October 2022 Performance Report

Industry Benchmark Performance                                                                                            

Smaller gains for the equity funds than the index markets, but better year-to-date results. Futures continue to be the bright spot with double-digit returns for the year. The Fed announcements in November and December will set the course for the rest of the year.

Kaufman’s Most Popular Books (available on Amazon)

Trading Systems and Methods, 6th Edition. The complete guide to trading systems, with more than 250 programs and spreadsheets. The most important book for a system developer.

Kaufman Constructs Trading Systems. A step-by-step manual on how to develop, test, and trade an algorithmic system.

Learn To Trade. Written for both serious beginners and practiced traders, this book includes chart formations, trends, indicators, trading rules, risk, and portfolio management. You can find it in color on Amazon.

You can also find these books on our website, www.kaufmansignals.com.

Blogs and Recent Publications

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

October Performance in Brief

A surprisingly good month for stocks in the face of sharply rising interest rates. Our benchmark Daily Trend portfolio gained 8.5%, slightly more than the S&P, while the Weekly Trend portfolio gained 9.4% The Timing program added 4.4% and is now ahead by nearly 12% for the year.

Futures continue to gain, up by 3% to nearly 5% in the four portfolios, and now better than 38% to 57% for the year. Given the reversal in energy, the quieting of the FX market, and the anticipated easing of interest rates, we find that an unusually good return. Other portfolios also gained. Altogether a good month.

Major Equity ETFs

A rally in October after testing the lows of June shows how traders are anxious for the bear market to be over. If the Fed does not indicate that it will start to “pivot,” that is, reduce the size of the increases, we could see a new low. But even then, traders will expect a pivot at the next meeting. Hope never dies.

CLOSE-UP: The Return of Seasonality

The Covid pandemic, triggering supply disruptions and soaring inflation have played havoc with price patterns, including seasonality. During months when commodities were plentiful, prices were driven by the inability to deliver them. Now, with inflation at 8%, we have the added problem of higher costs of processing and shipping.

Seasonal patterns have always been reliable. For corn and soybeans, farmers in the North plant in March and April and harvest in September and October. Nothing can change Nature.

The same for energy. Refiners switch from heating oil to gasoline in March, and back to heating oil in August. These seasons don’t change, but crude oil prices are influenced by OPEC, and natural gas flows to Europe have been disrupted by Russia.

There are justifiable increases in costs, and others who just take advantage of the situation to raise prices. The cost of gasoline always seems to go up quickly and come down slowly. The most difficult issue for inflation is labor costs. Wages have increased significantly for low-end labor. I’m not criticizing that, but it is now baked into costs. As other prices normalize, wages will remain higher. Inflation will ease, but prices will not go back to where they were two years ago.

Markets anticipate policy. Traders are anxious for the decline in the stock market to be over, so they buy every time there is a rumor that the Fed will slow down its pace of rate increases. At some point they will be right, but not so far.

Commodities are no different. Demand distorts seasonality and there are still some supply disruptions. But as the stock market looks to stabilize, commodities are doing the same thing – getting back to normal. We will look at normal seasonality and compare it with the past two years, then see if this year’s patterns are returning to normal.

Housing

One of the most important indicators of inflations is housing. The cost of new construction is mainly labor and lumber. The price sold is based on supply and demand. While lumber prices have completely reversed their rise (see Chart 1), the demand picture is confusing. While claiming there is a shortage of homes, there was a drop of 10.9% below August sales and 17.6% below a year ago (“census.gov/construction/…/new sales”). At least part of the housing industry has normalized. We expect the rest to follow.

Chart 1. Lumber cash price, last 5 years. (Source: tradingeconomics.com)

Grain

Corn and soybeans are primarily grown in the North, so the seasonal pattern (Chart 2, blue line) shows declines at the September-October corn harvest. On the left, the scale for the 2000-2019 years shows modest variation, +/- 4% around the yearly average price. But in 2020 and 2021, the variation has been 10 times that, from -15% to +30%. While the orange line has some similarity to the blue seasonal line, The seasonal decline is minor, and the following rally from August through December is 40%.

Chart 2. Corn seasonal patterns.

But this year, 2022, is different. The peak in May corresponds to the normal seasonal peak, and while prices have rallied slightly in August, they show signs of coming back into alignment with seasonality. Perhaps soybeans will paint a clearer picture.

In Chart 3 we see the same extreme rally in 2020-2021 (the orange line), but this year (grey line) prices seem to be tracking normal seasonality and volatility is much lower. It is a clearer picture than corn, and they have similar growing seasons.

Chart 3. Soybean seasonal patterns.

Wheat is a winter crop, harvested in May ahead of the summer planting. But during 2020-2021 there were fear of shortages due to transportation. In 2022 there are shipments from Ukraine that are stopped by Russia. Then the rising price in 2022 from February to May represents the Russian blockade of Ukrainian wheat (Chart 4). The decline is where Russia agreed to allow shipments, and recent September rally is nervousness about supply. Still, the pattern seems close to normal seasonality.

Chart 4. Wheat seasonal patterns.

Sugar

I’ve included sugar (Chart 5) as representative of other agricultural products. The seasonal pattern is not the same as northern grains, as seen by the blue line. The rally in 2020-2021 occurs at the same time as the seasonal rally, but the volatility is much higher, seen by comparing the scale on the left with the one on the right.

Chart 5. Sugar seasonal patterns.

This year, the sugar seasonal pattern started out higher by 5% rather than dipping 5%. That is likely to be both supply disruption due to the lack of container ships, and generally higher costs. But prices are now returning to normal, as seen by the grey line from July.

Energy

I’ve saved energy for last, although it may be the most important. Gasoline is in demand everywhere, heating oil is primarily for home use and diesel, and natural gas is for home heating in the U.S. and Europe and used to run many power plants. Heating oil and gasoline are both highly seasonal.

Heating Oil

Oddly enough, the past two years, 2020-2021 shows the same pattern as normal seasonality, although at much higher volatility (Chart 6). Increased crude prices will cause higher heating oil and gasoline prices, but buyers cannot change the timing of their purchases, normally committing to a winter delivery price in the last summer. The pattern remains the same.

Chart 6. Heating oil seasonality.

Unleaded Gasoline

Gasoline has more flexibility in demand. At higher prices, there is less driving. The years 2020-2021 show a steady increase through October, and then a volatile sideways pattern at the end of the year. It shows that demand flattens after the Summer, even though it is not the usual seasonal pattern seen by the blue line (Chart 7). This year (the grey line) shows the typical seasonal pattern, with volatility returning to near normal.

Chart 7. Unleaded gasoline seasonality.

Natural Gas

Natgas has been the focus of the energy problem in Europe, the result of Russian retaliation for Europe’s support of Ukraine. Natgas seems to be the main source of heating for Europe’s housing.  Chart 8 shows an odd seasonal pattern. I would have expected demand to increase in October to December as cold weather begins, but the chart (which corresponds to other seasonal charts) shows otherwise.

Natgas is stored during the Summer, so inventories are highest in September and lowest in April. I can only suppose that users commit to prices in the Summer, in the same way as heating oil in the U.S., so it is the lack of buying in the Fall that causes prices to decline.

Chart 8. Natural gas seasonality.

We have seen prices drop significantly this year, even while European supplies are limited by Russia. Germany is said to have filled their reserves to capacity, but that is not the case for some other countries. Still, we see this year’s pattern (in grey) now tracking closely to the normal seasonal pattern, again with much higher volatility.

Summary

Supply interruptions, however severe, tend to be short-term. Buyers adjust by reducing demand or by finding alternatives. That seems to be what we are seeing in grains and energy. We can expect higher volatility as long as Russia continues its attack on Ukraine; otherwise, seasonality seems to have returned.

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 equity portfolios. Our work over the years shows that downturns in the stock market are most often short-lived and it is difficult to capture with a longer-term trend. The upwards bias also works against shorter-term systems unless using futures, which allows leverage. Our decision has been to take only long positions in equities and control the risk by exiting many of the portfolios when there is extreme volatility and/or an indication of a severe downturn.

PORTFOLIO METHODOLOGY IN BRIEF

Both equity and futures programs 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 on the specific system, 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 outperforming 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 since are simulated but the returns from 2013 are the systematic daily performance added day by day. Any changes to the strategies do not affect the past performance, unless noted. The system assumes 100% investment and stocks are executed on the open, futures on the close of the trading day following the signals. From time to time we make logic changes to the strategies and show how the new model performs.

Groups DE1 and WE1: Daily and Weekly Trend Program for Stocks, including Sector Rotation, Income Focus, and DowHedge

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. It will hold fewer stocks when they do not meet our condition and exit the entire portfolio when there is extreme risk or a likely drawdown.

Both Daily and Weekly Equity Trend portfolios rebounded, recovering more than they lost last month. The Daily portfolio is fractionally lower for the year, while the Weekly portfolio is now positive. While the charts below look sloppy, remember that the recent bear market activity is a smaller percentage move than previous bear markets because prices are higher.

Income Focus and Sector Rotation

The Daily Income Focus portfolio last less than 1% while the Weekly portfolio gains over 1%. Both programs are off by 7% to 8% for the year, but far better then the SPY and QQQ, now lower by 17% and 29%. This program is performing well even as interest rates move in the opposite direction. Once the Fed stops raising rates, this strategy should regain all its losses.

Sector Rotation

This classic strategy looks to rotate into the stock sectors that are performing best, but is not able to go short the S&P, cannot sell interest rates (shorting means higher rates), and the U.S. dollar is not a “sector.” This month saw a 1% loss, putting the returns for the year off 20%.

DowHedge Programs

A strong rally is part of the pattern for this strategy. The Daily portfolio gained 15% and the Weekly gained 12%, far more than the overall market. While the volatility never exceeded the threshold that would get the program out of the market, it seems poised to take advantage of a change in Fed policy.

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.

Gains in both the 10- and 30-Stock portfolio in October, but still significant losses for the year. This program keeps looking for a trend that has not yet appeared.

Group DE3: Timing Program for Stocks

The Timing program is a relative-value arbitrage, taking advantage of undervalued stocks relative to its index. It first finds the index that correlates best with a stock, then waits for an oversold indicator within an upwards trend. It exits when the stock price normalizes relative to the index, or the trend turns down. These portfolios are long-only because the upwards bias in stocks and that they are most often used in retirement accounts.

The Timing program has jumped in and out of positions quickly, but has managed to capture profits while doing it. It is a strategy that seems to work in many markets but gains more when prices are volatile. This month it added more than 4% to each portfolio, posting an 11% gain for the 10-Stock and a 6% gain for the 20-Stock programs.

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 down 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.

Please read the report describing our revised portfolio allocation methodology. It can be found in the drop-down menu under “Articles.”

We never get tired of a profit, and the more the better before the market turns. Gains of 3% to 4.6% in the four portfolios put the U.S. $250K ahead by 57% this year, and the larger $500K and $1 million higher by 53% and 49%. Only the smaller $250K lags at 38%. Still, very acceptable.

Group DF2: Daily Divergence Portfolio for Futures

The Futures Divergence Portfolio is struggling in the same was as the Equity Divergence program, trying to get on the right side of a trend that has not yet appeared. It posted mixed results, marginally higher in the $250K portfolio and fractionally lower in the larger ones. They remain lower by 12% to 15% for the year.

Blogs and Recent Publications

Perry’s books are all available on Amazon or through our website, www.kaufmansignals.com.

October 2022

An interview with Perry was featured in the October anniversary issue of Technical Analysis of Stocks & Commodities. The interviewer is his wife, Barbara Diamond, giving a different perspective on his career.

September 2022

“The Real Risk of System Trading” can be found in the September issue of Technical Analysis of Stocks & Commodities. It summarizes the many way we can measure risk and suggests ways that will help you.

July 2022

The basis for this month’s Close-Up was posted on Seeking Alpha June 16. This month, Perry posted “3 Ways to Reduce Risk and 2 Ways to Increase Profits.”

June 2022

The July issue of Technical Analysis of Stocks & Commodities has Perry’s latest article, “Is It Too Volatile to Trade?” It is important to understand when the risk is greater than the reward.

Perry posted “How To Tell When the Bear Market Has Ended” on Seeking Alpha. You might find it useful if you are thinking about getting back in.

May 2022

Perry’s webinar on risk, given to the U.K. Society of Technical Analysts, can be seen using the following link: https://vimeo.com/708691362/04c8fb70ea

he May issue of Technical Analysis of Stocks & Commodities has a new article by Perry, “In-Sample Test Data, Out-of-Sample Data – Does It Really Matter?” It is a different look at testing.

March 2022

The 2022 Bonus Issue of Technical Analysis of Stocks & Commodities published Perry’s latest article, “50 Years On. What Have I Learned?” It is a summary of the most important trading and development lessons he has learned.

Sunny Harris (MoneyMentor.com) interviewed Perry on Saturday, March 26. Her approach combines both personal and technical questions, having known Perry for many years. You should find it interesting. Go to MoneyMentor.com

Four articles have been posted on Seeking Alpha in March. They are

  • How To Control the Risk of Cryptos in Your Portfolio
  • How To Find Low-Volatility Stocks That Outperform the Market
  • The Best Balance of Stocks and Bonds Will Surprise You
  • Determining Whether Crisis Alpha Is A Good Idea Or A Flash In The Pan

January 2022

There is a new interview of Perry by Ali Casey, a Canadian podcaster. You can find it at https://youtu.be/7fGBUjlPENE. He asks some interesting questions.

An article by Mr. Kaufman, “Trading a Moving Average System” in the January Technical Analysis of Stocks & Commodities shows the best rules to use for with a moving average.

November 2021

We managed to finish November with a webinar for MetaStock, Trade View (Australia), and two for FinecoBank (Milan), in English and Italian. You will be able to find recordings of the MetaStock and Trade View presentations by going to their websites.

Book Interview

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

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, Michael Covel’s website, TrendFollowing.com, and Talking Trading.com.

In May 2021, Mr. Kaufman gave a 30-minute presentation, “Lagged Trends,” for The Money Show on Tuesday, May 11. You can see it using the following link: https://youtu.be/bh2fA8oBwBk

November 1, 2020, Mr Kaufman taped a session with Andrew Swanscott’s BetterSystemTrader.com.

“The 1st and 2nd Cross” has been very popular with readers. It was published in Technical Analysis of Stocks & Commodities in the March 2020 issue. It is based on an idea of Linda Raschke and captures small but reliable pieces of a trending move. You can find it online.

You will also find back copies of our “Close-Up” reports on our website, www.kaufmansignals.com. You can address any questions to perry@kaufmansignalsdaily.com.

© October 2022, Etna Publishing, LLC. All Rights Reserved.

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