February 2021 Performance Report

Industry Benchmark Performance

After the first day of reporting, all benchmarks show gains for February, with futures posting very good returns. It looks like a good start for the year.

Blogs and Recent Publications

Don’t forget our new book, “Kaufman Constructs Trading System.”  You can find it on Amazon or on our website, www.kaufmansignals.com.

Find recent publications and seminars at the end of this report. We post new interviews and reference new articles each month.

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.

February Performance in Brief

Some good performance, some not as good. Overall, most programs were profitable. The benchmark 10-stock Trend portfolio lost fractionally, while the equity Divergence program gained more than 6%. The weekly equity program gave back 7.4% but still remains higher by 25% for the year. The best return was in the futures Trend program, up 10% in February. It looks as though the market is trying to regroup, or rotate, whichever comes first!

So far, the downturn seems limited to Nasdaq, even with a small turn in the other equity index markets. Given previous volatility, it is too soon to declare the end of the bull market. It is interesting that the small caps (IWM) have been strong during the past six months, an indication of more speculative interest. SPY and DIA are tracking each other, showing the broad market is still sound but not overheated. A 10% drop in SPY should raise eyebrows.

CLOSE-UP: The Reality of Balancing Stocks and Bonds in Your Portfolio

We have been in a bull market since just after the financial crisis of 2008. That is more than 12 years. Anyone trading stocks during that time should have done well.

From 2009, the end of the financial crisis, the stock market (we will use SPY) gained at the rate of 14.6%, a remarkable amount given that history shows it much closer to 8%. It did that with an annualized standard deviation of 18% (the risk), giving us a reward to risk ratio of 0.80. History also shows this is normally closer to 0.40.

Then we have Nasdaq performance, benefiting from innovation in technology and the stay-at-home stocks during the Covid pandemic. From 2009 it returned 22.1% with a risk of 20.2%, 8% per year higher than the S&P and with a relatively lower risk.  Figure 1 gives you a view of the price moves.

Figure 1. Four primary equity index ETFs from 2009.

At the same time, long-term interest rates (using TLT) have had a return of 4.34% and a risk of 15%. Its reward to risk ratio was 0.29, far lower. Figure 2 shows that prices have been rising (yields falling) for the same period and has only now started to change direction.

Figure 2. Prices of TLT, the long bond ETF.

This bring us the question of why anyone would have a stock and bond portfolio when stocks are clearly outperforming bonds by a gigantic amount. The professional recommendation is to have 60% in stocks and 40% in bonds, given that you are not over 65 years of age. And, of course, you are not risk-averse.

Given the last 10-12 years, why would you bother having bonds in your portfolio?

Balancing Stocks and Bonds from 2009

We are going to use Excel’s Solver to find the best combination of stocks and bonds from 2009. How do we want to measure success? If we use the highest returns, we will get a solution of 100% stocks. There is no reason to use Solver when we know the answer.

Our measure will then be the reward to risk ratio, which is said to be the most rational solution. You want the highest return for the lowest risk. We do that two different ways, combining AGG, the long-term bond aggregate index, with SPY, and also AGG compared to an equal weighting of SPY and QQQ. Given the history of Nasdaq performance, many investors would like to get part of that return.

Figure 3 shows the combinations of stocks versus bond (stocks first, bonds second), so that “20-80” means 20% stocks and 80% bonds.

Figure 3. Mixing stocks and bonds in a portfolio, from 2009.

The result is what we would expect, the more bonds (the blue line), the lower the returns, the more stocks (the gray line), the higher the returns. No surprise. What is interesting is that the best reward to risk ratio of 1.12 goes to the 20% stocks, 80% bond portfolio. When you favor stocks in the 60-40 portfolio (as normally recommended) you get a ratio of 0.85, much lower. So you are taking on more risk by overweighting stocks, even during a bull market. It is easy to accept that risk, knowing that the decline at the end of 2019 was short-lived.

A Longer View of Performance

The answer is always based on hindsight. Of course, had we known that stocks would do so well, we would have put all of our money in both the S&P and Nasdaq and none in bonds. But now let’s look at the longer-term returns.

We will switch to the S&P (ES) and 10-year Note futures (TY), which go back to the early 1980s. TY is considered the benchmark interest rate. Note that both series are back-adjusted, so that the older prices are not the prices at that time, and TY goes negative because each backwards roll is adjusted lower. That does not affect our results. Figures 4 and 5 show the history of prices.

Figure 4. S&P futures from 1982, back-adjusted.

Figure 5. 10-Year Note futures from 1982, back-adjusted.

It is interesting to see that the little S&P downward blip in 1987 was actually one of the worst sell-offs in history. It tends to fade from memory over time, just as the 2008 financial crisis, this bull market, and Covid-19 will seem less important to the next generation.

We can see from the two charts that Notes have a steady upwards climb while the S&P has more volatility. Because the sharp drop at the end of 2019 recovered quickly, it does not seem to take on the importance of either 1987 or 2008.

The Best Portfolio Balance

Does Warren Buffet worry about this year’s returns when he buys a railroad, or makes a strategic investment? He looks to the long-term. We will do the same, because we expect to live a long time.

Ask yourself if you believe the market will continue at the rate we have seen over the past 12 years. Can it continue to produce wealth at the rate of nearly 15% each year? That would mean a $100,000 investment would be $201,00 in 5 years, $404,000 in 10 years, and over $1 million after 17 years. It would be outstripping inflation, which is typically 2% to 4%, giving you a very positive increase over the cost of living.

                No matter how much we regulate the markets and the economy, another crisis will happen. This time it was Covid. Next time? Who knows?  The mission to Mars can bring back rocks and some small critter that takes over the Earth. At least that is the way it happens in the movies.

                To assess this accurately, we invest $25,000 in both the S&P and T-Note futures. We calculate the position size each day using the 20-day average true range in order to make them equal in volatility and risk. We then plot the results in Figure 6.

Figure 6. Returns of S&P and 10-year Note futures, from 1982, volatility adjusted.

We can see that T-Notes are much more consistent than the S&P. Combining them results in excellent returns, boosted by the S&P but without adding a lot of S&P risk. Rather than the standard recommendation of 60% stocks and 40% bonds, a better allocation is 40% stocks and 60% bonds. For an even higher return to risk ratio, consider only 20% stocks, but somewhere between 20% and 40% stocks, depending on your financial goals and risk preference, would be a good portfolio.

Remember that you will outlive this bull market in stocks.

ONE LAST NOTE: Rising interest rates are negative for bonds, but rising rates are also negative for the stock market. Once the stock market reacts to higher rate, rates tend to fall. It is part of the economic/business cycle. The numbers show that a larger position in bonds stabilizes your portfolio. There are always blips along the road.

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 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. It will hold fewer stocks when they do not meet our conditions, and exit the entire portfolio when there is extreme risk or a likely drawdown.

We reset our portfolios at the beginning February after exiting on our “extreme risk” criterion. We were not out long and reentered at much the same place, but with a much smaller number of markets. We continue to have a lighter portfolio while the system searches for stocks that have performed well in this new market.

                February results were mixed for all portfolios, but posted a small loss for the Daily Trend program. Given the run last year into this January, that shows as a minor regrouping. The weekly program gave back more, 7% for the 10-stock, but then it is still up 25% for the year. Volatility works both ways.

Income Focus and Sector Rotation

We like to be philosophic in times when systems go through difficult periods. Both the daily and weekly Income Focus programs posted fractional losses in February and both are lower by about 2.5% for the year. That is not a lot, but we like this program because the interest income offsets any downside. But in a market that is gaining yields, the ETFs use here will post losses. It happens.

Sector Rotation

After two years of quiet performance, the Sector Rotation program seems to be springing to life! February showed a gain of 14% and has now recovered all losses and moved ahead by over 9%. It does not looks like a trending pattern, but it offers diversification in ETFs.

DowHedge Programs

While the Daily DowHedge program posted only fractional gains, the Weekly program was higher by 5.5%. Both are profitable for the year, although not by a lot. The overall market keeps shifting from large caps to tech to small caps day-to-day. While these large caps are safe, and the performance is good, we would not mind if investors could decide what they want to do.

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.

This program did the best of all portfolios this month, gaining over 6% and is ahead of the S&P. It shows a good uptrend and may be more adaptable to the changing markets. This strategy holds trades for about 5 to 8 days and can shift quickly.

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 does not depend on market direction for profits, although these portfolios are long-only because the upwards bias in stocks and that they are most often used in retirement accounts.

The good news is that this program continues to post gains, with February up 5% to 8% and 2021 higher by 13% to 23%. At the moment, buying on a pullback is still working, and is likely to continue during a period of uncertainty.

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 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.”

A good month for Futures, higher by 10% to 12% in the $250K and $500K portfolios, and even better for the year. Futures do not always offset losses in stocks, even though the idea of “crisis alpha” showed that in major downturns in stocks, futures posted good returns. We see that as the ability to go short equity index markets. At other times, futures programs wait for a trend to develop somewhere. This time we have rising energy prices and fast moving copper.

Group DF2: Daily Divergence Portfolio for Futures

Gains between 2% and 3% for all portfolios gives this program a nice start for 2021. Its pattern of controlled swings continues, although odd. We are the first to admit that this is not the normal pattern that we see in performance. Life would be easier if we knew more.

Blogs and Recent Publications

Kaufman Constructs Trading Systems

You will find 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 at the end of 2019 by John Wiley. It is completely updated and contains more systems and analyses.

MetaStock Strategies

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

November 2021!

Mr. Kaufman will present for TradeView in Melbourne, Australia, on November 27th, Covid-permitting. We are looking to see as many as possible there. We all need to get away!

February 2021

Mr. Kaufman will present to the technical students at the Universidad Politecnica de Madrid on February 3, 11 am CST. He will discuss risk and offer advice that comes from years of trading.

January 2021

Technical Analysis of Stocks & Commodities published an article on Short-Term Patterns, with lots of computer code so that you could do it yourself.

November 2020

November 1, he taped a session with Andrew Swanscott’s BetterSystemTrader.com

November 18, he presented a webinar on trading to the Italian bank, Fineco, this time in English.

November 27, he presented another webinar to Fineco subscribers in Italian.

October 2020

Mr. Kaufman had a full schedule in October and November.  You can find videos and recording of the following sessions:

On October 3 he addressed 1,000 members at the Indian Technical Analysis group You can find more at https://www.algoconvention.com/schedule

On October 10 he recorded a session on volatility and risk for TopTradersUnplugged.com

On October 22 he addressed another large group for the Italian bank Fineco (in Italian).

September 2020

“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 kaufmansignals@gmail.com.

June 2020

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.

March 2020

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

February 2020

“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.

Book Interview

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.

You will also find many articles posted under Articles on our website, www.kaufmansignals.com. You can address any questions to perry@kaufmansignalsdaily.com.

© February 2021, Etna Publishing, LLC. All Rights Reserved.

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