Industry Benchmark Performance
Mixed results in Fund performance although the stock market continues slowly higher. Long bias programs have the advantage and posted gains, while Fund of Funds and Multi-Strategy show losses. It could be that the higher fees of those programs chip away at profits.
Futures had losses everywhere, but still hold onto gains for the year, much like our programs. Barclays hedge fund website is no longer posting BTOP50 results, so we’re looking for other benchmarks. We added the Wisdom Tree Managed Futures Strategy, which is a traded ETF and likely to show real values. The problem with some benchmarks is “survivorship bias.” When a company goes out of business they don’t often post the last, and worst, month, so the index results are “optimistic.” There is also no guarantee that the returns submitted to the companies posting the performance are accurate. As an ETF, that won’t be a problem. We’ll try to find others to add to our report.
More Forbes (and other) Blogs
Another article was posted on Forbes last month, “Uncovering The Best Tradeable Bond Fund,” discusses which bond funds are most likely to work with algorithmic trading models. You can find all of Mr Kaufman’s Forbes articles at https://www.forbes.com/sites/perrykaufman.
You will also find a new article, “Entering a Trade at the Right Time Can Double Your Long-Term Profits,” posted on www.equities.com.
There should be another article appearing in Modern Trader but we don’t get have the issue. You can address any questions to email@example.com.
August Overview: Creeping, creeping higher, without enthusiasm
Combined with the Trend Strength Index, the overall equity market is forming a rounded top, hanging near its momentum highs. The possibility of a rate hike will attract money to the U.S. but also stifle trade and raise our foreign trade debt. But then, we’ve lived with that scenario for a long time. We always seem to buy more and sell less.
The small caps, IWM are the strongest, usually a sign of a robust market. When there is uncertainty, investors tend towards blue chips, or in this case, the Dow. So it’s surprising that IWM would be leading. Maybe we don’t understand how the investor is thinking, or we’re in for an unexpected rally.
To show what a short memory the market has, the British vote to exit the EU doesn’t seem to have had any lasting impact. It’s likely that the market will now wait for actual economic statistics in Europe and the U.K. before picking a direction. More about this further on.
So Soon We Forget
The equity markets, even in the U.K. and Europe, have shrugged off the British exit vote, even though it was only in late June. We have been under the opinion that the Scottish vote to stay, conflicting with the final British vote, will surface at some point not too far in the future. If the Scots vote for independence, the value of the British pound will take another leg down. The chart below shows that the euro is holding its own, but the sterling is slowly fading, or at least no one is willing to bet that the exit is a good move for the U.K. No matter how we interpret this, price movement is most often correct.
We can understand why interest rates in Europe have been steadily dropping, because they are still actively managing a weak economy, but why are U.S. futures still in an uptrend? It seems that through mid-July expectations were that the Fed had forgot about raising rates, didn’t want to do anything in front of the election, or just continued to be uncertain about world economic weakness. In the past month and a half, the market is less certain and is giving a sign that rates might rise. The spread between the 30-year bond and the Eurobund is steadily narrowing. We’ll go on the record saying that the U.S. bonds have posted their high and will turn down.
Last month we voted against a sustained rally in energy, but the XLE shows that companies have adjusted to the current price levels even as futures dropped, rallied, and are now dropping again. That makes it a difficult market to trade. Still, we need to recognize that long-term gains in energy stocks depend on higher oil prices, so at best these companies are managing well and biding time. It looks as though there is still some opportunity in being long stocks and short futures.
After a bumpy ride over the past few years, Tata Motors seems to have gotten their act together. With lots of advertising for their iconic brands of Jaguar and Land Rover, and some very nice styling for the new Range Rover Sport, they have overcome the days when their only warranty was 12,000 miles because, after that, maintenance soared (from personal experience). This month they have posted a better than expected year-over-year sales gain of 8%. We’ve been holding Tata in our trend portfolios with good success. So far, so good, but keep an eye on the trend if you invest.
Portfolios Selected by Performance are High Beta
As a reminder, our automatic portfolio selection process uses past performance to select stocks and futures. Markets that are outperforming the averages tend to continue to outperform, but they also have higher volatility than the broad index. Outperformance means that profits on any day are higher, which also means that on a losing day, losses will usually be larger. It’s the basic principle of volatility and risk: you can’t achieve higher returns without higher risk.
Smaller portfolios that are less diverse are more likely to generate higher returns during “good” markets (the ones that work well for the strategy) and larger losses during “bad” markets. More diverse portfolios will have smaller gains and losses. To decide which is best for you, you must decide your risk tolerance and have capital can be put at risk.
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 250 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.
More gains in the S&P and the Trend Strength Index (TSI) around 50 puts it is in an overbought situation. From our history, a bit over 60 is the highest TSI value posted. Combined with rumors of a Fed rate hike, we can only expect a sell-off in the equity markets, although no one can know how much.
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.
Strongest and Most Undervalued Sectors
There are two ways to view sector rotation, trade the strongest expecting them to stay strong, or trade the weakest expecting the business cycle to rotate them to the top. We have both. The Trend Rotation trades the strongest and the Timing Rotation trades the weakest. The Trend program may hold positions for a long time, so it’s possible for two ETFs to be in both programs. For example, XOP (Oil and Gas) can be in a long-term uptrend, but a short-term oversold situation. The new Sector Rotation program also buys the strongest sectors and is reviewed with the Trend Equity Program.
The Trend Sector ETF program buys the 6 strongest sectors of the SPDRs. August started with the following:
Preferred (PFF), Reits (VNQ), Technology (XLK), Staples (XLP), Utilities (XLU), and Metals & Mining (XME)
At the end of August, we had changed 3 positions, replacing Staples (XLP), Utilities (XLU) and Reits (VNQ), favoring more industrials rather than services. We now hold:
Preferred (PFF), Technology (XLK), Metals & Mining (XME), Materials (XLB), Energy (XLE), and Industrials (XLI)
The Timing Program buys 4 ETFs that are undervalued with respect to SPY, in expectation of rotation. As of the beginning of August we held positions heavily favoring a rally in the Energy sectors:
Preferred (PFF), Oil & Gas Equipment (XES), Energy (XLE), Oil & Gas Exploration (XOP)
At the end of August we had switch to more diversified holdings:
Preferred (PFF), Oil & Gas Equipment (XES), Utilities (XLU), and Health Care (XLV).
When an ETF appears in both the Trend and Timing programs, it means that market is very strong but is in a short-term retracement.
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 and ETFs
The Trend program seeks long-term directional changes in markets and the portfolios choose stocks and ETFs that have realized profitable performance over many years combined with good short-term returns.
It’s not as though these programs are doing badly or are showing some strange pattern, but we’re ready for some more definitive move in equities that lets the programs leverage up and capture substantial profits. In the meanwhile, our programs, as well as those of the management industry, are biding time and controlling risk. In the bigger view, that happens a lot. We do have the U.S. election on the horizon, which might stimulate some more serious price movement. The truth is that we never know when a major trend will start, so we keep following the rules.
Although posting small losses, the Weekly program for stocks maintain a nice upwards trend, especially in the smaller 10-stock portfolio. The ETF program remains off its recent lows, a positive sign for the weeks ahead.
As we discussed last month, the Sector Rotation program has a lot of volatility, this month moving against us, but overall holding a gain of more than 5% for the year. As of month-end it was long Emerging Markets (EEM), Energy (XLE), and Metals & Mining (XME), all volatile sectors.
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.
Fractional losses in the Divergence stock program keep the chart looking steady. As with the other programs, a little encouragement from the overall equity markets will put this program on new highs.
The ETF program was essentially flat in August and keeps its very steady trend upwards.
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.
Gains in the 10-Stock portfolio and the ETF portfolio make this the best performer of August, although still waiting for new highs in the stock portfolios. Buying undervalued stocks with a good history of recovery is best in a clear bull market, but is holding its own during this weak rally.
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.”
Another drawdown in all program still leaves the futures portfolios with a gain of 5% to 9%, well above the industry benchmarks. The past two months have struggled with a lack of trends: currencies look as though they are on life support, energy has flopped up and down, and interest rates are uncertain whether or when the Fed will act. Only the stock market has been creeping higher. If the Fed does raise rates, everything can change. The dollar should strengthen and equities should fall; commodities are likely to sell off as well. The only issue is whether it will be a big enough move to capture trend profits.
Group DF2: Daily Divergence Portfolio for Futures
Fractional losses in the smallest portfolios and fractional gains in the largest still leaves this program showing a loss for the year. Given the normal swings in equity, this is not out of pattern, although we would enjoy a turn to the upside here.
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