July 2015 Performance Report

Jul performance table

Overview

The Greek financial crisis and all its gloomy expectations have disappeared from the news with remarkable speed. While we’re sure there is more to come, it seems clear that the EU will accept any compromise to keep Greece within the fold. We should expect that to continue, most likely with the same level of drama, into the future.

Overall, July was a month of extremes. While the overall market seems to be weakening further (see the Trend Strength Index in the next section), health care and high-tech retailers (Google and Amazon) surprised the market on the upside. Amazon (AMZN), with a rare show of profits, gained 20% on the 24th, GOOGL moved 18.5% from the 16th to the 22nd (24% from the 1st of the month), and Biotech (BIB) rallied 16% by the 20th then dropped by 9% by the month end. While the SPY gained 2.2% for the month, we would not see it as a broad market rally.

July drivers

 

In futures markets we see a renewal of the drop in crude prices, based on inventories that are too high, lower Chinese demand, and the possibility of Iran oil coming back on the market. There is no sign that Saudi Arabia will lower its output. Gold also moved lower with a modest strengthening of the dollar, all in anticipation of the Fed acting on interest rates in September. We’re still not sure. Yes, they need to start raising rates, but the economic recovering hasn’t spread to housing, and more people are employed but at lower salaries. Our main concern is that the dollar is already near its highs and raising rates will have a noticeable impact on exports. We don’t think the Fed wants that to happen, so we’re still looking for December at the soonest for the first rate hike, or maybe early next year. After all, what’s the hurry?

July System Performance

Performance in July was noticeably better, with 22 of our 24 portfolios profitable and year-to-date returns for the Trend programs tracking the overall market well, but protecting risk at the same time. The best returns were in the Futures Trend program, gaining 6.76% in the small portfolio. The worst performance is the Timing Program, which buys undervalued stocks and those have refused to rally.

Of the three major ETFs, SPY, QQQ, and IWM, the Qs showed much greater strength in July, while the SPY gained a small amount and the small cap IWM posted losses. We would say that the weakest pattern appears to be the SPY, but the past 5 years has shown that all of the equity markets have managed to creep higher, and betting against them has not been a good decision.

Major ETFS for 2015

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 250 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.

Trend Strength Index

It’s easier to see in the chart above that a rounded top has been forming in the SPY over the past two months. At the same time, our Trend Strength Index (TSI) took a dive. Because the TSI is equally-weighted, the effects of AMZN, GOOGL, and Biotech don’t affect the results as much as the cap-weighted S&P. The large drop reflects a much weaker trend in most stocks. Without a few of these mega-cap stocks performing very well, we should see a drop in the overall SPY price.

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.

Strongest and Most Undervalued Sectors

There are two ways to view sector rotation, trade the strongest expecting them to stay strong, or trade the weakest expecting the business cycle to rotate them to the top. We have both. The Trend Rotation trades the strongest and the Timing Rotation trades the weakest. The Trend program may hold positions for a long time, so it’s possible for two ETFs to be in both programs. For example, XOP (Oil and Gas) can be in a long-term uptrend, but a short-term oversold situation.

Strongest

The Trend Sector ETF program buys the 6 strongest sectors of the SPDRs. This month started with

Financials (XLF), Healthcare (XLV), Consumer Discretionary (XLY), and Retail (XRT).

Because of market weakness, we exited Retail (XRT), leaving us with only 3 of the possible 6 ETFs. Those positions are:

Financials (XLF), Healthcare (XLV), Consumer Discretionary (XLY

Undervalued

The Timing Rotation program (buy low) entered some positions during July, hedged them with up to two of three possible hedges in both the SPY and QQQs (showing weakness reflected in the Trend Strength Index), then exited all positions, leaving us again with no positions at the end of July.. Buying weakness in a market that is declining in the majority of stocks is not a successful strategy. This program will outperform when there is an upward move in the broad market by buying stocks that are likely to rebound faster

This month started with no position and ended with no positions.

No positions held

When an ETF appears in both the Trend and Timing programs, it means that market is very strong but is in a short-term retracement.

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 of 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.

PEFORMANCE 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 and ETFs

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

The Trend Equity Programs outpaced the SPY for the stock portfolios and was profitable but slightly below the benchmark for ETFs. Unexpectedly, the small ETF portfolio is up 8.95% for the year, beating the other Trend programs. We know that the stock programs were able to benefit from a number of unexpected, positive announcements in health care, but the health care ETF (XLV) did not perform as well as either Financials (XLF) or Consumer Discretionary (XLY), which gained 3.4% and 4.9%, respectively. On the other hand, avoiding energy (XLE) saved a loss of 7.69% in July. In this uncertain market, we consider these net gains, combined with strict risk controls, as a good outcome.

Trend equities

The Weekly Stock programs continue to look good, even in this market. The advantage of the Weekly signals is that there is less switching of positions. In this case, that turns out to be good.

Weekly Equities

 

Group DE2: Divergence Program for Stocks and ETFs

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 had positive returns in all portfolios and outperformed the benchmark in the smaller 10 stock portfolio. For 2015 only the smallest portfolio is showing a profit with the others posting small losses. The Divergence Program is looking for specific patterns, which cannot always be found. It remains in a mostly sideways period.

Divergence equities 

Group DE3: Timing Program for Stocks and ETF Rotation

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.

The Timing Program gained in the 15 stock portfolio but added to losses in the larger portfolio and the ETF Sector Rotation portfolio. Buying undervalued stocks in a weakening market is a different fight. While the program seeks opportunities in stocks that have performed well in the past under the same conditions, those same stocks are not rallying now. The Sector Rotation Program, which looks primarily as the sector SPDRs, has no positions at this time due to unfavorable conditions.

Timing equities

Futures Programs

The Trend and Divergence Futures both continued to gain, with the smallest Trend Program up 6.76% and the others better than 3.5%. The Divergence Programs posted smaller gains but has been out of the market for the past week or so, which limits both profits and losses. Although energy, gold, and the euro have resumed a downtrend, those moves are small compared to the plunge taken a few months ago. Still, the continuation is in the direction of the trend, which results in profits.

The Weekly Trend Futures Program is outperforming the Daily Program, showing nice gains for the year while the Daily Program is flat to down for the year. There must be something to be said for not reacting too quickly to price changes.

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 new report describing our revised portfolio allocation methodology. It can be found in the drop-down menu under “Articles.”

In July, the CTA industry also posted gains but below the returns of the Trend Program and similar to the Divergence Program. The Industry is now about flat for the year.

CTA performance

July performance halted the “give back” that has followed the large gains in 2014, which was nearly 50% of the extraordinary gains at the end of 2014 The Weekly Trend Futures program has held on to far more. We need to remember that this performance still reflect the losses from the sudden announcement of currency intervention by the Swiss Central Bank. That impacted the smaller daily portfolios far more than the larger, diversified ones.

Futures trend

Group DF2: Daily Divergence Portfolio for Futures

Another gain for the Divergence Futures Program this month. Returns appear to be stabilizing after the much higher volatility of the past few months. Even in the Divergence Program, which looks for a specific pattern, a trend in prices always helps.

Futures divergence

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