1 Peform Table

Equity Overview

Will the equity markets continue higher, or are they exhausted? That seems to be the major theme for investors. On the one hand, this 5-year run is due for another pullback, and on the other hand, there seems no reason why it should halt its advance. It’s easy to find supporting commentary on either position, which makes us all the more comfortable not believing either side. Markets always defy understanding, and the percentage of times that it does what we expect conforms to standard probabilities of chance.

NASDAQ has been the biggest move to the downside, driven by a pullback in the high-beta, mostly biotech stocks. Even more extreme is the separation between the SPY and the small cap IWM, which occurred only in the past week or so. The chart below shows a clear sideways movement for QQQ and IWM, with the SPY pushing its previous high. Still, the overall picture doesn’t seem bullish.

2 Benchmark Indices

The good news is that short-term sideways patterns most often resolve themselves in the direction of the previous trend, which we can agree is up. So odds favor new highs.

Looking at the sectors, we’ve been holding XLU long most of the year and watching it go straight up. The energy sectors, XLE and XOP are also doing well after a small retracement early in the year. The Trend program ETF sector rotation buys the strongest sectors, and that seems to be working.

Of our three daily equity programs, only 3 of 11 were profitable in April, but the losses were small and 7 of 11 are profitable for the year. The weekly program also posted losses.

Note on Short Sales. The “All Signals” reports show short sales in stocks and ETFs, even though shorts are not taken in the portfolios. Our recent 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 a welcome risk reduction. In this case we prefer paying for risk insurance, even without the expectation of any significant gain from it.

Note on Tracking. 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.


Groups DE1 and WE1: Daily and Weekly Trend Program for Stocks and ETFs

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

While still maintaining a slight edge over the equity benchmark index markets, the recent sideways performance is especially disappointing when we’ve been used to the outstanding gains over the past few years. In the two charts below we see recent drawdowns in all but the ETF rotation program. Still, these pullbacks are well within the normal pattern.

3 Trend Equities Apr 2014

To show it clearly, we have extracted the returns for the stock Trend program from January of 2013 and shown them below. The pattern still seems very good and the drawdown gives some signs of ending. We will need some help from the market to confirm that.

4 Trend stocks from 2013

Weekly NAVs for the Trend program show a similar, although not quite as much of a pullback in equity as the daily program. The ETFs are more stable, as would be expected. Because ETFs are an index, which averages a set of stocks, the performance will never be as extreme to either the upside or the downside. It plods on.

5 Weekly Equity Trends

Group DE2: Divergence Program for Stocks and ETFs

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.

It is interesting that the Divergence program is the most dependable recently. Pattern recognition is a common, but not well-documented approach to trading. Many discretionary traders use patterns, specifically classic divergence, for their entry timing. But it’s difficult to scan all the stocks looking for the pattern set-up, and more difficult to decide which stocks should be entered and where to exit.

This strategy looks for simpler patterns, but patterns that must appear in more than one time frame. For us, using multiple time periods is a way of finding a robust trade, rather than an isolated pattern.

6 Divergence Equities April 2014

One problem with looking for patterns is that you may not find enough each day to fill the portfolio. That’s why the total NAV for this program is less than half the Trend program. Most often, the portfolio can only be filled to about 50% and leveraging up would add risk to a portfolio with fewer assets, a sure ingredient for volatility. As you can see in the chart above, the 10-stock portfolio is filled to a much higher degree, resulting in greater returns but higher risk.

One advantage of this program is that it is generally underleverage, which means that risk is expected to be lower, and funds are generally available to earn interest or to trade other markets. Still, during the past two years, results have doubled in both the 10 and 30-stock portfolios.

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 the 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 posted small losses in April but held on to profits for 2014. It suffered large losses in those stocks in NASDAQ, which sold off sharply. The program entered 1 of 3 parts of a hedge in the SPDRs, then lifted the hedge when prices moved back up. Not so for NASDAQ. At the end of April, QQQ added to the short hedge and is now short 2 of 3 parts.

Remember that these hedges don’t normally net a profit, but reduce the risk of stocks that use them for hedging. The short positions in SPY, QQQ, or IWM don’t normally last long enough, or decline far enough, to net an outright profit in the hedge. But that’s just what we expect. We want to reduce the size of the loss in stocks during a decline. And that’s what happening in April. The small losses in the stock

programs were the result of hedging. We would rather take a loss on the hedge, which is only partial protection, and see all stocks rally.

The ETF rotation portfolio has a strategy contrary to the Trend Rotation. This one buys undervalued ETFs while the Trend program buys the outperformers. While the Trend program can achieve high returns with high risk by selecting from a broad range of stocks, the Timing program targets moderate returns with low risk. Not all stocks qualify because they do not necessarily track any index.

The Rotation program follows stock in a tight sideways pattern, similar to 2010 but with much lower volatility. Trading sector ETFs has limited upside potential because these sectors are averages of stocks; there are no outperformers in sectors to the degree that Apple (AAPL) or Tesla (TSLA) can run away from the rest of the market.

7 Timing stocks April 2014


Futures Overview

In futures, 2 of the 6 daily programs posted gains, one in each of the Trend and Divergence programs; however all 3 weekly Trend portfolios showed gains. It remains difficult to find profitable trends in futures markets, a situation that has gone on since interest rates peaked. Still, trends appear when least expected which is why macrotrend programs are still a significant part of institutional portfolios.

The Newedge CTA Trend index is down -5.07% for 2014.

Groups DF1 and WF1: Daily and Weekly Trend Program 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.

Futures programs continue down the path of disappointing returns. The Trend program is particularly problematic, but is typical of Industry performance. There a just no profits because there are no significant trends in any of the sectors. Interest rates, which had started higher (futures prices lower) in expectation of the end of tapering, have flipped and flopped based on the latest employment numbers and geopolitical risks (currently Ukraine). Economic sanctions on Russia will impact Europe and filter through to other economies.

As we can see below, the Trend program is taking the brunt of the problem, with only fixed income and energy posting any profits for the month, and no sectors profitable for the year. We have been using a new portfolio allocation method and preparing it for launch, we will keep you posted.

This is the result of the traditional method of assigning fixed asset allocations. While diversification is much easier with futures than stocks, it also means that you’ll be including those markets whether or not they are trending or showing losses. It may be better to focus assets in those markets that are actually trending, and avoid allocating anything to non-trending markets. Of course that means we would be late entering a trending market, but the “classic approach” is clearly not working in the current market. One of the most important rules of trading, and system development, is to stay aware of change and adjust to market conditions.

8 Futures Sector Comparison April 2014

The daily Trend Futures program is showing a larger drawdown than the weekly equivalent, 10% this year compared to 6.8% for the weekly. While not out-of-line given past patterns, it continues to be frustrating. Can we expect trends in the near future? The best scenario is that interest rates rise because inflation was underestimated. We’ve seen inflation in food prices, but that doesn’t seem to count in the Fed’s calculations. They look mostly at wages and the cost of living for those who are renting. They don’t count energy prices, although those seem to be creeping back up, because it is supposed to be reflected in all other costs at some point.

The main driver over the past 30 years has been interest rates. Occasionally we get a geopolitical event, mostly affecting oil supply, but that doesn’t seem to be on the table right now. Can Russia and the Ukraine spark anything? If we put strong sanctions on Russian exports and Russia retaliates , then energy prices will soar and the Euro will be more volatile. Not a good scenario for Europe but perhaps for futures trading.

9 Daily and weekly futures April 2014

Daily Divergence Portfolio for Futures

This program is showing small losses in April and small losses for the year. It is not dependent on trends but on specific patterns. That seems to be a benefit now that trends are scarce. The $500K account has taken a larger drawdown, but that’s very dependent on the specific markets in that portfolio. Because it’s based on a fixed asset allocation, the portfolio is determined in advance. The best way to assess the underlying strategy is with the largest, $1 million account, which is the most diversified. Smaller accounts can do much better or much worse for short periods, but should eventually be similar to the larger account.

10 Divergence futures April 2014

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