May 2018 Performance Report

Industry Benchmark Performance

Early reporting for equities show gains in the Hedge Fund Index and the Long Bias programs. Futures are having a difficult year so far. We give more credibility to the SG Index because the BTOP 50 seems to have survivorship bias. That puts the industry off about 6%, not unusual given the history of volatility performance, but we would always rather see it higher. The reversal in interest rates would have been the biggest problem.

Blogs and Recent Publications

Find this at the end of this report. We post new interviews and reference new articles each month. This month we also show a new trading program.

April Performance in Brief

The programs again posted mixed performance, very good in equities, poor in futures. The smaller stock portfolios all beat the S&P this month, with the 10-stock Trend portfolio up by 7.53% and the Weekly Trend up 4.58%. That puts the 10-stock Daily up 14.72% for 2018, which seems good given the S&P is only up 1.93%.

Futures, on the other hand, continue to post losses. Only one of the three daily portfolios show profits for the year, while the weekly futures programs are still higher by 5% to 12%, well above the industry which is lower by about 5%. The sharp reversal in interest rates seems to be the culprit. We have the Fed pushing rates higher while the market wants yields lower.

Major Equity ETFs. Beauty is in the eye of the beholder. Depending on your bias, the major equity ETFs could be bullish or bearish. IWM and QQQ are clearly heading up, with IWM on new highs. But SPY and DIA are struggling. They’ve gone above the most recent high but are well below the previous two highs. We’ll argue about it in this month’s Close Up.

CLOSE-UP: Should We Be Getting Concerned?

The market is all about good news. Better earnings, the lowest unemployment in many years, some manageable inflation, and civilized negotiations with North Korea. What could be wrong?

It turns out that only a few companies have turned their tax windfall into employee gains. We give credit to Wal-Mart for higher starting pay at $14/hour and free higher education. Almost a living wage. Most are using the money to buy back stock, which only helps those who have stock accounts, about 1/3 of the families in the U.S., but limited to the higher incomes. Many of the companies gave out bonuses, a one-time boon. Thank you! So trickle-down economics has not yet sufficiently trickled down. But those of use with stock portfolios are doing well.

As we did last month, let’s break down the issues:

The Fundamentals

The Good News

  • North Korean negotiations are on again, we think. But expectations have been tamped down.
  • The Tax Law is working its way through the economy, slowly.
  • Tariffs have been delayed for China, we think.
  • Deregulation is helping business
  • Employment is at record levels.
  • Stock earnings have been generally good.

The Bad News

  • Tensions with Iran are increasing, as mid-East relations are deteriorating. The EU and other partners to the Iran agreement are unhappy with the U.S. but are forced to comply by virtue of the U.S. size. However, “A man convinced against his will, is of the same opinion still.” This is not a good scenario.
  • Tariffs on, tariffs off, tariffs on. Tariffs on aluminum and steel were imposed for Canada, Mexico, and the EU (but not China?). These tariffs are said to help 100,000 workers and hurt 100 million consumers. This is not going to improve relations with our neighbors and friends.
  • The Fed is still planning three or more rate hikes. Yes, rates are still pretty low, but the market often trades on the emotion, rather than reason. Higher rates are good for retirees, bad for companies and bad for housing.
  • Corporate bonuses are a one-time event. Salary increase is a small part of the corporate benefits. Apple used its tax saving for the buy-back biggest in history.
  • Harley Davidson is moving its operation to Asia where the market is stronger. That’s after the getting its tax break.
  • Dysfunction in the White House? We have no way to judge how that affects the market.

The Net Impact

Again, we can’t really weigh the good and bad to tell you how the market will react. We’ll turn to how prices are netting out all this information.

The Technicals

Interest rates have a big impact on corporate borrowing, credit card debt, and housing. Figure 1 shows Eurodollar futures (3-month rates) rising from 1.75% (always higher than U.S. T-Bills) to above 2.65% in four months (see Figure 1). The resent reversal is the market’s way of objecting but is not likely to affect the Fed decisions to keep raising rates. Crude oil, a big component of disposable income, peaked at $72 after an average of about $63, a gain of 14% (Figure 2).

Figure 1 (Left) Eurodollar interest rate futures.

Figure 2 (Right) Crude oil futures.

Then we have the value of the U.S. dollar, which has strengthened from 1.24 to 1.17 in the past few weeks, a gain of 5.6% (see Figure 3). That’s bad for exports, but good for imports, which are far larger.

Figure 3. The euro currency futures.

Are these important? If the U.S. continue to impose sanction on Iran, the flow of oil will decrease, and prices will rise. Even though interest rates have reverse lower, if the Fed is going to raise rates two or three more times in the near-term, it will reverse again. In a fight between the market and the Fed, the Fed always wins. And the stronger dollar will attract some flow of funds into the U.S. but not as much as if the stock market was also rallying. In all, we see more stress on the stock market from these three factors.

Our Analysis

Last month we still had a bearish interpretation of the S&P technical factors. To avoid confusion, we’ll look only at SPY. We had an upwards breakout of the downward trendline, but cautioned that, as the downward wedge narrowed, a “breakout” was inevitable, but not meaningful. The market cannot keep narrowing forever. Market noise will prevent any charting formation from getting too small. We see the main trading range as about 101 to 109, defined by the horizontal lines, usually a good indicator. A break of either side is not expected to have any follow-through. There is too much negative news to allow the market to continue its long bull rally, and a drawdown of more than 10% is rare without some exceptional news, such as the financial crisis or an internet bubble. Given that analysis, we would prefer watching a breakout on either side, then taking a mean-reverting position, selling an upwards breakout and buying a downwards. A momentum oscillator would be a useful indicator if you wait until it starts to reverse from either its highs or lows. Sometimes you need to wait until the market tells you what it’s doing. You lose a little on the timing, but have much lower risk.

Figure 4. SPY trends from January 2018.

The Trend

To show the same uncertainty, we plotted the 30-, 60-, and 120-day trends on the SPY chart (Figure 5). The 30-day and 120-day show slight uptrends and the middle 60-day average shows a slight downtrend. That would net to a weak uptrend. We have no doubt that investors want the market to go higher, and new money may help. But at this point we believe the market will remain in a trading range until the Fed is done raising rates. Although mean reversion may be the best strategy, we don’t expect much of a loss from staying with the trend, whatever it is.

Figure 5. Three trends applied to SPY.

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 has stalled at about 10, slightly above neutral. That confirms to 2 of 3 slightly upwards trends discussed in the previous section. The index seems to be in-line with SPY, so it could go either way.  That may not be much help, but we’ll let the Trend Strength Index resolve it.

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 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, 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.

New high profits in the 10-stock Daily Trend program as well as the 10-stock Weekly Trend program, although the daily program gained 7.5% for May, up 14.7% for 2018. The Weekly program gained 4.5% in May, up 6.5% for the year. That is still very favorable compared to the SPY, up 2.4% in May and 1.9% for 2018. Most of the month saw portfolios concentrated in energy markets, but then a sharp reversal near the end of the month caused the program to divest most of those stocks. Concentration now seems to be in the tech sector.

Income Focus and Sector Rotation

The Weekly Income Focus is now outperforming the Daily program with a gain of 0.57% for May, although both programs are down for 2018. Even with income to offset the rising interest rates, this program will struggle while the Fed keeps raising rates. Given that 2018 is a worst-case scenario for this program we think it’s doing well.

Small losses in Sector Rotation this month keeps chipping away at the equity, now down 6% for 2018. This classic program worked well through 2014 but has been struggling. New highs in April looked as though it was back on track, but we’ll need to see an upturn to be convinced.

DOW Arbitrage

We don’t need to make excuses for the Dow Arbitrage program. It did have a small setback when the stock market had its sharp reversal, but it has been steadily outperforming the S&P, up about 2% in May and 3.25% for 2018.

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 outperforming the larger portfolio, up 3% in May and 6% for 2018. The larger portfolio, which will normally have smaller gains and smaller losses, was up 1.5% in May but is down 2.3% for the year.  Still, the 30-stock portfolio is doing what we expect as seen in the chart below.

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.

Buying undervalued stocks in a market that’s declining is not normally a formula for success, although in a rising market it tends to outperform by buying stocks lower. Although this program had a good period in the first quarter, it is now trying to recover modest losses. The 15-stock portfolio was up 3.85% in May, down 1.9% for the year, and the larger portfolio was up 1.8% in May, down 4.4% for the year. A continued sideways market, or a turn up will help this program recover.

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 Futures Funds are struggling as seen in the Benchmark Performance earlier in this report. Our Daily Futures Trend program posted losses in all portfolios, and only the $500K is holding on to a gain for the year.  On the other hand, the Weekly Program had only fractional losses and is still up from5% to 12% for the year. Interest rates have been the program, first turning down as rates rose, then sharply reversing, taking the U.S. dollar with it. If you remove the two sources of profits, the programs are going to struggle.

Group DF2: Daily Divergence Portfolio for Futures

This program posted a large loss in May, due to holding a single position rather than being diversified. All portfolios were down about 10% putting them also down about the same for the year. The lack of diversification in finding divergence signal causes the volatility that can be seen in the chart below. So far, the chart is not showing a break in pattern and we look forward to a turnaround.

Blogs and Recent Publications

New Trading Program

KaufmanSignals has a short-term futures trading program being traded at Striker Securities, a Chicago Futures Broker. As of May 2018, having started 10 months ago, it is ahead by 35% on a $20,000 account before subscription fees. For more information contract Striker at (800) 669-8838 or go to:

https://striker.com/En0302_trading_systems_list.php?webpageID=7&webmainID=3&detail=on&sysID=1663

June

A new article on “Defense is Your Best Defense” will appear in ProActive Investor Magazine this month.

A new article, “In Search of the Best Trend,” will appear in Technical Analysis of Stocks & Commodities this month.

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 will post 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 (https://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.

© May 2018, Kaufman Signals. All Rights Reserved.

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