February 2014 Performance

Full Table

February Overview

A good turnaround in the stock market during February recovered from January’s set back, leaving the SPY up 87 basis points for the year (see chart below). Of the 15 equity portfolios we track, 14 of them were profitable for February and 11 of them (73%) are ahead of SPY for 2014. The Trend Programs, both daily and weekly continue to outperform, taking advantage of new highs in most of the index markets.

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Futures are not doing as well, lacking in any significant trends in any of the sectors (a breakdown can be found later in this report). Returns were mixed based on what is being held in the various portfolios. NewEdge posted fractional gains for the CTAs in February (as of the 27th) and a loss of 4.24% YTD for trend followers.

Our Weekly Trend Programs for Equities and Futures continue to do well, showing that weekly data helps smooth out the trend with little adverse effects.

Short Sales

Note that the “All Signals” reports show short sales in stocks and ETFs, even though shorts are not taken in the portfolios. Our recent 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 a welcome risk reduction. In this case we prefer paying for risk insurance, even without the expectation of any significant gain from it.

PEFORMANCE BY GROUP

NOTE that the charts show below represent performance “tracking,” that is, the older results are simulated but the new returns are the systematic daily performance added day by day. Any changes to the strategies do not affect the past performance.

TREND Program for Stocks and ETFs

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The Trend program seeks long-term directional changes in markets and chooses stocks and ETFs that have performance over many years combined with good short-term returns.

Both Daily and Weekly Trend portfolios for stocks and ETFs all outperformed its benchmark index SPY in February, resulting in positive YTD returns for all portfolios. We admit that a great deal of that was the extraordinary rise of Tesla (TSLA), NetFlix (NFLX), and the airlines, especially Hawaiian (HA), but this seems to follow from the persistence of trends.

The ETF program is a based on sector rotation. For the Trend, this means buying the strongest performers. Nevertheless, choosing 5 of 15 sectors will track closer to the broad index than individual stocks. Instead, it offers lower volatility, a higher information ratio, and the ability to mix in a portfolio of other strategies.

The charts below show the remarkable rise during past few years, the results of choosing high beta stocks with persistence. We need to remember that high-beta portfolios will also have larger drawdowns alternating with larger gains.

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Weekly NAVs look very similar to Daily, as seen in the charts below, with the Weekly 10 ETF portfolio NAVs outperforming its Daily counterpart:

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DIVERGENCE Program for Stocks & ETFs

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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.

February posted small gains for the stock portfolios, and a fractional loss for ETFs.

 

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The smaller 10-stock portfolio continued to outperform the larger 30-stock, but with higher risk. The ETF portfolio shows similar ups and downs in returns, but risk somewhat in between the two stock portfolios. This program holds trades for an average of 5 to 8 days and is out of the market for at least 50% of the time. Being out of the market means that you are less likely suffer a price shock, which inevitably moves against your positions. Positions are entered during sideways price movement, making this a candidate for diversifying a trend strategy.

TIMING Program for Stocks and ETF Rotation

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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 the 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.

This program had modest gains in stocks during February, with the 10-stock portfolio outperforming the 30-stock. In many cases, the 30-stock portfolio will not be completely filled; therefore, returns will be somewhat muted. Out of the approximately 220 stocks tracked, there may not be enough trading signals satisfying the two performance criteria plus a current open position. Then the 10-stock portfolio may always be filled but the 30-stock may be filled an average of only 75%. This will dampen the monthly returns whether they are gains or losses.

During February, the Timing program hedged 1/6 of the stock risk for those stocks tracked against the SPY. That represents the minimum hedge possible. These hedge protect portfolio from severe downturns but do not often end up with a net gain. They are important for crisis insurance. The hedge was lifted near the end of February when the index trend turned up again.

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 Trend Program for Futures

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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 interesting in lower leverage can simply scale all positions equally in proportion to their volatility preference.

February performance was mixed for the Daily Trend and positive for the Weekly Trend, better than Barclays’ CTA Trend Index of +0.28% but still slightly worse year-to-date than Barclays’ -4.24%. This addresses the fact that there are still no dominant trends in any of the sectors. Energy, often a good driver of trends, has shown both volatile and unsustained direction, as seen in the chart below.

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When we compare the Futures Trend and Divergence performance for February, we again see a very different pattern. Divergence attempts to pick up conflicts in direction between price and momentum, but these tended to be resolved in an erratic way, resulting in losses mainly in the Index sector. The Trend program fared a little better, with the Index and Metals sector returning profits enough to offset losses in FX and Energy. History shows that trends will reappear, although we would prefer sooner than later.

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The NAV charts for the Daily Trend Futures program looks normal (left, below), with all three portfolio tracking about the same. The Weekly Trend Futures program had more consistent returns in February but still shows net losses since the beginning of the year.

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Expectations are that the trends in equities will continue to be bullish as long as investors are uncertain. While there is more money flowing in to the equity markets, it is not clear yet that the final stage of the bull market is here. The way it normally works is that steadily rising interest rates will yield profits in that sector as well as FX, which will reflect interest rate trends with a strengthening US dollar (if it’s the US rates increasing faster). That will show a better economy and drive up the prices of energy and metals. So that, in exchange for the end of the bull market in stocks, we get strong trends in most other sectors and the equity positions revert to giving us diversification rather than absolute returns. That makes futures portfolios a good hedge for most stock portfolios.

Daily Divergence Portfolio for Futures

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Small losses in February net similar losses to other CTAs so far this year, although the pattern of overall performance in the Divergence program is more stable than the Trend program and offers additional diversification. The chart below shows that the year-to-date drawdown is in line with historic performance. We’re just waiting patiently for an upward move in the returns.

The chart of sector performance shown in the previous section on the Trend program shows larger losses in Index and Metals sectors not able to offset smaller gains in FX and Energy. Meanwhile, the equity markets march upward.

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// ©KaufmanSignals, February 2014

 

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