Kaufman Signals

November 2019 Performance Report

Industry Benchmark Performance

Our very early look at Industry returns shows that CTAs performed slightly lower than our programs, with gains of between 1% and 2% compared to 1% to 3%. Equity programs had modest gains and are posting only about 1/3 of the performance of SPY. We are sympathetic because a strategy needs to have risk control, which means giving up some profits.

Kaufman’s Fast Strike Systems on MetaStock

For more information on these short-term trading systems, contact MetaStock at 800-882-3040 or go online to www.metastock.com/kaufmana.

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

A good month for nearly all of our portfolios, but difficult to keep up with the broad index markets and still implement risk control. Our benchmark 10-stock Trend portfolio is higher by 15% this year, but well below SPY which is up nearly 28%.

The stock market has benefitted from 10 years of a bull market, which can be seen in the performance table at the beginning of this report.  The last 10 years has averaged a return of 13.5% while a 20 year history, including these 10 years, averages on 6.9%. Clearly returns are running far above normal. On the other hand, our 10-stock portfolio averages 21% for that period, showing that it performs more consistently over time.

Futures had a better November with gains in all portfolios. The Divergence program and the smallest Trend portfolio lead, each with a gain of more than 19%. Larger portfolios that offer more diversification also have lower returns.

Major Equity ETFs. Nothing seems to stop the equity market from going higher – not the trade issues with China, not the impeachment hearings, not higher interest rates – nothing. It seems to come down to the old adage that as long as investors are worried, stocks go higher. The only index not making new highs is the IWM. The theory is that investors don’t take chances when they are concerned, and the small caps are the most speculative of the stocks.

CLOSE-UP: Another Earnings Season

I trade stocks using the portfolios shown in the summary at the beginning of the report, but mostly the Trend. I’ve noticed over the years that when I’m holding a stock that announces earning, the move on the following day is usually in my favor – usually, not always. Often there are big gains, sometimes big losses, but on balance the program is net ahead a substantial amount. Perhaps you’ve had the same experience.

As an analyst, I have always been interested in how accurate the earnings forecasts are. First, we need to understand that earnings are preempted by the price move in the quarter before the earnings announcement. That is, if the company is doing well, prices rise. The earnings forecast is really a measure of how the rise or fall of the stock price matches the future earnings announcement. It should all be baked into the prices.

In the days ahead of the earnings release, analysts give their estimates and the market should go up if earnings beat estimates and down if earnings fall short of estimates. It seems logical. But logic doesn’t always explain the events.

Evaluating the Earnings of Tesla, Walmart, and Google

I picked three very different markets to see how the price moves following the earnings announcements confirmed the forecasts. I would have done more but putting the data together is very time consuming, so we’ll only look at these three, understanding that it’s a small sample.

TESLA

Table 1 shows the results of Tesla earnings announcements for the past two years. There are two earnings estimates on the left, from different organizations, followed by the difference between the actual and the estimates. The four columns on the right try to give you an idea of the success or failure of the estimates.

Table 1. Tesla earnings estimates.

Included on the right is the direction of the 80-day moving average, representing the direction of a typical macrotrend system. “Up” means the trend was up during the previous quarter, and “Down” means the trend was down.

For Tesla the reaction on the day following the announcement was consistent with the price being higher or lower than the estimate 66% of the time. That is, if earnings beat the estimate, prices moved higher the next day. That’s what we would expect.  Sometimes, as on 8/1/2018, the actual EPS was slightly lower, but prices jumped 16%. One never knows!  Eight of the 12 earnings shown resulted in a lower price move even though the actual price of Tesla kept going higher.

If we add the quarterly returns relative to the 80-day trend, we find that when the trend was up, Tesla gained 84%, and when the trend was down it gained (on the shorts) 22%, for a total trend profit of 106% since February 2017. The trend was only observed at the time of earnings, so the actual trend profit is likely to be lower.

Walmart

Walmart (Table 2) is far less volatile than Tesla and Google (shown next). The company beat estimates in all but one month (Feb 2018). The reaction on the day following the earnings release was small, so that accuracy of only 25% didn’t amount to much in the way of profits or losses, but 10 of 12 prices moves after the announcements were down. Trying to profit from anticipating the earnings would be boring.

Table 2. Walmart earnings estimates.

If we again look at the 80-day trend we find that, when the trend was up, prices gained 83%, and when the trend was down, prices dropped 6%. Again, the trend gained from big moves while anticipating the earnings report amounted to very little.

GOOGL

Google (Alphabet to be technical) is interesting because it sells at a much higher price and has larger moves, in both dollars and percent. Table 3 shows the statistics.

Table 3. GOOGL earnings estimates.

Google had a very low confirmation rate, that is, when earnings beat estimates, prices only went up 54% of the time. Price reactions were large but inconsistent. If we look again at the trend, when the previous month was up, the net gain was 51%. When the trend was down, the net drop was 17%. The total was 68%.

Conclusion

Are all forecasts this bad? Some reports that have studied earnings say “yes.” But it’s not the forecast, it’s how the traders react to the forecast that is far less predictable. You would think that, if the Actual EPS beats the Estimated, then prices will go higher. But then if prices are already high, traders may want to take profits. The market is made up of individuals, each with his or her view of each price move.

The one thing that glares out at us is the profits from using the trend. Yes, the trend exposes us to risk, but it also produces impressive gains over time. And, if you’re holding a long trend position in a stock that announces earnings, odds favor a profitable move.

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.

Last month’s advice to follow your system (if it’s a trend method) seems to have been good. The S&P has steadily advance with our TSI tracking alongside. We will watch to see if the resistance level at +40 continues to hold. Given that the retail sector will top out later this month, we expect that the overall market will follow that pattern.

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.

Gains in both Daily Trend portfolios put year-to-date returns above 15%. Normally we would say that’s a good year, but we lag the S&P by quite a bit. We need to point out that our strategy, as with most strategies, must provide risk protection. That often means lagging the price move to be sure it’s actually going to continue. Most years we beat the index, but there are always exceptions. Still, a 15% return on your investment is nothing to be ashamed about.

Income Focus and Sector Rotation

Fractional losses in both the daily and weekly Income Focus programs show a small decline on the charts. After a fast run-up that seems to be a normal pattern. Commentary by the Fed that rates are not going to go lower would also contribute to this rally stalling out.

Sector Rotation

A gain of nearly 5% is one of the best returns of this year for the Sector Rotation program, putting it higher by 11% for 2019. While clearly not as smooth as the returns of other programs, it can provide important diversification into ETF sectors.

DOW Arbitrage

After a prolonged sideways period, this program gained nearly 6% in November, moving the NAV to new highs. Year-to-date returns are better than 18%, not as good as the S&P but sill a very nice number. This program will hedge its positions when volatility becomes excessive, so it provides considerable risk control in addition to good returns.

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 10 Stock Equity Divergence program is the best portfolio this year, gaining 4% in November and 29.6% for 2019, slightly ahead of SPY. This program captures the pause in a long-term trend move, when traders are uncertain which way the market will turn. It holds trades for about 3 to 8 days, exiting when the trend reasserts itself. Its success indicates the uncertainty in the market.

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.

Small gains for both Timing portfolios puts them ahead for the year, a small but positive consolation prize. This program buys undervalued stocks and hedges when its broader, correlated index market turns down. It seems that, in this market, investors are not buying weakness, but buying strength; therefore, this program is lagging the others. The time will come when investor confidence increases and they buy weakness.

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.”

Gains of 2% to 3% in both Daily and Weekly Futures portfolios are good, but the smallest Daily Program is higher by 19% for the year while the Weekly Program has mixed results. Normally, both programs have similar returns, but this year trends are changing midweek, favoring the faster response. In other years we find that midweek changes can be false signals, which then favors the weekly program. In the long run we expect both daily and weekly programs to have similar returns.

Group DF2: Daily Divergence Portfolio for Futures

Gains of about 2% in all portfolios keep this Divergence Program ahead by 19% for the small portfolio, remarkably similar to the Equity Divergence Program. The two larger portfolios are ahead by more than 12%, a respectable amount. The erratic pattern continues but seems perfectly normal for this program.

Blogs and Recent Publications

Trading Systems and Methods, Sixth Edition

The sixth edition of Trading Systems and Methods was released the last week of October by John Wiley. It is completely updated and contains more systems and analyses.

MetaStock Strategies

MetaStock has launched the Kaufman Fast Strike add-on. It has three short-term trading systems, holding positions for one to three days in two of the programs, and about one week in the third program. They trade noisy markets, including most major index ETFs and futures, plus one program trades the VIX. You can see a description of the programs and a record of past performance on MetaStock. Anyone interested should contact MetaStock at 800-882-3040 or go online to www.metastock.com/kaufmana

December 2019

Technical Analysis will publish an interview with Mr Kaufman in the December issue.

MetaStock Seminar held in Sunnyvale

Mr. Kaufman was a keynote speaker at the MetaStock conference in Sunnyvale, November 3. You can hear this presentation by going to the MetaStock website.

November 2019

Technical Analysis of Stocks & Commodities published “Running for Cover,” an article by Mr Kaufman that looks at whether buying bonds after a sudden drop in the S&P can still be profitable.

September 2019

“A Simple Way to Trade Seasonality” was published in the September issue Technical Analysis of Stocks & Commodities. Seasonal trades and filters can be a big asset to market timing and put you on the right side of a price move.

Book Interview

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

May 2019

A second part of the interview with Caroline Stepan at TalkingTrading.com was just posted.

March-April 2019

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.

January 2019

Technical Analysis of Stocks & Commodities will publish “Volatility: What They Don’t Teach You In Grad School,” in the January edition.

December 2018

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.

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, systemtrade.pl, the website for Alex Gerchik, and Michael Covel’s website, TrendFollowing.com.

Mr. Kaufman spoke in Tokyo and Osaka to the Japanese association of Technical and was a keynote speaker at the 2018 IFTA conference in Kuala Lumpur, both last October. You should be able to get a copy of the presentations by MATA, the Malaysian Association of Technical Analysts.

 “In Search of the Best Trend” was published in Technical Analysis of Stocks & Commodities in July 2019. An article on “Defense is Your Best Defense” will appear in ProActive Advisor Magazine also appeared in July 2019.

Mr. Kaufman was a keynote speaker at a number of IFTA conferences, the most recent in 2018 in Kuala Lumpur, and Milan in 2017. You can find his presentations on their website.

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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