December 2019 Performance Report

December 2019 Performance Report

Industry Benchmark Performance

Early reporting shows that the Hedge Fund Industry turned in another profit, bring the total of all funds reporting to 10% for the year. Long-only funds did much better, as we would expect, up over 16%. Only the Fund of Funds were disappointing.

Futures posted reasonably good gains, unusual during a strong equity market. Typically, the interests rate markets move the wrong way (yields higher when stocks are higher), but this year the best gains were also in the interest rate sector, declining yields after a fast rally. Investors may find that not capturing the full returns of the broad index is frustrating, but the skill of the professional manager is tested when stocks decline.

Kaufman’s Fast Strike Systems on MetaStock

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.

December Performance in Brief

We expected a seasonal sell-off of stocks following Christmas, but that didn’t happen. Instead, all of our portfolios posted good gains, finishing with an outstanding year. Notably, the smaller portfolios, which also carry the most risk, finished up from 23% (the 10-stock trend) to 34% (the 10-stock divergence program). Daily futures also posted strong gains in the trend and divergence programs, from 17% to 22% in the smaller portfolios.

Major Equity ETFs. New highs in all but the small caps (IWM) finish an exceptional year. There is little to say that hasn’t already been said. Let’s hope it continues!

CLOSE-UP: New Risk Feature + Year-End Review

Risk – You Never Know When

This month we’re adding a new risk control to the 10-Stock Trend strategy. It’s a similar approach that we’ve always used for futures but have never applied it to stocks.

The concept is that a trending system makes more money when volatility is low. When volatility is high, it may have some positive returns, but those over overwhelmed by the amount of risk you take. The key to this approach is that the volatility is not stock price or the broad index, such as SPY, but the daily returns of our system, whether very good or very bad.

Some analyst believe that you should only look at downside volatility. After all, the downside represents losses. They are happy to have large gains. But they don’t recognize that volatility, even large gains, can change to large losses. Volatility means big price or equity swings, and volatility doesn’t care if those swings are up or down.

Our New Volatility Filter

The new volatility filter will cause all positions to be exited if volatility exceeds a high level, but it is based on the history of the specific trading system and its portfolio. We reenter when volatility falls below that threshold.

There are likely to be some false signals, just as there are false signals in trend following. But in the long run it works. “It is better to be out of the market and wish you were in, then in and wish you were out.”

The following chart shows the current NAVs of the 10-stock portfolio compared to the NAVs with the new volatility filter. It’s going to be difficult to see when the system was out of the market, so the following is a summary:

Chart 1. Comparison of original system NAVs and volatility-adjusted NAVs

  • 2005 Out of the market for a continuous 20 days
  • 2007-2010 Out of the market 8 times for a total of 155 days
  • 2015 Out of the market for a continuous 9 days
  • 2018 Out of the market for a continuous 17 days

That’s a total of 11 events, 201 days or 4.6% of all trading days during our 17- year history. It’s an average of about 2 ½ weeks for each filtered period, but much less if you remove the 43 days in May, 2009, the longest period. On the other hand, returns are much higher and risk is lower. We think it’s worth waiting out the volatile periods, and we’re particularly concerned about the volatility we may experience in this election year.

Why only the daily 10-stock trend portfolio? First, remember that the trend is best when volatility is low, so this does not apply to systems not based on a long-term trend. Second, the 30-stock portfolio is far more diversified and does not have volatility spikes that we can exploit. And last, the weekly program cannot react quickly enough to take advantage of changes in volatility. That leaves us only with the smaller, less diversified, trend portfolio.

Year-End Review

For the stock market, it doesn’t get much better than this (Chart 2). On the other hand, there are now four years during the last 20, with returns very similar. Which makes this pattern interesting is that the annualized return for the past 21 years is only 6.99% for SPY and 7.76% for QQQ.

For QQQ (Chart 3) the same years as SPY were good, with higher returns than SPY, but mixed with some very volatile and worse years, notably 2000 through 2002 following the “tech bubble.”

Chart 2. Annual returns for SPY                                                 

Chart 3. Annual returns for QQQ.

Now compare that with the returns of the 10-stock trend portfolio that we offer. Chart 4 shows the returns of the current model (out of sample from 2005), and Chart 5 the new volatility-adjusted returns of the same portfolio. The difference is the consistency of returns. For the new volatility-adjusted method, the drawdowns are uniformly small.

Chart 4. Annual returns of daily 10-stock portfolio.           

Chart 5. Volatility-adjusted 10-stock portfolio.

The idea behind trend following hasn’t changed. It looks for consistent and persistent price moves. We never know where they are until they happen, but we can follow along and take advantage of them. Instead of the SPY annualized return of 6.99%, we can expect to get closer to 18% with less volatility.

Could Anyone Have Picked the Best Stocks in 2019?

The “best” stocks in the S&P are easy to see after-the-fact. Looking back, the best of 2019 were Advanced Micro Devices (AMD), Lam Research (LRCX), KLA Corp (KLAC), Target (TGT), Qorvo (QRVO), Chipotle (CMG), Copart (CPRT), Xerox (XRX), and Applied Materials (AMAT). But best returns do not mean best trending. As you can see, neither Apple nor Tesla make the list of the best returns.

Charts 6 and 7 show the 2018 and 2019 performance for AMD and AMAT, the first and last stocks in the top picks. BUT would you have bought them at the end of 2018? Would you have held them through 2019?

Chart 6 (left). AMD from 2018.                                   

Chart 7. (right) AMAT from 2018.

As of December 31, 2018, AMD had just traded off 21%, the official drawdown that defines a bear market. AMAT had been declining all year, from a high of 60 to a low of 30, a 50% drop. Neither of those patterns are conducive to buying.

Then there are the newsworthy candidates, Apple (AAPL) and Tesla (TSLA).  Apple is being touted as the greatest buy of the decade, while Tesla has also had a great rally. But looking at 2018, would you have bought them? Where?

Chart 8. (Left) AAPL from 2018.                                                  

Chart 9. TSLA from 2018.

Let’s face it. Stock picking is not easy. Our solution is to have a system and follow it. For most investors, and traders, a trend-following strategy works best. It stays with the stock when there are small corrections and bails out when there is a sharper decline.

In our portfolio selection, we don’t wait for the sharper decline. We trade those stocks that are doing the best according to our strategy. If another stock is doing better than the ones in our portfolio, we get rid of the worst one and replace it with the new stock. The stock being replaced may still be making money, but not as good as the new stock. We don’t need to wait for a loss to replace a stock. As of December 31st the daily trend program was holding:

  • Apple (AAPL)                                                     Lam Research (LRCX)
  • Applied Materials (AMAT)                            NVIDIA (NVDA)
  • Amgen (AMGN)                                                Reliance (RS)
  • Best Buy (BBY)                                                   Teradyne (TER)
  • Darling (DAR)                                                     Tesla (TSLA)

AAPL and TSLA are in our portfolio, not because they did well in 2018, but because they are doing well now. A stock stays in our portfolio for an average of three weeks.

Performance of Hedge Funds in 2019

It should be seen that the hedge fund industry returned 9.98% overall in 2019 and 13.5% for long-only equities. Fund of Funds returned 7.14%, but then they have added costs. Why the gap between hedge funds and our portfolios?

Hedge funds pride themselves on “sophisticated” strategies, such as market neutral, merger arb, and a variety of “value” approaches. Barclays Hedge Fund report shows Event Driven strategies are up 5.88% for 2019 but there is no indication that there are any systematic strategies reported, and no category for trend following. Yet there is a trend category for futures traders. Does that mean professional stock traders don’t use a trend approach? Or do they just not report it that way?

It should be clear that managing your own money on a systematic strategy is better than giving your money to a manager who adds costs and does not always explain the rationale for a trade, either entering or exiting. Are you better off managing your own portfolio? On the basis that nobody cares more about your money than you do, we say, “It’s your money. Trade it wisely.”

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.

As we said last month, we expected the Trend Strength Index to follow the pattern of the market. While it has not posted values as high as early 2018, it has breeched the highs of mid-2019. The market is clearly overbought, but there is no way to predict when it will turn. Investors seem to be happy about pushing prices higher. While we would like to take some risk protection, it would have proved to be wrong for all of 2019. The only choice is to wait for prices to actually turn down.

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.

A very good month for both Daily and Weekly Trend portfolios, with the Daily gaining 7% and 4.7% to bring the 10-stock daily to 23.7% and the 30-stock to 18.4%. The Weekly program also jumped up in the last part of the year, with both 10- and 30-stock portfolios finishing up over 21%. We will start the

Income Focus and Sector Rotation

Back on track, this program gained more than 1% in both daily and weekly portfolios, bring the year-to-date up to 8.98% and 8.13% respectively, about 10% better than the long-term average for this program. A good way to finish the year.

Sector Rotation

A back-to-back gain of 5% brings the yearly return of the Sector Rotation program to over 17%. That is well above the long-term returns of 8.3%. This program has gotten bad publicity during the past few years but it may be on track for a comeback.

DOW Arbitrage

This program finished up 22.6% after gaining 3.45% in December. The chart shows a nice move to new highs, always a good sign. There were no hedge positions this year because volatility was never extreme.

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 program was the best performer of all our portfolios, up 3.7% for December and 34.5% for 2019. It beat SPY but fell short of QQQ by a small amount. That’s a big return and it is the result of many trades held for only a few days. This program captures price moves during pauses in the trend and offers excellent diversification for trend followers.

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.

Another month of small gains leaves this program at the back end of our performance. Its approach is to buy lagging stocks that are correlated to a broad index. But in a strong market, it is the outperforming stocks that keep outperforming, much like buying the best painting by Renoir will appreciate faster than buying his pencil sketch. Still, this program netted a gain for the year and will live to trade again!

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.”

A reasonably good year for the Daily Futures program, unchanged in December but higher by 17.8% in the $250K portfolio, and 8.8% and 10.6% in the $500K and $1M portfolios. Even with that, the pattern is very erratic because gains alternate between interest rates and equities. FX has been mostly sideways all year, despite uncertainty in the U.K. politics and uncertainty in the EU economy. The Weekly program gained 2% to 3% in December but finished weaker than the daily program. In a trending environment, the Weekly will outperform.

Group DF2: Daily Divergence Portfolio for Futures

All three portfolios gained about 3% in December, resulting in an outstanding performance for this short-term futures program. The $250K portfolio finished up 22% and the other two portfolios higher by 16%. That beats the long-term average of 10% to 12% for this program. Similar to the Divergence Stock program, it tries to exploit turning points in the trend. That turned out to be a good approach during 2019.

Blogs and Recent Publications

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 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

December 2019

Technical Analysis 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.

November 2019

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.

September 2019

“A Simple Way to Trade Seasonality” was published in the September issue Technical Analysis of Stocks & Commodities. Seasonal trades and filters can be a big asset to market timing and put you on the right side of a price move.

Book Interview

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

May 2019

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

March-April 2019

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 2019

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

December 2018

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.

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.

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.

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 2019, KaufmanSignals. All Rights Reserved.

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