April 2022 Performance Report

Industry Benchmark Performance                                                                                            

Hedge funds are doing much better than the index markets, even though they are posting losses. We don’t have information showing which sectors are better or worse, but the multistrategy is faring better than others.

Futures are showing that the traditional sectors are easier to find direction. Their returns nearly offset losses in equities. Then again, they can be short the index markets, a term called “crisis alpha.”

New articles and two webinars

Perry will be giving a webinar for the U.K. Technical Analysts (STA) on Tuesday, May 10 at 11:30 am (NY), and for MetaStock the week of May 16. No day or time is assigned yet. There is a new article appearing in the SAMT Journal (Swiss Market Technicians, also posted online) on trading EFFs.

Kaufman’s New Book, “Learn To Trade: Trade To Win with a Rule-Based Method”

Written for both serious beginners and practiced traders, this book includes chart formations, trends, indicators, trading rules, risk, and portfolio management. You can find it as a print or ebook on Amazon using the following link:

Don’t forget, “Kaufman Constructs Trading System.”  You can also find it on Amazon or on our website, www.kaufmansignals.com.

Blogs and Recent Publications

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

April Performance in Brief

It was not possible to hide from the sharp declines in April, but our systems performed well, and some actually netted a gain.

The benchmark Equity Trend portfolio lost about 3.5% and is now down a little over 1% for the year, putting us in a position for recovery. That is far better than the S&P which lost over 8% and is down 13% for 2022. Not to mention Nasdaq, now off 21% this year. The program holds mostly energy positions, which has caused gains, losses, and volatility. But energy is still a main focus of the market.

The Timing program was clever enough to stand aside most of April and still holds a 5% gain for the year. The best returns are in the Trend Futures portfolios, which have been long interest rates and long energy as news develops. We can’t speak to future returns but do not see any immediate change in geopolitical issues.

The chart below is not a pretty picture. The small caps (IWM) and Nasdaq (QQQ) have given back all of their gains from the start of 2021, but then they are traditionally the most speculative of the index markets. IWM is often the first to see traders run for the door. Nasdaq, having posted remarkable gains during the Covid lockdowns as well as during the 10-year bull market, now finds that value investors have been saying they are unreasonably priced and can drop further. But they are still a vital part of our economy. That argues for volatility.

The strongest of the index markets is the S&P with the DOW not far behind. They still show net gains of 10% to 15% since the beginning of 2021. All is not lost! The Fed need only announce a less aggressive plan and the decline can come to a screeching halt.

CLOSE-UP: Interest Rates and the Fed

As a futures trader for many years, I have always believed that futures prices lead the news. Whenever there is a possible drought, grain futures rally. If the U.S. economy may go into a slump, the euro futures gain. Now we have inflation. We all know that the solution is to raise interest rates and we would expect futures to signal those rate hikes even before the Fed announces them.

Following interest rate futures should be the key to interpreting Fed action and profiting from it. Let’s look at the two clearest cases, our current anticipated rate hikes and the ones following the internet bubble, starting in 2003. We can’t look at the Feb action following the financial collapse of 2008 because rates never increased.

First, We Look at 2003

We will use Fed Funds (FF) to represent Fed action and the 10-year Note futures (ZN) as the benchmark futures rate. To make it more understandable, we “discount” the Fed Funds rate by subtracting the price from 100. The price rising will show lower yields and the price falling shows higher yields, just like futures. Both discounted Fed Funds and Notes are shown in Figure 1 for 2002 through 2007.

Figure 1. Fed Funds rate (discounted) and 10-year Note futures, 2002-2007.

In the first half of the chart, yields are falling. Both FF and TY prices are rising, indicating that the Fed is still accommodating the negative impact of the dot.com losses with lower yields.

In 2004 that changes. The Fed starts raising rates steadily. It stops in 2006 and we know it will drop rates to near zero after the 2008 financial crisis. During the rate increases that start in 2004, 10-year notes increase only slightly while Fed Funds rally to over 5%. While the direction of ZN is the same as FF, it lags the increase in rates, is more volatile, and never fully reflects that increase.

Remember that, as the maturity increases, the traders try to anticipate future rates. If we look at the 2-year Notes (TU) for the same period, Figure 2, we see that it is smoother and reflects the rate increase after 2004 more than ZN.

Figure 2. Fed Funds compared to 2-Year Notes, 2002-2007.

The Current Fed Hikes

It is no secret that the Fed is planning to raise rates often. Chairman Powell has even suggested 75 bp on the next round. How has the futures market anticipated that news? We start with the 2-year Notes.

Figure 3 shows that 2-year Notes have tracked Fed Funds closely. They start by declining a bit too fast, realize that it was wrong, rally back to the Fed Rate before starting the steady decline. There doesn’t seem to be any anticipation in the price of TU.

Figure 3. Fed Funds vs 2-year Notes from January 2021.

Looking at Fed Funds vs 10-year Note futures in Figure 4, we see more uncertainty. We do not see anticipation of the rate increases, which are guessed to end at about 5%. When I looked up the current yield of the 10-year note online, it showed 2.8%, above the actual FF rate but not discounting expectations.

Figure 4. Fed Funds (discounted) vs 10-Year Note Futures, from 2021.

To be complete, Figure 5 shows Fed Funds futures, anticipating a 50 bp point increase next week. It does not show any anticipation of futures rates, or the threat of a 75 bp increase, regardless of the Fed’s messaging.

Figure 5. Fed Funds Futures (AUG), shows 99.25 in blue on the right, indicating a 50 bp increase.

How To Use Interest Rate Information

The problem with price anticipation is that it is noisy. Traders change their minds and prices do not go in one direction. The only way that I know of fixing that is to use a trend, which smooths out those prices moves. But which trend?

Rather than optimizing, we consider that Fed action is slow, and their interpretation is spaced out over months using the information we see in economic reports. To reflect that, I chose to use a 63-day moving average for all futures prices, equal to one quarter of a tading year.

Rather than make it complicated, the direction of the trend, +1 or -1, was multiplied by the change in the interest rate for that day. A unit value of 1 was used for the 5-year, 10-year, and 30-year, while a unit value of 2 was used for the 2-year Notes. The actual contract sizes are 1,000 and 2,000, so the relationship is the same. Figure 6 shows the cumulative returns taking both long and short positions.

Figure 6. Cumulative returns of interest rate futures using unit sizes, based on a 63-day moving average.

I won’t analyze this because the results are obvious. Trend following works for interest rates. It is why most futures fund managers have a large allocation to trend following of interest rates.

If this seems like a good solution, you need to test it yourself, applying your own trend and allocating your own investment size. I have no doubt that you will find the results to be good.

Trying to sort out the information about what the Fed will do and how the market will react is just too complicated. Following the trend is a better way to benefit from these interest rate moves. Of course, I’m a trend follower.

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 equity portfolios. Our work over the years shows that downturns in the stock market are most often short-lived and it is difficult to capture with a longer-term trend. The upwards bias also works against shorter-term systems unless using futures, which allows leverage. Our decision has been to take only long positions in equities and control the risk by exiting many of the portfolios when there is extreme volatility and/or an indication of a severe downturn.

PORTFOLIO METHODOLOGY IN BRIEF

Both equity and futures programs 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 on the specific system, 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 outperforming 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 since are simulated but the returns from 2013 are the systematic daily performance added day by day. Any changes to the strategies do not affect the past performance, unless noted. The system assumes 100% investment and stocks are executed on the open, futures on the close of the trading day following the signals. From time to time we make logic changes to the strategies and show how the new model performs.

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

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. It will hold fewer stocks when they do not meet our conditions, and exit the entire portfolio when there is extreme risk or a likely drawdown.

Even with a loss this month, both Daily and Weekly Equity Trend charts look positive. Both programs have been heavily weighted in energy stocks for all of April, which provided a run of profits but also volatility. Returns have been uncorrelated with the overall market. When oil prices drop, the market rallies, and when oil gains, the market falls. We can’t anticipate what will happen next, but it does not seem as though the oil crisis will go away anytime soon. However, demand can ease.

Income Focus and Sector Rotation

Neither the daily or weekly Income Focus portfolios have had much exposure this month. The daily program was able to exit before a big jump in rates. It is lower by 3% this year, while the weekly program is off by nearly 7%, mostly due to preferred stocks. There are no positions in either program and money market is not providing enough return to make a difference. This program will be back on track once interest rates stop rising (or are fully discounted by the market).

Sector Rotation

The Sector Rotation program continues its drawdown, losing 3% this month and 10% for the year. In view of the overall market, it isn’t too bad and offers diversification.

DowHedge Programs

Even choosing the best of the DOW stocks, we cannot avoid a loss in April. The daily program lost less than 2% and the weekly program less than 4%, both significantly better than the Dow ETF, which lost almost 4%.  Returns for all of 2022 are also better than DIA and the charts below look stable. We look forward to better times.

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.

The Divergence program posted the largest losses of our portfolios, but still remains far better than the equity index markets, having had better gains recently. The chart show that April’s loss gave back more of the previous  gain but there is no indication of a downtrend in performance.

Group DE3: Timing Program for Stocks

The Timing program is a relative-value arbitrage, taking advantage of undervalued stocks relative to its index. It first finds the index that correlates best with a stock, then waits for an oversold indicator within an upwards trend. It exits when the stock price normalizes relative to the index, or the trend turns down. These portfolios are long-only because the upwards bias in stocks and that they are most often used in retirement accounts.

Our Timing program is clearly the smartest of the equity program. It looks for pullbacks in a uptrend, and without any uptrends, it has been on the sidelines in April, with the exception of one trade which was short-lived. With losses of less than 1% it will wait patiently for a better pattern to develop.

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 down 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.

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

It is always good to have a bright spot in difficult times. Futures has been credited with “Crisis Alpha” for the ability to profit when stocks are declining. That is due to being able to go short with significant leverage. A small position in futures can offset a large loss in equities – when it works. It worked in 2008 and it seems as though its time has come again. This program gained between 5% and 8%i in April and is how ahead by 13% to 24% for the year. That turns out to be about right for offsetting equity losses.

Group DF2: Daily Divergence Portfolio for Futures

Unlike the Futures Trend program, the Divergence program lost an average of 8% in April, offsetting its 2022 profits. Its patter remains volatility. As a short-term program, it relies on pauses in a trending market, which does not seem to be happening at the moment. But markets return to “normal,” and algorithmic systems can be patient.

Blogs and Recent Publications

Kaufman’s New Book, “Learn To Trade: Trade To Win with a Rule-Based Method”

Written for both serious beginners and practiced traders, this book includes chart formations, trends, indicators, trading rules, risk, and portfolio management. You can find it as a print or ebook on Amazon using the following link:

Don’t forget, “Kaufman Constructs Trading System.”  You can also find it on Amazon or on our website, www.kaufmansignals.com.

Trading Systems and Methods, Sixth Edition

The sixth edition of Trading Systems and Methods was released at the end of 2019 by John Wiley. It is completely updated and contains more systems and analyses.

May 2022

Perry will be giving a webinar for the U.K. Technical Analysts (STA) on Tuesday, May 10 at 11:30 am (NY), and for MetaStock the week of May 16. No day or time is assigned yet. There is a new article appearing in the SAMT Journal (Swiss Market Technicians) on trading EFFs.

The May issue of Technical Analysis of Stocks & Commodities has a new article by Perry, “In-Sample Test Data, Out-of-Sample Data – Does It Really Matter?” It is a different look at testing.

March 2022

The 2022 Bonus Issue of Technical Analysis of Stocks & Commodities published Perry’s latest article, “50 Years On. What Have I Learned?” It is a summary of the most important trading and development lessons he has learned.

Sunny Harris (MoneyMentor.com) interviewed Perry on Saturday, March 26. Her approach combines both personal and technical questions, having known Perry for many years. You should find it interesting. https://anchor.fm/sunny-j-harris/episodes/Perry-Kaufman-Pontificates–Market-Pundit-and-Trader–Prolific-Author-and-Programmer–Perry-is-definitely-a-Guru-to-get-to-know-e1gf30s

Four articles have been posted on Seeking Alpha in March. They are

  • How To Control the Risk of Cryptos in Your Portfolio
  • How To Find Low-Volatility Stocks That Outperform the Market
  • The Best Balance of Stocks and Bonds Will Surprise You
  • Determining Whether Crisis Alpha Is A Good Idea Or A Flash In The Pan

January 2022

There is a new interview of Perry by Ali Casey, a Canadian podcaster. You can find it at https://youtu.be/7fGBUjlPENE. He asks some interesting questions.

An article by Mr. Kaufman, “Trading a Moving Average System” in the January Technical Analysis of Stocks & Commodities shows the best rules to use for with a moving average.

November 2021

We managed to finish November with a webinar for MetaStock, Trade View (Australia), and two for FinecoBank (Milan), in English and Italian. You will be able to find recordings of the MetaStock and Trade View presentations by going to their websites.

September 2021

For those practicing their Spanish, Mr Kaufman has an article being published in Hispatrading, an on-line Spanish technical analysis magazine. It is about how to execute a trend-following strategy.

July 2021

 “Playing It Safe with Cryptos” appeared in Technical Analysis of Stocks & Commodities. It’s a challenge trying to trade these markets given their extreme volatility.

Book Interview

Mr. Kaufman appears as a chapter in Mario Singh’s book, Secret Conversations with Trading Tycoons, published by FXI International.

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, systemtrade.pl, the website for Alex Gerchik, Michael Covel’s website, TrendFollowing.com, and Talking Trading.com.

In May 2021, Mr. Kaufman gave a 30-minute presentation, “Lagged Trends,” for The Money Show on Tuesday, May 11. You can see it using the following link: https://youtu.be/bh2fA8oBwBk

November 1, 2020, Mr Kaufman taped a session with Andrew Swanscott’s BetterSystemTrader.com.

“The 1st and 2nd Cross” has been very popular with readers. It was published in Technical Analysis of Stocks & Commodities in the March 2020 issue. It is based on an idea of Linda Raschke and captures small but reliable pieces of a trending move. You can find it online.

You will also find back copies of our “Close-Up” reports on our website, www.kaufmansignals.com. You can address any questions to perry@kaufmansignalsdaily.com.

© April 2022, Etna Publishing, LLC. All Rights Reserved.

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