February 2022 Performance Report

Industry Benchmark Performance                                                                                            

Modest losses in all equity funds and gains in futures, probably due to shorts in equities long U.S. dollar, and long energy futures. There is a lot to be long in commodities. The equity funds are holding about the same as the equity index ETFs so far this year.

Kaufman’s New Book, “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 following link:

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

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.

Blogs and Recent Publications

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

February Performance in Brief

Given the history nature of February’s price moves, both erratic and volatile, our portfolios performed well. The benchmark 10-Stock Daily Trend strategy gained 2.7% while the S&P, Nasdaq, and Dow all lost from 3% to 4.5%. We are concentrated in energy stocks, which is good for now.

Nearly all of our portfolios gained in February, a triumph for stock picking. The only program posting small losses was the Timing strategy, which has been out of the market for nearly the entire decline in equities. It remains up by more than 4% for the year.

Futures also gained although only one of the portfolios show a net gain for the year.

Equities continue lower as the market tries to digest the effects of sanctions on Russia, the possibility of less crude oil, higher inflation, and changing Covid restrictions. It seems a lot to resolve. Investors have decided that it is not a promising scenario.

We are including a chart of XLE, the energy ETF, along with the nearest futures contract data. The scale on the right, and the orange line, is crude oil, now at $100. The blue line is XLE, showing a value above 70 and nearing the highs of 2008, at the same time crude reached $150/bbl.

CLOSE-UP: Price Patterns During the Month

The stock and futures markets are a combination of simple and complex. That sounds mutually contradictory. Futures are driven by supply and demand. Stocks are driven by the economy and interest rates. That’s the big picture. But there is more to it than that.

It’s about the flow of money. When the economy appears risky, money flows out of stocks into bonds as it has been doing in February. When everything is rosy, investors pile into stocks, as they did for the 10 years after the financial crisis of 2008. Again, that’s the big picture.

But there are smaller money flows that represent how investors and financial institutions operate day after day, month after month. They have strict rules that they follow.

For example, the Morgan Stanley Commodity Index (MSCI) publishes when they will roll from one futures contract to the next. It is part of their prospectus and public information. This has given rise to a subset of traders that takes advantage of the large MSCI orders that sell the nearby delivery and buy the next delivery. It’s called convenience yield. You can find all the information needed online.

Why Patterns Occur

There are two factors that drive price patterns during the month:

  • Repatriation of funds to foreign accounts at the end of each month
  • Investment flows by large financial institutions required to add and redeem customer money, mostly for retirement accounts.

Today we are interested in the effects of these large flows in and out of retirement accounts. Just like convenience yield, large institutions have a strict pattern in the way they execute these flows. If they are arbitrary, then customers will complain that some investors are treated better than others.

Money will flow in and out of interest rate markets, futures, and ETFs, as well as stock index futures and their ETFs. We won’t look at other markets which are affected to a lesser degree.

Our Analysis Tool

We will use futures markets from 2010 to the end of 2021. That will include a selection of interest rate maturities, equity index markets, and currencies.

We have a program that aligns each month from the first trading day for the next 10 days, and aligns the end of the month from the last day backwards for 10 days. That misses a few days in the middle of the month, but we don’t think that will be important.

Interest Rates

Let’s look first at the U.S. 10-year Note futures, considered the benchmark interest rate. Figure 1 shows the average price differences for the past 12 years. We used price differences because futures prices are back-adjusted, so the prices in the older deliveries are not the prices at the time. That changes the returns and can produce some odd numbers.

Figure 1. Price differences for 10-year Note futures from 2010, aligned by day of the month.

It seems clear that the end of the month favors upward moves. That translates into lower interest rates. Anytime there is a demand for interest rates, the yield will decline.

The beginning of the month is less clear but favors lower prices. It appears that the funds are selling at the beginning of the month and buying at the end of the month. Perhaps they use the other days to earn interest for themselves on the uncommitted money. However, that is just speculation.

We cannot forget that interest rates spend most of their time declining (towards lower yields, futures rising). Figure 2 shows the percentage of the 12 years that prices rose on each day. If we average that frequency, we get 55.8%, very similar to the upwards bias in the stock market. We see a pattern similar to Figure 1: about 30% rising prices early in the month and 70% to 90% at the end of the month.

Figure 2. Frequency of upward moves in T-Notes by day of the month.

U.S. Rates

To be sure that one interest rate is not the exception, Figure 3 shows the average price moves by day for three major maturities, FV (5-year), TY (10-year), US (30-year). The pattern is very consistent even though we expect interest rate price moves to be highly correlated. The beginning of the month favors selling and the end of the month, buying. The size of the moves reflects the relative volatility (and length of maturity) of the markets.

Figure 3. Four U.S. interest rate futures.

As the U.S. Goes, So Goes the World

Should we expect the same patterns in other world interest rate markets? Perhaps in the stronger economies, which would have similar dynamics. The U.S. is likely to have the largest retirement accounts, so it is not always clear that interest rate markets in other countries will have the same pattern.

Europe may be considered a market similar to the U.S. although its stock market is not used for financing new companies to the extent used in the U.S. However, retirement is a major benefit for EU workers. Figure 4 shows the 5-year eurobobl (EBM) and the longer-term 10-year eurobund (EBL) with a similar pattern to the U.S. markets. The extent of the upwards price moves during the final eight days of the month depends entirely on the entry rules for the financial institutions, which are then based on the amount of money they are investing.

Figure 4. Medium and long-term interest rate futures in the EU.

Figure 5 shows the rate pattern for Australia, Japan, and the U.K. We had no expectation that these markets would reflect the same pattern as the U.S., so we were surprised at the similarity.

Figure 5. Australian (YT2 and YT2), Japanese (JGB), and British (FSS) interest rate patterns.

While the Japanese Government Bond (JGB) overwhelms the other rates, it is highly biased towards the end of the month (with the exception being the last day). The other rates show consistent buying during the last week and erratic returns early in the month.

Then we have Canada, shown in Figure 6. Again we see the consistency of upward moves at the end of the month.

Figure 6. Pattern of Canadian bond price changes.

Summary

It should be clear that there is a consistent pattern in the way developed countries buy and sell interest rate futures. This pattern can be used to create a trading system or as a trading filter. Entering a long position a week ahead of the month-end should prove to be a consistently good approach to trading interest rates – but be sure to be out by the last day of the month!

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 conditions, and exit the entire portfolio when there is extreme risk or a likely drawdown.

Although still in our sideways pattern, the Equity Trend portfolios were mixed to higher compared to the major stock index markets which all posted lower returns. Both weekly and daily portfolios hold mostly energy-related stocks, such as Chevron, Marathon, Excelon, and Haliburton. On some days they do well, then reverse unexpectedly. Still, they are holding their own in a volatile period.

Income Focus and Sector Rotation

This program had no position throughout February, which turns out to be good. It remains with a small loss for the year. However, there are signs that the Fed may not raise rates as often or as much as originally planned, and interest rate futures have declined in the past few days as traders move to safety. We have no expectations of new positions anytime soon.

Sector Rotation

First interest rates, then energy, then technology – it is difficult to find the sector that can sustain a move. Even with that frustrating performance, the Sector Rotation program only lost 1.6% in February. At some point the market will settle down.

DowHedge Programs

Small gains in February in both the Daily and Weekly DowHedge portfolios is a pleasant surprise. This strategy has held up during the recent nasty downturn and it would not take much to reach new highs. On the other hand, small losses are also acceptable in this market.

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 Divergence program returned gains of better than 6% for the 10-stock portfolio and 1% for the 30 stock. It seems to be capturing the small rallies then exiting, a strategy that is working nicely in this market.

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.

As the old saying goes, “It is better to be out of the market and wish you were in, than in and wish you were out.”

If the Timing chart looks the same as last month it is because it was only in the market for one trade that lasted less than two days. That netted a small loss but kept the year-to-date positive. This program buys pullbacks in an uptrend, but there are very few uptrends that can be found right now.

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.”

Gains of 1% to 3% argue for diversification. It’s not the “Crisis Alpha” where futures completely offset losses in equities, but a profit is better than a loss. Year-to-date results are mixed but it would not take much to turn them all to profits.

Group DF2: Daily Divergence Portfolio for Futures

A nice recovery this month of 6% to 7.3% after a nasty loss last month. This program outperformed all others. Timing is everything, but finding stocks that are pausing in an uptrend can be a difficult task in a market that continues to sell off.

Blogs and Recent Publications

Kaufman’s New Book, “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 following link:

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 was released at the end of 2019 by John Wiley. It is completely updated and contains more systems and analyses.

January 2022

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.

November 2021

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.

September 2021

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.

Soon

There are two pending articles to be published in Technical Analysis of Stocks & Commodities. The first, “50 Years On,” is a recap of the most important lessons learned by Mr. Kaufman. This will appear in the Bonus Issue. The other article, “Trading a Moving Average,” looks at two key moving average rules as well as how to time an entry. We have no dates yet for the publication.

July 2021

 “Playing It Safe with Cryptos” appeared in Technical Analysis of Stocks & Commodities. It’s a challenge trying to trade these markets given their extreme volatility.

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:

March 2021

There are new articles being published in Technical Analysis of Stock & Commodities. The next one is “Better Entries,” scheduled to appear in the May issue.

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.

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 perry@kaufmansignalsdaily.com.

© February 2022, Etna Publishing, LLC. All Rights Reserved.

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