Less bloodletting at the closing bell today.  However, we think John Hussman’s term “ovobody” may very well have proven itself so far as the market performance’s Black Swan.

Ovobody is a term coined by Hussman citing certain conditions that the S&P 500 must meet to confirm an overbought market coupled with pressure on Treasury yields price escalation.  The warning sign might have gone unnoticed, though there were “bear tracks” signaling the potential in the past quarter.

Basically, you go back four years (2010), and then look to see if the index is trading at 5% or higher then it did in July 2013.  Confirmed.  A brief notation of the Advisers Sentiment Index showing it is above 53% and price/peak earnings are above 18.  The zeta in this equation is the three-month Treasury bond trading above last July’s levels.

What constituted fundamentalist’s optimism of overcoming the Wall of Worry, is now a moot point.

S&P 500 Chart

If you’re invested in self-directed portfolio asset allocation, such as Motif Investing you may want to consider risk parity allocation as a re-balancing strategy.  This is a target specific approach to set levels of risk and divide that risk equally across the entire prospectus to achieve what you full well know – optimal diversification of assets to minimize negation of profits.  The 60/40 portfolio approach will not perform well under current market conditions.

STRATEGIC INTERVENTION

We’ve revised the four components (equities, credit, interest rates and commodities) to meet retail traders asset accessibility; primarily equities, ETFs and mutual funds.  We’re not big on bonds, however, derivatives can spread out your risk out by lessening the volatility.  For option trading we highly recommend Dough if you want to expand your risk parity instruments, which comes highly recommended.

Decision Theory will be applied as an interdisciplinary approach; bringing psychology, statistics, philosophy and mathematics into the analytical decision-making process.  Every investment tells a story, a narrative, and it’s up to every investor to know that story’s minute details, whether it turns out to be a tragedy or a windfall.

Thus, we’re going utilize “Health – psychology” “Volatility – statistics” “Efficient Market Hypothesis” – philosophy” and “Optimization -mathematics” analytics to construct our Chinese Solar story.  These italicized categories are found on Macroaxis – a financial portfolio analysis website that exceeds all others in efficiency and professional grade portfolio management used by money managers and private financial advisers.

To illustrate how to perform risk parity, let’s take a look at Motif Investing’s top rated 1 year return earner: Chinese Solar.  “Basking In Solar Power’s Glow” at a 98.0%.

This motif is thematic, comprised of 10 ETFs all from the same sector, thus no diversification to negate profits in an adverse market.

Currently, out of the 10 ETFs included in this motif, only two have shown a monthly gain.  The rest are at a monthly minimum loss between -7% to  -25%.   Thus, profits prior to the market’s mean reversion trend are being negated in a bearish market.   Based on traditional portfolio performance success, it is founded upon risk aversion compared to probabilities of profit.  The most robust indicators are the Sharpe Ratio, Treynor Measure and Jensen Alpha.

We’ve replicated Chinese Solar on Marcoaxis to illustrate risk parity allocation using Decision Theory as a means to show how to re-balance this motif to meet risk parity.  Our benchmark is the S&P 500 and baseline assumptions are set at a 30-day time horizon, with a moderate risk investor rating.

Back testing 30 days as our executed trade date, the motif has a -7.35% loss.  That’s being generous.  You can look at the current status of Chinese Solar’s assets here on Chrome.  (Bookmark this webpage and return anytime to see it’s performance.)

Expected returns are only part of the story.  If you are serious about being self-directed in portfolio management, then understanding the assessment of over twenty different technical performance indicators will broaden your insights and break through personal biases so you diversify away unsystematic risk. Let’s get started.

Chinese Solar

Health:  Over the past 30 days this portfolio has “0” performance, thus generated negative risk-adjusted returns.  Included in our Health parameter is the Information Ratio.  For Chinese Solar it is a negative -0.18).

Alpha (Return over Market is 0.39; Beta (Market Sensitivity) is 2.69; Sharpe Ratio (Efficiency) is -0.03; Risk (Volatility) is 4.28 and Expected Return is -0.11.

The Treynor Ratio is -0.30 and the Jensen Alpha is -0.29.  Chinese Solar has an eyebrow rising Coefficient of Variation of -419.94. Comparatively, the potential upside is 4.39 compared to a drawdown of 13.12.   Risk to reward is nearly 3 to 1 odds.

Volatility: Chinese Solar receives a score of 55 (Speculative) with volatility rated at 4.28% – translated this is the standard deviation of daily returns in correlation to all the assets in the portfolio.

Moreover, Chinese Solar is 4.6% more volatile than the S&P 500.  So whatever percentage movement the S&P 500 makes, you can amplify this by 4.6% for gains or loss on Chinese Solar.

Lastly, the portfolio’s Value at Risk  shows an estimated negative 247.93 for the next 30 days.

Efficient Market Hypothesis:  Though disputed by investors and researchers both empirically and theoretically; price to earning losers have proven to have higher returns over winners in a similar time period, we’ll take it with a grain of salt; it’s all speculative entwined in a combination of cognitive and informational biases.

Based on the preponderance of Chinese Solar’s negative indicator outcomes projected on our 30-day time horizon, we’re inclined to execute a mean-variance passive risk parity rebalancing strategy. Considering the current loses, it’s best to replace those assets that have the most negative returns, replaced with risk reducing assets, and re-set to the same allocation percentages to minimize loses.

Passive rebalancing of Chinese Solar advises to sell all assets except IEHC, CSIQ, EGT, and DQ.

Repurchase shares volumes are as follows:

IEHC 115.95 shares

CSIQ 14.26 shares

EGT 929.85 shares

DQ 6.6 shares

Total market value $1,840.00 with an expected return near .25% in 30 days.

PART II

Risk Parity – Refining diversification.

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