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 for the TSI is +1 to –1.
Is this consolidation or distribution? Continued low volatility and a creeping advance will always show as declining momentum. It gets tiresome saying “more of the same” but the equity markets keep plodding upward with no surprises. Market fundamentals reflect this same pattern, they are all slightly positive but not enough to cause the Fed to act quickly, hence cautious optimism. Even Greece has developed a “ho-hum” attitude for investors. We expect conflict between the Greek ministers and the European Central Bank but Greece will eventually capitulate. Then, when they don’t do anything or meet the milestones, we start all over again speculating about a default and withdrawal from the EU. Meanwhile, the Trend Strength Index is consolidating in a triangular formation, with the end of May values in the center. There is no way to forecast the outcome, but a price break either up or down will be eventually materialize.
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.
This month we made important changes to the Divergence programs for both equities and futures. That program has shown greater volatility because there can be only a few divergence signals during quiet market periods. We’ve improve the way the program decides which way prices will move based on the divergence pattern. In doing that we’ve increased the expected number of trading signals. The more signals, the greater the diversification, and the lower the risk.
Otherwise, the equity markets had no major surprises in May. One of our longest positions, Hawaiian Holdings, was very volatile, as were other airline stocks. Hawaiian dropped 9% in a few days, then rebounded 7% in one day. As is often the case, prices from month-end to month-end look normal, but the path during the month can be nerve wracking.
Both stock and ETF Trend Programs outperformed the benchmark SPY in May, recovering most of the lost ground for stocks. The ETF Program is running well ahead of the SPY this year.
The Divergence stock programs gave back their year-to-date gains in May and are now slightly down for the month. We are looking forward to June, where the program changes will be effective.
The Timing Program posted modest gains for May and is profitable for all models year-to-date.
Trend and Divergence Futures programs showed very small profits and losses for May. Those programs still reflect the large swings in the Swiss franc and Swiss Market Index, mostly in the larger portfolios.
Of the three major equity index ETFs, the SPY gained the least, up 1.29% for the month, while both QQQ and IWM were up 2.25% and 2.24%. On the chart below, the QQQ pattern is clearly the strongest.
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 Trend Sector ETF program buys the 6 strongest sectors of the SPDRs. This month started with
Preferred stocks (PFF), Consumer Discretionary (XLY), Technology (XLK), Oil & Gas Equip (XES), Energy (XLE), Materials (XLB)
We removed Preferred (PFF), Oil & Gas Equip (XES), and Energy (XLE). We added Financials (XLF) and Industrials (XLI), in addition to Healthcare (XLV). Current positions are:
Material (XLB), Financials (XLF), Industrials (XLI, Technology (XLK), Healthcare (XLV), and
Consumer Discretionary (XLY)
The Timing Rotation program (buy low) removed the hedge in the SPY and QQQ as those markets reversed losses from April. What has been discarded by the Trend (strength) program is being picked up by the Timing (undervalued) program as having fallen too far.
This month started with:
Preferred stocks (PFF), Vanguard Reits (VNQ), Industrials (XLI), Healthcare (XLV), Consumer Discretionary (XLY), and Retail (XRT)
At the end of May, the program held only four positions, indicating that deleveraging was in order. It added energy (XLE) and Oil & Gas Equipment (XOP), which fell out of the Trend sector portfolio and are now oversold relative to the SPY. Positions at the end of May were:
Vanguard Reits (VNQ), Retail (XRT), Energy (XLE), and Oil & Gas Equipment (XOP).
When an ETF appears in both the Trend and Timing programs, it means that EFT 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.
PEFORMANCE 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.
The Trend Equity Programs gained nicely this month, making up for most of the shortfall in April. The smallest 10 stock portfolios gained 4.03% for daily and 6.89% for weekly, and the larger portfolios as well as the ETFs also posted good returns. The charts below show the improvement as a confirmation of the upwards trend in the NAVs.
The Weekly Stock programs also look better, with the smaller portfolios for both stocks and ETFs hovering at their highs.
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.
The Divergence Program lost its year-to-date profits in both stock programs but gained in the ETF portfolio. The pattern remains sideways for stocks, but maintains a nice uptrend in ETFs. This month the new rules will become effective, adding more trades and more diversification.
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.
The Timing program Gained in all three portfolios. Performance in both stocks and ETFs are remarkably uneventful, maintaining a sideways pattern now for the past few months.
The Trend and Divergence Futures Programs put in mixed returns in May. The Trend Program showed marginal gains in two portfolios and a small loss in another. The Divergence program added to year-to-date losses. The Futures Divergence Program was also modified to add more trading signals in order to increase diversification. Results will show in June’s performance.
The sector returns below show mixed results. Bonds for the Trend Program is the big winner while it is just the opposite for the Divergence program. The Trend gained in the Index and Ag sectors and lost a smaller amount in FX, energy, and metals. The Divergence program gained in FX and Ags but lost more in Bonds. Note that these charts show only 2015 performance. The longer-term returns would be significantly positive everywhere.
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.”
In May, the CTA industry also posted fractional gains overall, similar to our programs. Year-to-date returns range between 2% and 3%.
The Trend Futures Programs are still in a moderate “give-back” after last year’s spectacular performance. This pattern has been written up as “crisis alpha,” the extreme profits when you need them, sometimes followed by extended periods of sideways or modest gains. With two of the three futures portfolio showing gains for 2015, there isn’t much of a give back.
Group DF2: Daily Divergence Portfolio for Futures
The Divergence Futures Program remains in a drawdown although the NAV charts show that the patterns remain up. This strategy has been modified in order to increase the number of trades and improve diversification. With only 20 to 40 markets traded, there are periods where few divergence trades can be identified, causing a lack of diversification which in turn can increase risk. Beginning this month, we expect changes to the strategy to provide more diversification.
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