Industry Benchmark Performance
Equity fund performance was better than the broad index, although lower for the month, with long bias funds returning about the same as the index markets for 2022. Meanwhile, futures gained and would offset equity losses in what we call “crisis alpha,” where futures outperform when equities are in a bear market.
Kaufman’s “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 link at the end of this report.
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.
August Performance in Brief
All of our equity portfolios posted small to modest losses, however, better than the broad index markets, if that is any consolation. Of those portfolios, Equity Trend and Equity Timing were the best.
Futures Trend continue on an outstanding run for the year, now up another 6% in August and 35% for 2022. Profits are overwhelmingly in interest rates, with some FX and energy as well. The new $250K U.S. markets only portfolio is doing well.
Major Equity ETFs
The bear market rally looks to be fading, but traders never give up hope. For every article on analysts looking for new lows, there are offsetting articles looking for another rally. This month’s Close-Up covers the key markets and tries to assess what will happen next.
CLOSE-UP: “There is Always a Bull Market Somewhere”
Anyone who watches the market news knows Jim Cramer’s (Mad Money) closing line. And it’s true, but it’s getting difficult to find those bull markets.
On August 26, Chairman Powell indicated that the Fed will continue to be hawkish, that is, it will raise rates and keep them there until they control inflation. That sent the stock market down in an ugly day, and it continues to sell off. As with many “price shocks,” stocks that are not affected by the news also suffer drawdowns as some investors liquidate to cover margin calls, in other cases to reduce their risk.
Let’s look at energy and interest rates, plus some individual stocks that will be directly affected by the Fed’s policy. Caveat emptor: Things change. What appears logical now might not by next month. It is always best to continue to reassess the underlying situation and watch the trend.
Fad Stocks Suffer the Most
I watch certain stocks because I find their past performance the result of short-term euphoria and the current pattern a dose of reality. In that group are Peloton (PTON) and Beyond Meat (BYND). PTON benefited from the stay-at-home COVID period, but how big is the market for a $2,000 exercise bike? And people tend towards eating meat, even if (theoretically) non-meat may be better for them. PTON is down 93.7% from its highs and BYND is down 89.6% from its highs, neither showing any sign of recovery.
In this group of “fad” stocks I need to add MEME and cryptos. AMC is the poster-boy of MEMES and some investors profited from the fight between the short sellers at the early stage of Robinhood growth. But no longer. Even with a few upward spikes, AMC is now down 84.6% from its highs. Robinhood is down 82%, a sign that traders are losing interest. Attention has now shifted to Bed, Bath & Beyond.
Cryptos are an area of contention, with many (young) traders buying into the concept of an independent currency and brokerage houses promoting them for their personal gain. But there is no fundamental basis for cryptos and in a bad economy, even the young figure that out. Dogecoin (which I pronounce “doggie coin”) is now down 89.2% from its highs, and Bitcoin is toying with 20,000 again, down from 60,000.
One exception is Cathie Wood’s ARKK (“Innovation”) fund. In theory, we all would agree that technology is a “buy.” But Wood appears to be a discretionary trader and is picking stocks that are at lows without any sign that they are recovering. The latest is Nividia, a great company but a declining stock price. As a trend follower, I always wait for a stock to turn up before I enter. That puts the odds on my side and gives a clear place to exit if I’m wrong. ARKK is now down 73.2% and near its lows. The market speaks for itself. ARKK benefited from being at the right place at the right time, but has failed to evolve.
Hedging With Gold and Silver
Physical gold (not gold stocks) has been the classic “go-to” when the U.S. dollar is weak. Silver has been the poor alternative. The dollar is now on 25-year highs, on par with the euro as the U.S. raises rates and Europe fights with energy shortages.
How long will this last? Even if the dollar does not strengthen further, Europe is in a bind that will likely take 3 to 6 months to stabilize. Winter is coming. Germany announced that its reserves are 85% full, which should get them through the Winter. They can also continue with nuclear energy. It is not clear that all the EU countries have solved the problem. While these changes have caused volatility in energy, I expect the dollar not to weaken into the Winter.
Energy is Driving the Market into Confusion
Let’s focus on the energy markets which, along with interest rates, are the basis for many of the market moves. Fuel costs impact everything, from transportation, storage, household heating, and personal driving.
The U.S. has no shortage of either gasoline or natural gas, but prices are driven by world demand and in some cases, sympathetic movement. Crude prices, which in turn determines gasoline and heating oil prices, have been subject to OPEC quotas since the 1970s. They control what is called the “marginal barrel,” the available crude if you need to import any. That marginal barrel determines the world price.
Chart 1 shows that both products trade at similar prices, in $/barrel. Crude ran up to $150/bbl in 2008 and reached near $120/bbl recently. Yet the product prices spiked higher now than in 2008 before selling off 20%. The cost of extracting crude oil from the ground in the U.S. is $36. It appears that oil companies are profiting, but then their costs can be higher.
Chart 1. Cash price of unleaded gasoline and heating oil, as of August 29.
It is clear why natural gas has been rising. Europe has been dependent on natural gas from Russia and has had that supply severely curtailed. While other countries are trying to provide liquid natural gas (LNG), we were told that it is not enough and the facilities to receive and convert LNG are limited. This week that story changed. Germany announced that it had filled its winter NG capacity to 85%, and Norway is providing more NG. On Tuesday, NG prices fell 4.5%.
NG usually sells for $4/MMBTU (per million British Thermal Units) and is now at $9. There is no way to know where prices will go, only that it will be increasingly volatile as winter approaches and demand increases. Chart 2 shows that demand is in the winter, starting in October. The past two years have not changed that pattern.
Chart 2. Seasonality of natural gas shows that demand increases in October.
There is no easy solution to the energy crisis. The end of the Ukraine war seems far off. Russia wants to punish Europe for supporting Ukraine. China and India will buy Russian oil which will continue to fund the war. But all prices reach a peak where users are no longer willing to buy, and eventually Europe will find a long-term solution for its natural gas usage.
The chart below shows that natural gas prices are still rising. Until we see a topping formation, we won’t know how high it can go. My own sense is that it will not reach $12. Because of seasonal demand, which starts now, it is likely to have another move higher.
Chart 3. Natural gas nearest futures.
Energy stocks, such as XOM, MRO, VLO, and HES have taken a big hit in the past few days. Our Timing strategy has been long an overwhelming number of oil stocks. It was profitable at first, then gave those profits back. It is clearly high risk. If you are going to trade oil stocks, be sure you have a system that will get you out when prices turn down. We still expect that oil companies are profitable and should see a turn to the upside.
Interest rates are at the center of the inflation dilemma. Raising rates brings down inflation but can also cause a recession. So far, rates have risen from near zero to about 3.5%, higher for mortgages, without causing a noticeable economic slowdown.
Even as the Fed is clear in its policy to raise rates further, the market continues to believe that it will temper its plan as prices decline. We don’t know who will win. Chart 4 shows the 10-year Treasury Note futures. Prices rallied (yields fell) in expectation of the Fed raising rates by 50 bp rather than 75 bp. The market was disappointed, yet we are still off the lows. It is a continued sign that investors are optimistic. At some point they will be right. Even with that optimism, we expect to see a new low.
Chart 4. 10-Year Note futures.
Analysts always recommend “stock picking” when the overall market is declining. They never say, “go to cash.” And Jim Cramer is usually right, there is always a market that is going up. The problem is to find it.
Our programs have been successful simply by applying a strategy and seeing which stocks are profitable using that strategy. We then trade the best and switch them as other stocks perform better. It’s called “persistence.” Stocks that perform well often continue to perform well. Stocks that outperformed in the past quarter often outperform in this quarter.
None of that is without risk, but you must take risk to outperform the market and to get a return better than the risk-free return of government bonds.
Right now, stock-picking favors energy companies, even with their sell-off. It is a combination of traditional oil companies, such as Marathon, oil services, and clean energy (FSLR), but that may shift to pharma if Covid surfaces stronger in the Fall. Look for groups of stocks in the same industry that are performing well to assure that you have not just found a single-stock outlier.
Summing It Up
Energy prices may have peaked, but they are still high. And interest rates may be heading higher. It will take time for inflation to come down. The Fed will still be on course to continue raising interest rates. But perhaps not as fast. That will keep pressure on the stock market. Energy markets should continue to be volatile.
As for finding a bull market, not right now. The best plan is to wait for the trend to turn up, using no faster than a 20-day moving average. Once you have that, you can exit when the trend turns down or on a new low. That gives you two ways to control your risk. Controlling your risk is the path to success.
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 condition and exit the entire portfolio when there is extreme risk or a likely drawdown.
Small losses in the Daily Trend portfolios and small gains in the Weekly portfolio seems good for a difficult market, one that rallied quickly and is now retracing. Both Daily and Weekly programs are controlling risk, which is the priority in a bear (bearish) market, giving it a chance to produce gains when this decline is over.
Income Focus and Sector Rotation
Small losses in both the Daily and Weekly Income Focus portfolios are partially offset by money market income. This program has been mostly out of the market, favoring positions that take advantage of declining yields. History shows that that is the majority of the time. There is always an exception.
A small gain in August but still a loss for the year. The market is having a difficult time settling on which sectors are going to perform with any consistency. Eventually, it will settle down.
Both the Daily and Weekly DowHedge programs are paralleling the Dow Index. Both are down for the month and the year in similar numbers to the Index. History shows that our portfolio has much lower risk, but in this market it has had a larger drawdown.
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.
Moderate losses this month puts this program’s returns similar to the overall market. This strategy looks to enter long positions during a pause in an uptrend. This month, that pause did not continue upwards. As with other programs, a bear market in the major indices is always difficult.
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.
We reentered the Timing program after being out for about three months. We started with a gain early in the month followed by a loss that offset that gain. All positions were in energy stocks, a high-risk, high-return scenario. The portfolio is now only partially exposed to energy. Even with a small loss for August, the Timing program holds onto a gain for the year.
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.”
Another outstanding month, higher by more than 6% in all portfolios with gains of 24% to 35% for 2022. This may now qualify as “crisis alpha,” where futures offset losses in equities when there is a bear market. In this case, the gains are not from being short the equity index markets, but from being short the interest rates, as seen in the chart of sector returns that follows the Daily Trend Program.
Group DF2: Daily Divergence Portfolio for Futures
Losses of 3% to 4% make this our worst performing program of the year. It has similar problems to the equity divergence strategy. It tries to capture the pause in a trend, before it continues in the trend direction. There are not enough markets showing this pattern but things change, as we know.
Blogs and Recent Publications
Kaufman’s “Learn To Trade: Trade To Win with a Rule-Based Method”
Is 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 (both in color) on Amazon or our website.
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 is completely updated and contains more systems and analyses. You can find it easily on Amazon along with Perry’s other books.
An interview with Perry will be featured in the October anniversary issue of Technical Analysis of Stocks & Commodities. The interviewer is his wife, Barbara Diamond, giving a different perspective on his career.
“The Real Risk of System Trading” can be found in the September issue of Technical Analysis of Stocks & Commodities. It summarizes the many way we can measure risk and suggests ways that will help you.
The basis for this month’s Close-Up was posted on Seeking Alpha June 16. This month, Perry posted “3 Ways to Reduce Risk and 2 Ways to Increase Profits.”
The July issue of Technical Analysis of Stocks & Commodities has Perry’s latest article, “Is It Too Volatile to Trade?” It is important to understand when the risk is greater than the reward.
Perry posted “How To Tell When the Bear Market Has Ended” on Seeking Alpha. You might find it useful if you are thinking about getting back in.
Perry’s webinar on risk, given to the U.K. Society of Technical Analysts, can be seen using the following link: https://vimeo.com/708691362/04c8fb70ea
The presentation for MetaStock is available on Youtube using the link:
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.
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
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.
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.
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.
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 firstname.lastname@example.org.
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