Industry Benchmark Performance
Hedge funds posted fractional gains but are still nicely position for the first quarter. If they can maintain this rate of return, investors will see a good year. CTAs are also gaining slightly, bringing some of the year-to-date returns positive, but not the BTOP50, which we see as the benchmark. Interest rates are the center of profits this year, as expectations of a further increase have dimmed.
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
A much better month, with our equity portfolios higher by 1% to 3%, in line with the major index markets. Futures put in a much better showing, up 4% to 7% in the Trend program and 9% to 11% in the Divergence program. The Divergence portfolios are now up 20% for 2019. Both daily and weekly Income Focus programs are well ahead of their long-term returns.
Major Equity ETFs. Continued gains in equity index markets puts the 2019 returns higher by 13.5% to 16.6%, outstanding by any measure. Can it be sustained? We’ll look at that in our Close-Up report this month. Meanwhile, the DJIA and IWM seem to be struggling here. It’s not surprising given the recent downgrade in the GDP and mixed signals from the Fed as to whether they will raise rates again.
CLOSE-UP: One Quarter Down, Three to Go
If you watch the financial news on television, we’ve had the greatest start for a year since the cavemen. That’s not quite true, but it’s close. Still, the equities markets face considerable uncertainty:
- The Fed is sending mixed signals with regard to raising rates again.
- The GDP estimate has dropped suddenly to 2.2, due to a delayed trade resolution with China and uncertainty about how Brexit will affect Europe, and consequently, the U.S. At 2.2%, the U.S. debt would not be reduced. See Figure 1.
Figure 1. U.S. quarterly GDP from January 2018.
- Technically, the trends for the equity index markets have not all turned up. The previous chart of index ETFs shows that most indexes are rounding out below the previous highs during the 4th quarter 2018.
- The P/E ratio is now at 21.2 after extreme volatility starting in 1995, reaching as high as 68. While the long-term average is about 15.7, it currently stands at 21.2, still a bit high. A higher P/E ratio indicates that investors are optimistic about higher prices. See Figure 2.
Figure 2. History of P/E ratios, now at 21.2, above the long-term average of 15.7.
For those interested, the CME has a “Fed Watch Tool” that gives the probability of a rate increase (of different amounts) for each of the future Fed meetings. Given the Fed policy of “no surprises,” the accuracy of this tool is very good as the Fed meeting gets closer.
Does a Good Return in the First Quarter Have Follow-Through?
Should we be optimistic about the rest of the year, or should we take our profits (if any) and stand aside? Are we able to evaluate the fundamentals and decide on their market impact over the next few months? We would rather look at the price history.
First, the truth. The first quarter of 2019 was up 13.5% based on month-end values of SPY. As you can see in Figure 3, this year’s 1st quarter return was slightly below that of 1998 and slightly above 2012. Clearly a good result.
Figure 3. 1st Quarter SPY returns from 1994.
Now let’s look at how the 1st quarter relates to the rest of the year. Figure 4 is a scatter diagram with the 1st quarter results along the bottom and the results for the following 3 quarters shown on the left. The good 1st quarters are to the right of the center vertical axis. This year doesn’t appear because there are no following quarters to compare.
Figure 4. Comparing 1st quarter results with the rest of the year.
The best years are the ones farthest to the right. The rest of the year for those outperformers shows returns from a few percent to about 25% For all years with a positive 1st quarter there were only three cases showing a loss. So the chances of a positive return from April through December is very good. We can also see on the left that large losses in the 1st quarter had varying results from up 30% and 40% to down 30%.
Most economists and statisticians will say that the best forecast is the average of the past forecasts. They tend to play safe. When we average the returns of the last 3 quarters over the past 25 years, we get 8.25% — not bad. If we drew a horizontal line across the right side of Figure 4, a little below the 10% line, it would look about right. In general, a higher return in the 1st quarter looks as though we would get a good follow-up return. The upwards bias of the stock market seems to be the overwhelming factor. In answer to the original question, we should stay in the market. We are ever hopeful.
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.
Not much movement in either SPY or the Trend Strength Index in March. The TSI seems to have stalled just above 20 while SPY is also lingering at the same levels. Both indicate a very weak upwards momentum. There is no indication yet whether a slow upwards move will continue or if we’ll see another drawdown. Based on the Close-Up commentary above, small gains are most likely for the rest of the year.
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 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.
Small gains in both daily and weekly equity trend programs are in-line with SPY returns in March. The daily program is showing a good recovery, adding to previous gains and now ahead by 9.6%, while the weekly program is lagging behind, up less than 3% for the year. Now that most stocks have trends that have turned up, we have a better selection to choose from. We expect to keep gaining on the major index markets.
Income Focus and Sector Rotation
This program continues to outperform expectations, up another 1.3% and 1.5% for the daily and weekly versions. The chart shows a clear steepening of the equity. This has been based on expectations of no increase in rates and the possibility, however unlikely, that the Fed will lower rates. Still, constant interest income keeps the program steady even as rates rise.
A fractional loss in the Sector Rotation program leaves it up about 3% for the year, slightly ahead of it’s long-term return history. The NAV pattern still looks promising.
A small gain of 71bp puts this program up by 11.3% for the year, a little behind the S&P but clearly recovering from the recent drawdown. It shows that it can keep drawdowns smaller than either the S&P or NASDAQ and recover quickly.
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 Equity Divergence program posted the continued to gain, mostly in-line with SPY gains. The 10-stock portfolio is up 13% for 2019. Given the diversification this program offers, it’s a great performance.
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. 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.
Given that not all trends have turned higher, this program remains partly hedged. With that in mind the 15-stock portfolio gained 2.7%, more than SPY in March, and the larger portfolio gained 80bp. Both portfolios are testing their equity highs.
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.”
A good month for the daily Futures Program, gaining 4% to over 7% in the three portfolios and bringing 2019 returns mostly positive. The Weekly Program also gained in all portfolios, but not as much. Interest rates continue to be driving the market, although the gains in the equity index markets have helped as well.
Group DF2: Daily Divergence Portfolio for Futures
Continued outstanding performance from the Futures Divergence Program, up 9.5% to 11.4% in the three portfolios and now higher be about 20% for 2019 across the board. This program enters when the trend pauses and only holds trades for about 5 to 8 days. Given the uncertainly of the market, that seems to be the right pattern.
Blogs and Recent Publications (for the past 12 months)
MetaStock will be offering a program with four of Mr. Kaufman’s short-term trading strategies for ETFs, stocks, and futures. They should be available now but are running late.
“A Simple Way to Trade Seasonality” will be published in Technical Analysis of Stocks & Commodities. We’ll let you know when we have a date.
Mr. Kaufman appears as a chapter in Mario Singh’s new book, Secret Conversations with Trading Tycoons, published by FXI International.
Mr. Kaufman was interviewed by Caroline Stephen at TalkingTrading.com. It covered a wide range of topics. It has not yet been posted but should be available soon.
We thought the article in ProActive Advisor Magazine would be in March, but it should appear any day in April. It is “Let’s Be Realistic About Drawdowns.” Most traders don’t pay enough attention to the drawdown history of their trading, or of any system trading. Large drawdowns are infrequent but can be ugly. This article shows how to assess them and some ideas on reducing drawdowns.
Technical Analysis of Stocks & Commodities will publish “Volatility: What They Don’t Teach You In Grad School,” in the January edition.
An article appeared in ProActive Advisor Magazine looking at all calendar patterns, including the Santa Rally, the Presidential Cycle for 2019, the January and May effect, and seasonal patterns in ETFs.
In January Technical Analysis of Stocks & Commodities will publish an article showing the real relationship between price and volatility, which will surprise you. It should change the way you size your positions.
Mr. Kaufman spoke in Tokyo and Osaka to the Japanese association of Technical Analysts on various techniques for trading Japanese markets. You can contact the organization for a copy of the presentation. Mr. Kaufman was presented with a Japanese translation of his newest book, A Guide to Developing a Successful Trading Strategy.
He also spoke about “Making Volatility Work for You” at the 2018 IFTA conference in Kuala Lumpur. It was an excellent conference with many good speakers. You may be able to get a copy of the presentation by contacting MATA, the Malaysian Association of Technical Analysts.
“In Search of the Best Trend” will appear in Technical Analysis of Stocks & Commodities this month.
A new article on “Defense is Your Best Defense” will appear in ProActive Advisor Magazine this week.
Mr Kaufman spoke to the Austin chapter of the CMT Association (previously the MTA)
He was interviewed by Jacek Lempart for his blog systemtrade.pl, serving the European Polish investors. The interview will be posted soon.
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, the website for Alex Gerchik, and Michael Covel’s website, TrendFollowing.com.
Mr. Kaufman has been a keynote speaker at a number of IFTA conferences, the most recent this year in Kuala Lumpur, and the previous year in Milan. You can find his presentations on their website.
© March 2019, KaufmanSignals. All Rights Reserved.