January 2022 Performance Report

Industry Benchmark Performance                                                                                           

The fund industry favors less volatility, so this month’s losses are less than the overall market. On the other hand, the futures funds posted small to modest gains, showing that diversification can be a benefit.

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.

January Performance in Brief

A poor start for all markets in January. Our own program moved to energy stocks in time for the market to switch back to tech stocks, then away from tech stocks to value stocks. Given the conflict in Ukraine, energy may still be the place to be.

Other sectors and strategies had similar problems, except our Timing program, which was in and out for a small gain, then is standing aside while the market decides what it will do next.

The good news is that the saying “As goes January, so goes the year” is not true. The market is biased to the upside and it is just as likely to be higher at the end of the year, with or without January.

A sharp turn-around for the index markets, with the small caps and Nasdaq dropping the most, and the Dow down the least. At the lows, two days before the end of January, Nasdaq had given back all the it had gained in 2021 but the S&P, a better indicator of the overall market, is holding above the lows of the previous drawdown and still shows a substantial gain since the beginning of 2021. It is a sign that this drawdown is not a crisis.

CLOSE-UP: The Fed and the Stock Market

News of the Fed finally raising rates has caused a nasty drawdown in stocks, especially Nasdaq. Given that we expected the Fed to act on inflation, perhaps not to this extent, the market should have sold off earlier and have stabilized by now. “Sell the rumor, buy the fact.” Perhaps our breed of traders are more like dinosaurs, reacting in slow motion to data.

Reasons for Hikes and Cuts

Historically, the Fed raises rates to dampen inflation. They have also been known to do it to dampen stock market speculation, as in 1987, although they won’t admit it. They lower rates when the economy is weak in order to stimulate business and consumer spending. They temper their actions with an eye on encouraging employment. Sometimes that can be tricky, as it is now.

The Current Stock Market

If you haven’t looked, the stock market sold off in January. The chart below was printed two days before the end of January at the lowest point of the sell-off. As of January 27, SPY was down 8.75%, QQQ down 13.39%, and IWM down 11.90%. This is not a disaster, although the financial news has turned to gloom and doom. The tech stocks seem to be taking the biggest hit, but then they gained the most during the most severe part of the Covid lock-down.

Figure 1. The decline of stocks during January 2022.

Anticipating the Fed

If you have been a trader for a while, you know that interest rate futures, in particular the 30-year bonds, anticipate the Fed action. Sometimes it’s wrong, sometimes it’s early, but traders always want to be ahead of the facts. Let’s look at Fed Funds as representing action by the Fed, and 30-year bond futures as the trader anticipation (Figure 2).

Figure 2. 30-Year bonds anticipate Fed rate cuts, usually.

The red vertical lines on the left half of Figure 2 show where interest rate futures began to anticipate Fed rate cuts. On the far right, bond futures prices decline anticipating a rate increase. The two small shaded green areas show false anticipation. The bond market expected the Fed to indicate tightening, which did not happen.

The erratic movement in 30-year bonds is all about anticipating what the Fed will do next. When bonds are wrong, they usually correct quickly. The most recent move, started in the early part of 2021, is shown the larger green area. While very early, it correctly anticipates higher rates without being excessive.

Stock Market Reaction

In a posting by Marc DeCambre on January 15, he shows that the stock market does well during rate increases and decreases. The reasoning is that the economy is strong in order for the Fed to raise rates. In the opposite situation, the Fed lowers rates to stimulate a sluggish economy, which will cause the stock market to rally. His table is below. We can conclude that the market always goes up.

Figure 3. Market reaction to rate cuts and rate hikes. (Posting by Marc DeCambre, January 15, 2022)

Then why do we get a stock market sell-off as we did in 2008, or in 2000? Because the Fed cannot always anticipate problems. It often reacts. Those big moves were not caused by the Fed (except for 1987). But it was the Fed’s job to control it after it happened. Note that the table conspicuously omits 1987.

The Fed Lowers Rates During a Recession

Figure 4. History of Fed Funds rate.

The Fed lowered rates after the dot.com collapse of 2000 and during the 2008 financial crisis. It tried raising rates slowly during the last part of the bull move, 2016 to 2019, then lowered them to zero as Covid set in. Covid depressed the economy and put millions out of work.

What Happens During Rate Hikes?

Figure 5. Three periods of rate hikes by the Fed.

The green areas in Figure 5 show rate hikes by the Fed. To confirm DeCambre’s table, we can see that the stock market was unphased by the rate highs until they reached 5%. Investors seem hard to discourage.

What About 1987?

Figure 6. The 1987 Crash.

1987 is a special case because it does not fit the other patterns shown by DeCambre. The economy was good, and the stock market (in orange) gained 45% through August of 1987. That’s a lot. The Fed started to raise rates in April to slow the rise, but it wasn’t until October that the market capitulated, selling off sharply starting in early October and collapsing in mid-October. It is a situation where stocks fell as rates rose, and it was a serious decline. We should not forget it. We hope that Chairman Powell remembers it as well.

Which Scenario Do We Have Now?

Did the Fed learn anything from 1987? They have kept rates low during the entire bull market from 2010, unlike 1987. Because of the stress on the economy due to Covid, they have continued to keep rates low.

Now they face the problem of inflation. They do not have a problem with employment, so one of their two objectives satisfied. Raising interest rates will dampen inflation, but not eliminate it. Higher wages are now built into the economy. That’s OK because wages were unreasonably low for the low-end workers.

The Fed plans to raise rates four times in 2022. If those hikes are ¼ of 1%, Fed Funds will still be very low. It is now at 0.375%, about 3/8ths of 1%. If they raise rates by 1% in 2022, it brings it to 1.378%. How important is that when we paid 8% for mortgages and 20% for credit card debt during the 1990s?

The Fed is not supposed to watch the stock market, but it does. I don’t think it will let 1987 happen again. I think the market is overplaying its hand, reacting to a “potential” 1% increase in rates. If stocks start to drop past what is “normal,” say 20%, the Fed can simply announce that it will delay its rate hikes. It’s an easy way to stop a rout in the stock market.

We also hear that the Fed may start with a ½% hike. Maybe. But the policy of the Fed is “full disclosure.” Unless they make it clear, they will be using inuendo to control the market.

It’s just my opinion, but now that the news is out, we should get a stabilization in the market. Sell the rumor, but the news.

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.

It would be nice to be out of our drawdown, but we are not. The market is not cooperating. At the same time, the Weekly Trend program has taken a loss. Both programs had a nice rally before another drawdown. Price patterns keep changing. In order to capture the large returns, we need to accept the drawdowns. These programs have multiple risk controls and we are confident that we will serve their purpose. We also note that the more diversified 30-stock portfolios have had much lower volatility.

Income Focus and Sector Rotation

Losses of 1.5% to 2% do not appear important in the charts below, but this program is fighting with higher rates by adding interest income. It has helped stabilize results while we wait for interest rates to top out.

Sector Rotation

Although a loss in January, this program is holding up nicely, with a chance of posting new highs once the market settles down.

DowHedge Programs

Losses in January but the pattern looks firm, much like the Sector Rotation program. Holding losses to a minimum puts us in a better position to move to new highs.

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.

Although this program suffered the same losses as most of the other program, viewed in the long-term those losses look manageable. The equity patter remains much the same as always.

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.

There is always a bright spot and this Timing program spent most of the month without any positions. It entered a few stocks, then exited a few days later, capturing 4%. Given the performance of January, it is a welcome profit.

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.”

The Futures Trend program posted mixed to lower returns in January, but better than the equity markets. The chart below shows a sideways pattern developing, but near the high equity levels. We cannot expect interest rates or equities to sustain performance, but energy could be the next big trend.

Group DF2: Daily Divergence Portfolio for Futures

An unusually large loss for the Futures Divergence program, from 8% to 10%. This happens when the program has only a few positions due to the nature of the divergence pattern. Still, it is within the profile of the strategy, so we look forward to a quick recovery.

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. 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.

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.

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.

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

Leave a Comment

Your email address will not be published.

Scroll to Top