The Year “Diversity” Didn’t Save You

The ditty goes: “in well diversified cheap index funds”. The ditty goes: “when some things are down others are up”

Here is a pictorial of the S&P 500’s year in review. Red is Bear, Orange is negative but not bear, Gray is even, Light green is +, Green is ++, and Gold is golden +++

This is a picture of diversity, the picture of the ditty. I follow this metric of the relative balance between bull and bear stocks in the S&P as an indicator of economic health For the whole year 20% was in a bear market and 20% underwater. 20% dormant 20% up and 20% flying. About 40 stocks of the top 20% accounted for 1/3 of the growth and the FANG (FB, AMZN, NFLX, GOOG AAPL MSFT) was responsible for 13% of the S&P’s price. Let that sink in, because that is the true nature of equity risk. My chart actually over dramatizes the reality but that drama points out the risk. It’s not a bear yet. We’re down 7.5% not 27.5% but the point is the point. Ditty’s don’t save you. But you say “I have a side gig” to which I say good deal, what happens to a side gig in a bear?

I quack a lot about non correlated diversity so here is a picture of non correlated diversity this year.

reference

Natural Gas worked, Wheat worked, VIX worked well, some of the short ETF’s that leverage triple an index in a negative direction worked, but those instruments require expertise to trade. There is nothing cheap or buy and hold about owning them and a wrong move will clean your clock. I’ve traded the VIX through ETF’s I do not recommend.

The world seems ready to roll over. S&P was down 7.46. Nikkei down 11.87, DAX down 18.12, I would say your Foreign assets in your 3 fund didn’t save you. (VGTSX down 18.8% compared to 7.5% for S&P). Real Estate? VNQ is down 10.35% compared to 7.5% for the S&P. Bonds are down, the 30 year down 5.35% and even shorter term government debt typically a safe haven lost money. The 5 year note is down 1.97% as the FED unwinds it’s balance sheet. Cash lost by the rate of inflation. Even TIPS were down. The 3 month The 3 monthT-Bill was up a penny for the year, BONANZA. The 3 month T-Bill is the risk free asset against which the efficient frontier is calculated.

This year demonstrates the risk of a leveraged retirement in a leveraged world in a very real way, and the more equity exposure the more real the demonstration. The farther off the efficient frontier the more real the demonstration. Governments and corporations are swimming in debt and leveraged not all that different from the housing crisis of yore. Peter is being robbed to pay Paul and debt derivatives are being sliced and diced, same as it ever was, same as it ever was. The only way out is through the gauntlet. Santa Claus is not coming. The curves are regressing to the mean. Statistics are pesky things. We’ve been living a charmed 2 SD life buoyed by easy money and easy expectations and government manipulation for 10 years. China is eating our lunch by stealing IP. IP accounts for creative destruction and creative destruction = exponential jumps in productivity and growth in national value. I can’t over emphasize that enough. It’s been the US’s motor for 300 years. If the motor leaves or is snatched away our goose is cooked. “Worst December since 1931” should give every one pause. So far it seems an orderly regression. I think it’s the best we can hope for. Someday “the means” will be obtained, hopefully not by a dramatic overshoot. There is a lot to be learned here.

The robots respond to mathematical representations of the above picture and set about to optimize, maximize gain and minimize loss. We live in a three dimensional world and typically optimize on one dimension, reward, or the fancier of us in 2 dimensions, risk and reward. The robots live in as many dimensions as they like or need for optimization and they scale in and scale out in other words the dimensions aren’t necessarily linear, hence trading the triple short fund in a way that’s not just randomly shooting bullets. They trade and they learn from the trade and hone their skill set. If you think you’re not exposed to that process by being buy and holder, think again. Every “return” consists of an investment component and a speculative component. The VIX is often called the “Fear” index. It is not. It is the chaos index. It makes it’s money from chaos. Wrap your little buy and hold mind around that. You own chaos, it’s called variance and it’s not fixed. The bottom line is as long as your next door neighbor is getting up and going to work every day we will be fine. It won’t be fun, but we will be fine. Your existence as a retired rests on his going to work and adding value to what ever process he performs. While you get cocky about retiring at 30 understand how you depend on him. He deserves your respect. If he quits going to work lay in some Valium because a hard rain gonna fall.

2 Replies to “The Year “Diversity” Didn’t Save You”

  1. Wow. That really brings home the point Gasem.

    This is one of the moments you have to buckle and bear it as the vast majority of assets people use for diversity are all headed on a downward path.

    It is a shame you can’t buy vix cheap and hold a small portion as a safety net in times like this

    1. Every time I bought VIX I lost money. You need bullet proof trading rules IMHO

      Things are not horrible just bad, but in bad times denial is not your friend

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