StumpGrinder: Early June 2013 Update

StumpGrinder had a tough May, but recovering in early June.

Overview: StumpGrinder down 1.5% in May

I’ll be following up with more details soon, but wanted to post a few things quickly.

First of all, StumpGrinder lost 1.5% in May 2013 (3% with leverage). That’s a big drawdown for this sort of portfolio, an “asset allocation” strategy.  But I’ve heard through the grapevine that hedge funds following similar approaches were down even more, as much as 7%.

Most of this decline came in the second half of the month. For those who were watching the market carefully, it was obvious that that traditional relationships were unravelling: For instance, bonds were no longer anti-correlated with stocks. They became correlated as they both went down.

Underlying cause of drawdown: We knew this was coming

One of our core assumptions with StumpGrinder is that it’s core holdings, namely BOND and low volatility equity ETFs USMV and SPLV are anti-correlated.  This ensures that our portfolio has overall low volatility because when one zigs, the other zags.  Those relationships began failing in the second have of May.  Why?

The main cause is that the first hints that the Fed is going to reduce its bond-buying strategy emerged. Nearly all bond-related ETFs were hit hard as a result (short term bonds were OK). This was going to have to happen eventually, but perhaps came a bit earlier than we expected. We were always going to take a bond hit when this announcement came (more on this below).

That explains the bond drawdowns, what about equities?

Well, I’ve been bearish on equities for a while, see my earlier post DOW 15,000 is a sugar high, so we were already reducing our holdings there.  Usually equity drops are offset by bond climbs, but not in May.  That leads us to…

Sanity checks

You should never blindly follow an investment strategy. When someone says, gold IRA are always a sure thing, you need to do some research before accepting other people’s research, or lack there of.  I’ve heard so many times “strategies work until they don’t work.” You should be prepared to exit when things seem to be headed south. But how can you tell the difference between a short term down trend and a systemic failure?

An important component of any strategy is a set of “sanity checks.”  Sanity checks are assumptions you’ve made about your portfolio’s performance, that you can check at any time to see if they are true. When they become not-true, that’s when to go to cash.

I mentioned one of the assumptions we make about StumpGrinder above, namely that we assume BOND is anti-correlated with the low-vol equity ETFs USMV and SPLV.  Those three ETFs are, together, our largest holdings, so this relationship is important.

As towards the end of May we saw many days when BOND and SPLV were both down together — becoming correlated, and not performing as they should.  In fact on the last day of May the two were exactly — not-correlated (more detail to come in another blog).  I was poised to move to cash on the June rebalance, but for the next few days we’ve seen anti-correlation creeping back.

Why I didn’t exit BOND

One of the reasons I held off on going to cash was that I learned that Bill Gross, manager of BOND, called the top of the bull market in bonds on May 10:

Gross: The secular 30-yr bull market in bonds likely ended 4/29/2013. PIMCO can help you navigate a likely lower return 2 – 3% future.

— PIMCO (@PIMCO) May 10, 2013

Bill Gross is a smart guy, and BOND is actively managed. His track record with PTTRX has been amazing through all sorts of markets.

Still keeping an eye on things

So, the return to anti-correlation of BOND and SPLV, and the fact that Bill Gross saw the downturn coming restored my confidence in this portfolio.  But I’m ready to move to cash if the sanity checks fail.