Kaufman Signals

August 2018 Performance Report

Industry Benchmark Performance

Early reporting of equity long programs shows that a new leg in the bull market translates into hedge fund gains. All the funds that we follow posted profits in August, but year-to-date still lags the passive indices by a long way. CTAs had a much better month, allowing them to reduce losses. The last quarter of the year tends to be good for trading, so the final word in not yet in.

Blogs and Recent Publications

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

August Performance in Brief

An impressive return for most portfolios in a month where most investors are said to be on vacation. The small daily stock trend program is now up 23% for 2018 and the weekly program up 15%. Futures are also doing well. Most of the news centered around trade negotiations with both NAFTA and China the biggest players. First bad news, then good news, or at least that’s the way the market is interpreting it. Still, there is no deal yet for either Canada or China, and talks with Europe have stalled, so there may be more downside to come. Balancing that are continued good earnings, allowing the equity index markets to break to the upside.

Major Equity ETFs. There is no doubt the uptrend is back. NASDAQ is by far the strongest, then the small caps and the S&P. The Dow is not quite at new highs. More about it in this month’s Close-Up.

 

CLOSE-UP: More Bull Ahead? What About the FAANGS?

Although we thought the fundamentals of higher interest rates and trade uncertainties were enough to stall the bull market, we took the technical approach that the market would tell us what it wanted to do. It’s clear now that it wants to continue higher. The sideways pattern that started at the beginning of 2018 no longer looks important.

Leading the new leg of this bull market are the FAANGs (see Figure 1), now with Amazon considered one of “the group.” We also want to look at Twitter (TWTR).  Both Facebook and Twitter to a nasty drop at the end of July. TWTR has had some recovery but FB has gone quiet. They both face scrutiny over fake accounts from foreign users seeking to disrupt U.S. elections. Facebook has been vocal about trying to combat the problem, even announcing (along with Google) that it has identified and stopped a number of users. But the problem is daunting. You block one place and they pop up somewhere else. Security issues are eating into the profits of most internet companies and it’s not at all clear that success is on the horizon.

Figure 1. FAANGs + TWTR since the November 2016 election.

Apple (AAPL) and Amazon (AMZN) don’t seem to have these issues because they are not the vehicle for news or social media. They have continued a slow, steady climb. What else is driving the market?

In Figure 2 we show the major ETFs along with SPY as the benchmark. Only retail (XRT) and heathcare (XLV) are beating SPY. Emerging markets (EEM) are struggling along with metals and mining (XME). Retail has done well, especially Macy’s and Target, and healthcare is always in the background. That leaves the tech stocks, which were shown in Figure 1. Apple and Amazon are such large caps that the overwhelm most of the other stocks and skew the benchmark in their direction.

Figure 2. What’s driving the market?

The third quarter is typically healthy of stocks. Investors come back from their holidays, the Christmas shopping season approaches, with deep discounts attracting customers earlier and earlier each year. There is no reason to think that this year will be any different. The only events to watch continue to be higher rates by the Fed, but the market already expects that – and trade with China and Europe, still unresolved. That could eat into corporate profits, which is what the bull market is all about. Our advice is to follow the trend.

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 S&P did pullback as the Trend Strength Index dropped to near zero, but then it has recovered in what to be a weak uptrend. Some would argue that it’s the return to the bull market, but the Index doesn’t agree with that yet. Uptrend yes, strong no.

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.

An outstanding month for the Equity Trend program, with the 10-stock daily program now +23% for the year. The weekly program recovered with a 9.3% gain in August, no higher by 15.7% for 2018. The more diversified portfolios also did well but more stocks generally means both diversification and lower returns.

 

Income Focus and Sector Rotation

Profits in both the daily and weekly Income Focus portfolio gives us a short reprieve during a rising interest rate environment. The weekly program was higher by almost 1% in August and now is up +1.89% for 2018, good performance for that strategy in a difficult year. The daily program gained 0.53% but is still off fractionally for the year.

Another gain this month of 1.9% in Sector Rotation continues the recovery for this classic trading strategy. Perhaps it’s turned the corner.

 DOW Arbitrage

While the DOW is lagging most of the market, especially NASDAQ, a 3% gain in August helps put the performance back on track. Another good month and the program will be a new highs.

 

 

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.

Both 10 and 30-stock portfolios gained about 3% and 2% in August. The smaller portfolio is now up over 11% for 2018 while the large portfolio, which is often not filled due to the sparse signals, is only higher by 1.6%. In this case, the larger portfolio has smoother returns.

 

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.

Another gain for both portfolios in August puts them profitable for the year. This program buys the weakest stocks and hedges when the broad market turns down. This year that pattern has fooled the strategy, turning down for short bursts, then returning to the uptrend.

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.”

All futures trend portfolios had a good month with the smallest daily portfolio +9.58%, recovering from a nasty setback. The weekly program is doing well in all portfolios, the 250K up 12.3% for the year and the 500K up 17.25%. In both daily and weekly, the 500K portfolio is well ahead of the others.

Group DF2: Daily Divergence Portfolio for Futures

The Divergence program struggled in August trying to find trades. It finished the month down 1% to 2% but is still off for the year.

Blogs and Recent Publications

Upcoming events:

Mr. Kaufman will be speaking in Tokyo and Osaka to the Japanese society of technical analysts on October 20th and 21st. Please contact us through our website if you need further information.

Also, Mr. Kaufman will be a Keynote Speaker at the annual IFTA Conference to be held in Kuala Lumpur, October 26 through October 28. They are now offering an early-bird special for attendees. Go to the IFTA website for more information.

July

“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 Investor Magazine this week.

March

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.

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 (https://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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