I introduced in last month’s visit.

Hussman Strategic Growth has a two track strategy. It buys reasonably priced growth stocks based on a variety of factors. The fund also uses futures and options to enhance returns when it expects a bull market or protect capital when a decline is expected.

AXA Rosenberg Global Long-Short Equity uses its own valuation measures to buy undervalued stocks and sell short unattractive stocks worldwide. The fund also can benefit from changes in the dollar.

AXA Rosenberg is available through most NTF programs. Hussman is available for a trading fee. Other fund families do not have similar funds. If you cannot buy them, buy a growth or index fund and sell if it falls more than 7% from its high after your purchase.

Follow international bonds closely. A strong dollar rally is likely to trigger our American Century International Bond sell signal.

Balanced Portfolio

This Managed Portfolio is in largely the same position as the Sector Portfolio.

I recommend that you buy the same funds as recommended for the Sector Managed Portfolio. The recommended allocations are on page 10. Again, keep an eye on the sell signals.

Income Growth

Investors’ new love for bonds and dividend-paying stocks has benefited this portfolio. I continue to like all the funds in the Managed Portfolio and recommend holding them.

The only fund to watch closely is Cohen & Steers Realty Shares. While holding up much better than the indexes, it keeps getting close to its sell signal. Hold any sale proceeds in a money market fund until the next issue.


A flight to safety caused Treasury bond yields to drop to their lowest levels in 44 years in mid-March. That means there isn’t much potential left for capital gains in treasuries. It also creates a risk of loss.

If interest rates rise one percentage point, a typical bond portfolio with a duration of four years will decline 4% decline in value.

We hedged against that possibility with portfolio adjustments a few months ago. The Managed Portfolio is filled with quality corporate bonds, high yield corporate bonds, and international bonds. These are less susceptible to losses from rising U.S. interest rates than are treasury bonds. In fact, if rising rates are caused by a stronger economy, the corporate bonds and high yield bonds are likely to appreciate.

Still, there are risks. Further weakening in the economy could cause worried investors to sell corporate and high yield bonds. A stronger U.S. economy might help the dollar and cause our international bonds to decline.

For those reasons, I established sell signals for our bond investments. If any sell signals are triggered, move the sale proceeds to Vanguard Short-Term Corporate Bond fund.



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