Industry Benchmark Performance
It is surprising how little the hedge funds are benefiting from the stock market rally, unless they are all heavily invested in the DOW. At least they are all ahead for the year. Futures are mixed, with the BTOP 50 fractionally lower and the systematic programs doing the best.
Blogs and Recent Publications – A New Book on Amazon!
Thank you for the very kind comments that I’ve gotten for the new book, “Kaufman Constructs Trading System.” I wrote it to help traders and developers avoid going down the wrong road, which is easy to do with the powerful analytic tools available to us. I am very please that it has been received so well.
Find recent publications and seminars at the end of this report. We post new interviews and reference new articles each month.
We are pleased to announce the publication of Kaufman Constructs Trading Systems, available on Amazon as both an ebook and a print book. It is an excellent complement to Trading Systems and Methods, showing step-by-step how to create and develop a trading system, with many examples. Order it through our website, www.kaufmansignals.com or on Amazon.
Kaufman’s Fast Strike Systems on MetaStock
If you are interested in short-term trading, look at Kaufman’s Fast Strike strategies. Contact MetaStock at 800-882-3040 or go online to www.metastock.com/kaufmana.
August Performance in Brief
It is as much a surprise to us as it is to the rest of the investors. Return keep piling up while we wait for the inevitable reversal. The stock splits in Tesla and Apple have been met with added buying, when we normally expect this to form a top. Nothing seems to be rational, but a systematic approach avoids imposing judgment on the market.
Our benchmark 10-Stock portfolio gained 13% this month, up 37% for the year. There are accounts with a slightly lower return based on the ability to execute “on the open.” Some months actually fills will be better than the system and some months worse. We use the opening price posted by CSI for out performance tracking.
The Timing program is the outstanding performer this year, and we have heard that other “pullback” strategies have also had similar returns. It’s the reason for diversification. The Divergence program, with a much shorter holding period, is also outperforming this year. We don’t expect any of this to continue, but we will keep following the system.
Major Equity ETFs
Nasdaq continues to separate itself from the rest of the market, driven by technology, but dominated by TSLA and AAPL. There is no way to forecast when this will end, although we offer our opinion on the pattern of ending in the next section.
CLOSE-UP: How Does This End?
We are living in a world of extremes, the rich getting richer and the poor poorer. In the stock market the tech stocks, internet, and some pharma stocks have gained in unprecedented amounts while other companies stagnate. If we look at the DOW we see the same picture. A few stocks are doing very well, but the majority of stocks are lower, seen in Figure 1.
Figure 1. Dow components from January 2020.
To make this easier to see, Figure 2 sorts the DOW components by year-to-date returns. The horizontal line is at 100, where the year began. Nine of the thirty stocks show a gain for 2020. That’s 30%, yet the S&P and Nasdaq averages are on new highs.
Figure 2. Dow returns, high to low, from January 2020.
We know what has happened. Everyone has stayed home and used the internet to send messages and buy things. Apple, Amazon, eBay, ETSY, not to forget Tesla, Nvidia, PayPal, and Home Depot. Nowhere in there do we see an airline, hotel, or restaurant group. Even Walmart has dropped out of sight. The only pharma that has outperformed has been Moderna, and that story is still to be told.
How Does This End?
Of course, I have no special vision of the future, but I was recently asked this question by an associate, and I think it deserves an answer.
Do the tech stocks collapse when we have a vaccine? Do the airlines and cruise ships spike up? Probably not. Let’s think about the tech stocks first.
The pandemic has driven many people to online shopping. Some will continue to do that more than they had in the past, but many will go back to stores, where they can touch the merchandise. If that turns out to be true, earnings will drop, but not collapse. It will be a slow change for the shoppers. Not all will rush to the stores. Those stocks will not make new highs, but should drift lower.
The same will happen with airlines, cruise ships, and resorts. People will start using them at an increasing rate, not all at once. Some airlines will not survive. But then we never thought PanAm or TWA would disappear. We will always have airlines, even if their names change.
Some of the pharmaceutical companies will reap huge profits while others will post modest gains. It is likely that there will be more than one vaccine. It is also possible that we may end up taking more than one. Once the millions (or billions) of doses are distributed, it becomes a case of producing a new version each year, much like the flu vaccine. Earnings will stabilize, perhaps even decline. Competition could cause the price of the vaccine to fall, although that may be wishful thinking. As long as the government is paying, there is no incentive to reduce the price.
I see this ending, as they say, “not with a bang, but with a whimper.” A decline in earnings by those companies that benefitted the most, tech, stay-at-home companies, and some pharma. An increase in travel, restaurants, and theatres, but none of it fast. Businesses that don’t survive, and the massive debt incurred by the government, will be a drag on the economy for some time to come. The best we can hope for is a prolonged sideways period where our wounds heal.
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.
The Daily Trend program had an exceptional month while the Weekly program exited on extreme volatility, missing a good move higher. It is up only 1% for the month. The weekly program has measured volatility using weekly returns but is now measuring it with daily returns. A lesson learned, even though the weekly program could have been the beneficiary. We can only judge by hindsight.
Both programs have been concentrated in the tech stocks, up 11%, with an occasional position in pharma, solar energy, and FedEx. We’re happy to see some diversification which will avoid large swings in equity if and when technology reverses.
Income Focus and Sector Rotation
Fractionally higher for the Daily Income Focus program, but then there is little income from interest rate vehicles. The chart, however, looks stable. The Weekly program gained over 3% mostly based on the preferred stock component. It is clawing its way back from its drawdown.
An outstanding month for Sector Rotation, up 12%, cutting the year-to-date losses in half. We’ll need to see more gains like this to have the chart looks as though it is resuming an uptrend.
A gain of more than 7% is close to the gain in the DOW this month. We updated the DOW components, which changed on September 1. This year the program is higher by more than 10% while the DOW ETF (QQQ) is ahead by 2.3%. There is clearly more volatility in the market.
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 10-stock Divergence portfolio continues to keep pace with the 10-stock Trend portfolio, higher by 12.2% this month and up 37% for the year. The larger 30-stock portfolio is only up 18% for 2020, a gain that we would normally consider outstanding. We hanging on for the ride.
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.
Buying undervalued stocks continues to be the best game in town. The 10-stock Timing program gained another 8.6% for a remarkable 55% in 2020. Even more surprising, the 20-stock portfolio gained 6% and is now ahead by 63% for the year. While this is unlikely to continue, we’re not complaining.
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.”
A mixed month for the futures portfolio. The $250K portfolio lost just shy of 3% while the larger portfolios gained 3% and 5%. All are well up for 2020, from 20% to 31%, as can be seen in the chart below. The more diversified $1M portfolio is doing the best this year.
Group DF2: Daily Divergence Portfolio for Futures
Small losses in all three portfolios, but still positive for 2020. This program continues its pattern of back-and-fill with a long-term return of about 12% to 13% per annum.
Blogs and Recent Publications
Kaufman Constructs Trading Systems
We have posted both an ebook and a print version of Perry’s new book, Kaufman Constructs Trading Systems, published on Amazon. It is a complement to Trading Systems and Methods. It takes you step-by-step through the process of developing a trading system, with many examples. Order it through our website, www.kaufmansignals.com or directly on Amazon.
Trading Systems and Methods, Sixth Edition
The sixth edition of Trading Systems and Methods was released the last week of October by John Wiley. It is completely updated and contains more systems and analyses.
MetaStock issued an upgrade to the Kaufman Fast Strike add-on in late January. This add-on 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
Mr. Kaufman will be presenting in a webinar for the Indian Technical Analysis group in Mumbai on October 3. The presentation will be geared towards beginning to intermediate traders. You can find more at https://www.algoconvention.com/schedule
“Fools Rush In,” an analysis of the best time to buy an IPO, will be published in the September issue of Technical Analysis of Stocks & Commodities. There is also a full description of Kaufman Constructs Trading Systems in the “Books for Traders” section.
Mr. Kaufman gave a presentation at Jake Bernstein’s “Cycle” seminar. Anyone interested in a copy of the presentation should send a request to firstname.lastname@example.org.
The June issue of Technical Analysis of Stocks & Commodities published the article “Crashes and Recoveries.” It will help you figure out how the Covid-19 pandemic will play out. It will also have the TradeStation code for the “2nd Cross” strategy, requested by readers.
There are some comments in the April issue and on the current stock market drawdown and a correction to Mr. Kaufman’s article in the March issue of Technical Analysis of Stocks & Commodities
“The 1st and 2nd Cross” was published in Technical Analysis of Stocks & Commodities in the March issue. It is based on an idea of Linda Raschke and captures small but reliable pieces of a trending move.
A new article “Essential Math For Traders” will be published in the Bonus 2020 issue of Technical Analysis of Stocks & Commodities.
ProActive Advisor Magazine (on-line) published “Controlling risk that doesn’t go away,” posted on January 15.
Both of these articles are important for understanding your investment risk.
Technical Analysis of Stocks & Commodities published an interview with Mr Kaufman in the December issue.
MetaStock Seminar held in Sunnyvale
Mr. Kaufman was a keynote speaker at the MetaStock conference in Sunnyvale, November 3. You can hear this presentation by going to the MetaStock website.
Technical Analysis of Stocks & Commodities published “Running for Cover,” an article by Mr Kaufman that looks at whether buying bonds after a sudden drop in the S&P can still be profitable.
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.
Mr. Kaufman spoke in Tokyo and Osaka to the Japanese association of Technical and was a keynote speaker at the 2018 IFTA conference in Kuala Lumpur, both last October. You should be able to get a copy of the presentations by MATA, the Malaysian Association of Technical Analysts.
“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.
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