Industry Benchmark Performance
Futures are separating themselves from the equity field, even though the BTOP 50 is barely profitable for the year. We expect that when the numbers are all in, futures will have had an outstanding month, capitalizing on the Brexit volatility. Initial returns for MacroTrend traders show a gain of 5.29%, while our program posted gains of about 12%.
Mr Kaufman has posted another blog on Forbes, this one updating the previous look at the Presidential Cycle and forecasting the remainder of 2016 and then 2017. The attitude towards politics has been consistent over decades and even centuries — no one likes it now, and no one liked it then.
Another article appears in Modern Trader this month. You can address any questions to firstname.lastname@example.org.
June Overview: Outstanding for futures, a case of Crisis Alpha
Equity portfolios for the Trend program all gained nicely, exceeding the broad index markets by 1.5% to 4% and are now all ahead for the year. The Divergence and Timing programs were mixed for the month and for the year.
The big gains were in the Trend Futures program, which rallied move than 5% on the day following the Brexit vote, while stocks fell over 3%. That’s a classic example of Crisis Alpha. We think there is more to come (see the next section). The Divergence program did not do as well, posting losses in the two smaller portfolios and profits in the largest one.
The major equity ETFs, shown below from the beginning of this year, are slightly higher in SPY and IWM, but lower in QQQ. The effects of Brexit can be seen at the far right. As of today, U.S. markets have nearly erased the loss of last Friday.
Our View of the British Vote
There is no doubt that the vote to leave the European Union was a price shock – an unexpected outcome. Had it been expected, the market would not have moved. On Friday morning the European Index markets were down 6% to 8% and the US down over 3%. A nasty day for everyone holding long positions. But in the U.S. the equity markets have mostly recovered as have the energy and metals markets (see charts below). So, is it all over?
We don’t think so. There may be a rude awakening when the U.K. finds out that the EU does not want to give them a favorable trade agreement without allowing the immigration that they have just voted against. There is some irony if that comes to pass. But none of it is clear and it can all change as the days unfold.
The bigger problem for the Brits is Scotland, then Ireland. The Scots voted to stay in the EU and now want to talk directly to the EU about separate representation. If they don’t get that, will they go further and again test the vote to become independent? We think so because this issue is a fundamental chasm. Then, if Scotland goes, does Ireland follow? In either case the British pound could lose considerable value in the process.
What is the risk that the pound will rally? It doesn’t seem likely in the short-term, while the EU members are upset at England. While the anti-exit supporters are rallying in hopes of changing the outcome of the vote, it’s hard to see that happening. “The people have spoken.” The argument that the campaigning was unfair holds very little validity when most political advertising is false. So we see a much more likely decline in the pound with minimum upside risk. There is no way to put any numbers on these moves, but a first target for the pound would be 1.20. If Scotland actually separates, then perhaps even 1.00 (par with the U.S. dollar).
Portfolios Selected by Performance are High Beta
As a reminder, our automatic portfolio selection process uses past performance to select stocks and futures. Markets that are outperforming the averages tend to continue to outperform, but they also have higher volatility than the broad index. Outperformance means that profits on any day are higher, which also means that on a losing day, losses will usually be larger. It’s the basic principle of volatility and risk: you can’t achieve higher returns without higher risk.
Smaller portfolios that are less diverse are more likely to generate higher returns during “good” markets (the ones that work well for the strategy) and larger losses during “bad” markets. More diverse portfolios will have smaller gains and losses. To decide which is best for an investor, you must understand their risk tolerance and their financial well-being.
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.
Our Trend Strength Index dropped from about 45 to 30 in the days leading up to the British vote, then dropped to about 18 following the vote. That’s still positive but has yet to show a pattern that we can trade. The TSI is definitely weaker than the SPY, which is not a good sign, given that the TSI has been good as a leading indicator.
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 new Sector Rotation program also buys the strongest sectors and is reviewed with the Trend Equity Program.
The Trend Sector ETF program buys the 6 strongest sectors of the SPDRs. June started with the following:
Metal & Mining (XME), Oil & Gas Exploration (XOP), and Materials (XLB), Preferred (PFF), Materials (XLB), Energy (XLE), and Industrial (XLI)
At the end of June, we had kept PFF and XOP, but switched all other positions. We now hold:
Preferred (PFF), Reits (VNQ), Technology (XLK), Staples (XLP), Utilities (XLU), and Oil & Gas Exploration (XOP)
The Timing Program buys 4 ETFs that are undervalued with respect to SPY, in expectation of rotation. As of the beginning of June we held:
Technology (XLK), Industrials (XLU), Consumer Discretionary (XLY), and Metals & Mining (XME).
At the end of June we had closed out all positions are were setting one new one:
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.
PERFORMANCE 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.
A good move in June stocks, up over 4% despite the volatility caused by Brexit, puts our Trend programs just under their all-time highs and positive year-to-date in all portfolios. The ETF portfolios did well given that ETFs aren’t as volatile as individual stocks, also posting gains everywhere.
The smallest 10 stock portfolio continues to outperform the other weekly programs, which posted nearly 1% for June. The 30-stock portfolio posted marginal gains while the ETF portfolios both posted fractional losses. The ETFs continue a slow decline in performance.
This month the Sector Rotation program lost 2% but seems to be holding onto the gains of the past few months. We peeked at the results of the last week of June and saw that it was up 4.5%, taking advantage of the British vote. The program has held the same positions all month, long Materials (XLB), Energy (XLE), and Metals & Mining (XME). Those still look good, with energy continuing to rally and gold moving higher on economic uncertainty.
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.
While both Divergence Equity portfolios posted losses in June, their uptrend remains intact. The 8 ETF portfolios continued to crank out small but steady profits, this month gaining nearly 2%.
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.
Similar to the Divergence Program, the Timing Program lost in both stock portfolios but gained 1.71% in the Sector Rotation program. The Equity portfolios seem to be caught in a sideways pattern while the ETF portfolio has started to recover from its drawdown. This strategy, buying the weakest stocks that have a pattern of recovery, gives you excess returns in a bull market but just holds its own when there is no trend.
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.”
Gains of over 10% to over 13% this month brought total returns for Trend Futures to 13.5% to 17% for the year. The Friday following the British vote saw a 5% gain in most portfolios, a perfect example of “crisis alpha,” where futures offset losses in stocks on extreme days. The Weekly portfolios did well, gaining about 5% for the month, but those returns seem disappointing compared to the daily program.
Group DF2: Daily Divergence Portfolio for Futures
The Divergence program has to find specific patterns in order to set a trade, and the British vote did not produce those patterns. The two smaller portfolios lost this month, while the largest portfolio gained by diversification. The upside of this program is that it is uncorrelated to others, which can be a big advantage during a bear market.
©Copyright June 2016, Kaufman Signals. All Rights Reserved.