Industry Benchmark Performance
Equities continue to post gains, although trailing the equity index markets. We are halfway through the year and if this continues it will be a very good 2021. Futures are also doing well, in part to energy and commodities in general. It has been a while since we saw strong trends, both up and down, across a broad sample of futures markets.
Blogs and Recent Publications
Don’t forget our new book, “Kaufman Constructs Trading System.” You can find it on Amazon or on our website, www.kaufmansignals.com.
Find recent publications and seminars at the end of this report. We post new interviews and reference new articles each month.
June Performance in Brief
A small loss in our benchmark 10-stock Daily Trend program, while the Weekly Trend portfolio is higher by 34%. Sometimes diversification pays off and a smaller selection of stocks increase the changes of both gains and losses. We are still recovering from out tech-based drawdown and the program has settled on energy as the best chance of success. As much as we would like to recover quickly, the market will do what it always does, flounder around until a theme surfaces.
Our other programs also posted losses with the exception of Income Focus which profits from high-yield bonds and munis. There is still a long way to go this year, and we have every expectation of beating the S&P before the end.
June shows mixed results, some would interpret as a rotation. Tech stocks again took the lead, gaining more than 6%, the S&P higher by 2.24%, small caps up 1.87%, and the Dow down fractionally. On the chart below, the S&P and IWM look the smoothest and are still about the same in year-to-date results as the other equity index ETFs.
In this month’s Close Up we will look at trying to identify which index is leading.
CLOSE-UP: Index Momentum
Quite a few years ago I wrote Global Equity Investing with Alberto Vivanti, a Swiss private banker. Essentially, it looked that momentum of various regions in the world and conclude that, had you shifted your money to follow momentum, you would have come out well ahead.
This month we will apply a simple momentum calculation to the four major equity index markets. By momentum, we mean the rolling quarterly returns, 64 trading days. In some ways you might think of this as Index Rotation rather than Sector Rotation, but our strategy is very simple.
- Calculate the rolling returns of the past 64 trading days. That is as close as we can get to a calendar quarter, which reflect the earnings schedules for NYSE stocks.
- Rank the four index returns, highest to lowest.
- Find the equity index market with the highest 64-day returns.
- Calculate the return for the best index, lagging one day.
We should calculate a position size as, for example, $10,000 divided by the entry price, but that was too difficult using our spreadsheet, so each position was one share. That will make more recent data more important because the prices, but I think the results will still be useful.
Which Index Dominated 2020 and 2021
If you were to guess, no doubt you would be right, it was the NASDAQ (QQQ) earlier in the year, then the NASDAQ alternating with small caps (IWM). The pattern is shown in Figure 1. I don’t know why it was IWM, but investment theory says that, when investors are optimistic, the take more risk, hence both QQQ and IWM. If they think QQQ is overbought, the IWM is more likely. It’s just a theory.
Figure 1. Index momentum, in %, for 2020.
It is interesting that, at no time, did either the DJIA or the S&P lead in 2020.
2021, this year, is a different story. Figure 2 shows that the small caps that ended the year 2020 continue to dominate for the first three months of this year. Eventually, the investors settled on the DJIA, no doubt looking for “value.” Only this past month, June, has seen a switching between the S&P and NASDAQ, but nothing as consistent as last year.
Figure 2. Index momentum, in %, for 2021 through June.
Can This Be Traded?
This may all be interesting, but can we make money trading it? We applied the simple rules from the first section, going back to May 2000 when all three ETFs were trading. That’s 21 years with a lot of extremes moves.
As mentioned earlier, we did not calculate a position size or charge a commission, but there are long periods where the same equity index ETF was held, so we do not think that commissions are important.
Figure 3 shows the NAVs from 2000 to now. There is the usual drawdown in 2008, and a drawdown following the dot.com bubble at the end of 2000. In those cases, all the equity markets declined, so you would need to introduce some risk control to avoid those losses. Otherwise, this simple ranking does well.
Figure 3. NAVs from the momentum ranking method.
Final Thoughts and Spreadsheet
We are always looking for ways to diversify. This program has no moving averages, but shows there is persistence in the way traders focus on one area of the market at a time. It does speak to their psychology.
To trade this approach, you will need to calculate the position size. Given the consistency, you might want to use weekly data and a lookback period of 13 weeks, equivalent to the daily period of 64 days.
There is a spreadsheet available which was used to create these charts and the NAVs in Figure 3. You can get it by sending an email to firstname.lastname@example.org. Good trading!
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 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. 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.
While the Daily 10-Stock Portfolio is slowly recovering from its drawdown, the Daily 30-Stock portfolio is far ahead, and the Weekly portfolios are also better. It’s the good and bad for trading a smaller number of stocks. When the system picks them correctly, it far outperforms the overall market. But it can suffer when a few stocks reverse combined with volatility.
This drawdown has been typical of other drawdowns in percent, and it will no doubt end with new highs in the not distant future. Meanwhile, we follow the trend. Both 10- and 30-stock portfolios lost about 2% in June, but the 30-stock has a roaring gain of 34% for this year. Normally, it is the smaller portfolio that is far ahead.
Income Focus and Sector Rotation
Fractional gains continue to keep the long-term pattern looking higher. With the Fed changing its long-term outlook for rates and causing volatility, this program remains a small but steady winner.
This program lost about 3% in June, not much compared to the gains during the past six months. It is holding on to three ETFs, Energy, Financials, and Metals & Mining, all of which are doing well. It is easy to see from the results.
Small losses in both the Daily and Weekly Dow Hedge program but net gains of 6% and 10% for the year. Our Close-Up report showed that traders moved to the Dow stocks early this year and have helped it keep pace with the broader market.
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.
This program is lagging the market but is ahead for the year in both portfolios. The chart below shows a sideways pattern for the past few months, but little drawdown. We are looking for a renewal of the uptrend.
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.
Fractional gains and losses continues to keep the pattern of this program moving higher, now up 34% and 20% for the 10 and 20 Stock portfolios this year. This program buys on pullbacks within an uptrend, a strategy that seems to be just right for this market.
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.”
After a few good months, futures markets are selling off sharply, reversing the uptrend. Our program lost in all portfolio, but more so in the smallest $250K, with the largest $1M essentially flat. Even with that, returns for the year are up by 15% to 17% and it appears that the sell-off is over.
Group DF2: Daily Divergence Portfolio for Futures
Fractional losses in June does not change the overall performance pattern of the Divergence program. It continues to hold gains for the year between 7% and 10%. It also continues its unorthodox pattern.
Blogs and Recent Publications
Kaufman Constructs Trading Systems
You will find both an ebook and a print version of Perry’s new book, Kaufman Constructs Trading Systems, published on Amazon. It is a complement to Trading Systems and Methods. It takes you step-by-step through the process of developing a trading system, with many examples. Order it through our website, www.kaufmansignals.com or directly on Amazon.
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.
There are even more articles are scheduled for Technical Analysis of Stocks & Commodities. We don’t have a date yet, but keep checking!
Expect to see the article “Playing It Safe with Cryptos” in Technical Analysis of Stocks & Commodities. It’s a challenge trying to trade these markets given their extreme volatility.
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:
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.
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.
Technical Analysis of Stocks & Commodities published an article on Short-Term Patterns, with lots of computer code so that you could do it yourself.
November 1, he taped a session with Andrew Swanscott’s BetterSystemTrader.com
November 18, he presented a webinar on trading to the Italian bank, Fineco, this time in English.
November 27, he presented another webinar to Fineco subscribers in Italian.
Mr. Kaufman had a full schedule in October and November. You can find videos and recording of the following sessions:
On October 3 he addressed 1,000 members at the Indian Technical Analysis group You can find more at https://www.algoconvention.com/schedule
On October 10 he recorded a session on volatility and risk for TopTradersUnplugged.com
On October 22 he addressed another large group for the Italian bank Fineco (in Italian).
“Fools Rush In,” an analysis of the best time to buy an IPO, will be published in the September issue of Technical Analysis of Stocks & Commodities. There is also a full description of Kaufman Constructs Trading Systems in the “Books for Traders” section.
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.
“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.
© June 2021, Etna Publishing, LLC. All Rights Reserved.