Industry Benchmark Performance
We have preliminary performance for May, but the Barclays Hedge Fund Index seems to be at odds with the Fund of Funds. We have always considered the Fund of Funds as a realistic return to the investors, and an aggregate of all funds. It now differs by about 1.5%. We’ll need to see if there are any adjustments going forward.
Similarly, Barclays CTA Index was flat in May while the SG Index was down -1.81. These results should be close to the final numbers, but also differ quite a bit. The BTOP 50, the 50 top CTAs, are closer to the SG Index than Barclays. We always need to watch out for missing data. In months where one or more large funds close, they often don’t report their final losing month. It gives an optimistic slant to the Index.
The Barclays Trend Index, which we consider our closest benchmark, is the same as our worse portfolio, but our other futures portfolios are better.
A New Forbes Blog
We’re changing the content of the monthly summary to include a more detailed review of some markets, rather than a “white paper,” reflecting some of our research. This will be our opinion of what might be interesting in the next month and we hope you find it helpful.
From now on you can find those original reports on Forbes under the blog for Perry Kaufman but we might also continue to publish in Modern Trader, as we have this past year. We hope you’ll follow them. You can address any questions to email@example.com.
May Overview: Underperforming Equities, Flat for Most Futures
The sharp reversals in stocks, seen in SPY below, is a difficult scenario for most systems. The Stock Tend Portfolios held steady while the ETF portfolios lost up to 6%, reversing what was a profitable year so far. The smallest Divergence portfolio also lost in May. The biggest disappointment was the Timing program, which was well ahead for the year and now shows a small loss.
Daily Futures were steady to lower, as were Weekly Futures, but both remain positive for the year. The best performance was in the Sector Rotation program, which added nearly 5% for a net of 8% this year.
Metals (XME) and Energy (XLE) have been of interest this month. The chart below shows that both have been tracking together since the beginning of the year and show good returns. Our Sector Rotation program has benefited from XME, although with some volatility. While the energy fundamentals are confusing, and there is no expectation for a surge in gold prices, we think that the upward trend is founded in the housing market.
The chart of Fannie Mae (FNMA) shows a steady rise for most of this year. Improved housing means improved non-ferrous metals (most of those traded on the LME) and is an important component of the economic recovery, to whatever extent that has happened. A little consumer confidence goes a long way towards purchasing. We’ve now seen a 5-month upwards trend that we think will last through the summer. The upcoming election may then destabilize it.
For those traders interested in more excitement, Amazon has a pattern nearly identical to FNMA, a smoother uptrend since February but a large drawdown from late January for about two weeks. These may all be just correlated consumer stocks, but the returns have been excellent. Quant analysts believe that it’s safer to put your money into markets that have been consistently rising than to buy one that is falling and hope for a turnaround.
Portfolios Selected by Performance are High Beta
As a reminder, our automatic portfolio selection process uses past performance to select stocks and futures. Markets that are outperforming the averages tend to continue to outperform, but they also have higher volatility than the broad index. Outperformance means that profits on any day are higher, which also means that on a losing day, losses will usually be larger. It’s the basic principle of volatility and risk: you can’t achieve higher returns without higher risk.
Smaller portfolios that are less diverse are more likely to generate higher returns during “good” markets (the ones that work well for the strategy) and larger losses during “bad” markets. More diverse portfolios will have smaller gains and losses. To decide which is best for an investor, you must understand their risk tolerance and their financial well-being.
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 of the TSI is +1 to –1.
Our Trend Strength Index stalled just under +50 (moderately overbought) and pulled back slightly. At the same time the SPY is flirting with highs again. We think there is some more upside, but a slow grind without the TSI making new highs. The Index also tends to lead the market, so a drop in the Index may come weeks before the broad market.
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.
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 new Sector Rotation program also buys the strongest sectors and is reviewed with the Trend Equity Program.
The Trend Sector ETF program buys the 6 strongest sectors of the SPDRs. May started with the following:.
Utilities (XLU), Reits (VNQ), Metal & Mining (XME), Oil & Gas Equipment (XES), Oil & Gas Exploration (XOP), and Materials (XLB).
At the end of May, we had switch off XLU, VNQ, and XES for oil and gas sectors, reacting to the recovery in industry prices. We now hold:
Metal & Mining (XME), Oil & Gas Exploration (XOP), and Materials (XLB), Preferred (PFF), Materials (XLB), Energy (XLE), and Industrial (XLI)
The Timing Program buys 4 ETFs that are undervalued with respect to SPY, in expectation of rotation. As of the beginning of May we held:
Reits (VNQ), Technology (XLK), Consumer Staples (XLP), and Retail (XRT).
At the end of May, the three of the four ETFs had changed. We now hold:
Technology (XLK), Industrials (XLU), Consumer Discretionary (XLY), and Metals & Mining (XME).
Technology (XLK), When an ETF appears in both the Trend and Timing programs, it means that market 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.
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 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.
Although the Trend stock portfolios were flat for the month and slightly down for the year, the ETF programs were off more, turning the YTD gains to losses. We can explain it because of the erratic market behavior, which does not favor trend following, which can be slow to react. This delayed response is both the good and the bad of trend following. It avoids false moves, or whipsaws, but then is slow to change when the move is real. History shows that slow response has the best performance.
Weekly stock portfolios did better than daily, netting a small gain for the month and holding on to profits for the year. ETFs to a loss in May, offsetting the year to date profits.
The Sector Rotation Program is the shining light for equities, gaining nearly 5% during May and up 8% for the year. It has been volatility due to sharp reversals, mostly in XME, but has also switched from a defensive mode in bonds back to a bullish position in stock sectors. We are currently long Materials (XLB), Energy (XLE), and Metals (XME). Expect more volatility in these ETFs.
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 smaller 10 stock Divergence portfolio lost more than 4% this month, while the other two portfolios posted small losses. The charts below show that these programs are still on track, with the ETF program remaining one of the most stable performers, up 3.59% for 2016.
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 took the biggest losses this month, the combined result of the new program having higher volatility and the short hedges not protecting enough of the stocks in the portfolio. In this case, when the broad market rallied, some of our undervalued stocks failed to move higher. The problem with correlations is that they don’t guarantee a relationship, only provide a general affirmation. We have seen other times when both the hedge and the stock moved in our favor.
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.”
Even with mixed results this month, the Trend Futures program has good gains for the year in the mid- and larger portfolios, up 5.7% and 3.54%. Given the uncertainty of the economy, interest rates, and the US dollar, that seems good. The program is also ahead of the CTA benchmarks.
Group DF2: Daily Divergence Portfolio for Futures
This month showed gains in all portfolios, although year-to-date remains below water. The pattern below looks normal, so we’ll expect more positive results ahead.
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