Kaufman Signals

September 2018 Performance Report

Industry Benchmark Performance

An uninspiring month shows mostly losses and a few marginal gains in both equity and futures programs for the Industry. Given that the major equity index markets are up 10% to 20%, it’s a disappointing performance. The problem is that capturing the trend isn’t as easy as looking at a chart after-the-fact. We expect the 4th quarter to be better, as we show in our Close-Up below.

Blogs and Recent Publications

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

September Performance in Brief

Small changes in our programs and in the major equity index markets hides the volatility during the month. The summer months are generally weak for equities but the end-of-year usually sees a good recovery. That will be the subject for our Close-Up report this month. Meanwhile, our benchmark portfolios, the daily and weekly 10-stock programs, are up by 22% and 17% for the year, well ahead of the S&P and small caps and slightly behind the much more volatile NASDAQ returns.

Major Equity ETFs. Small gains and losses in the major equity index markets doesn’t change the steady upwards trend. Even the Fed’s announcement of higher rates and more increases to come only had a 1-day effect. The on-going trade issues, still unresolved with China and Canada, seems to have settled into the market. There are some forecasts that holiday shopping might be affected by tariffs, but we won’t know that for a while. So far, the market has brushed off all negative news.

CLOSE-UP: 4th Quarter Expectations

As we just said in the overview of the major equity markets, investors seem to have brushed off all negative news and continue to push prices higher. Companies are still benefiting from the new tax law and there is more news about higher wages for minimum wage employees. With a tighter labor market, companies are actually improving benefits to attract qualified help. We keep waiting for these changes, plus China tariffs, to show up in the inflation numbers, but no one seems to care yet.

What can we expect for the 4th quarter? First, we are going to make the assumption that we’re still in a bull market. That’s not hard to do by looking at the previous chart of the index markets. We also believe that there may be some inflation pressure, but that higher employment and better wages should make this a good holiday shopping season – even with somewhat higher prices for Chinese imports (which is almost everything at the big discount stores). Given those assumptions, we’ll look at the S&P returns from 1993 through 2008, and from 2009 through September 2018. We think that the period starting just after the financial crisis of 2008 will be a better indication of the 4th quarter, but it’s good to see what happened in the past so you have a Plan B.

One of the simplest and best measures of seasonality is the frequency of months when the average price was higher than the previous month. Of course, there will be the usual upward bias but that’s OK because it still means profits. Figure 2 shows the erratic pattern of higher months from 2009. In fact, all months show 50% and higher, indicating that, on average, the stock market is likely to be higher any time during the year; however, the second half of the year is clearly stronger, and November and December have been higher 89% of the time from 2009.

That would tell us that the 4th quarter is most likely to be higher, but by how much and with what risk? The “how much” part can be seen in Figure 3, comparing monthly average returns from 1993 though 2008 with more recent returns from 2009. We can see the pattern of a bull market in the returns from 2009. Except for a tiny average loss in June, every month was profitable, with January up 2.6% and November-December showing the next best returns. Over the longer period, the summer months extending into October, showed losses. November through January look very promising.

 

Lastly, we look at the risk, shown in Figure 4. We calculated volatility as the monthly price range divided by the average price for that year. It’s not perfect, but it prevents more recent years at higher prices from overwhelming the results. Results for October are most interesting. Figure 3 shows an average 1% loss, but volatility shows a price swing of 7.5% (including 2008) and 6.5% since then, still quite big. However, November through January shows volatility declining sharply while returns increase.

We can conclude that October is best left alone, but entering at the end of October and holding through January seems to be the sweet spot for equity performance.

CAVIAT EMPTOR. Markets can change without notice. If November turns negative or disappointing, the rest of the analysis is no longer valid. November must be higher for everything else to follow.

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.

Although the SPY has regained its upward trajectory, the Trend Strength Index shows that it is a weaker move than previous parts of the bull market, hovering below 30. That does not indicate that a sell-off is imminent and we see the next few months as stable. However, the November elections might change the picture.

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.

The weekly program outperformed the daily this month, posting returns up 1% to 2% and bringing the 2018 returns for the 10-stock portfolio to over 17%, well above the S&P. The daily program lost fractionally in the 10-stock portfolio but remains higher by 22% for the year. For both the daily and weekly, the larger portfolios are doing well but lagging well behind.

Income Focus and Sector Rotation

The flattening out of the equity curves for both daily and weekly Income Focus programs is the result of continued higher interest rates. Interest income into the program has done a good job preventing losses but cannot offset the upward move of yields. We expect that this program will show steady profits again when the Fed signals the end of rate hikes.

Unchanged for the month leaves this program still looking ready to move higher. It would be doing better if there was not as much rotation in the sector rotation, but the equity market can’t seem to settle down to a sustained move in any of the sectors.

 

DOW Arbitrage

A small gain in September puts this program up 7.73% for 2018, respectable for the largest cap stocks, although lagging more aggressive portfolios. This program has proved out over the years, so we are very pleased with the return to risk ratio and the overall look of the NAV chart.

 

 

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 Divergence program is having a good year. The 10-stock portfolio was up more than 3% in September, up 14.7% for 2018. Given the diversification that this program offers, we are pleased with that return. The larger portfolio tends to lag because it is often underexposed. The system cannot always find divergence patterns for more stocks and the program does not leverage up exposure when there are fewer opportunities. That can make the risk unreasonably large.

 

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.

Mixed results for the Timing Program with the smaller portfolio gaining fractionally and the larger losing fractionally. This program buys stocks that have sold off, which is not the best strategy in a bull market where stocks move steadily higher and buying sooner is better. Over the long term it has had good performance, so waiting for the right market conditions is part of the strategy.

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.”

Losses of 2% to 3% in the Daily Futures program turned the 250K and 1M portfolios negative for the year, but the 500K portfolio is still ahead by 7.26%. The Weekly program also had fractional losses but it’s year-to-date returns are good, ranging for up 10% to up 18%. Compared to the Futures Industry performance, both programs are well ahead.

Group DF2: Daily Divergence Portfolio for Futures

A better month for the Divergence program, up by 2.8% to 3.2%, trimming year-to-date losses and maintaining its volatility but profitable upward trajectory. If history proves out, it will move higher.

Blogs and Recent Publications

Upcoming events:

Mr. Kaufman will be speaking in Tokyo and Osaka to the Japanese society of technical analysts on October 20th and 21st. Please contact us through our website if you need further information.

Also, Mr. Kaufman will be a Keynote Speaker at the annual IFTA Conference to be held in Kuala Lumpur, October 26 through October 28.  For more information, go to their website

https://kl2018.ifta-conferences.org/

Book Interview

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

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 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 (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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