Do You Have An Investment Drawbridge? Here’s How To Build Your Own

2022.04.24 16:54

This is not the typical picture of a drawbridge one might conjure up. There are many different kinds.

I was recently in South Florida for some time this Winter to escape the Northern cold and snow. Occasionally I got stopped at the Intracoastal drawbridge that gets raised to allow the large yachts and sailboats to keep moving. I didn’t pay attention to the schedule, and unfortunately, I’d hit it at the wrong time (they go up twice every hour during the day).

It got me thinking about the origins of drawbridges and their initial use. Their origins go back to medieval times. There are many different versions of drawbridges, but the original conception was to build castles with moats around them that would keep assailants and enemies out.

Usually located on hills, these castles had an advantage because they could see in any direction and for many distances. These castles were connected to the other side of the moats by drawbridges which could be pulled up at a moment’s notice.

The castles also created other kinds of defensive drawbridges like the picture above that could seal off the main part of the castle should the enemy further penetrate the other encumbrances.

As we have come to understand, these concoctions were invented with one goal in mind…creating a defensive, protective, and lifesaving mechanism.

We’ve done something similar by developing trading rules, proprietary indicators, and mechanical trading systems that integrate acute risk-averse methodologies.

This emanated from our many years of experience trading in the commodity pits in NY. Since we were trading our own accounts (our own $), we had to know, believe, and understand that RISK mattered in dollars and cents. It was self-preservation.

To this day, the mantra holds true. If you can protect your investment dollars from unforeseen enemies, you will preserve capital and have more to work with in the next upcycle. This is why we spend so much time and effort building investment solutions and educating people about the “hidden enemies” of risk and drawdowns.

This concept has been a main construct in all of our investment strategies. Whether looking at Sector Plus (ETFs), investing in highly volatile small-cap, NASDAQ, cryptocurrencies, and even our own Mish’s discretionary service…all employ risk-averse techniques to mitigate the dangers that might be lurking from the market enemies.

This week saw more evidence of having to combat these enemies, which seem to all hit at one time: higher (spiking) interest rates, out of control inflation, rapidly rising food and energy prices, all on the backdrop of a slowing economy, stricter monetary policy, and the expectations of ongoing Fed interest rate hikes.

The result is high volatility, contracting multiples on stocks, a huge sell-off in fixed income securities, and tremendous uncertainty about our capital markets.

More importantly, as recent as this past week, we have seen a high percentage of stocks (and ETFs) incurring selling pressure leaving investors with virtually nowhere to hide but cash.

Our own Mish, appearing on several National TV business shows, has continued to “buck” the trend and convey that she was not excited about buying stocks and felt that the markets remained “rangebound.”

Even after a huge one-day rally. For those of you not so familiar with rangebound, it literally means: it is a traders’ market. A huge move up over a day or two followed (like this week) by sudden reversals and two down days.

The market has been exhibiting patterns like this since the beginning of the year. It is a choppy churn and, for most investors, exhausting. Little to no progress is made for the average investor. If you follow the likes of ARK Innovation ETF (NYSE:ARKK) and other recent hot dot managers, it may mean your investment is down 25-50%.

Investors need to stay apprised of one of the most important rules of investing. Rule #1 minimize losing money. Rule #2 don’t forget Rule #1. Here is an important chart to remind you of the dangers of NOT having your investment drawbridge:

30% Loss In Portfolio

Here are some ways that you could build your own drawbridge:

1. Make sure you include CASH as one of your asset classes. It is far better to rotate into cash and preserve capital when the market is overly volatile and you feel uncertain. Don’t let anyone (even your Advisor) tell you that you should not park your assets in cash.
2. Diversify, diversify, and diversify. Several of our investment strategies have been investing in agricultural, energy, and metals ETFs since the latter part of 2021. These strategies are mostly positive for the year.
3. Look to other markets other than the United States. Don’t get put into a corner of only investing in our markets. Often, when our markets are faltering, another country may be doing well. We have a strategy for this. Lately, some of the emerging markets around the world have begun to look attractive.
4. Utilize hedges and put on appropriate ways to minimize wild swings. A few of our investment strategies have invested in an inverse ETF which is effectively putting the investor in a position to prosper during a downward moving market. These ETF instruments can be traded in seconds during the trading day, have huge volume and are easy to get in and out of.
5. If you own stocks, even with low-cost basis, DO NOT be afraid to sell some of the shares. Far better to pay the IRS then Mr. Market which can be ruthless when you have nice profits given up very quickly. Look at Netflix (NASDAQ:NFLX) this past week as just one good example.
6. Consider using derivatives to hedge your positions. This would include “writing” call options, buying puts or purchasing other instruments that can hedge your whole portfolio. Mish recently had her subscribers put on a volatility instrument which is effectively investing in a trade that focuses on insurance against an ugly market. (And it got very ugly this week).

This week’s market insights:

Risk Off/Bearish

• All Key US Indices closed in Bearish phases across the board on their daily charts, and are not oversold based on our Real Motion indicator (-)
• Volume patterns are showing strong distribution across 3 of the 4 key indices—excluding the DIA)—led by NASDAQ 100 with zero accumulation days over the past two weeks which is not surprising considering that QQQ is down over -18% YTD and -3% on Friday alone (-)
• Sector summary took no prisoners this week, with essentially everything getting dumped across the board, with especially bad breakdowns in Retail (XRT) -4.5% and Energy (XLE) -4.6% on the week (-)
• The hottest spot in the market this week was Volatility (VXX) which should come as no surprise given the significant breakdowns across all major indices and the profit taking in commodities to end the week (-)
• Market internals deteriorated, but are not oversold which is an indication that there is very likely more downside potential going into next week (-)
• There was a significant reversal in the New High / New Low ratio for both SPY and QQQ, with a sharp spike to the downside signifying new lows across each index (-)
• Despite the selloff this week, risk gauges are still in a weakening neutral phase and are likely to break down more next week (-)
• Short-term Volatility (VXX) broke out and closed above both the 50 and 200-day moving averages, as well as saw a golden cross last week on those same moving averages. Another significant point to watch is that VXX closed just above its long-term 50-weekly moving average (-)
• The number of stocks in SPY that are above their 10-day moving average is only at 17% and is moderately oversold, but there is still plenty of room for more deterioration (-)
• The Yield Curve is still inverted in further out durations (-)
• There was a breakdown in both Value (VTV) and Growth (VUG) stocks this week, however, VUG sold off about -4% vs only -1.8% in VTV (-)
• Every member of Mish’s Modern Family is in a Bear phase and not yet oversold according to Real Motion (-)
• Foreign Equities were not spared from this week’s breakdown, with both EEM and EFA selling off and in bearish phases. However, Triple Play indicates an improvement of foreign equities over US equities on a relative basis (-)
• Essentially the entire commodity market mean reverted to the downside but are still handily outperforming equities (-)

Neutral

• The US dollar (UUP) gained across the board when compared to nearly every other major fiat currency this week (=)
• The US Long Bond (TLT) sold off once again thanks to another rise in bond yields, but TLT still outperformed equities by a wide margin and could be setting up for potential mean reversion from oversold levels (an indication that the Fed’s rate hikes may already be priced into the market) (=)

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