Kaufman Signals

November 2018 Performance Report

Industry Benchmark Performance

Early reporting shows gains for equities and losses for futures. We expect that equities will get better as more funds report, but futures continue to decline. Without even analyzing the markets, we know that interest rates have stopped declining and stocks have made a reversal from the downside. Both of those patterns do not help trend-following, which is the basis for most futures funds. We still think there is good chance that equity funds will end the year with a gain. December is filled with hope.

Blogs and Recent Publications

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

November Performance in Brief

It’s good to see nearly all positive returns in November after a crushing decline in October for most stocks. Our portfolios had switched out of tech stocks but there is no place to hide when the entire market sells off quickly. The portfolios now reflect less volatile stocks, as the system seeks stocks that performed much better during last month’s rout.

Our benchmark 10-stock Trend program is now up 14%, nearly 10% better than the SPY and 5% better than the NASDAQ index QQQ. The weekly equity trend program was not as fortunate, but this month’s gain puts it back ahead for the year.

Futures remain very mixed. The daily program is ahead in the $500K portfolio but slightly lower for the year in the $250K and $1M programs. It is far better than the industry, but no one wants a loss. The weekly futures trend program is higher by 14% in both the $250K and $500K programs, and slightly higher in the $1M. It turns out the reacting faster to trend changes hasn’t been the better approach this year.

Major Equity ETFs. Volatility was in evidence at the beginning of November following the sharp declines in October. Prices look as thought they have stopped at the January lows, the previous volatile sell-off. The rally that followed the Thanksgiving holiday is a welcome change. History is on the side of a good December.

CLOSE-UP: The Price Knows Everything

How many times have we seen the price move in the opposite direction from an economic report? We know that the price action reflects the difference between the report and the expectations. If we expect the GDP to rise by 0.4% and it only rises by 0.2%, prices fall. The fact that 0.2% is a good number isn’t important because 0.4% is already in the market. But any trader knows that.

What is more interesting is when prices say one thing and the analysts or the government says something different. We’ll look at three cases, emerging markets, Facebook, and interest rates.

Figure 1 shows the price of the emerging market ETF, EEM, from January of 2018. Clearly prices have been going down, yet there is talk on the business networks that we should be looking for a bottom, that perhaps this is a good time to start setting a long position. Maybe, maybe not.  Is the price telling us that EEM is going up? Not yet. The advantage of technical analysis and trend following is that it tells you when the direction of prices has changed. Is that better than buying the bottom? Yes, because everything will look like a bottom when you are anxious to buy. In the EEM chart, the rally in July could have been a bottom, or the recovery from the early February selloff could have been the start of an uptrend. But they weren’t.

Figure 1. Emerging market ETF EEM from January 2018

The problem with bottom-picking is that you are wrong far more often than right. Trend following has a very similar pattern with some exceptions. It provides discipline, so that it will get out with a small loss if the uptrend doesn’t develop. And, it will keep trying and not get discouraged until it captures that new trend. People can’t do that. Long-term trend following has a low percentage of good trades, but a very big payout when it’s right. That’s a profile you’ll need to learn to live with for long-term success. So, are we ready to buy EEM? Not yet.

Facebook

Yes, Facebook is still relevant. It has a huge amount of business and big challenges. Trying to stop “fake news” may be impossible. It’s just like hackers. They keep finding ways around the firewalls. The end of July saw the biggest 1-day drop in Facebook prices. Now that it’s down 36% from that peak, analysts are talking about buying value. Figure 2 shows that prices are declining steadily. Again, where is the bottom? What investors are not told about buying value is that it often takes one to three years before the value position become profitable. Waiting for the trend to turn up is a much better way to invest.

Figure 2. Facebook’s fall from grace.

Interest Rates

Interest rates drive a large part of the market. This week, the Fed blinked. It signaled that it might not raise rates as much or as often as the current plan. The market rallied. The fact is that the Fed does look at the stock market to make decisions. We know this from other Central banks, who will carefully watch the price moves before acting. Case in point, the Japanese central bank when they are looking to intervene because the yen is getting too strong. They won’t fight the traders but wait for a lower volume, lower volatility period to announce the intervention. White papers released by the New York Fed have shown that they invest a lot of time and effort trying to figure out how traders will react to their actions.

What is happening now? Interest rates have been rising as seen in Figure 3. The Eurodollars, the 3-month rate, has had a steadier trend because it is more closely tied to Fed policy. 30-Year bonds reflect the opinion of the traders on the longer-term effects and tend to be more volatile. Bonds are first to drop and first to rally. It is interesting that Eurodollars started to rally a full 10 days before the Fed made an announcement about its “possible” change in plans. Bonds have also made a new high above recent resistance.

Figure 3. Eurodollars versus 30-year bonds futures.

Does this mean that we’ve seen the bottom on the bond market? Possibly, but trends don’t always turn smoothly. The most uncertain part of the trend trade is the beginning, and only 30% of trend trades are profitable, so it’s most likely that prices will turn back down before a steady uptrend develops.

Our scenario is that the Fed announcement caused a good rally, so now the Fed can raise rates in December, but it may push off any other increases based on how the equity index prices react. We don’t think the market will like the December rate hike unless the Fed makes it clear that futures hikes are not certain. But a December rally gives them room to act.

Meanwhile, we can watch other markets for signs of change. Higher rates make the dollar stronger, as seen in Figure 4, the Euro/US dollar exchange rate. It doesn’t yet show signs of strength, but then Europe is dealing with Brexit, the French are dealing with public unrest, and Germany is trying to figure out its future after Merkel.

Figure 4. The EURUSD exchange rate.

The Price Knows Everything

We repeat our opening salvo, the price knows everything. If a news announcement does not move prices, then it’s already in the market or not important. If prices move and there is no news, it is telling us about the future. But if you want to be long, wait for the price to turn up. Watch the price, not you instincts.

Expectations for December

Before moving on, let’s see what we should expect for December price moves. Following a generally strong start to the holiday season at the end of November, Figure 5 shows that we should expect some moderate buying during the first week of December, a lag before the final weekend ahead of Christmas, buying around Christmas and for a day or two afterwards (gift cards?), then selling during the last two days of the month. The last two days could be liquidation for tax purposes, or repatriation of funds for foreign investors that have had a profit for 2018.

Figure 5. Average returns for SPY in December, first and last 10 days.

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 shows just how fast the October sell-off happened, with some follow-through into November. It’s now stopped at a possible support level and the small consolidation area is typical of the other two largest drops. It is still possible that we could see more downside, but history says that it is very limited. A sharp turn up is more likely, if only until Christmas.

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.

After a disheartening October, the benchmark 10-stock portfolios gained 4.55% for the daily and 3.43% for the weekly. That puts the daily program back over 14% for 2018, well of it’s highs but far better than the 4.65% posted by SPY. The larger program that held tech stocks longer are still posting losses for the year.

It is important to know that, when there is a sharp selloff, the portfolio strategy seeks more conservative, steadier performing stocks, so it’s possible that the system will be clawing its way back over a longer time. We believe that is a better alternative than staying fully exposed with high beta stocks when there is still a good chance of further downside. Even with the new choice of stocks, both the daily and weekly 10 stock portfolios outperformed the SPY.

Income Focus and Sector Rotation

A small gain in the daily Income Focus program and a tiny loss in the weekly program leaves both programs down slightly for the year. Given that the program is fighting rising interest rates, it is holding in nicely waiting for a turn.

The Sector Rotation program was us slightly in November, but not enough to change the pattern on the chart. It is still holding near the top of the chart and should start to outperform if we can get some stability back into equities.

DOW Arbitrage

A gain of 6% in November follow that pattern that this program recovers quickly. It may not be on new highs, but it cut losses quickly and looks to be the strongest of our program. The year to date is also up about 5.75%.

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 also gained in November and the 2018 returns for the 10-stock portfolio are slightly better than the SPY while offering good diversification. Both 10 and 30-stock portfolios gained between 2% and 3%.

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.

A good month for the Timing program, with gains of 3.55% and 5.91% while being hedge in both SPY and QQQ about 30% to protect against a further downside move. That puts the programs up 4% and 5.7% for the year, still below their target returns. There is still December.

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.”

The Weekly Futures Trend Program continues to outperform the daily program, which is not normally the case. The $250K daily program gained 3.21% in November while the weekly program gained 11.48%. It shows that being more sensitive to price changes using the daily program is not paying off this year. But that can and does change without notice.

Group DF2: Daily Divergence Portfolio for Futures

All three Futures Divergence portfolios posted about the same 2.5% gain in November, paring the year-to-date losses. Given the volatile pattern of this program, we would like to see this as the beginning of a significant recovery.

Blogs and Recent Publications

MetaStock Strategies

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 by mid to late November.

Book Interview

Mr. Kaufman appears as a chapter in Mario Singh’s new book, Secret Conversations with Trading Tycoons, published by FXI International.

December

There will be an article appearing in ProActive Investor Magazine this month 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.

October

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 Technical Analysis organization.

July

“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 Investor Magazine this week.

March

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.

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 posted 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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