Industry Benchmark Performance
More small gains for hedge funds, putting the overall index up by 6.35% for 2019, slightly lower than our trend performance. Equity Long, however, is higher by 9.9% for 2019, showing that taking advantage of the upwards bias in stocks pays off.
CTA’s search for a trend has some good results, with the BTOP 50 up 4.92% and the SG Trend Index up 7.13%. Both of those are better than our Trend portfolios but not anywhere near our Divergence portfolios. The good news is that the industry is showing gains in nearly every area.
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
It’s frustrating to post profits but continue to lag far behind the broad market. Still, the need to use a strategy that take protective action when prices drop 20% also causes a slow return to normal. We now have a broad selection of stocks to select for our portfolio, so we expect to gain on the overall market in the next few months.
The Divergence program, both futures and equities, has been the winner in this market, with the smaller portfolios up 18% for stocks and 26% for futures. We’ll discuss this more when we review the specific portfolios further down.
The daily and weekly Income Focus programs continue to exceed expectations, while producing returns at low risk.
Major Equity ETFs. Another good month for equities puts NASDAQ and SPY on all-time highs, the Dow right at their old highs, and the small cap IWM lagging. We can look back and say that this was all about the Fed raising interest rates. With each rate hike, the market got increasingly nervous until it finally broke. The Fed, which is not supposed to care about the market, sent a clear message that it would put rate increases on hold. We can see the recovery that followed. The next question is, now that we’ve recovered, will the Fed start signaling another increase?
CLOSE-UP: Where to Invest?
It’s probably nonsense to say that this is a strange year, because every year is strange. Much like the weather, we can always find areas of new highs and new lows, and many of the forecasts don’t turn out as expected. Let’s look at what has been happening. If we take a broad view, Figure 1 shows a sample of sector performance from 1998.
Figure 1. Energy (XLE), Financials (XLF), Health Care (XLV), Technology (XLK), Retail (XRT), and Emerging Markets (EEM).
In the big picture, the average of these sectors moves higher much like the broad index, SPY. Heathcare and Technology are the best performers. Personally, I confuse technology with internet, which seems to me as the technology that I see most often. But XLK is mostly semiconductors and software, not the same as the FAANGs, shown in Figure 2. Although AMZN and GOOGL have outpaced the other three, all of these stocks have performed well. Yet they are not quite back to highs, while SPY and QQQ are on new highs.
Figure 2. FAANGs. (Left scale) AMZN and GOOGLE, (right scale) AAPL, NFLX, and FB
The two biggest players in social network are Facebook (FB) and Twitter (TWTR), shown in Figure 3. Facebook has come under fire for using personal information and failing to stop foreign posts that have influenced our elections and divided our country. Twitter seems to have fallen under the radar. Yet Facebook is outperforming Twitter by a wide margin. It’s a case of “the price knows all.”
Figure 3. Facebook (FB) and Twitter (TWTR), the major social network stocks.
I’m not a fan of war but it seems to be there all the time. In studies that I’ve done, the defense stocks are always a good investment. Boeing (BA) is sometimes included and sometimes not, because it has a large commercial component, which is not the case with Northrop (NOC), Lockheed (LMT), and Raytheon (RTN). Yet Boeing is the best performer and has recovered the most after the last setback, even though its Max aircraft are grounded. It seems hard to explain unless it is such a small part of their business that losses due to grounding a fleet are incidental to their bottom line.
Figure 4. Defense stocks, Boeing (BA), Northrop-Grumman (NOC), Lockheed-Martin (LMT), and Raytheon (RTN).
LYFT and other IPOs
The LYFT IPO brings back a study done about two years ago, that I published in Forbes. It showed that, in general, it took two years for a company to show gains above its IPO price. Once public, a company needs to figure out how to spend its new investment, and then how to show profits. I think that only 20% of the IPOs post gains during that early period. LYFT may not be one of them. The IPO price, near $80 (or was it $87?) was very high. Naturally, the company and underwriters want to get as much as possible, but the investors that buy into it should not be abused. Some companies can do it, such as Google, but they are the exception. Then there is the competition. One is clearly Uber, but there will be others. If that happens in the two years it takes for LYFT to be profitable, it may not turn out to be much of an investment.
Figure 5. LYFT from the IPO.
Placing Your Money
The two things to remember when selecting stocks for your portfolio are the individual risk of each stock (its volatility) and whether it offers diversification. IPOs are not something we recommend.
It turns out that companies that have performed well, or sectors that perform well, are most likely to continue, so Healthcare and Technology are likely to be good choices. Of the internet stocks we don’t like BIDU but we do like GOOGL and AMZN, although with smaller positions because of their volatility.
We still favor defense stocks, including Boeing. Just like heath care, war is inevitable. There are many stocks that could perform well in the next year but it’s easier, and most often safer, to pick among the ones that are already doing well. When diversifying, remember to put an equal dollar investment into each stock or futures market.
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.
There is no sign of weakness yet in the Trend Strength Index, but it is coming into resistance below 60. We expect that to hold. This doesn’t look like the bull market of 2009-2017, so expect some more volatility as prices move to new highs.
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 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.
Another month of small gains while the broad index markets move higher at a faster pace. As mentioned early, a strategy needs to take defensive action when price drop quickly and significantly. It then needs to wait for enough stocks to recover and show stability before reentering. Now that we’re far enough along, this program should start to outpace the broad market, as it has done for years.
Income Focus and Sector Rotation
Another month of good performance in this program. The main reason seems to be the White House pressuring the Fed to lower rates. That may not happen, but raising rates seems to be getter further away. As only as rates remain the same, this program will profit from interest income. It’s unlikely it will get another boost up on lowering rates.
Almost too good to be true that the Sector Rotation program gained 4.7% in April, moving it to fractional new highs. It does show that sectors performance is becoming more consistent, especially Technology. A few months more of good returns and this program may regain some popularity.
While not outperforming the S&P, this program is up by 14.27% in 2019 and has just made a new high in equity. It also did not decline as much as the index markets, so we’ll take the smaller gain with less risk and a chance to move up nicely.
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 good month, up 18% and 11% for 2019 in the 10 and 30-stock portfolios. This program targets a short holding period when the trend stalls before deciding which direction it will go. It can be a good compliment to trend following or other strategies.
Group DE3: Timing Program for Stocks
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.
Modest but steady returns this year shows a definite upturn in the performance. This program buys undervalued stocks and hedges when the major trends turn down. As of the end of April, it still held a small hedge position because the longest trends have not yet turned up.
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.”
While all portfolios were profitable in April, we continue to wait for a price run in any of the major markets. April was a bit better than other months this year, but strength in one trend is offset by noise in another. We all know that, when trends surface, futures programs will capitalize on those moves. We’re still waiting patiently.
Group DF2: Daily Divergence Portfolio for Futures
This program put in another good month, now up 20% to 26%, about twice its long-term expectation. As we said, it is impossible to predict future performance, so diversification is the going method of risk control. This program has shown cyclic but outstanding returns.
Blogs and Recent Publications (for the past 12 months)
MetaStock will be offering a program with four of Mr. Kaufman’s short-term trading strategies for ETFs, stocks, and futures. They should be available anytime now!
“A Simple Way to Trade Seasonality” will be published in Technical Analysis of Stocks & Commodities. We’ll let you know when we have a date.
Mr. Kaufman appears as a chapter in Mario Singh’s new book, Secret Conversations with Trading Tycoons, published by FXI International.
Mr. Kaufman was interviewed by Caroline Stephen at TalkingTrading.com. It covered a wide range of topics. It has not yet been posted but should be available soon.
We thought the article in ProActive Advisor Magazine would be in March, but it should appear any day in April. It is “Let’s Be Realistic About Drawdowns.” Most traders don’t pay enough attention to the drawdown history of their trading, or of any system trading. Large drawdowns are infrequent but can be ugly. This article shows how to assess them and some ideas on reducing drawdowns.
Technical Analysis of Stocks & Commodities will publish “Volatility: What They Don’t Teach You In Grad School,” in the January edition.
An article appeared in ProActive Advisor Magazine looking at all calendar patterns, including the Santa Rally, the Presidential Cycle for 2019, the January and May effect, and seasonal patterns in ETFs.
In January Technical Analysis of Stocks & Commodities will publish an article showing the real relationship between price and volatility, which will surprise you. It should change the way you size your positions.
Mr. Kaufman spoke in Tokyo and Osaka to the Japanese association of Technical Analysts on various techniques for trading Japanese markets. You can contact the organization for a copy of the presentation. Mr. Kaufman was presented with a Japanese translation of his newest book, A Guide to Developing a Successful Trading Strategy.
He also spoke about “Making Volatility Work for You” at the 2018 IFTA conference in Kuala Lumpur. It was an excellent conference with many good speakers. You may be able to get a copy of the presentation by contacting MATA, the Malaysian Association of Technical Analysts.
“In Search of the Best Trend” will appear in Technical Analysis of Stocks & Commodities this month.
A new article on “Defense is Your Best Defense” will appear in ProActive Advisor Magazine this week.
Mr Kaufman spoke to the Austin chapter of the CMT Association (previously the MTA)
He was interviewed by Jacek Lempart for his blog systemtrade.pl, serving the European Polish investors. The interview will be posted soon.
Older Items of Interest
For older articles please scan the websites for Technical Analysis of Stocks & Commodities, Modern Trader, Seeking Alpha, ProActive Advisor Magazine, and Forbes. You will also find recorded presentations given by Mr. Kaufman at BetterSystemTrader.com, TalkingTrading.com, FXCM.com, the website for Alex Gerchik, and Michael Covel’s website, TrendFollowing.com.
Mr. Kaufman has been a keynote speaker at a number of IFTA conferences, the most recent this year in Kuala Lumpur, and the previous year in Milan. You can find his presentations on their website.
© April 2019, KaufmanSignals. All Rights Reserved.