Hedging against market corrections

The recent market draw-downs reminds us why it is crucial to stay diversified. Our market timing system is designed to spot major bear markets conditions like the one prevailed during 2000-2002 and 2008, usually it means that the market (s&p500) can lose about 15% - 20% before we will exit the sector positions. 

Fast corrections like the recent one on January or extremely fast market crash like the one happened in 1987 are very hard to spot and act upon, trying to time the market in very high frequency often results in many whipsaws and lower return, so how can we reduce our portfolio draw-downs ?  Our preferred way is to diversify with assets which have negative or very loose correlation to the s&p500:

  1. Long term treasuries are excellent for hedging since they are usually negatively                    correlated to the market and also pay coupons (see attached chart).
  2.  Gold acts as an inflation Hedge.
  3. Short Term treasuries acts as a safe heaven.
 S&P500 vs long term treasuries.

S&P500 vs long term treasuries.

How much to allocate to each asset is depending on your personal risk preference and your investment goals. We also use the Contrarian Equity Allocation   to help us estimate if the market is under/overvalued and hedge accordingly. An example of aggressive allocation:

  1. Gold weight= 10% of the portfolio.
  2. Equity weight=1-Average Investors Equity Allocation (can be found in the sector portfolio page) : about 50-75% of the portfolio weight.
  3. Long Term Treasuries: 100%-(gold weight+ equity weight) : about 15-40% of the portfolio.

During Bear market conditions when Alpha Asset Allocation signals to get out of all sectors we replace the equity holding with Short Term treasuries.