Kaufman Signals

September 2019 Performance Report

Industry Benchmark Performance

Fractional gains for equities funds, moderate losses for futures, larger for trend-following systems. Equities have been exceptionally volatile given both economic and political news, although the economic news, the lowest manufacturing numbers released at the end of September, seems to have had the most affect. Futures, which normally profit from interest rate moves, lost money in every sector, the largest in interest rates. Gold also reversed from it’ uptrend, which added to the losses (see more in the Futures Trend review).

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.

September Performance in Brief

Our programs underperformed the broad equity index markets, posting fractional losses compared to gains of 1% to 2% in the broad market ETFs. Futures posted larger losses, after a solid run up for the past few months. As mentioned above, interest rates flopped around, resulting in the largest of the sector losses (see more in the Futures Trend review).

Major Equity ETFs. An unusual sideways pattern, reflecting the uncertainty about the economy and especially the impact of tariffs. Recent comments about delisting Chinese stocks and other retaliatory actions by the government do not sit well with investors. And other comments about breaking up Facebook reflects a growing rift between the government and industry. Perhaps this will motivate Facebook to work harder to contain “fake” posting, but that seems to be a very difficult job. Unless something unexpected happens to resolve the myriad of issues, it is hard to see why the markets would go higher.

CLOSE-UP: Why Is the Dollar Strong?

I keep thinking that our problems with trade, slowing GDP, lower interest rates by the Fed, pending impeachment hearings, and a subculture where workers are accepting lower skilled jobs for less pay, all contribute to a dismal forecast for the U.S. dollar. So why isn’t it going down? In fact, where is it going?

Figure 1 shows the USD gaining against the euro, pound, and yen, beginning January 2019. It shows that the dollar has been steadily stronger against the euro and pound, but essentially unchanged against the yen. Why?

Figure 1. The USD against the euro, pound, and yen, since January 2019.

The dollar is stronger when more money is flowing into the U.S. That happens for three main reasons: (1) the dollar represents safety, (2) the equity markets are expected to continue moving higher, and (3) the return on investment, net of inflation, is greater than other countries. To confirm that the USD is attractive, Figure 2 shows the net capital inflows for 2019 published by the U.S. Treasury Dept. The first quarter of 2019 shows an outflow, followed by a slow inflow. That is very similar to the pattern of the yen, which shows its strongest posting where the outflows were greatest.

Figure 2. Net capital inflows for 2019.

Given the three currencies, the yen seems to be on the outside looking in. It is not affected by Brexit and has been able to maintain uninterrupted and unthreatened trade with the U.S.

The Euro

The value of the euro is the easiest to explain. If we don’t consider Brexit at this point, the European economy is still not as robust as the European Central Bank wants; therefore, it has kept rates lower than in the U.S. Even while the U.S. has had slowing growth and the Fed is expected to continue to lower rates, Figure 3 shows that Europe has yielded consistently lower bond returns than the U.S. With inflation at very low levels, that attracts investor money into the U.S.

Figure 3. Eurobund futures show consistently lower yields than U.S. bonds.

Gold

An interesting side effect is the rally in gold. As interest rates decline, gold becomes more attractive. Combined with uncertainty in the economy, the somewhat unpredictable behavior of the administration, and potential conflicts with Iran and (while not at the moment) North Korea, gold is considered a safe haven for many investors. Given forecasts for a pending recession by “experts,” there is added reason to hold gold. Figure 4 shows how gold has moved higher in synch with falling bond yields.

Figure 4. Gold moves are very correlated to lower bond yields.

The Effect of Headline News

Headline news drive prices, but only for a short time. The markets have a short memory. The next headline pushes the previous one down, unless it has caused a structural change in the economy. For example, the Brexit vote was both a surprise and a structural change for the U.K. The British pound was rallying ahead of the vote, expecting the U.K. to remain in the EU. Figure 5 shows the drop in the USDGBP the day after the vote. Because it was a structural change, the value of the pound continued lower before stabilizing.

Figure 5. Reaction to the Brexit vote.

More recently we have the resignation of Prime Minister Teresa May, the ascent of Boris Johnson, the suspending of Parliament, and the overturning of the suspension by the Supreme Court. Figure 7 shows the reaction of the pound to those events, a total drop of less than 10%. It is interesting that the suspension of Parliament was taken as a positive for the pound, and the overturning of that suspension now appears to be a negative. If we look back at Figure 1, we see the steady decline of the pound as the Brexit deadline approaches -- a major structural change.

Figure 7. History of recent Brexit events.

The Effect of Tweets

Threats and tweets are not structural changes, and neither are protests. Two examples of this can be seen in the currencies of Mexico and Hong Kong. Mexico has been the focus of both trade and immigration confrontations, yet Mexico is our second largest trade partner (after Canada and ahead of China) and the threats have not turned into legislation. Figure 8 shows the volatility caused by news events, yet over all of 2019, the peso remains about the same, perhaps 3% weaker right now, having been in this range for most of the year.

Figure 8. The peso shows volatility but little net change.

Then there is Hong Kong. Protest began in June when China wanted to extradite Hong Kong citizens to the mainland to stand trial. As protests continued, the HKD actually strengthened (fewer HKD to the USD), peaking on the anniversary of the British turnover and the largest demonstration. Since then, the HKD has returned to its long-time value. Total disruption in the currency has been 3 months, as seen in Figure 9.

Figure 9. The Hong Kong dollar reacting to protests.

What Can We Learn?

This argues for distinguishing between structural (or potentially structural) events and “headline news” that doesn’t have any lasting effect but does have mean-reverting opportunity. Brexit is the best example of a potentially structural event while the Fed lowering rates is an actual structural event.

There are two things to watch at the same time: (1) The relative yield of the U.S. bonds compared to the eurobund. Both are stable economies and money will flow to the country offering the highest returns net of inflation. (2) Structural changes, such as actually imposing tariffs, trade agreements, surges in debt, wars, and of course, a different president. But the answer to “Why is the dollar strong?” is that it’s not, it’s just that other economies are weaker.

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.

After a small rally in SPY, failing to make new highs, the Trend Strength Index continues to be weak. As a leading indicator, we expect the major index markets to decline. TSI values are near zero, which would be interpreted as neutral, but they are also lower than they were during the extended period from March through September of 2018. It’s hard to see good news coming, although markets have been surprised in the past. We’re favoring at test of -20 on the TSI.

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.

Reversing last month’s performance, our Equity Trend Program was fractionally lower while the broad index ETFs were higher by 1% to 2%. We maintain a healthy gain for the year, although well behind the overall market (except IWM, the underperformer). The charts below are mostly unaffected by this month’s performance, but a deteriorating economy is not encouraging.

Income Focus and Sector Rotation

Fraction losses in the Income Focus Program after months of steady gains. This reflects the uncertainty in the interest rates markets, but is offset by the flow in interest income into these ETFs. Returns for the first three quarters of 2019 already match the long-term annual returns for this program.

Sector Rotation

There have been a number of articles on the failure of sector rotation during the past few years. That highlights the inconsistency of the market, first concentrating on one sector, then switching to another in the hopes of catching a big move. This month was different, with the Sector Rotation program gaining 6.54%. It doesn’t look like much on the chart, but the overall picture is still an uptrend for performance and a help with diversification.

DOW Arbitrage

Essentially unchanged this month, the Dow Arbitrage program is still higher by 13% for 2019, an acceptable return given that its drawdowns are far smaller than the other equity index ETFs. This program is still near its performance highs.

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.

A mixed month for the Divergence program, with a small gain in the 10-stock portfolio and a small loss in the 30-stock portfolio. Year-to-date remains higher by 19% for the smaller portfolio and 9.2% for the larger, still very respectable returns.

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.

Even with gains of 2% in September, the Timing Program is mixed for the year. Given the fast sell-offs and the following recoveries, this program takes defensive action by hedging, the has its stock gains offset by the hedges when the market rallies. That makes for a difficult scenario for this program. Still, it hasn’t shown a net loss, so we’re hopeful that it will outperform in a declining economy or lift its hedges on a rally.

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.”

After a run of gains for the Daily Futures Trend Program, September posted losses of between 4.5% and 5.7%, seen on the chart as the drop on the last bar. Still returns for 2019 are holding between 10% and 23%. The culprit was the interest rate market, usually the source of consistent gains. News of the trade war with China first being better, then worse, followed by recent threats of delisting Chinese stocks, is not adding confidence to the investment community. Sector returns, shown below the performance charts, shows that interest rates have offset all other sectors, but was the main problem in September.

Group DF2: Daily Divergence Portfolio for Futures

Modest losses in September still leave this program higher by 13% to 17.5% for the year. The charts show a remarkably consistent pattern of volatility, but new highs following each cycle. The volatility is the result of mostly few positions that satisfy the divergence criteria that includes the requirement that there are multiple divergence signals across predefined calculation periods.

Blogs and Recent Publications

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

New Interview and Article

Technical Analysis will be interviewing Mr Kaufman for the December issue. We’re trying to cover more interesting topics than the same old ones! In the November issue, an article “Running for Cover” shows that there can still be profits by buying interest rates when there is a stock market shock to the downside.

MetaStock Seminar the beginning of November

Mr. Kaufman will be a keynote speaker at the MetaStock seminar in San Francisco the first weekend of November.

September

“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

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

March-April

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

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

December

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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