Kaufman Signals

April 2018 Performance Report

Industry Benchmark Performance

Small gains in most hedge funds and 2018 returns on both sides of zero. Futures CTAs are not doing any better, with small gains and slightly larger losses for the year. Short-term trading seems to be doing better, if only with positive returns for the year.

Blogs and Recent Publications

Find this at the end of this report. We post new interviews and reference new articles each month.

April Performance in Brief

Mixed results this month with the smaller portfolios in each equity group outperforming the larger portfolios. We attribute that to the lack of choice in selecting stocks, given the erratic price movements and sharp declines. The portfolio selection program can find 10 good stocks but adding another 20 for the larger portfolios introduces marginal returns.

The Weekly Futures program is performing the best, now up from 6% to nearly 13%, while the Daily Futures program is looking good but lagging the Weekly. The Weekly Equities program had a good month, bringing year-to-date returns positive and ahead of SPY.

Major Equity ETFs. The “market” rarely conforms to your predictions and we expected another downturn last month. So far, nothing has happened except consolidation. More about this in our In-Depth report.

IN-DEPTH: We’re Still Waiting…

Last month we expressed the opinion that a break of support was more likely than a rally for the S&P. We’re still waiting. During that time, the market can change its bias. To decide if that has happened, we summarized to fundamentals and technical.

The Fundamentals

The Good News

  • Tensions with North Korea easing
  • Tax Law getting positive reviews. Business planning is budgeting for more money, they have given bonuses, and in some cases, salary increases. Expensing new investments 100% will help. There is a positive psychological impact on works to spend more.
  • Tariffs have been delayed for Canada, the EU, and Mexico.
  • Deregulation helping business
  • Personal taxes decreased by $40 billion compared to an increase of $50 billion in the 4th

The Bad News

  • On Friday, April 27, the GDP came out at a disappointing 2.3%, down from 2.9% last quarter. The market sold off.
  • Tensions with Iran are increasing
  • Corporate bonuses are a one-time event. Salary increase is a small part of the corporate benefits. Apple used its tax saving for a buy-back biggest in history.
  • Chinese reprisals for U.S. tariffs have increased, targeting agriculture and specific products made from aluminum and steel, as have the U.S. list of tariffs on Chinese products. The EU has a list of U.S. items to tax.
  • The Tax Law is getting negative reviews for its affect on the debt and focus on the wealthy.
  • Deregulation eliminates some protection of clean water and clean air.
  • Ford moving small car production to Mexico, keeping SUVs and trucks. Implies any incentives from the State or Administration isn’t enough.

The Net Impact

The problem with fundamental information is that it’s difficult to put a value on each item to weight its impact on the economy and on investors. Most economists say that it will take a year to know the impact of the tax law. Right now, tariffs seem more likely to have a impact.

The Technicals

Our specialty is algorithmic trading. We prefer to look at trends, indicators, and actual price moves to decide how the market is behaving and where it is likely to go. Economists also have technical forecasts, primarily Leading Indicators. The OEDC publishes the Composite Leading Indicator (CLI) as a measure of future business activity. The current CLI, shown below, indicates that it is as confused as everyone else, although there might be a slight bias to the downside.

Figure 1 OEDC Composite Leading Indicator (CLI)

If we combine the pattern in the CLI with the current pattern in the major equity index ETFs (Figure 2), we increase the bias to the downside. The black lines indicate an “elongated downward triangle” or a “descending wedge” formed at the top. Both of these patterns are traditionally interpreted as bearish.

Figure 2. A descending triangle or wedge in SPY prices.

The Trend

The trend, usually the direction of a moving average, has a history of success, but that success increases with the longer-term averages that capture macro-economic factors. Below (Figure 3 and Figure 4) are the 30-, 60-, and 120-day moving averages applied to SPY and QQQ. The two faster averages have turned down, but the 120-day is still up. Both Figures look nearly the same, perhaps SPY is a little weaker.

Figure 3. Three trends applied to SPY.

Figure 4. Three trends applied to QQQ.

What Next?

It’s very difficult to net out the fundamentals; there is always a positive and negative interpretation. The technicals are also mixed, with the CLI sideways, a descending wedge waiting for a breakout, and two of three trends pointing down. We’d say that nets to a slight bias to the downside.

The good think about technical analysis and algorithmic trading is that we don’t need to forecast. We can wait for the market to tell us what it’s doing, then act. In our current situation that means waiting for the price to break below support in the descending wedge and/or having the 120-day trend turn down (which, at the current rate, take another 10 days). For a scenario that restores the bullish trend, a break above the descending wedge, but also a break above resistance at about 270. As the wedge narrows, the chance of an upward break due strictly to noise becomes very likely. Using the clear resistance level avoids a false readying.

Trend Strength Index

One measure of market strength is our Trend Strength Index. Our Trend strategy is a composite of many trends, medium term to slow applied to about 275 stocks. When combined, these determine the position size of the current trade. If the faster trends are down but the slower one up, then the position size might be zero. The appearance is that trend positions scale in and out based on the strength of the trend. The Trend Strength Index appears at the bottom of the Trend Stocks All Signals report each day. We’ve tracked it from the beginning of 2014, and the chart below compares it with the SPY. TSI is the Trend Strength Index and SPY is the SPDR ETF. TSI values about zero indicate a positive trend. The range of the TSI is +1 to -1.

The Trend Strength Index reflects the internal strength (momentum) of all the stocks that we track, about 275. These stocks tend to have a stronger trend than the typical stock. It is also a mix of stocks from the S&P and Nasdaq, with a few smaller caps, but none trading fewer than an average of 1 million shares per day.

The Trend Strength Index was a leading indicator for this decline and has not reached its neutral point near zero, a place where most of the price declines have stopped. The overall price formation looks weak, but this is the place where patience is most important – not acting until price indicate a higher or lower move.

We offer this Index for those investors who select their own trades rather than following our sample portfolios. Daily Index values are available to subscribers.

A Standing Note on Short Sales

Note that the “All Signals” reports show short sales in stocks and ETFs, even though short positions are not executed in the portfolios. Our review of using inverse ETFs to hedge stocks during a decline showed that downturns in the stock market are most often short-lived and it is difficult to capture those moves with trend systems. This confirms our approach to the Timing systems, which hedges up to 50% of the long stock risk using multiple trends. In the long run, returns from the hedges are net losses; however, during 2008 the gains were welcomed and reduced losses.  In any correction, we prefer paying for risk insurance, even without the expectation of a net gain.

Portfolio Methodology in Brief

All of the programs -- stocks, ETFs, and futures -- use the same basic portfolio technology. They all exploit the persistence of performance, that is, they seek those markets with good long-term and short-term returns, rank them, then choose the best, subject to liquidity, an existing current signal, with limitations on how many can be chosen from each sector. If there are not enough stocks or futures markets that satisfy all the conditions, then the portfolio holds fewer assets. In general, these portfolios are high beta, showing higher returns and higher risk, but have had a history of consistently out-performing the broad market index in all traditional measures.

PERFORMANCE BY GROUP

NOTE that the charts show below represent performance “tracking,” that is, the oldest results are simulated but the newer returns are the systematic daily performance added day by day. Any changes to the strategies do not affect the past performance, unless noted.

Groups DE1 and WE1: Daily and Weekly Trend Program for Stocks, including Sector Rotation, Income Focus, and Dow Arbitrage

The Trend program seeks long-term directional changes in markets and the portfolios choose stocks that have realized profitable performance over many years combined with good short-term returns.

The smaller 10-stock portfolios are outperforming the larger 30-stock portfolio and ahead of SPY. We attribute that to the erratic performance of most markets and the difficulty in finding 30 stocks with returns nearly as good as the top 10 performers. Even with that, positive returns are small. It’s difficult to fight a market that may go lower.

Income Focus and Sector Rotation

After a good March, both Daily and Weekly Income Focus programs gave back the year-to-date gains and are showing small losses for the year. But then, an environment of higher interest rates can be offset by interest income, but it’s not likely that the interest will be enough to offset the loss due to higher yields. We expect the interest income will prove the winner when yields stabilize.

Another loss in April makes this classic Sector Rotation program the worst performer of all portfolios for 2018. While it maintains its overall uptrend, it has been more volatile than most other programs. Still, it does make money and can’t be written off given its history.

DOW Arbitrage

While not exactly running away with gains this year, the Dow Arbitrage program had a profitable April, a positive 2018, and is performing better than SPY. These large cap stocks tend to be more stable than the overall market and gains have been steady. As with the S&P, it’s not clear where the market is headed.

 

 

Group DE2: Divergence Program for Stocks

The Divergence program looks for patterns where price and momentum diverge, then takes a position in anticipation of the pattern resolving itself in a predictable direction, often the way prices had moved before the period of uncertainty.

A small gain for the 10-stock portfolio and a small loss for the 30-stock portfolio keeps the recent pattern looking the same as the broader index, but with less volatility. Even with a loss, the 30-stock portfolio continues to look stable, with low overall performance volatility.

 

Group DE3: Timing Program for Stocks and ETF Rotation

The Timing program is a relative-value arbitrage, taking advantage of undervalued stocks relative to its index. Its primary advantage is that it doesn’t depend on market direction for profits, although these portfolios are long-only because they are most often used in retirement accounts. When the broad market index turns down this program hedges part of the portfolio risk. The ETF Rotation program buys undervalued sectors, expecting them to outperform the other sectors over the short-term.

The Timing Program buys undervalued stocks so that it will buy the weakest even in a declining market until that stock shows that it is not expected to rally. Risk is protected with an absolute stop of 15% and also by hedging the broad index.

Again we see small gains in the 15-stock portfolio and small losses in the 30-stock portfolio, but the year-to-date is down 5% to 6%. This program has been partly hedged during April based on the short-term trend of SPY and QQQ both being down. That’s still a relatively small hedge but would be valuable if the overall market turns down.

Futures Programs

Groups DF1 and WF1: Daily and Weekly Trend Programs for Futures

Futures allow both high leverage and true diversification. The larger portfolios, such as $1million, are diversified into both commodities and world index and interest rate markets, in addition to foreign exchange. Its performance is not expected to track the U.S. stock market and is a hedge in every sense because it is uncorrelated. As the portfolio becomes more diversified its returns are more stable.

The leverage available in futures markets allows us to manage the risk in the portfolio, something not possible to the same degree with stocks. This portfolio targets 14% volatility. Investors interested in lower leverage can simply scale all positions equally in proportion to their volatility preference. Note that these portfolios do not trade Asian futures, which we believe are more difficult for U.S. investors to execute.

Using the same strategy and portfolio logic, the Weekly Trend Program for Futures has the added smoothing resulting from looking only at Friday prices. While it will show a larger loss when the trend actually turns, most price moves are varying degrees of noise which this method can overlook.

Please read the report describing our revised portfolio allocation methodology. It can be found in the drop-down menu under “Articles.”

Good returns in both Daily and Weekly Futures Programs, with the Weekly outperforming the Daily program, the reverse of last year. The Weekly is not up 6% to 13% with the $500K portfolios in both Daily and Weekly outperforming the others.

Group DF2: Daily Divergence Portfolio for Futures

The Futures Divergence struggled to find trades this month, and succeeded in holding positions for only a few days. That resulted in a fractional loss added to the fraction loss so far in 2018. A lack of positions didn’t hurt the program in April and, if prices decline, it may be the right strategy.

Blogs and Recent Publications

Look for upcoming articles in Technical Analysis of Stocks & Commodities, Modern Trader, and ProActive Investment Magazine.

In March, Mr Kaufman spoke to the Austin chapter of the CMT Association (previously the MTA), and was interviewed by Jacek Lempart for his blog systemtrade.pl, serving the European Polish investors. The interview will be posted soon.

February

A new interview with Mr Kaufman has been posted on the FXCM website (Forex Capital Markets) as of a few days ago.

Mr. Kaufman spoke at the Trader’s Expo in New York on Monday, February 26th. His presentation was on ways to reduce risk that traders forget to use.

January

Mr. Kaufman has a presentation in Jack Schwager’s FundSeeder webinar, which should now be available online.

There is an interview on YouTube conducted by Alex Gerchik for his Russian audience. We think you will find it enjoyable and helpful. The link is:

https://www.youtube.com/watch?v=TznkQtPQXgM&t=3s

Technical Analysis of Stocks & Commodities published Part 1 of a two-part article on profit-taking and resets, in their January issue.  The first part looks at trend following and the second at short-term trading. Part 2 is scheduled for the February issue. Before that, they published “Optimization – Doing It Right,” in the September issue.

Mr. Kaufman was a Keynote Speaker at the IFTA annual conference, hosted by the Swiss technical analyst’s association (SIAT) held in Milan, Italy, in October 12-16, 2017. A video of the presentation has been posted on the IFTA website.

“Portfolio Risk in Uncertain Times” was just posted on Seeking Alpha. It shows a better way to structure your portfolio. Prior to this, you will find “Living Off Profits,” which shows how much you can safely withdraw from your account without seeing spiral down out of control. Before that Seeking Alpha published “What Are the Odds?” a look at how to assess the risk of loss for any investment.

Modern Trader published “Dogging the Dow in the current edition, and a new article “Trading Opening Gaps” in stocks, scheduled for January 2018.

The IFTA Journal published an interview with Mr Kaufman in the most recent quarterly issue.

The broker FXCM will post a live interview with Mr Kaufman, taped on October 30.

ProActive Investor Magazine published Keeping Risk Under Control on June 22. Check their website. It will be publishing other articles later this year.

Andrew Swanscott at BetterSystemTrader.com (a good source for trading systems) has put up an edited version of an older presentation of Mr. Kaufman’s. It’s all about price noise and the Efficiency Ratio.

Look for past articles by Mr. Kaufman on Seeking Alpha (www.seekingalpha.com), Forbes (http://www.forbes.com/sites/perrykaufman). www.equities.com, Modern Trader, Technical Analysis of Stocks & Commodities, and Proactive Advisor Magazine. You will also find many articles posted under Articles on our website, www.kaufmansignals.com. You can address any questions to perry@kaufmansignals.com.

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