December 2016 Performance Report

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performance-summary-dec

 

Industry Benchmark Performance

Hedge Fund early reporting for December shows good returns for the Index and positive for Long Bias. Other data were not yet available.

We are pleased that our Daily Trend Futures program is running 10% better than the industry.

CTA returns were slightly better in December, the end of a difficult year for most of the industry. Trend following continues to be the weakest area, which can be seen the BTOP50. A large part of the Futures Funds rely on trend following to stabilize their performance. But there is hope that significant new Administration policies will produce profitable trends in 2017,

benchmark-performance

December Performance in Brief

A profitable month for all equity programs, but below our expectations, given the run-up in November. We did forecast that the election rally would stall in December, but we also see one more run-up until the inauguration on January 21, another pause, then a rally depending on how new policies develop.

The Weekly Equities programs for stocks outperformed all others at about 12%, a good showing. Of the daily programs, both the Trend and Timing strategies returned about 7%, although the ETF version of Trend netted less and the Weekly Trend ETF posted a small loss.

In futures, the Daily Trend program did well, returning 7% to 13%, with the $500K portfolio the best. But the Weekly version of the Trend program netted losses for the year. We can only say that, given specific price patterns, it can be out-of-phase with the markets. Its long-term performance remains strong.

Major Equity ETFs. The small caps (IWM) continued it’s amazing rally this month, closing the year up 21%. Does that mean the individual investor has returned to the market? The S&P still performed well, with the SPY up 12% in 2016. All of the index ETFs beat their long-term returns, but most of the gains that occurred were in the first quarter and since the election.

major-equity-etfs

 

Blogs and Recent Publications

The next issue of Technical Analysis of Stocks & Commodities will feature a new article by Mr Kaufman, VIX or Historic Vol – Which is Better for Position Sizing? This article shows the effects of using volatility parity based on both historic volatility and implied volatility (VIX) to find the right position size for your trade.

Look for other 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 shortly on 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.

December Insight: Will 2017 Be Different from 2016?

Yes, in two ways. We believe that the likelihood of a favorable business environment, including less regulation and lower taxes (perhaps to 20% and not 15% for corporation), will produce better returns for companies. and  the overall stock market. Add to that the new EPA Director, Scott Pruitt, who favors corporate profits and, like Mr Trump, doesn’t believe (or so he says) in global warming or climate change.

We strongly believe that 2017 will be much more volatile, partly because of the uncertainty of the new administration’s policies, but also because Mr Trump will be the “Tweet President.” We don’t want to underestimate the impact or damage that can be done with a spontaneous tweet about an important issue. Nor do we think Mr Trump will be able to rein in his spontaneous statements or his fingers. One can only hope. Meanwhile, the unpredictability of his tweets will produce volatility. Option traders should have a good year.

The Old Favorites Are Still Delivering

It seems hard to believe that Amazon, as large as it is now, can continue to deliver gains at the same rate. But the 2nd quarter earnings report shocked the market, and their revenues continue to increase. Compare that with Apple, which saw a decline in revenues so far in 2016, and is not on new highs.

There is no doubt that Apple is a great company, but we see that it faces increasing competition for all of its products. The company gets a reprieve this quarter because Samsung’s Galaxy 7 has been withdrawn, but that will only last a few months before either Samsung or another company fills the gap. No matter what the quality of the competition, it will draw business away from Apple.

Not so with Amazon, yet. Individual stores try to make online shopping easy, and that helps them, but there is no place you can go to by everything and anything, except Amazon. And often you can get it delivered the same day, even Sunday. That’s customer gratification! It’s a certainty that Amazon prices will round out at the top, and it may happen next year. There’s just no sign of it yet.

amzn-and-aapl

 

What Happened to the FANGs?

The technology giants filled the news during the bull market that ended in 2015. We’ve looked at Apple, but what about Facebook, NetFlix, and Google? In the chart below (left), we see that Google had marginal gains in 2016, while the other three ended up about 10%, in line with the overall market. Apple and Google tracked one another closely, but then Google faded in the last quarter. Facebook had the same pattern, only with better gains through the first 10 months, then they fell off at the end. We wouldn’t be surprised if there was an arbitrage alive and well here.

the-fangs

Then we have Alibaba (BABA) and Twitter (TWTR), the “new kids in town.” Alibaba continues to have great potential but doesn’t seem to impress investors. It followed much the same pattern as the FANGs, finishing the year with a slight gain but still failing to make all-time highs. Twitter (TWTR) still disappoints, with most everyone thinking it will end up as a take-over target. It’s off 30% for 2016.

What Happened to Health Care?

We were sure that the new administration was going to replace the Affordable Care Act, which would give the Health Care providers more business at favorable margins. Regulation would also be pared back. The Health Care ETF, XLV, shows a jump after the election, but has now declined about 7% from its highs. It’s confusing.

On the other hand, the financials (XLF) are experiencing a justifiable rally, with some certainty that regulations will be eased. It’s up 48% from its lows in February and has room to go higher. Energy (XLE) is up 30% this year, more from its lows, on expectation of OPEC controlling output, a phenomenon rarely seen since the 1980s. The market moves on talk, not action, so we don’t expect this to go very far from here. With good news, crude could make it to $60.

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Can the U.S. Dollar Break Par?

So far, the dollar is struggling to resist going under 1.00 to the euro. It’s now at 104. In the left chart below, the US 30-year bond has been falling since mid-year (interest rates rising), while the Eurobund has been resisting. The dramatic change in the spread results in the dollar strengthening, and money flowing into the U.S. stock market. Given that, the euro has held up well.

interest-rates-and-currency

 

The dilemma for the Fed is that raising rates will cause the dollar to strengthen more, and slow down U.S. exports. Consumers enjoy the benefit of cheaper imports and other countries enjoy providing them. We find it inconsistent that U.S. companies will return to manufacturing in the U.S. in an environment of a strong dollar, unless the new administration lowers taxes enough to offset. That may not be possible. Will the new administration impose restrictive tariffs on imported goods by U.S. companies operating abroad? It’s possible, but not easy. If so, they will get a lot of resistance from Apple and many of the businessmen sitting in the cabinet and advisory councils. It’s hard to believe they would vote for a policy that affects their own income.

 

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.

The Trend Strength Index has been tracking SPY during the December advance, but is falling well below the previous highs just below and just above 50. History shows that the TSI starts its decline before SPY, so we need to wait for a confirmation. We anticipate the equities market to be in a back and forth pattern, with marginal new highs.

trend-strength-index

 

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.

Strongest

The Trend Sector ETF program buys the 6 strongest sectors of the SPDRs.

At the end of November, we had Oil & Gas Exploration (XES), Materials (XLB), Energy (XLE), Financials (XLF), Industrials (XLI), and Retail (XRT).

We held all positions except Retail, which we replaced with Metals & Mining (XME). We now hold:

Oil & Gas Exploration (XES), Materials (XLB), Energy (XLE), Financials (XLF), Industrials (XLI), and Metals & Mining (XME)

Undervalued

The Timing Program buys 4 ETFs that are undervalued with respect to SPY, in expectation of rotation. We started December with only two positions, Preferred Stocks (PFF), and Oil & Gas Exploration (XES).We still hold Preferred Stocks and have switched XES for Financials (XLF).   We now hold:

Preferred Stocks (PFF), and Financials (XLF).

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, including Sector Rotation and Income Focus

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.

We have a clear move up in the stock portfolios, with the smaller 10-stock gaining 2.58% for the month, netting 6.56% for the year. Even though the 30-stock portfolio posted only about a 1% gain, it’s year-to-date returns are 7.63%. The 10- and 20-ETF portfolios differed by more, with the 20-stock outperforming the smaller portfolio this year. The 20 ETF gained 5.91% while the 10-ETF gained 1.63%. The Trend Sector Portfolio gained 1% in December to finish up 4.45%.

equity-trend

 

As with the Daily Stock Trend Program, the Weekly Trend Program is posting the best overall returns, making new highs in both portfolios. The 10-stock finished the year up 12.45% and the 30-stock up 10.34%. It’s NAV pattern now looks promising. On the other hand, the two ETF portfolios returned marginal losses in December to finish the year down 3% and down 1% in the 10- and 20-ETF portfolios.  While these programs have much lower goals, we are optimistic for 2017.

weekly-equities

 Income Focus and Sector Rotation

The Daily and Weekly Income Focus programs are very quiet, but the Daily program finished the year up 4.81% and the Weekly up 5.87%, both below the long-term returns of 9.5% to 10%. Both seem to have stabilized after a small decline, so we expect a return to profits. Meanwhile, these programs serve as a hedge to the equities long portfolios.

income-focus

 

 

The Weekly Sector Rotation continued to return fractional gains, leaving it only up 1% for 2016, a disappointment. The pattern, however, looks as though it’s trying to recover from its drawdown, so we’ll stand on the sidelines and cheer it on. This program has been a basic investment approach for decades and a sideways period is part of the course.

weekly-sector-rotation

  

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.

A positive month for all Divergence portfolios, with the larger 30-stock portfolio finishing up 5.51%, but the smaller one finishing lower for the year. There’s no doubt that trading fewer stocks in a portfolio has more risk, and more potential, but this year it was the risk. The long-term returns for both portfolios are still very good. The ETF program is still moving higher slowly, it’s slow climb based mostly on waiting for opportunities.

equity-divergence

 

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.

A good month and a good year for the Timing Program, up 7.85% and 7.38% for the smaller and larger portfolios. That puts the smaller 15-stock portfolio on new equity highs with the larger portfolio not far behind. The ETF program, that buys undervalued stocks, gained 6.65% for the year and seems to have broken above its sideways pattern.

equity-timing

 

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.”

An unusual year for futures, with the Daily and Weekly Programs diverging in performance. The Daily Program gained 7% to 13% while the Weekly Program lost 4% to 10%. Although the long-term returns are actually better for the Weekly Program, delays in switching positions was the culprit this year. Normally the delays can be an advantage when a minor price shock is reversed within a day or two. If it’s any consolation, the Weekly Program return were in line with the CTA industry, while the Daily Program outperformed the industry by 10% to 15%.

futures-trend

 

 

Group DF2: Daily Divergence Portfolio for Futures

Small losses ended a poor year for the Divergence program, off from 8% to 10%. The NAV chart shows that it’s due for a rebound based on past performance. The Program was very inactive in December, searching for opportunities that never materialized.

futures-divergence

 

©Copyright December 2016, Kaufman Signals. All Rights Reserved.

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