Kaufman Signals

March 2018 Performance Report

Industry Benchmark Performance

Due to the holiday, equity performance has not yet been updated. We will post industry performance as soon as it is available.

Futures posted minor losses in March, similar to our own performance. This will also be updated.

Blogs and Recent Publications

Find this at the end of this report. We post new interviews and reference new articles each month.

March Performance in Brief

Another month of losses in most portfolios resulting from high volatility and erratic price movement. Large moves down followed by large moves up in equities, with the net effect being down. Futures are holding up the best, still showing year-to-date gains in both daily and weekly trend portfolios. The Futures Divergence program is the only one to post gains in all portfolios.

Major Equity ETFs. Last month we looked at the serious possibility of the end of the bull market. We’ve now seen a pullback of more than 10% in most of the equity index markets and the signs are still looking negative. We’ll discuss it more in this month’s In-Depth report.

 

IN-DEPTH: Is It A Bear Market Yet?

Last month we argued that the recent price moves were reminiscent of the crash of 1987, including the sustained bull market, the economic situation, and action by the Fed. No, we are not expecting a drop of 35%, but we cautioned that risk protection was in order. We still recommend further risk protection because we believe that the decline is not yet over.

What appeared optimistic in the world economy at the beginning of the year seems to have completely disappeared. Instead of looking forward to growth everywhere, we are now expecting a trade war with China as well as with many other countries, the possible exception being Canada and perhaps Mexico. Europe doesn’t seem to be an exception. Continued higher interest rates is also not an aide to a bull market.

What is the effect of tariffs? Higher prices for a large number of products in exchange for a smaller number of new jobs. While the U.S. should never be without steel manufacturers, will the U.S. rebuild its steel industry by taxing foreign steel 30%? Very unlikely. But the consumer will pay more for cars and everything else made from steel and aluminum. They won’t be happy with that. It was the same situation was saw with energy. At $100/barrel, those working in the energy industry were doing well, at least the corporations, while consumers struggled to make ends meet. The net result is burdening many for the benefit of a few.

The Chart

The stock market is reflecting this concern. Higher retail prices mean fewer sales and less economic growth. Let’s look at how the chartist would see the major equity EFTs in Figure 1.

Figure 1. A chartist view of the major equity ETFs.

The blue lines angling down and to the right show the declining tops in all but Nasdaq (QQQ). The bottom blue line is nearly horizontal, showing recent support. This forms a downward angling triangle which is usually resolved by a downward breakout. The two red upward angling straight lines show that Nasdaq is holding onto a weak uptrend. While Nasdaq can be very different from the other index markets, they typically move together. Table 1 below shows the pattern of rallies and declines from the beginning of February. SPY and DIA are hovering at a 10% drop, while QQQ and IWM have rallied off the lows.

Table 1. Rallies and declines in the major equity EFTs.

The Trend and Volatility 

What do the trend programs say? In our trend portfolios we trade multiple parameters. That means in a strong market we have a full position and as the market weakens we deleverage. As of today, the 10-stock portfolio can only find eight stocks that are performing well enough to trade. That’s not a good sign for the bulls.

Volatility has been increasing, as seen in Figure 2. VIX had been near 10% during the long bull market but is now near 20% after running up to 35%. The interesting thing about trends and volatility is that trend profits are made during periods of low volatility. High volatility is associated with smaller gains and more risk. That seems to be the direction we are headed. We will change our opinion if volatility starts declining back to 10%.

Figure 2. VIX has moved away from its 10% level and is now at 20%.

The Leading Stocks

Some of the stocks that we relied on to produce profits are now struggling. Tesla, which seemed to go up no matter what, is now off its highs by 25% (see Figure 3 left). Similarly, our reliable Amazon is looking weak, more from Trump’s tweets claiming they are taking unfair advantage of taxes (not true) rather than the weakening economy (Figure 3 right). But they will suffer if the economy takes a downturn.

 

Figure 3 (Left) Tesla is now 25% off its highs. (Right) Amazon is holding up for now.

How Do We Play Defense?

It may turn out that the trade war never happens, the market recovers, Russia pulls out of Syria, North Korea denuclearizes, and life becomes rosy again. Until then, it is best to take some defensive position. Following a trend system will get you out of the market when the trend turns down. History shows that trading the trend works. When it’s wrong, you lose a little opportunity. When it’s right, you save a lot of grief.

In addition, a few months ago we discussed the advantage of trading defense stocks, namely Northrop (NOC), Lockheed (LMT), and Raytheon (RTN). Our trend portfolios have now included them based on outperforming other stocks. In Figure 4, while they are not rallying (for now), they are holding up well. The worst, LMT, down 5.2%; the best, RTN, near its highs. There is a lot of tension in the world, and the addition of John Bolton, who has said (in the past) that he would bomb Iran and North Korea out of existence, is not a statement that eases tension, and is not constructive ahead of negotiations with North Korea. The performance of these defense stocks will tell you how investors feel about the likelihood of peace versus conflict.

Figure 4. Defense stocks have been stronger than the overall market.

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 275 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.

The Trend Strength Index reflects the internal strength (momentum) of all the stocks that we track, about 275. These stocks tend to have a stronger trend than the typical stock. It is also a mix of stocks from the S&P and Nasdaq, with a few smaller caps, but none trading fewer than an average of 1 million shares per day.

The Trend Strength Index may show declines when the stock market pauses, but it seems to be a leading indicator before a more serious downturn. At the moment its value is near zero, showing that there is no upwards bias in the overall market. Below zero would indicate a net downturn. For the past few years, drawdowns have been small and the recovery fast. We may predict a further slide, but we would rather see a recovery.

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.

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, 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.

Another drawdown in March shows an increase in volatility on both the daily and weekly Trend Portfolios. The 10-stock daily portfolio is holding onto a 4% gain for the year, while the weekly 10 stock portfolio is flat. It’s similar to the average of the equity index markets, which are lower for SPY and higher for QQQ. Given the volatility we’ve seen this month, as small loss seems acceptable.

Income Focus and Sector Rotation

A welcome gain in March for the Weekly Income Focus, even while the daily program last fractionally. This may not be exciting but it offers diversification in a stressful market.

A larger loss in March puts this portfolio negative for the year. The erratic nature of prices is making it difficult to hold one sector for very long.

DOW Arbitrage

Another loss in March, making it two months in a row. Year-to-date is now negative 0.39%, not too bad considering the reversal in the overall market.

 

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.

A second month of small losses leaves the 10-stock portfolio still up by 2.5% for the year, but the larger portfolio down by the same amount. The chart below shows the same performance volatility as the other programs.

 

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.

Small losses in March added to the year-to-date loss. This program is partially hedged in both SPY and QQQ positions due to the first leg of what it sees to be a downtrend. Hedging will reduce the loss but not turn a loss into a profit. It’s an approach to “biding time” until the trend turns up again.

Futures Programs

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.”

Futures are advertised as being able to offset losses in equity portfolios during a crisis. So far, both daily and weekly Trend Portfolios are still ahead for the year but posting losses of 1% to 3% in March. We hope that we don’t need to be bailed out by futures, but during a sharp sell-off, this program will go short the equity index markets as a hedge against long-only equities.

Group DF2: Daily Divergence Portfolio for Futures

This program posted gains in all portfolios and is about flat for 2018. It has a history of volatility due to the small number of positions it typically holds, but manages to keep making new highs.

Blogs and Recent Publications

In March, Mr Kaufman spoke to the Austin chapter of the CMT Association (previously the MTA), and was interviewed by Jacek Lempart for his blog systemtrade.pl, serving the European Polish investors. The interview will be posted soon.

February

A new interview with Mr Kaufman has been posted on the FXCM website (Forex Capital Markets) as of a few days ago.

Mr. Kaufman spoke at the Trader’s Expo in New York on Monday, February 26th. His presentation was on ways to reduce risk that traders forget to use.

January

Mr. Kaufman has a presentation in Jack Schwager’s FundSeeder webinar, which should now be available online.

There is an interview on YouTube conducted by Alex Gerchik for his Russian audience. We think you will find it enjoyable and helpful. The link is:

https://www.youtube.com/watch?v=TznkQtPQXgM&t=3s

Technical Analysis of Stocks & Commodities published Part 1 of a two-part article on profit-taking and resets, in their January issue.  The first part looks at trend following and the second at short-term trading. Part 2 is scheduled for the February issue. Before that, they published “Optimization – Doing It Right,” in the September issue.

Mr. Kaufman was a Keynote Speaker at the IFTA annual conference, hosted by the Swiss technical analyst’s association (SIAT) held in Milan, Italy, in October 12-16, 2017. A video of the presentation has been posted on the IFTA website.

“Portfolio Risk in Uncertain Times” was just posted on Seeking Alpha. It shows a better way to structure your portfolio. Prior to this, you will find “Living Off Profits,” which shows how much you can safely withdraw from your account without seeing spiral down out of control. Before that Seeking Alpha published “What Are the Odds?” a look at how to assess the risk of loss for any investment.

Modern Trader published “Dogging the Dow in the current edition, and a new article “Trading Opening Gaps” in stocks, scheduled for January 2018.

The IFTA Journal published an interview with Mr Kaufman in the most recent quarterly issue.

The broker FXCM will post a live interview with Mr Kaufman, taped on October 30.

ProActive Investor Magazine published Keeping Risk Under Control on June 22. Check their website. It will be publishing other articles later this year.

Andrew Swanscott at BetterSystemTrader.com (a good source for trading systems) has put up an edited version of an older presentation of Mr. Kaufman’s. It’s all about price noise and the Efficiency Ratio.

Look for past articles by Mr. Kaufman on Seeking Alpha (www.seekingalpha.com), Forbes (http://www.forbes.com/sites/perrykaufman). www.equities.com, Modern Trader, Technical Analysis of Stocks & Commodities, and Proactive Advisor Magazine. You will also find many articles posted under Articles on our website, www.kaufmansignals.com. You can address any questions to perry@kaufmansignals.com.

 

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