Industry Benchmark Performance
Small gains in the equity hedge funds in June are somewhat disappointing, with many stocks moving higher and NASDAQ on new highs. Year-to-date results are similar to the S&P returns. Most CTA performance was better, with systematic programs doing the best, higher by 2.4%. Still, there is nothing exciting going on here.
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 this at the end of this report. We post new interviews and reference new articles each month.
June Performance in Brief
One thing that I’ve learned about the market is that, in the short-term, it is unpredictable – and that is normal. In the long-term we can count on the economic indicators, home sales, employment, and interest rates to drive stock prices, but getting there can be a very bumpy road.
It’s easier to explain what is happening after-the-fact, but predicting how next month will go is beyond anyone’s skill. That’s why I stay with systems. They perform in the long run, as long as you understand the risk and the months of boredom.
While we are very pleased with the performance of our benchmark equity trend programs, we would never have expected, or predicted, that the Timing Program would be ahead by 40% to 50%. That strategy buys oversold stocks in an uptrend and reflects the incredible rebound that we see across some sectors. We also have anecdote evidence that other managers with a similar strategy are doing just as well.
There are some strategies that work together to give a more stable portfolio return. Our Timing and Divergence programs are both short-term and try to capture profits at the point where a trend program might be giving them back. Whether you use our programs or others, try to get strategy diversification.
Major Equity ETFs
Even as tech stocks (QQQ) posted new highs, there is a sign that the rally is peaking. The S&P made its last high on June 8 and has be struggling since then. The Dow and small caps are lagging further. Stocks doing well are those that benefit from more people staying home, that is, internet stocks, NetFlix, and some of the pharmaceuticals, if you can figure which ones are likely to benefit from Covid-19 from day to day. We expect this pattern to continue, with the tech stocks continuing to do better and a recovery still some time off.
We continue to look at some stocks that represent how the market is reacting to the Covid-19 crisis. First, five sector ETFs, energy (XLE), metals & mining (XME), financials (XLF), healthcare (XLV), and retail (XRT) show similar patterns, with the exception of healthcare, which is not surprising.
The chart below shows that sector patterns, while similar, exhibit much different strength. Surprisingly, retail is outperforming other sectors, while energy, not surprising, is lagging. Healthcare seems to have played itself out and has now been sideways for three months. It is the pharmaceutical research and development companies that have been the focus of speculation.
Looking at the same companies as last month, we can see that Moderna remains volatile but is no longer running away to the upside. Regeneron has been accepted as a drug able to shorten hospital stays even while it is not a cure. They have now priced the drug, so investors can decide how that will affect the stock returns. Gilead seems no longer of interest. However, these perceptions change from day to day. Just today, Pfizer was in the news as having a possible vaccine. It is up almost 5%. Before today it looks very much like GILD shown below.
Shopping at Home
It looked as though we were going to move towards “normal,” but the recent increase in cases and hospitalizations in the south and California has driven consumers back to on-line shopping. The three beneficiaries are Amazon, ETSY, and eBay, all of which show good increases in June. Perhaps more for ETSY. We’re going to take a chance and say this pattern will continue. Even if there is a vaccine, we think the on-line shopping industry will continue to have a greater number of customers. Let your fingers do the walking!
There was a lot of optimism about the airlines that was short lived. While Delta was keeping center seats open, American was filling planes. Plus, there were ugly events between passenger wearing and not wearing masks. This is causing (soon) the government to step in an regulate how airlines will deal with the capacity. For now, passengers seem to have backed away from flying in the near future. It looks as though air travel will be slow to recover and be less profitable for some time to come.
CLOSE-UP: Pullbacks, Part 2: A Trading Strategy
Last month we looked at timing an entry by waiting for a better price. The conclusion was that, for markets with a lot of noise (for example, the S&P), you can improve results by quite a bit by just entering on a minimum pullback. If you demand more, you are likely to miss entering at all. And applying this to interest rates are not a good choice because they tend not to pull back as often as they continue in one direction.
This month we will look at a strategy based on waiting for a pullback. For those of you that follow my writing, I published an article in Technical Analysis of Stocks & Commodities on Linda Raschke’s 1st Cross System, which buys after a new trend signal on the first oversold condition. I then showed that the 2nd cross was even more reliable. So, buying on a pullback can be a valuable trading method.
Now we will look at our own Timing Strategy, which also buys stocks on pullbacks in an upwards trending market. It turns out that, in our very erratic stock market, this system is outperforming all others. We have also spoken to a brokerage firm that is also trading a similar strategy and has similar returns.
The Way It’s Done
Buying on a pullback, that is, buying when a stock is oversold can simply be a price decline or it can be a decline relative to some benchmark. Our approach uses a benchmark. Here are the steps:
1. Apply a simple momentum calculation to determine the trend. The range is between 40 and 100 so that it is a “macrotrend,” tracking the fundamental direction of interest rates and its affect on stock prices.
2. Find which major index, SPY, QQQ, DIA, or IWM that stock is most correlated with over a shorter time period.
3. Track the relative difference (ratio) between the best correlated index and the stock.
4. Apply a momentum indicator to the difference between the correlated index and the stock.
5. When the momentum indicator is oversold and the macrotrend is up, we buy the stock.
6. When the momentum indicator returns to normal (i.e., 50), we exit the trade.
That makes the trade last from about 3 to 8 days and complements a trend-following system by entering when stock prices are declining.
Performance for the past 20 years, net of $8 per trade, are shown below. You can see that this strategy fits the market extremely well, but also that older performance was credible. It is also unusual that the larger 20 stock portfolio is outperforming the smaller 10 stock portfolio. Normally, the selection process favors the smaller portfolio, even with greater risk.
A Simplified Way
It is not likely that you will want to go through the process of finding the correlations between an index and stock. You can simplify the process:
1. Use a moving average between 60 and 100 days to determine the trend.
4. Use a smoothed stochastic to decide when the price is oversold.
5. When the momentum is oversold and the trend is up, buy the stock.
6. When the momentum indicator returns to normal (i.e., 50), exit the trade.
This is similar to Linda Raschke’s 1st Cross System, which performs quite well.
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 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, including Sector Rotation, Income Focus, and Dow Arbitrage
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.
The Daily Trend program was finally able to find stocks to make the portfolio more robust, selecting internet, pharma research, and some stay-at-home stocks. The 10-stock portfolio gained 6.05% in June, bring YTD to +13.1%. The weekly program gained 4.04% for a YTD of 14.9%. Both programs are returning about the same but getting there in very different ways. We would like it to continue.
Income Focus and Sector Rotation
The daily Income Focus portfolio continues to perform well while the weekly portfolio has not yet recovered from its sell-off. We can see that the volatility of the weekly program has always been greater than the daily program and the long-term returns are slightly lower. Even while we expect the weekly program to recover, investors should know that situations that require a faster response will not favor the weekly program.
The Sector Rotation program holds the honor being our worst performing portfolio, a combination of erratic market action and the slower response of a weekly program. We only worry that the traditional sector rotation rebalances monthly, a scenario that could even be worse. At some point this program will get back on track, but it has a way to go.
Once again we see that the Dow Hedge program recovers quickly from drawdowns. This month it took a rest, losing 3% but holding on to a YTD gain of 3%. We’ve added the DIA performance to the summary at the beginning of this report to allow comparison. DIA gained 1% in June but is still down 9% for 2020, so this program is well ahead.
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 smaller 10-stock Divergence program is running away from the larger portfolio, up 8.65% for June and 12.3% for 2020. The 30-stock portfolio was higher by 1.45% in June and only up 3.35% for 2020. Still, both returns are good and the charts show new highs, always a good sign.
Group DE3: Timing Program for Stocks
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.
We have discussed the underlying strategy for this program at the beginning this month’s report. Every system has a market that is good for it, and this recovery favors undervalued (oversold) stocks. It could simply be an overwhelming number of speculators sitting at home with nothing better to do that find stocks that are “undervalued.” We can only follow the system, which seems to be doing fine. The 10-stock portfolio was up 7.1% for June, up 42% for the year. The larger 20-stock portfolio was up 9.4% in June and 52% for 2020.
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 report describing our revised portfolio allocation methodology. It can be found in the drop-down menu under “Articles.”
Again we see that in this market a weekly program cannot respond in a timely manner to the fast changes and shifts from market to market. The daily program gained about 2% in most portfolio and is higher by 12% in the $250K portfolio and up 7% in the $1 million. But all the weekly portfolios are lower by about 11% this year. That puts the daily program well ahead of the CTA benchmark while the weekly program is lagging. We still expect markets to return to “normal” and both programs to move higher.
Group DF2: Daily Divergence Portfolio for Futures
Continuing its erratic but successful pattern, this program was up by about 7% for all portfolios in June and is now positive from 5% to 7% for the year, beating the CTA benchmarks. We expected more from this and the futures Trend portfolio given the hype of “crisis alpha,” but gain in both futures and stocks at the same time are unusual, although a good situation.
Blogs and Recent Publications
Trading Systems and Methods, Sixth Edition
The sixth edition of Trading Systems and Methods was released the last week of October by John Wiley. It is completely updated and contains more systems and analyses.
MetaStock issued an upgrade to the Kaufman Fast Strike add-on in late January. This add-on has three short-term trading systems, holding positions for one to three days in two of the programs, and about one week in the third program. They trade noisy markets, including most major index ETFs and futures, plus one program trades the VIX. You can see a description of the programs and a record of past performance on MetaStock. Anyone interested should contact MetaStock at 800-882-3040 or go online to www.metastock.com/kaufmana
Mr. Kaufman gave a presentation at Jake Bernstein’s “Cycle” seminar. Anyone interested in a copy of the presentation should send a request to email@example.com.
The June issue of Technical Analysis of Stocks & Commodities published the article “Crashes and Recoveries.” It will help you figure out how the Covid-19 pandemic will play out. It will also have the TradeStation code for the “2nd Cross” strategy, requested by readers.
There are some comments in the April issue and on the current stock market drawdown and a correction to Mr. Kaufman’s article in the March issue of Technical Analysis of Stocks & Commodities
“The 1st and 2nd Cross” was published in Technical Analysis of Stocks & Commodities in the March issue. It is based on an idea of Linda Raschke and captures small but reliable pieces of a trending move.
A new article “Essential Math For Traders” will be published in the Bonus 2020 issue of Technical Analysis of Stocks & Commodities.
ProActive Advisor Magazine (on-line) published “Controlling risk that doesn’t go away,” posted on January 15.
Both of these articles are important for understanding your investment risk.
Technical Analysis of Stocks & Commodities published an interview with Mr Kaufman in the December issue.
MetaStock Seminar held in Sunnyvale
Mr. Kaufman was a keynote speaker at the MetaStock conference in Sunnyvale, November 3. You can hear this presentation by going to the MetaStock website.
Technical Analysis of Stocks & Commodities published “Running for Cover,” an article by Mr Kaufman that looks at whether buying bonds after a sudden drop in the S&P can still be profitable.
“A Simple Way to Trade Seasonality” was published in the September issue Technical Analysis of Stocks & Commodities. Seasonal trades and filters can be a big asset to market timing and put you on the right side of a price move.
Mr. Kaufman appears as a chapter in Mario Singh’s new book, Secret Conversations with Trading Tycoons, published by FXI International.
A second part of the interview with Caroline Stepan at TalkingTrading.com was just posted.
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, and Michael Covel’s website, TrendFollowing.com.
Mr. Kaufman spoke in Tokyo and Osaka to the Japanese association of Technical and was a keynote speaker at the 2018 IFTA conference in Kuala Lumpur, both last October. You should be able to get a copy of the presentations by MATA, the Malaysian Association of Technical Analysts.
“In Search of the Best Trend” was published in Technical Analysis of Stocks & Commodities in July 2019. An article on “Defense is Your Best Defense” will appear in ProActive Advisor Magazine also appeared in July 2019.
Mr. Kaufman was a keynote speaker at a number of IFTA conferences, the most recent in 2018 in Kuala Lumpur, and Milan in 2017. You can find his presentations on their website.
You will also find many articles posted under Articles on our website, www.kaufmansignals.com. You can address any questions to firstname.lastname@example.org.
© June 2020, KaufmanSignals. All Rights Reserved.