News commentators are asking anyone willing to make a comment about the Greek situation and we are told that Greece is a small part of the European Union, and virtually non-existent from the view of a U.S. investor. Why then, is there such an impact on our markets? Yesterday, the IMF told Australia that in order to boost their economy the government needs to create debt and spend money. This type of policy exposes the systemic problem of debt that underlies the world economy on every level.
Alexis Tsipras, the Greek Prime Minister, refuses to accept the terms of the EU bailout; consequently, the EU is refusing to lend them money. A vote this Sunday will be “yes” to effectively stay in the Euro and accept further austerity, and “no” to refuse and likely withdraw from the EU. The result will tell us if the Greek people have a clear understanding of common math or if they are as unrealistic as their new finance minister, poles favor a yes vote. A choice to face reality would be a long overdue signal to politicians that the people are not fools.
Our interest is in how it affects the markets here in the U.S., in Europe, and around the world. Below is a chart of the 10 year Greek government bond and below that the U.S. 10-year Note and the S&P. Interest rates are unaffected by the rising Greek yields, but the S&P reflects investor nervousness. So far, a drop of 1% is hardly a tragedy and the past month has already shown a slight decline from the sideways pattern that began this year. It seems that investors looking for positive news won’t find it in the Greek confrontation, but that effect on U.S. markets, so far, is very small. You can never eliminate the possibility that any event will cause a sell-off, but we think that, regardless of the outcome on Sunday, the U.S. market will adjust by midweek. That’s not to say it will go up, but the chances of a sustained impact seem small.
Our own trading programs had mixed results this month, and hovering near flat for the year. While we beat the benchmark SPY in all but one of the portfolios, the year-to-date lags slightly behind the benchmark. The best equity program so far is the Weekly Trend, which is ahead of the benchmark in June and for the year.
Futures showed a gain in the Divergence program and a loss in the Trend Program, a reversal of the past few months. The Trend Program turned negative based on June’s loss. Both programs are trailing the benchmark BTOP 50, which is also down for 2015. While all of us prefer gains all the time, we need to remember that futures offer “crisis alpha,” that is, they perform best when the equity markets are at their worst. Neither is happening at the moment and there are no significant trends to exploit.
The major equity index ETFs all declined sharply at the end of the month, reacting to news of the EU-Greece standoff. The SPY remains 1% higher for the year, with the Qs and IWM still a little stronger.
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.
June ended with a sharp dive in the Trend Strength Index (TSI), falling below zero on the last day. That means the net direction of all stocks that we follow are now negative, a mix of positive and negative trends. We saw this in September of last year, where the TSI led the market lower. This year it seems to be leading as well. The next few days will clear up this pattern but we expect a rally after the dust settles around the Greek referendum, regardless of the outcome. A rally, however, doesn’t mean a bull market, just a return to the current doldrums.
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.
The Trend Sector ETF program buys the 6 strongest sectors of the SPDRs. This month started with
Material (XLB), Financials (XLF), Industrials (XLI, Technology (XLK), Healthcare (XLV), and
Consumer Discretionary (XLY)
Because of market weakness, we exited Materials (XLB), Industrials (XLI), and Technology (XLK), and only added Retail (XRT), leaving us with less exposure and the following positions:
Financials (XLF), Healthcare (XLV), Consumer Discretionary (XLY), and Retail (XRT).
The Timing Rotation program (buy low) removed the hedge in the SPY and QQQ as those markets reversed losses from April. What has been discarded by the Trend (strength) program is being picked up by the Timing (undervalued) program as having fallen too far.
This month started with:
Vanguard Reits (VNQ), Retail (XRT), Energy (XLE), and Oil & Gas Equipment (XOP).
The Timing Program was hedged short SPY for part of the month, but exited all positions following the sharp sell-off last week. Currently there are;
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 were flat this month, beating the major index benchmarks, but not adding much to the year-to-date. The ETF programs were down but better than the SPY and QQQ., Holding our own in this market is as much as can be expected. The Trend Program can outperform when there is a good trend, but will continue to try new positions and cut losses during sideways periods, such as this year. Risk control is just as important as returns.
In the charts below we see most of the programs creeping higher, with the exception of the Sector ETFs which have come off their highs by a small amount.
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 outperformed the benchmarks, but did little to start an uptrend in returns. Still, it’s difficult to be profitable on the long side with the entire market declining. The only portfolio that has taken a larger drawdown is the smallest one, which we know will have both greater risk and greater reward.
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 performed in much the same way as the other portfolios, a small loss but better than the benchmark. The smallest 10 stock portfolio is holding on to a small profit for the year while the other two portfolios are posting small losses.
The Trend and Divergence Futures Reversed their recent pattern, with the Divergence gaining an average of 4% and the trend program losing about 7%. This year, unlike 2014, there are no strong trends to produce the gains we are looking for.
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 June, the CTA industry also posted losses making the year-to-date negative. It appears that we all stick together, even when we try to do something different.
Intellectually, we know that a “give-back” always occurs after a spectacular period of profits, but we never like it. The charts show that this drawdown is small compared to the gains of the past few years. The Weekly Program, which gained less, is now giving back less. We expect some consolidation into fall.
Group DF2: Daily Divergence Portfolio for Futures
The Divergence Futures Program has a small blip up, hopefully the beginning of a rally. The larger portfolios, which show the most volatility are somewhat deceiving. The program manages leverage based on a target volatility, expressed as a percentage. A drawdown at a NAV of 4500 (left scale) will seem bigger than on at 1700, but may be the same percentage. While we prefer profits, the current performance remains consistent with its history.
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