In yesterday's missive, we exposed the fact that a diversified portfolio is dramatically underperforming the return of the U.S. stock market in 2013. While some may argue that we will soon see this phenomenon dissipate due to the propensity of financial assets to ultimately revert back to the mean, this fact isn't helping investors who are currently staring at returns which are at best, in the low single digits this year.

As I stated yesterday, part of the problem is that the long-term bull market in bonds is likely in the process of morphing into a secular bear market. Another big part of the problem is the fact that the U.S. economy as well as the dollar are heading the wrong direction for trades in commodities and emerging markets. Now toss in the ongoing difficulties in Europe and it becomes clear that the problems being created by what is usually considered a "well diversified portfolio" may be with us for quite a while.

What's the Solution?

Unlike so many of the self-proclaimed gurus on the financial channels, I don't claim to have all the answers in the markets or with regard to investing strategy. However, I have been around a while (I've been managing "other people's money" for a living since 1987) and as such, I have seen a great many markets and more investing strategies than you can shake a stick at.

So, for those investors that like the comfort generally provided by a diversified portfolio, here's an idea that will allow you to (a) maintain a diversified allocation in your portfolio and (b) stay out of trouble when the big, bad bears come to call on an asset class or two.

The idea is to break your portfolio up into parts according to the desired asset allocation and then install a "risk management" strategy for each part of the portfolio. For this example, let's use the generic diversified portfolio I laid out yesterday (only the math will add up correctly today) which is broken up as follows: 50% stocks (25% U.S., 15% Foreign, and 10% Emerging) 30% bonds (10% U.S. 7-10 Treasury's, 10% U.S. 20+ Treasury's and 10% Junk), and 20% "real assets" (10% Commodities, 10% Gold).

In simple terms, we then create a "sell strategy" for each asset class. This can be something as simple as a 150-day moving average or as complex as a market model dedicated to each asset class being managed. And here's the kicker; it almost doesn't matter what sell strategy you use. No, it's the fact that you have one that REALLY matters.

What's This Portfolio Look Like Now?

Instead of lazily sitting in all asset classes at all times and being exposed to the brutality that accompanies most major bear markets, the idea is to use both components of the traditional "buy low and sell high" approach. The key is that the approach I championing here has the ability to take the exposure of each asset class in your portfolio to zero when the bears are present.

In order to keep things simple, let's use a 15-month weighted moving average as our "bear market" signal for each asset class. In short, if the asset class is above the 15-month average you hold long and if it is below, you move that portion of the portfolio to cash.

Here is an example of using this approach for the S&P 500 since the mid-1990's:

As you can see, the S&P 500 is currently above its 15-month ma, so you would simply hold on to the U.S. stock positions in your portfolio.

Running through the entire diversified portfolio, the current positions and signals would look like this:

• U.S. Stocks (25%) - SPY: Buy/Hold long
• Foreign Stocks (15%) - EFA: Buy/Hold long
• Emerging Market Stocks (10%) - EFA: Cash
• U.S. Treasury 7-10 Yr (10%) - IEF: Cash
• U.S. Treasury 20+ Yr (10%) - TLT: Cash
• High Yield Bonds (10%) - JNK: Cash
• Commodities (10%) - DBC: Cash
• Gold (10%) - GLD: Cash

The Bottom Line:

To be sure, this not a fool-proof strategy as using a single, very simplistic indicator on a monthly basis can produce a large amount of whipsaws over time. As such, it would be wise to utilize an approach incorporating at the very least, some technical analysis triggers such as trendlines and support/resistance zones as well. However, the bottom line is that your portfolio would currently hold a large amount of cash (60%) and would not be exposed to the damage occurring in bonds, junk, commodities and gold.

While such an approach makes infinite sense to me, you may be surprised to learn that the majority of financial advisors I come in contact with do not advocate such a strategy. Why not? In short, while the blind, "buy and hope" approach is easy, managing risk requires significantly more time, effort, and expertise.

But from my perch, if you have any hope of avoiding the big, portfolio crippling losses that have occurred in bear markets over the past 15 years, managing risk - in whatever fashion you may choose - is the way to go.

Publishing Note: I am traveling (for business this time - I am speaking at the Traders Library event), on Friday morning and will not publish morning report. Regular "State" reports will return on Monday.

Turning to this morning... With the market enjoying its best week in some time and Secretary of State John Kerry meeting with Russia today over Syria, traders can't be blamed for taking a step back at the present time. And based on the overseas action, this appears to be what is taking place as there is very little movement in the major markets. In the U.S. we'll get weekly jobless claims before the bell and futures are relatively flat at this point in time. However, it is worth noting that the fear trade appears to be taking a hit today as gold is diving $23 in the early going.

Positions in stocks mentioned: none

The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning’s opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed nor any Portfolio constitutes a solicitation to purchase or sell securities or any investment program. The opinions and forecasts expressed are those of the editor and may not actually come to pass. The opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security nor specific investment advice. One should always consult an investment professional before making any investment.

Any investment decisions must in all cases be made by the reader or by his or her investment adviser. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that the investment objectives outlined will actually come to pass. All opinions expressed herein are subject to change without notice. Neither the editor, employees, nor any of their affiliates shall have any liability for any loss sustained by anyone who has relied on the information provided.

The analysis provided is based on both technical and fundamental research and is provided “as is” without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.

The information contained in this report is provided by Ridge Publishing Co. Inc. (Ridge). One of the principals of Ridge, Mr. David Moenning, is also President and majority shareholder of Heritage Capital Management, Inc. (HCM) a Chicago-based money management firm. HCM is registered as an investment adviser. HCM also serves as a sub-advisor to other investment advisory firms. Ridge is a publisher and has not registered as an investment adviser. Neither HCM nor Ridge is registered as a broker-dealer.

Employees and affiliates of HCM and Ridge may at times have positions in the securities referred to and may make purchases or sales of these securities while publications are in circulation. Editors will indicate whether they or HCM has a position in stocks or other securities mentioned in any publication. The disclosures will be accurate as of the time of publication and may change thereafter without notice.

Investments in equities carry an inherent element of risk including the potential for significant loss of principal. Past performance is not an indication of future results.