Kaufman Signals

August 2019 Performance Report

Industry Benchmark Performance

Due to the holiday weekend, hedge fund postings are slow. There are no fund of funds or multi-strategy results yet showing on Barclays website. What is posted looks good for futures, with the BTOP50 higher by 16.25% for 2019, a very good performance by any standards. Most of the gains are in interest rates, with some added profits in the stronger U.S. dollar and higher gold prices. We would normally thing of these results as “crisis alpha” where futures surge while equities fall. But that’s not happening now. It seems to all  be about uncertainty and anticipation.

MetaStock Launches Kaufman’s Fast Strike Systems

For more information on these short-term trading systems, contact MetaStock at 800-882-3040 or go online to www.metastock.com/kaufmana.

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

Our programs held up well in the face of growing uncertainty.

Major Equity ETFs. A very strange consolidation pattern for the past month, the result of “trariffs on—tariffs off.” Add to that a possible inversion of the yield curve, the machinations of Boris Johnson, and a scary number of mass shootings, and we have an investing public losing confidence. NASDAQ has been holding up best and the small caps the worst. We’ll look at this in more detail in the monthly review.

CLOSE-UP: Expectations and Reality

One of the important reasons that I advocate algorithmic trading is that the expectation of what the markets will do, based on the bombardment of news, is not always what is actually happening. It may not even be right most of the time.

We know that econometric forecasts have a low percentage of success. Certainly, there is no “timing” in a forecast that uses fundamental data. In addition, investing in a stock with good “value” may take more than one or two years to pay out. With that in mind, we will look at the major events going on and see what the price moves are telling us.

The Trade War

We have been dueling with China since Trump put tariffs on Chinese imports in July 2018. A little more than a year later, we now have tariffs on nearly all goods coming from China. In turn, China has placed tariffs on U.S. imports. The latest on technology.

As we see in the chart of index ETFs in the previous section, tariffs went into place near the peak of the 2018 prices.  The sell-off that we saw in late 2018 was due to more tariffs or threats of tariffs, plus the Fed not accommodating expectations of an economic slowdown. Because QQQ, SPY, and DIA all made new highs afterwards, the Fed appeared to be right. The economy did not need to be stimulated.

How has all this affected China? In Chart 1 below we see that the recent peak occurred at the beginning of February 2018, five months before the tariffs went into place. No doubt the tariffs have not been good for China’s economy, but it has had a bit of a recovery since the lows. It is not collapsing.

Chart 1. Shanghai Composite 5 years showing the recent peak on February 2, 2018.

In Hong Kong, the riots protesting the proposed extradition law has been the driver of lower prices. That law was published on March 29, 2019 and the peak followed a few days later, shown in Chart 2. It would be difficult to say if the decline in the Hang Seng index was caused by tariffs because it closely aligns with their domestic problems.

Chart 2. Hang Seng Index, 1 year, showing the peak on April 10, 2019.

Then we need to consider Apple, which makes most of its iPhones in China and will be subject to the new tariffs. Chart 3 shows AAPL near its high for 2019, hardly what we would expect from a company about to lose a great deal of business. Do we sell it in anticipation of a downturn, or will there be a resolution with China and prices will move higher? Or won’t it matter at all?

Chart 3. Apple prices from January 1, 2019.

On the other side of the ledger is Bidu and Alibaba. Are the tariffs hurting these large consumer companies in China? Chart 4 shows a significant drop in Bidu, but it comes at the same time as the unrest in Hong Kong and not when the trade war started. But then Alibaba doesn’t seem to have been affected. So, what is driving these prices?

Chart 4. Bidu and Alibaba show a drop at the same time as the Hong Kong demonstrations.

Brexit

At least we can be sure that Brexit will be a disaster for the UK. A “no deal” Brexit will cost the British more for everything, reduce their supply of medicines and other vital goods, and turn them towards the U.S. as their primary trading partner. Now that’s scary.

Chart 5 shows the British pound (the sterling) and the euro from July, as it became clear that there was not going to be an agreement between the U.K. and Europe. Both have declined. The euro 3% and the sterling 4.7%. That almost makes sense, but is it because of Brexit or is it that the U.S. dollar has been giving higher interest rates than the EU and the Fed is not rushing to lower rates? And, why is the dollar stronger in the face of all these tariffs?

Chart 5. Brexit and the prices of the British pound and the euro.

Volatility

This past month has seen remarkable uncertainty in tariffs, an inverted yield curve, action (or inaction) by the Fed, even mass shootings – enough to unnerve any investor. To judge how the market is handling this, Chart 6 shows SPY on the left and the two volatility indices on the right, VIX and UVXY. We know that UVXY always has less volatility than VIX because investors sell volatility whenever volatility jumps up. So why was volatility declining for June and July when SPY was going straight up? We did get a little increase in volatility when SPY dropped from 292 to 273 in May (6.5%).

Chart 6. VIX and UVXY alongside SPY from March 2019.

What Do You Do?

What should you do about all the conflicting information? My experience tells me that you can’t decide where prices will go by weighing all the information (before it changes) and buying or selling just at the right time. An increase in volatility increase reflects the uncertainty of of investors.

I’m also convinced that when investors don’t enter the market because they don’t know why it’s going up, then prices continue to go up. But equity prices are stuck in a range now, so do you buy, sell, or stand aside? In order to participate you need a way to stay in the market that keeps you objective. My solution is to follow a macrotrend system. It may be wrong from time to time, but it limits your risk, and when the price move, you’re there to profit. As of today, September 1st, the stock index markets are neutral, bonds are long (favoring lower rates) in both the U.S. and Europe, the U.S. dollar is stronger, gold is long, and energy is weak.

I thought that being long bonds (looking for lower rates) would be a trap given that the Fed was raising rates, but bonds have again been the biggest winner for the hedge funds. And a stronger dollar has also added to the gains. If you think you could have figured this out on your own, you’re a better person than I am. I need to follow a system. What you hear is not what is happening.

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.

We’ll take a closer look at the Trend Strength Index from now on. It shows an ability to lead the SPY in most cases, notably in September and October of 2018. This month shows a clear divergence between new highs in SPY and lower highs in the Trend Strength Index, reflecting the investor sentiment. Concern over the economy is shown in the pattern but the TSI has reached a support level at zero. That leaves us neutral on the next move for SPY, but the weakness shown in the Major ETF chart above is cause for concern.

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.

It’s a good month when we are higher, and the broad index is lower. This month the 10-stock portfolio outperformed SPY by more than 4%. The weekly program posted a small loss, less than SPY. The Daily Program is showing a YTD gain of 12% and 13%, closing in on SPY. The Weekly program is holding its own, up 9.75% and 15.32% for 2019. We see this a good for a very uncertain and volatile market.

Income Focus and Sector Rotation

According to the continued gains in the Income Focus program, it expects the Fed to lower rates at least on more time. While profits in this program can be small, it have very low volatility and steady gains due to interest income. This month it added those gains again.

Sector Rotation

Uncertainty in the markets this month wiped out all of the gains for the year in this program. It’s just not possible to keep up with the switching from one sector to another. In the long term, this program is profitable and helps diversification. At the moment it is frustrating.

DOW Arbitrage

While this program lost a little more than SPY, it has had far smaller drawdowns and remains close to all-time highs. It’s up 13.5% for the year compared to SPY, up 18.1%. We believe it is a safer alternative and the DOW stocks benefit when investors see uncertainty.

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 first loss after a long run of gains. The 10-stock program fell -1.15% and the 30-stock program fell -2.50%, but they still remain higher by 18.8% and 10.3% respectively – an excellent year so far. This program holds positions for only a few days, offsetting the give-back from trend systems when they are about to turn or just in a drawdown.

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.

The Timing program buys undervalued stocks and hedges with one of the major equity ETFs when prices turn down. This month it was hedged about ½ of its exposure, making it difficult to net gains. On the other hand, if prices start a serious drawdown, this program will offset those losses with gains from the hedge. Recent up and down price moves leaves this program producing small losses.

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.”

Gains of 9.24% for the 250K Daily Futures Portfolio brings the 2019 returns to 18%. The more diversified portfolios gained from 4% to 5% and are still nicely ahead for the year. Because bonds seem to be driving the performance and the smaller portfolios have a larger proportion of bonds, they are outperforming.

Large gains for both daily and weekly programs, ranging from near 8% to near 9% in the daily, and 4.5% to 7.5% in the weekly program. The daily program has now topped 29% for 2019 in the smallest portfolio, with larger ones higher by 16% to 18%. This seems to be a case of “crisis alpha,” where the futures markets offset losses in the stock market. Most often it is due to selling the equity index markets on high leverage, but this is a case of leverage in bonds and currencies leading the way. Whatever it is, it shows the value of diversification.

Group DF2: Daily Divergence Portfolio for Futures

A loss in August keeps the chart for this program looking consistently volatile. Losses up to 4.2% still leave the three programs up by 23%, 18%, and 20% for 2019. Another case of “crisis alpha.” Given that the short holding period for this system reduces risk exposure, these results are very nice.

Blogs and Recent Publications

MetaStock Strategies

MetaStock has launched the Kaufman Fast Strike add-on. It has three short-term trading systems, holding positions for one to three days in two of the programs, and about one week in the third program. They trade noisy markets, including most major index ETFs and futures, plus one program trades the VIX. You can see a description of the programs and a record of past performance on MetaStock. Anyone interested should contact MetaStock at 800-882-3040 or go online to www.metastock.com/kaufmana

New Interview

Technical Analysis will be interviewing Mr Kaufman for the December issue. We’re trying to cover more interesting topics than the same old ones!

MetaStock Seminar the beginning of November

Mr. Kaufman will be a keynote speaker at the MetaStock seminar in San Francisco the first weekend of November.

Upcoming September

“A Simple Way to Trade Seasonality” will be published in the September issue Technical Analysis of Stocks & Commodities.

Book Interview

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

May

A second part of the interview with Caroline Stepan at TalkingTrading.com was just posted.

March-April

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.

January

Technical Analysis of Stocks & Commodities will publish “Volatility: What They Don’t Teach You In Grad School,” in the January edition.

December

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.

October

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.

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, and Michael Covel’s website, TrendFollowing.com.

“In Search of the Best Trend” was published in Technical Analysis of Stocks & Commodities in July 2019. An article on “Defense is Your Best Defense” will appear in ProActive Advisor Magazine also appeared in July 2019.

Mr. Kaufman was a keynote speaker at a number of IFTA conferences, the most recent in 2018 in Kuala Lumpur, and Milan in 2017. You can find his presentations on their website.

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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