Stock market investor optimism rises above historical average

“Optimism among individual investors about the short-term direction of the stock market rebounded, rising above its historical average.”

AAII Investor Sentiment Survey

The AAII Investor Sentiment Survey is a widely followed measure of the mood of individual investors. The weekly survey results are published in financial publications including Barron’s and Bloomberg and are widely followed by market strategists, investment newsletter writers, and other financial professionals.

It is my observation that investor sentiment is trend following.

Investor sentiment reaches an extreme after a price trend has made a big move.  After the stock market reaches a new high, the media is talking about and writing about the new high, which helps to drive up optimism for higher highs.

When they get high, they believe they are going higher.

At the highest high they are at their high point — euphoria.

No, I’m not talking about cannabis stocks, I’m just talking about the stock market. Cannabis stocks are a whole different kind of high and sentiment.

A few years ago, I would have never dreamed of making a joke of cannabis stocks or writing the word marijuana on a public website. Who had ever thought there would be such a thing? But here I am, laughing out loud (without any help from cannabis).

Back to investor sentiment…

Excessive investor sentiment is trend following – it just follows the price trend.

Investor sentiment can also be a useful contrarian indicator to signal a trend is near its end. As such, it can be helpful to investors who tend to experience emotions after big price moves up or down.

  • Investor sentiment can be a reminder to check yourself before you wreck yourself.
  • Investor sentiment can be a reminder to a portfolio manager like myself to be sure our risk levels are where we want them to be.

Although… rising investor optimism in its early stages can be a driver of future price gains.

Falling optimism and rising pessimism can drive prices down.

So, I believe investor sentiment is both a driver of price trends, but their measures like investor sentiment polls are trend following.

For example, below I charted the S&P 500 stock index along with bullish investor sentiment. We can see the recent spike up to 43% optimistic investors naturally followed the recent rise in the stock price trend. investor sentiment July 2018

However, in January we observed something interesting. Investor sentiment increased sharply above its historical average in December and peaked as the stock market continued to trend up.

Afterward, the stock market dropped sharply and quickly, down around -12% very fast.

Maybe the investor sentiment survey indicated those who wanted to buy stocks had already bought, so there wasn’t a lot of capital left for new buying demand to keep the price momentum going.

The S&P 500 is still about -2.4% from it’s January high, so this has been a non-trending range-bound stock market trend for index investors in 2018. The Dow Jones Industrial Average was last years more gaining index and it is still -6% from its high.

stock market 2018 level and drawdown

The stock index will need some buying enthusiasm to reach its prior high.  We’ll see if the recent increase in optimism above its historical average is enough to drive stocks to new highs, or if it’s a signal of exhaustion.

Only time will tell…

I determine my asymmetric risk/reward by focusing on the individual risk/reward in each of my positions and exposure across the portolio. For me, it’s always been about the individual positions and what they are doing.

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.

 

Does Your Firm Use Active ETFs?

Christi Shell was recently asked by ETF.com “Does your firm use active ETFs”.

Christi Shell Capital Management

Her answer from the interview:

Our portfolio manager, Mike Shell, doesn’t currently include active ETFs in our universe of tradeable ETFs, but that doesn’t mean he’d never include them. He tactically shifts between ETFs, based on investor behavioral measures and supply/demand. So our portfolio management style itself is the active management; we are, essentially, actively managing beta.

We use ETFs to gain specific exposure to a return stream such as a sector, country, commodity or currency. With an index ETF, we pretty much know what we’re going to get inside the ETF. (Of course, indexes are reconstituted by a committee of people, so we don’t know in advance what they’ll do. However, an index follows some general rules systematically.)

Therefore, if we discover an ETF we believe has a strategy and return stream that we want access to, then we would add it, whether it’s active or not.

Christi Shell is Managing Director and Certified Wealth Strategist® at Shell Capital Management LLC. Christi has 27 years in financial services ranging from bank management to wealth management giving her a unique skill set and experience to help clients get what they want.

Source: http://www.etf.com/publications/etfr/does-your-firm-use-active-etfs

Global Stock and Bond Market Trends 2Q 2018

Yesterday we shared the 2nd Quarter 2018 Global Investment Markets Review, which used a broad range of indexes on performance tables to present the year-to-date progress of world markets. The issue with a table that simply shows a return number on it is it doesn’t properly present the path it took to get there. In the real world, investors and portfolio managers have to live with the path of the trend and we can see that only in the price trend itself. So, today we’ll look at the price trends of stocks, bonds, commodities, real estate, sectors, and other alternatives like volatility. I don’t just look for potentially profitable price trends in stocks and bonds, I scan the world.

How is the market doing this year? Which market?

First, a quick glance at global markets including commodities, stock indexes, volatility, ranked by year-to-date momentum. We wee the CBOE Volatility Index $VIX has gained the most. One clear theme about 2018 is that volatility has increased and this includes implied or expected volatility. Overall, we see some asymmetry since the markets in the green are more positive than the markets in the red. The popular S&P 500 stock index most investors point to is in the middle with only a 2% gain for the year. Commodities like Cocoa, Lumber, Orange Juice, and Crude Oil are leaders while sugar, live cattle, and soybeans are the laggards. Most investors probably don’t have exposure to these markets, unless they get it through a commodities ETF.

 

Most investors probably limit themselves to the broad asset classes, since that’s what most financial advisors do. So, we’ll start there. Below are the trends of broad market ETFs like the S&P 500, Aggregate Bond, Long-Term Treasury. For the year, Emerging Markets has the weakest trend – down nearly -6%. Developed Markets countries are the second weakest. The rising U.S. Dollar is helping to put pressure on International stocks. The leader this year is Commodities, as we also saw above. The Commodity index has gained 8% YTD.

What about alternative investments? We’ll use liquid alternative investments as an example since these are publicly available ETFs. I’ve included markets like Real Estate, Private Equity, Mortgage REITs, and the Energy MLP. Not a lot of progress from buying and holding these alternative investments. This is why I prefer to shift between markets trying to keep capital only in those markets trending up and out of those trending down.

liquid alternative investments

The Volatility VXX ETF/ETN that is similar to the VIX index has gained so much early in the year I left it off the following chart because it distorted the trends of the other markets. It’s one of the most complex securities to trade, but we can see it spike up to 90% when global markets fell in February.

VIX VXX

Looking at the price trend alone isn’t enough. It would be incomplete without also considering their drawdowns. That is, how much the market declined off its prior high over the period. Analyzing the drawdown is essential because investors have to live with the inevitable periods their holdings decline in value. It’s when we observe these decline we realize the need for actively managing risk. For me, actively managing risk means I have a predetermined exit point at all times in my positions. I know when I’ll exit a loser before it becomes a significant loss. Many say they do it, I’ve actually done it for two decades.

The alternative investments are in drawdowns YTD and Energy MLP, and Mortgage REIT is down over -10% from their prior highs. The Energy MLP is actually down -51% from its 2014 high, which I don’t show here.

alternative investment drawdowns risk management

Next, we go back to the global asset class ETFs to see their drawdowns year-to-date. We don’t just experience the gains, we also have to be willing to live with their declines along the way. It isn’t enough to provide an excellent investment management program, we also have to offer one that fits with investors objectives for risk and return. The most notable declines have been in Emerging Market and developed international countries. However, all of these assets are down off their prior highs.

GLOBAL ASSET CLASS RISK MANAGEMENT TREND FOLLOWING 2018

Clearly, markets don’t always go up. The trends so far in the first six months of 2018 haven’t offered many opportunities for global asset allocation to make upward progress.

This is why I rotate, rather than allocate, to shift between markets rather than allocate to them. We also trade in more markets than we covered here, like leading individual stocks. The magnitude of these drawdowns also shows why I believe it is essential to direct and control risk and drawdown.

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.

 

 

 

 

2nd Quarter 2018 Global Investment Markets Review

It is no surprise to see global equity markets stall after such a positive trend last year. As we will see, the weakness is global and across both bonds and stocks.

Before we review the year-to-date gains and losses for indexes, I want to share some of the most interesting asset allocation indexes I’ve seen.

Keep in mind: we don’t offer this kind of asset allocation that allocates capital to fixed buckets of stocks and bonds and then rebalances them periodically. As a tactical portfolio manager, I don’t allocate to markets, I rotate between them to focus my exposure on markets in a positive trend and avoid (or short) those in a negative trend. I don’t need to have exposure to falling markets. We consider our portfolio a replacement (or at least a compliment) to traditional “asset allocation” offered by most investment advisors.

I want to present some global asset allocation indexes because, in the real world, most investors don’t allocate all of their investment capital to just stocks or just bonds; it’s some combination of them. If they keep their money in cash in the bank, they aren’t investors at all.

To observe what global asset allocation returns look like, we can look at the Morningstar Target Risk Indexes:

The Morningstar Target Risk Index series consists of five asset allocation indexes that span the risk spectrum from conservative to aggressive. The family of asset allocation indexes can serve as benchmarks to help with target-risk mutual fund selection and evaluation by offering an objective yardstick for performance comparison.

All of the indexes are based on a well-established asset allocation methodology from Ibbotson Associates, a Morningstar company and a leader in the field of asset allocation theory.

The family consists of five indexes covering the following equity risk preferences:

  • Aggressive Target Risk
  • Moderately Aggressive Target Risk
  • Moderate Target Risk
  • Moderately Conservative Target Risk
  • Conservative Target Risk

The securities selected for the asset allocation indexes are driven by the rules-based indexing methodologies that power Morningstar’s comprehensive index family. Morningstar indexes are specifically designed to be seamless, investable building blocks that deliver pure asset-class exposure. Morningstar indexes cover a global set of stocks, bonds, and commodities.

These global asset allocation models are operated by two of the best-known firms in the investment industry and the leaders in asset allocation and indexing. I believe in rotating between markets to gain exposure to the trends we want rather than a fixed allocation to them, but if I all I was going to do is asset allocation, I would use these.

Now that we know what it is, we can see the year-to-date return under the YTD column and other period returns. All five of the risk models are down YTD. So, it’s safe to say the first six months of 2018 has been challenging for even the most advanced asset allocation.

Below are the most popular U.S. stock indexes. The Dow Jones Industrial Average which gained the most last year is down this year. The Tech heavy NASDAQ and small-cap stocks of the Russell 2000 have gained the most.

The well-known bond indexes are mostly down YTD – even municipal bonds. Rising interest rates and the expectation rates will continue to rise is putting pressure on bond prices.

Morningstar has even more indexes that break bonds down into different fixed-income categories. Longer-term bonds, as expected, are responding most negatively to rising rates. The most conservative investors have the more exposure to these bonds and they are down as much as -5% the past six months. That’s a reason I don’t believe in allocating capital to markets on a fixed basis. I prefer to avoid the red.

Next, we observe the Morningstar style and size categories and sectors. As I wrote in Growth has Stronger Momentum than Value and Sector Trends are Driving Equity Returns, sectors like Technology are driving the Growth style.

International stocks seem to be reacting to the rising U.S. Dollar. As the Dollar rises, it reduced the gain of foreign stocks priced in foreign currency. Although, some of these countries are in negative trends, too. Latin America, for example, was one of the strongest trends last year and has since trended down.

At Shell Capital, we often say that our Global Tactical Rotation® portfolios are a replacement for global asset allocation and the so-called “target date” funds. Target date funds are often used in 401(k) plans as an investment option. They haven’t made much progress so far in 2018.

It is no surprise to see most global markets down or flat in 2018 after such a positive 2017.

But, only time will tell how it all unfolds the rest of the year.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.

The week in review

The week in review

In case you missed it, below are all of the observations we shared this week. When there are more directional trend changes and volatility, I find more asymmetries to write about. That’s because I look at markets through the lens of “what has changed”?

When I observe more divergence between markets and trends, I see more asymmetries to share.

When global markets are just trending up together and quiet, investor sentiment is usually getting complacent, I typically point it out, since that often precedes a changing trend.

All of it is asymmetric observations; directional trends and changes I see with a tilt.

The opposite is symmetry, which is a balance. Symmetry doesn’t interest me enough to mention it.

When buying interest and selling pressure are the same, the price doesn’t move.

When risk equals the return, there is no gain.

When profit equals loss, there is no progress.

In all I do, I’m looking for Asymmetry®.

I want my return to exceed the risk I take to achieve it.

I want my profits to far surpass my losses.

I want my wins to be much greater than my losses.

I want more profit, less loss.

You probably get my drift.

 

Here are the observations we shared this week: 

Growth has Stronger Momentum than Value

https://asymmetryobservations.com/2018/06/25/growth-has-stronger-momentum-than-value/

 

Sector Trends are Driving Equity Returns

https://asymmetryobservations.com/2018/06/25/sector-trends-are-driving-equity-returns/

 

Trend Analysis of the Stock Market

https://asymmetryobservations.com/2018/06/25/trend-analysis-of-the-stock-market/

 

Trend of the International Stock Market

https://asymmetryobservations.com/2018/06/26/trend-of-the-international-stock-market/

 

Interest Rate Trend and Rate Sensitive Sector Stocks

https://asymmetryobservations.com/2018/06/27/interest-rate-trend-and-rate-sensitive-sector-stocks/

 

Expected Volatility Stays Elevated in 2018

https://asymmetryobservations.com/2018/06/27/expected-volatility-stays-elevated-in-2018/

 

Sector ETF Changes: Indexes aren’t so passive

https://asymmetryobservations.com/2018/06/27/sector-etf-changes-indexes-arent-so-passive/

 

Commodities are trending with better momentum than stocks

https://asymmetryobservations.com/2018/06/28/commodities-are-trending-with-better-momentum-than-stocks/

 

Investor sentiment gets more bearish

https://asymmetryobservations.com/2018/06/28/investor-sentiment-gets-more-bearish/

 

Is it a stock pickers market?

https://asymmetryobservations.com/2018/06/29/is-it-a-stock-pickers-market/

 

Is it a stock pickers market?

Is it a stock pickers market?

Sometimes the stock market is trending so strongly that the rising tide lifts all boats. No matter what stocks or stock fund you invest in, it goes up. That was the case much of 2017.

Then, there are periods when we see more divergence.

When we observe more divergence, it means stocks, sectors, size, or style has become uncorrelated and are trending apart from each other.

I pointed out in Sector Trends are Driving Equity Returns; there is a notable divergence in sector performance, and that is driving divergence in size and style. Growth stocks have been outperformance value, and it’s driven by strong momentum in Technology and Consumer Discretionary sectors.

When specific sectors are showing stronger relative momentum, we can either focus more on those sectors rather than broad stock index exposure. Or, we can look inside the industry to find the leading individual stocks.

For example, Consumer Discretionary includes industries like automobiles and components, consumer durables, apparel, hotels, restaurants, leisure, media, and retailing are primarily represented in this group. The Index includes Amazon, Home Depot, Walt Disney, and Comcast. Consumer Discretionary is the momentum leader having trended up 9.7% so far this year as the S&P 500 has only gained just under 1%.

momentum sectors

If we take a look inside the sector, we see the leaders are diverging farther away from the sector ETF and far beyond the stock market index.

momentum stocks consumer discretionary sector NFLX AMZN AAPL

In fact, all the sectors 80 stock holdings are positive in 2018.

The Consumer Discretionary sector is about 13% of the S&P 500. As you can see, if these top four or five sectors in the S&P 500 aren’t trending up it is a drag on the broad stock index.

ETF Sector Allocation exposure S&P 500

So, Is it a stock pickers market? 

When we see more divergence, it seems to be a better market for “stock pickers” to separate the winners from the losers.

Another way to measure participation in the market is through quantitative breadth indicators. Breadth indicators are a measure of trend direction “participation” of the stocks. For example, the percent of the S&P 500 stocks above or below a moving average is an indication of the momentum of participation.

Below is the percent of stocks above their 50 day moving average tells us how many stocks are trending above their moving average (an uptrend). Right now, the participation is symmetrical; 52% of the stocks in the S&P 500 are in a positive trend as defined by the 50 day moving average. We can also see where that level stands relative to the stock market lows in February and April and the all-time high in January when over 85% of stocks were in an uptrend. By this measure, only half are trending up on a shorter term basis.

SPX SPY PERCENT OF STOCKS ABOVE 50 DAY MOVING AVERAGE 1 YEAR

The 200-day moving average looks back nearly a year to define the direction of a trend, so it takes a greater move in momentum to get the price above or below it. At this point, the participation is symmetrical; 55% of stocks are above their 200-day moving average and by this time frame, it hasn’t recovered as well from the lows. The percent of stocks above their 200-day moving average is materially below the 85% of stocks that were participating in the uptrend last year. That is, 30% fewer stocks are in longer trend uptrends.

SPY SPX PERCENT OF STOCKS ABOVE 200 DAY MOVING AVERGAGE 1 YEAR

In the above charts, I only showed a one-year look back of the trend. Next, we’ll take a step back to view the current level relative to the past three years.

The percent of stocks above their 50 day moving average is still at the upper range of the past three years. The significant stock market declines in August-September 2015 and December-January hammered the stocks down to a very washed out point. During those market declines, the participation was very asymmetric: 90% of the stocks were in downtrends and only about 10% remained in shorter-term uptrends.

SPX SPY PERCENT OF STOCKS ABOVE 50 DAY MOVING AVERAGE 3 YEARS

The percent of stocks above their 200 day moving average also shows a much more asymmetrical situation during the declines in 2015 and 2016 when the stock index dropped around -15% or more. Only 20% of stocks remained in a positive trend.

SPX PERCENT OF STOCKS ABOVE 200 DAY MOVING AVERAGE 3 YEARS

Is it a stock pickers market?

Only about half of the stocks in the index are in uptrends, so the other half isn’t. So, if we avoid the half that are in downtrends and only maintains exposure to stocks in uptrends and the trends continue, we can create alpha.

But, keep in mind, that doesn’t necessarily mean we should have any exposure at all in the S&P 500 stock index because happens to have the highest sector exposure in the leading sectors.

But, for those who want to engage in “stock picking”, the timing has a higher probability now to diverge from the stock index than last year because so fewer stocks are in uptrends and more are in downtrends.

For individual stocks traders willing to look inside the box, this is a good thing.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.

Investor sentiment gets more bearish

Investor sentiment gets more bearish

Investor pessimism shifted to an unusually high level for the time this year. It spiked up from 24% bearish to 41%.

investor sentiment investment strategy

Bearish investor sentiment is now as high as it was in April after the stock declined a second time and formed a double bottom. Interestingly, this time the stock market is only down about 6% from its high. The last time investors were so bearish it had reached -10%, for the second time.

bearish investor sentiment

Investors may be turning more bearish more quickly since the stock market remains in a drawdown. Investors tend to feel the wrong thing at the wrong time at extremes so this could be a bullish signal.

Investor optimism declined more moderately and still remains within its normal long-term range. We can see how optimism trend up to an extreme in January as the stock index reached an all-time new high and investors were becoming euphoric.

bullish investor sentiment signal

Investor sentiment measures show that investors do the wrong thing at the wrong time as their beliefs about future stock market returns reach the more extreme levels.

A good investment program isn’t enough to help clients reach their objectives.

We necessarily have to help them avoid the typical misbehavior the majority of investors fall in to.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.

Commodities are trending with better momentum than stocks

Commodities are trending with better momentum than stocks

Commodities are trending with better momentum than stocks over the past year.

A commodity is a raw material or primary agricultural product that can be bought and sold, such as copper or coffee. A commodity is a basic good used in commerce that are usually used as inputs in the production of other goods or services.

Soft commodities are goods that are grown, such as wheat, or rice.

Hard commodities are mined. Examples include gold, helium, and oil.

Energy commodities include electricity, gas, coal, and oil. Electricity has the particular characteristic that it is usually uneconomical to store, and must, therefore, be consumed as soon as it is processed.

The Commodity Trend

At first glance, we see in the chart commodities ETF Invesco DB Commodity Index Tracking ETF has trended meaningfully above the popular S&P 500 index of U. S. stocks. The relative outperformance is clear over this one-year time frame. Commodities, as measured by this ETF, are in an absolute positive trend and registering relative momentum.

Commodity ETF trend following commodites natural resources $GNR $GSG $DBC

Examining a price trend is incomplete without also considering its downside. On the downside, I look at the % off high drawdowns over the period. We see that commodities were more volatile than stocks before 2018 with four dips around -4%. Since the stock market -10% decline that started in February, commodities declined, too, but not as much as U. S. stocks.

asymmetry ratio commodity drawdown

Looking back at the trend chart, I added a simple trend line to show that communities are trending directionally better than the popular U. S. stock index. So, my quantitative Global Tactical Rotation®  system that ranks an unconstrained global universe of markets including bonds, stocks, commodities, currencies, and other alternatives like real estate signaled this trend has been generating asymmetric risk/return.

commodity ETF trend commodities

What is the that Invesco DB Commodity Index Tracking ETF? (the bold emphasis is mine)

The Invesco DB Commodity Index Tracking Fund seeks to track changes, whether positive or negative, in the level of the DBIQ Optimum Yield Diversified Commodity Index Excess Return™ (DBIQ Opt Yield Diversified Comm Index ER) plus the interest income from the Fund’s holdings of primarily US Treasury securities and money market income less the Fund’s expenses. The Fund is designed for investors who want a cost-effective and convenient way to invest in commodity futures. The Index is a rules-based index composed of futures contracts on 14 of the most heavily traded and important physical commodities in the world. The Fund and the Index are rebalanced and reconstituted annually in November.

This Fund is not suitable for all investors due to the speculative nature of an investment based upon the Fund’s trading which takes place in very volatile markets. Because an investment in futures contracts is volatile, such frequency in the movement in market prices of the underlying futures contracts could cause large losses. Please see “Risk and Other Information” and the Prospectus for additional risk disclosures. Source: Invesco

The challenge for some investors, however, is that Invesco DB Commodity Index Tracking ETF generates a K-1 tax form for tax reporting. That isn’t a terrible issue, but it means instead of receiving the typical 1099 investors receive a K-1. Some investors aren’t familiar with a K-1, and they can obtain them later than a 1099.

Then, there may be other investors who simply prefer not to own futures for the reason in the second paragraph of the above discription: “Because an investment in futures contracts is volatile, such frequency in the movement in market prices of the underlying futures contracts could cause large losses.” In reality, all investments have risk and stocks can have just as much risk of “large losses” as commodity futures, but it’s a matter of investor preference and perception.

Since we have a wide range of investor types who invest in my ASYMMETRY® Investment Program I could gain my exposure to commodities in other ways. For example, the SPDR® S&P® Global Natural Resources ETF often has a similar return stream as ETFs like DBC that track a commodity futures index, except is actually invests in individual stocks instead.

Key features of the SPDR® S&P® Global Natural Resources ETF

  • The SPDR® S&P® Global Natural Resources ETF seeks to provide investment results that, before fees and expenses, correspond generally to the total return performance of the S&P® Global Natural Resources Index (the “Index”)

  • Seeks to provide exposure to a number of the largest market cap securities in three natural resources sectors – agriculture, energy, and metals and mining

  • Maximum weight of each sub-index is capped at one-third of the total weight of the Index

Below we see the price trend of this ETF of global natural resources stocks has been highly correlated to an ETF of commodities futures.

global natural resources ETF replacement for commodity ETF no K1

In fact, as we step the time frame out to the common inspection date of each ETF in 2011, the SPDR® S&P® Global Natural Resources ETF has actually outperformed Invesco DB Commodity Index Tracking ETF overall in terms of relative momentum.

commodity ETF global natural resources trend following no K1

The bottom line is, commodities “stuff” is trending up over the past two years and when the price of “stuff” is rising, that is called “inflation”.  Commodities and global natural resources have been in a downtrend for so long it shouldn’t be a surprise to see this trend reverse up. Only time will tell if it will continue, but if we want exposure to it, we can predefine our risk by deciding at what price I would exit if it doesn’t, and let the trend unfold.Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.Buying and Selling ETFsETFs are flexible and easy to trade. Investors buy and sell them like stocks, typically through a brokerage account. Investors can also employ traditional stock trading techniques; including stop orders, limit orders, margin purchases, and short sales using ETFs. They are listed on major US Stock Exchanges.

ETFs are subject to risk similar to those of stocks including those regarding short-selling and margin account maintenance. Ordinary brokerage commissions apply. In general, ETFs can be expected to move up or down in value with the value of the applicable index. Although ETF shares may be bought and sold on the exchange through any brokerage account, ETF shares are not individually redeemable from the Fund. Investors may acquire ETFs and tender them for redemption through the Fund in Creation Unit Aggregations only. Please see the prospectus for more details. After-tax returns are calculated based on NAV using the historical highest individual federal marginal income tax rates and do not reflect the impact of state and local taxes. Actual after-tax returns depend on the investor’s tax situation and may differ from those shown. The after-tax returns shown are not relevant to investors who hold their fund shares through tax-deferred arrangements such as 401(k) plans or individual retirement accounts. Performance of an index is not illustrative of any particular investment. It is not possible to invest directly in an index. As with all stocks, you may be required to deposit more money or securities into your margin account if the equity, including the amount attributable to your ETF shares, declines. Unless otherwise noted all information contained herein is that of the SPDR S&P Global Natural Resources ETF. S&P – In net total return indices, the dividends are reinvested after the deduction of withholding tax. Tax rates are applied at the country level or at the index level.

 

 

Sector ETF Changes: Indexes aren’t so passive

Sector ETF Changes: Indexes aren’t so passive

Index funds and ETFs are often called “passive”, but in reality, they aren’t. Indexes change as their committees add and remove stocks or bonds from them. Though we generally know the exposure we can expect from an index ETF and we can see its holdings, we never know for sure in advance what stocks they’ll add or remove.

Not that we need to, we don’t.

But if we did know, we could front run them. Stocks that get added to an index trend up as all the index funds tracking that index have to buy the stock.

The opposite is true for stocks removed from the index.

General Electric (GE) was the last original Dow stock and was recently removed from the Dow Jones Industrial Average. So, the 30 stocks in that index are completely different today than the stocks it held when it started.

Alternative investment strategies are sometimes criticized for being too “black box”, implying the systems and methods are proprietary and are not disclosed to investors. The truth is, we can say the same for the most popular stock indexes. Indexes are also a black box since we don’t know what they’ll do next.

There are reasons they keep some things a secret, just as some of us keep the finest details of our systems and strategies private. Some things are intellectual capital and if you want to invest with someone who has it, well, you’ll just have to settle for not knowing every precise detail. If you don’t like it, don’t invest.

The U. S. Sector indexes have some changes coming.

In November 2017, S&P Dow Jones and MSCI announced that the Global Industry Classification Standard, or GICS, telecommunication services sector would be broadened and renamed “communication services.” The communication services sector will add select media, entertainment, and consumer Internet stocks from the consumer discretionary and information technology sectors to its current telecommunication services constituents.

In mid-January 2018, SPDJI/MSCI released a list of the largest companies affected by the GICS update. SPDJI/MSCI plans to release a full list of affected securities on July 2, 2018, and provide a finalized list of affected securities on Sept. 3, 2018, before the GICS update takes effect after the market closes on Friday, Sept. 28, 2018. This classification change will impact index funds that focus on the telecommunications, information technology, and consumer discretionary sectors.

Here is a diagram of the changes.

STOCK MARKET STOCKS SECTOR ETF ETFS SPDR SPY

Sector SPDRs has already launched their ETF for the communications sector.

Communication Services Sector $XLC is designed to reflect modern communication activities and information delivery mechanisms. Industries include Telecommunications, Media, Wireless, Entertainment and Internet Media. Components include Alphabet, Disney, AT&T, Verizon, Comcast and Netflix.

The media talks about the so-called “FANG” stocks, which is Facebook, Apple, Netflix, and Google. Well, this ETF is almost the FANG ETF.

fang stocks in xlc communication sector

So, we’ve adjusted our sector systems accordingly to adapt to these new changes.

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.

Performance is historical and does not guarantee future results; current performance may be lower or higher. Investment returns/principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Most recent month-end performance is available in the Performance topic. Past performance does not guarantee future results.

Sector SPDRs are subject to risk similar to those of stocks including those regarding short selling and margin account maintenance. All ETFs are subject to risk, including possible loss of principal. Sector ETF products are also subject to sector risk and non-diversified risk, which will result in greater price fluctuations than the overall market.

Expected Volatility Stays Elevated in 2018

Expected Volatility Stays Elevated in 2018

In late 2017, implied volatility, as measured by the VIX CBOE Volatility Index, was at abnormally low levels. I pointed out many times that vol is mean reverting, so when expected volatility is extremely low we can expect it to eventually reverse. The VIX spiked up over 200% in February and has remained more elevated than before.

VIX $VIX #VIX VOLATILITY INDEX CBOE RISK MANAGEMENT ASYMMETRIC ASYMMETRY

In the chart, I used a 50-day moving average for observation of how the VIX has remained more elevated than pre-February.

Volatility is asymmetric; when the stock market falls, implied volatility tends to spike up.

The VIX long-term average is 20, so the current level of 15-16 still isn’t high by historical measures, but the expected volatility is elevated above where it was.

Below is the VIX so far in 2018 in percentage terms. It shows the 200% gain that has since settled down, but it’s remaining higher than before.

VIX VOLATILITY 2018 RISK MANAGEMENT ASYMMETRY GLOBAL ASYMMETRIC ETF ETFS

The VIX has spiked up 45% the past 5 days.

VIX VOLATILITY ASYMMETRIC SPIKE GAIN THIS WEEK 2018 ASYMMETRY RISK

As I shared in The enthusiasm to sell overwhelmed the desire to buy March 19, 2018, I expect to see more swings (volatility) than last year, and that would be “normal” too. I said:

I define this as a non-trending market. When I factor in how the range of price movement has spread out more than double what it was, I call it a non-trending volatile condition.

Until we see either a new all-time high indicating a continuing longer-term uptrend or a new low below the February and April low indicating a new downtrend, the above holds true.

It’s a good time for a VIX primer from the CBOE:

What does it mean?

Some consider the VIX the “fear gauge”. When there is a demand for options, their premiums rise. Investor demand for options typically increases when they are concerned about the future, so they use options to hedge or replace their stocks with limited risk options strategies. Rising volatility also drives the VIX, since the VIX Index is a calculation designed to produce a measure of constant, 30-day expected volatility of the U.S. stock market, derived from real-time, mid-quote prices of S&P 500® Index

What is volatility?

Volatility measures the frequency and magnitude of price movements, both up and down, that a financial instrument experiences over a certain period of time. The more dramatic the price swings in that instrument, the higher the level of volatility. Volatility can be measured using actual historical price changes (realized volatility) or it can be a measure of expected future volatility that is implied by option prices. The VIX Index is a measure of expected future volatility.

What is the VIX Index?

Cboe Global Markets revolutionized investing with the creation of the Cboe Volatility Index® (VIX® Index), the first benchmark index to measure the market’s expectation of future volatility. The VIX Index is based on options of the S&P 500® Index, considered the leading indicator of the broad U.S. stock market. The VIX Index is recognized as the world’s premier gauge of U.S. equity market volatility.

How is the VIX Index calculated?

The VIX Index estimates expected volatility by aggregating the weighted prices of S&P 500 Index (SPXSM) puts and calls over a wide range of strike prices. Specifically, the prices used to calculate VIX Index values are midpoints of real-time SPX option bid/ask price quotations.

How is the VIX Index used?

The VIX Index is used as a barometer for market uncertainty, providing market participants and observers with a measure of constant, 30-day expected volatility of the broad U.S. stock market. The VIX Index is not directly tradable, but the VIX methodology provides a script for replicating volatility exposure with a portfolio of SPX options, a key innovation that led to the creation of tradable VIX futures and options.

To learn more about the CBOE, Volatility Index VIX visit their VIX website.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.

 

 

Interest Rate Trend and Rate Sensitive Sector Stocks

Interest Rate Trend and Rate Sensitive Sector Stocks

The interest rate on the 10 Year Treasury has gained over 20% so far in 2018, but I noticed it’s more recently settled down a little.

interest rate TNX $TNX

One of my ASYMMETRY® systems generated a short-term momentum signal today for the Utility and Real Estate Sectors. This signal indicated the short term trend is up, but it may have reached the point they may pull back before they continue the trend.

We see in the chart below, Utility and Real Estate Sectors are down so far in 2018, but they are gradually covering.

Utilities and Real Estate XLU XLRE $XLRE $XLU TREND MOMENTUM

I find it useful to understand return drivers and how markets interact with each other. The direction of interest rates, the Dollar, inflation, etc. all drive returns for markets.

In the chart below, I drew the black arrow to show where interest rates started declining this month and Utility and Real Estate Sectors trended up.

rising interest rate impact on real estate REIT housing utilities

Utility and Real Estate Sectors are sensitive to interest rates. These sectors use leverage, so as interest rates rise, it increases their cost of capital. Another impact is higher interest rates on bonds compete with them as investments. Utility and Real Estate Sectors are high dividends paying sectors, so as bond yields trend higher investors may start to choose bonds over these equities.

Below is a 1-year chart. You can see how interest rates increasing over 30% over the past year has had some impact on the price trend of the Utility and Real Estate sectors.

interest rate reit utilities sector

But, at the moment, these sectors have trended up, as interest rates have settled down.

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.

 

 

 

Trend of the International Stock Market

Trend of the International Stock Market

Conventional wisdom says to create a diversified portfolio of markets. However, it doesn’t do much good if those investments tend to move in the same direction in response to changing market conditions. Combining U.S. and international investments can result in a better-diversified portfolio whose holdings don’t march in lockstep – so when some go up, others go down, and vice versa. The result: a potential reduction in the volatility of your total portfolio in the long-run. Since International stocks may not always trend the same as U. S. stocks, I prefer to rotate between these markets rather than allocate to them all the time.

International stock markets can be broadly divided into developed countries and emerging markets. The MSCI EAFE Index includes developed countries. The MSCI Emerging Markets Index includes smaller countries.

So far in 2018, International stocks are down. Developed markets are down -4.6% and Emerging Markets are down -8%.

One reason International stocks and trending down for U. S. investors is the Dollar has trended up. Currency risk is a significant risk facing investors in International and emerging markets.

This is an example of why it’s useful to understand the driver of returns and how markets interact with each other.

Below is the same change, but I’ve added the U.S. Dollar Index.  The Dollar started trending up in April, which is no surprise with the interest rates rising, which means the yield on our Dollar is rising. Around the same time the Dollar trended up, we see these International stock indexes declined. These ETFs are traded in U.S. Dollars, but they are International stocks in other countries, so they are impacted by a change in currency.

If we wanted exposure to these markets, but want to hedge off the currency risk, we could instead get our exposure with the currency hedged ETF. The currency-hedged ETFs Seek to reduce the impact of foreign currencies, relative to the U.S. dollar, on your emerging markets allocation

The iShares Currency Hedged MSCI Emerging Markets ETF seeks to track the investment results of an index composed of large- and mid-capitalization equities from emerging market countries while mitigating exposure to fluctuations between the value of the component currencies and the U.S. dollar.

I’ve compared the non-currency hedged Emerging Markets ETF below to the Currency Hedged Emerging Markets ETF. I highlighted the uptrend in the Dollar with a black dotted line. You can see up until the time the Dollar started rising, where I marked with a black arrow, the two ETFs were trending close. Since then, their price trends began to diverge. As the Dollar gained and the Emerging Markets stock ETF declined, the currency-hedged ETF of the same index fell about half as much.

To be sure, I’ve zoomed in the show only the past 3 months of the price trends.

So far in 2018, the U.S. Dollar is rising, and International stocks are falling, but it doesn’t seem to be just the rising Dollar driving them down.

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.

 

 

Trend Analysis of the Stock Market

Trend Analysis of the Stock Market

After today’s -1.27% decline, the S&P 500 stock index is only positive about 1.6% for the year.

As we see in the one-year price trend chart below, it continues to be range bound so far in 2018.

stock market trend analysis $SPY $SPX TREND FOLLOWING ASYMMETRIC ETF ASYMMETRY

Fortunately, as I pointed out in Sector Trends are Driving Equity Returns, growth stocks in the Information Technology and Consumer Discretionary sectors have been stronger.

However, sometimes what goes up the most may come down the most, and that was the case today. The leading Growth sectors declined the most. It was Interesting to see such a substantial gain in Utilities and Consumer Staples today, defensive sectors during a recession or economic downturn.

stock market sector trends

At this point, the stock market indexes seem to be having another relatively normal decline within an overall non-trending, more volatile trend so far in 2018.

The stock index is over -5% off its January high and remains in a drawdown the past five months.

SPY SPX STOCK MARKET OFF ITS HIGH 2018

As I shared in The enthusiasm to sell overwhelmed the desire to buy March 19, 2018, I expect to see more swings (volatility) than last year, and that would be “normal” too. I said:

I define this as a non-trending market. When I factor in how the range of price movement has spread out more than double what it was, I call it a non-trending volatile condition.

Until we see either a new all-time high indicating a continuing longer-term uptrend or a new low below the February and April low indicating a new downtrend, the above holds true.

With that said, this bull market in stocks is now over nine years old. It’s the second longest bull market on record. It’s the second most expensive stock market in history. Everything is impermanent. Nothing lasts forever.

It is essential to have active risk management in place to manage, direct, and control drawdowns to avoid substantial losses that can take many years to recover. Don’t wait until after the fact to make necessary changes.

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.

Sector Trends are Driving Equity Returns

Sector Trends are Driving Equity Returns

In Growth Stocks have Stronger Momentum than Value in 2018 I explained the divergence between the return of the two styles of Growth and Value. I suggest the real return driver between size and style is primarily the index or ETF sector exposure. To be sure, we’ll take a look inside.

As I said before, the reason I care about such divergence is when return streams spread out and become distinctive, we have more opportunity to carve out the parts we want from the piece I don’t. When a difference between price trends is present, it provides more opportunity to capture the positive trend and avoid the negative trend if it continues.

Continuing with the prior observation, I am going to use the same Morningstar size and style ETFs.

Recall the year-to-date price trends are distinctive. Large, mid, and small growth is notably exhibiting positive momentum over large, mid, and small value.

growth stock momentum over value morningtar small mid large cap

To understand how these factors interact, let’s look at their sector exposure. But first, let’s determine the sector relative momentum leaders and laggards for 2018.

The leaders are Consumer Discretionary (stocks like Netflix $NFLX and Amazon $AMZN), Information Technology (Nvidia $NVDA and Google $GOOG). In third place is Energy and then Healthcare. The laggards are Consumer Staples, Industrials, Materials, and Utilities, which are actually down for the year. Clearly, exposure to Consumer Discretionary and Information Technolgy and avoiding most of the rest would lead to more positive asymmetry.

sector trend returns 2018

Below we see strongest momentum Large Growth is heavily weighted (41%) in Technology. The second highest sector weight is Consumer Discretionary, and then Healthcare is third. Large-Cap Growth is the leader just because it has the most exposure in the top sectors.

iShares Morningstar Large-Cap Growth ETF

On the other hand, Large Value, which is down -3% YTD, has its main exposure in the lagging Financial and Consumer Staples sectors.

iShares Morningstar Large-Cap Value ETF

Dropping down to the Mid-Cap Growth style and size, similar to Large-Cap Growth, we see Information Technology and Healthcare are half of the ETFs exposure.

iShares Morningstar Mid-Cap Growth ETF

We are starting to see a trend here. Much like Large-Cap Value, the Mid-Cap Value has top holdings in Financials, Consumer Discretionary, and Utilities sectors.

 

iShares Morningstar Mid-Cap Value ETF

Can you guess the top sectors of Small-Cap Growth? Like both Large and Mid Growth, Small-Cap Growth top sector exposures are Information Technology, Healthcare, and Consumer Discretionary.

iShares Morningstar Small-Cap Growth ETF

And to no surprise, the Financial sector 26% of Small-Cap Value.

iShares Morningstar Small-Cap Value ETF

So, Information Technology, Healthcare, and most Consumer Discretionary tend to be more growth-oriented sectors. Financials, Consumer Staples, Utilities, Real Estate, that is, the higher yielding dividend paying types, tend to be classified as Value. Each sector has both Growth and Value stocks within them, but on average, some sectors tend to include more Growth stocks or more Value stocks.

Value stocks are generally defined as shares of undervalued companies with lower prospects for growth.

A growth stock has higher earnings per share and often trade at a higher multiple since the expectation of future earnings is high. Growth stocks usually don’t pay a dividend, as the company would prefer to reinvest retained earnings back into the company to grow.

The Information Technology sector includes companies that are engaged in the creation, storage, and exchange of digital information. The Information Technology sector offers potential exposure to growth with the emergence of cloud computing, mobile computing, and big data.

Another Growth sector is Consumer Discretionary sector manufactures things or provides services that people want but don’t necessarily need, such as high-definition televisions, new cars, and family vacations. Consumer Discretionary sector performance is closely tied to the strength of the overall economy. Consumer Discretionary tends to perform well at the beginning of a recovery when interest rates are low but can lag during economic slowdowns

The Health Care sector is a Growth sector involved in the production and delivery of medicine and health care-related goods and services. Healthcare companies typically have more stable demand, so they are less sensitive to the economic cycle, though it tends to perform best in the later stages of the economic cycle.

It turns out, the three primary Growth sectors that tend to best strongest at the late stage of an economic cycle have been the recent leaders.

Consumer Staples sector consists of companies that provide goods and services that people use on a daily basis, like food, clothing, or other personal products.

The Financial sector is businesses such as banking and brokerage, mortgage finance, and insurance which are sensitive to changes in the economy and interest rates. They tent to perform best at the beginning of a business cycle.

This is why I prefer to focus my U. S. equity exposure on sectors and maybe the strongest momentum stocks within those sectors. Many traditional asset allocations use style and size to get their exposure to the stock market, but as a tactical portfolio manager, I prefer to get more specific into the trending sectors and their individual stocks.

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.

 

 

 

 

 

Growth Stocks have Stronger Momentum than Value in 2018

Growth Stocks have Stronger Momentum than Value in 2018

After a sharp decline in stock prices in February that seemed to shock many investors who had become complacent, the stock market indexes have been trying to recover.

At this point, the popular S&P 500 has gained 1.75% year-to-date and the Dow Jones Industrial Average is down -2.56%. I also included the Total Stock Market ETF, which tracks an index that represents approximately 98% of the investable US equity market. Though it holds over five times more stocks than the 500 in the S&P 500 SPY, it is tracking it closely.

stock market index returns 2018 SPY DIA

The Dow Jones Industrial Average was the momentum leader last year, but the recent price action has driven it to converge with the other stock indexes. Past performance doesn’t always persist into the future.

Dow was momentum leader

What is more interesting, however, is the divergence at the size, style, and sector level.

The research firm Morningstar created the equity “Style Box.” The Morningstar Style Box is a nine-square grid that provides a graphical representation of the “investment style” of stocks and mutual funds. For stocks and stock funds, it classifies securities according to market capitalization (the vertical axis) and growth and value factors (the horizontal axis).

equity style box

  • The vertical axis of the style box graphs market capitalization and is divided into three company-size indicators: large, medium and small.
  • The horizontal axis seeks to represent stock funds/indexes by value, growth, and blend which represents a combination of both value and growth.

Looking at their distinct trends, we observe a material divergence this year. As we see below, the S&P 500 Growth Index ETF has gained 16.45% % over the past 12 months, which is triple the S&P 500 Value ETF. So, Growth is clearly exhibiting stronger momentum than value over the past year. But, notice that wasn’t the case before the February decline when Growth, Value, and Blend were all tracking close to each other.

 

Equity Style and Size Past 12 Months

Year to date, the divergence is more clear. Growth is positive, the blended S&P 500 stock index is flat, and Value is negative.

momentum growth stocks 2018

Showing only the price trend change over the period isn’t complete without observing the path it took to get there, so I’ve included the drawdown chart below. Here, we see these indexes declined about -10% to as much as -12% for the Value index.

The Value index declined the most, which requires more of a gain to make up for the decline. The Value ETF hasn’t recovered as well as the others.

To look even closer, we can get more specific into the style and size categories. Below we show the individual Morningstar ETFs that separate the stock market into the Large, Mid, and Small size stocks and then into Growth vs. Value.

All three at the top are Growth. The three at the bottom are Value. So, the divergence this year isn’t so much Large vs. Small cap, it’s Growth vs. Value.

Clearly, Growth stocks are leading the stock market so far in 2018.

Why do we care about such divergence?

When there exists more difference between price trends, it provides more opportunity to capture the positive direction and avoid the negative trend if it continues.

In part 2, we’ll discuss how sector exposure is the primary driver of style/size returns.

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.

Memorial Day 2018

Memorial Day is the Federal holiday to honor over 1 million who DIED serving in the U.S. military.

At 3 p.m., local time across the Nation, Americans will pause for the annual Moment of Remembrance to reflect on the sacrifice of America’s fallen warriors and the freedoms that unite Americans.

Semper Fidelis 

Is the economy, stupid?

Many investment professionals admit they are unable to “time the market.”

What is “market timing,” anyway? Wikipedia says:

Market timing is the strategy of making buy or sell decisions of financial assets (often stocks) by attempting to predict future market price movements. The prediction may be based on an outlook of market or economic conditions resulting from technical or fundamental analysis.

One reason they “can’t time the market” is they are looking at the wrong things. The first step in any endeavor to discover what may be true is to determine what isn’t. The first step in any endeavor to discover what may work is to determine what doesn’t.

For example, someone recently said:

“A bear market is always preceded by an economic recession.”

That is far from the truth…

The gray in the chart is recessions. These recessions were declared long after the fact and the new recovering expansion was declared after the fact.

The most recent recession:

“On December 1, 2008, the National Bureau of Economic Research (NBER) declared that the United States entered a recession in December 2007, citing employment and production figures as well as the third quarter decline in GDP.”

So, the economist didn’t declare the recession until December 1, 2008, though the recession started a year earlier.

In the meantime, the S&P 500 stock market index declined -48% as they waited.

While the recession officially lasted from December 2007 to June 2009, it took several years for the economy to recover to pre-crisis levels of employment and output.

The stock market was below it’s October 2007 high for nearly six years.

Economists declared the recession had ended in June 2009, only in hindsight do we know the stock market had bottomed on March 9, 2009. The chart below shows the 40% gain from the stock market low to the time they declared the recession over. But, they didn’t announce the recession ended in June 2009 until over a year later in September 2010.

Don’t forget for years afterward the fear the economy will enter a double-dip recession.

If you do believe some of us can predict a coming stock market decline or recession, it doesn’t seem it’s going to be based on the economy. Waiting for economics and economic indicators to put a time stamp on it doesn’t seem to have enough predictive ability to “time the market” to avoid a crash.

I suggest the directional price trend of the stock market itself is a better indicator of the economy, not the other way around. Then, some other signals begin to warn in advance like a shot across the bow.

But, for me, it’s my risk management systems and drawdown controls that make all the difference.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.

Global Market Trends

Looking at broad indexes for global macro trends, global stocks are flat for the year, bonds are down as much as 6%, commodities are recently trending up.

At this point, U.S. stocks continue to look like a normal “correction” within ongoing higher highs and higher lows (a bull market). In this case, a correction is just a countertrend of “mean reversion” that has “corrected” the prior upside overreaction.

What would change the trend? changing from a normal “correction” within ongoing higher highs and higher lows (a bull market) to lower lows and lower highs. In that scenario, it would be a change in the dominant trend.

Only time will tell how it all plays out.

 

Mike Shell is the founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

The is no guarantee that any strategy will meet its objective.  Past performance is no guarantee of future results. The observations shared are for general information only and are not intended to provide specific advice or recommendations for any individual.

Is this correction and volatility normal?

With perfect hindsight, we now all know that January 26th was the recent price peak in the U.S. stock market. Since then, the S&P 500 has declined about -10% and the Dow Jones Industrial Average about -12%. For simplicity, I’m going to focus on U.S. stock market here.

I wasn’t surprised to see the decline and am not surprised to see “more volatility,” because it would be getting back to “normal.”

But I see recent price action has sure gotten the attention of many on social media. Some even seem dazed and confused.

I’m not surprised about that, either.

On January 11, before stock market declined prices started swinging up and down (volatility), I shared an observation with my friends on Twitter and a warning:

On January 24th, I again warned of complacency. The message was clear:

At this point, this is a normal and expected “correction” of what was an upside overreaction in the prior months. The stock index has declined about -10%, regained some of the loss in March and more recently retested the February 8th low. As long as the lows hold, I consider this a normal correction.

stock market spx

Sure, the decline was sharp and fast, but that’s no surprise for me after such an upside move. I said it was “expected” because, as I pointed out above, 2017 was very abnormal because it lacked the typical -5% to -10% declines we normally see over most 12 month periods in the stock indexes.

Another way I define a “normal correction” is a simple trend line drawn under the price over the past 12 months. Without adding a lot of complicated looking indicators to express it, below we see the stock index has just “reverted to its trend.” The peak in December and January was an abnormal overreaction on the upside, which I pointed out as it was happening. The recent -10% decline has simply put the trend back in a more normal range.

stock market normal correction trend

What is normal, typical, or expected? 

I’m observing a lot of commentaries as if this correction and volatility isn’t normal.  The fact is, many people often include their emotions and feelings along with price action.

Investors perceive what they believe is driving a price trend and what they believe is always true for them.

The February decline was commonly blamed on “the machines,” which got a little silly.

This time, it’s geopolitics.

I believe it’s just the market, doing what it does, and there are so many drivers at the same time I don’t bother to attempt such a narrative. My narrative is simple; the force of sellers took control and outweighed the enthusiasm of buyers.  It is just the market, doing what it does.

I’ve been seeing and experiencing these trends so closely for so long and I remember the regime shifts. I want to share with you my observations of what have been “normal” corrections in terms of drawdowns. A drawdown is the % decline from a prior price high to its low. I show only the period of the past 9 years, which is one of the longest bull markets in history (without a -20% decline).

stock market historical bear market length drawdowns

As you can see, since April 2009, we’ve seen four declines of -15% or more and it took them several months to recover.

These declines of -15% or more are why many people have been unable to hold on to the stock market since the March 2009 low with any meaningful allocation to stocks. When prices fall -10%, investor sentiment shifts from greed to extreme fear. Some of them may even begin to tap out by selling their stock holdings for fear of more losses.

To be sure, here is an investor sentiment indicator at the February 8, 2018 low.

Investor sentiment Februrary 8 2018

In fact, investment managers like me who have dynamic risk management systems may even sell to reduce exposure to loss as an intentional drawdown control. But this time, as I pointed out, the stock market was already at risk of a reversal before this decline. So, a robust risk management system may have reduced exposure before the decline, not after.

We find that declines over -10% get more attention, especially when they get down to -15%. Those can also be more hostile conditions for trend systems, too, as risk management systems cause us to exit and later re-enter.

The point is, over the past 9 years a -15% decline has been a “normal” occurrence and there are many -5% (or more) declines too.

It is only at a -10%, so far, and that’s not unusual.

I intentionally used the last 9 years. Not to show an arbitrary 9 year period, but instead to intentionally leave off March 2009. I did that because the first three months of 2009 was a -24% decline, a continuation of the 2008 waterfall decline. The stock market was still in the bear market that began October 2007. So, this wouldn’t be complete without a reminder of what that period looked like before I go on to show the pre-2008 period.

All bear markets do necessarily begin with declines of  -10%, -15%, -20% . They are actually made of many swings up and down along the way. We often hear people speak of the last bear market as “2008” as though the only loss was the -37% decline in the S&P 500 in 2008.

That is far from reality.

The decline was -56%.

2008 stock market drawdown length of bear market

The drawdowns we’ve seen since 2008 are more than twice what we saw in the bull market from 2003 to 2008 after the “tech wreck.” Below we see the typical decline then was closer to -5% with only a few getting into the -7% or more range. 2004 to 2008 bull market low volatility

Clearly, it was a lot easier to hold a larger allocation of stocks, then.

What is normal and what has changed?

The last 9 years has been more hostile for passive asset allocation investors to hold on to their stock positions because the declines were -15% or so and take months to recover. It’s also been more challenging for active risk managers since a drawdown control system necessarily reduces exposure as prices fall with the intent to control drawdown.

But, to define what is normal today, a -10% to -15% decline is within a normal corrective drawdown.

The recent past matters simply because that’s what investors and traders anchor to. Most people put more emphasis on the recent past. Our experience and how much we’ve studied and observed the trends determine how much we can recall easily. I’ve been an investment manager most of my life, over two decades now. For me, it hasn’t been a hobby or part-time venture, it’s what I do and who I am. So, my memory of these trends and intuitions about what is normal, or not, is what it is.

If you are wondering, here are the drawdowns for the S&P 500 going back about 70 years. I highlighted the -15% declines or more, which obviously gets investors attention.

stock market bear market length and dradowns

Clearly, there are a lot of -15% or greater declines. In fact, there are several -30% and three in the -45% or larger drawdowns.

Knowing this, it’s why I say:

We believe world markets require active risk management to avoid large losses and directional trend systems to position capital in profitable price trends.

And, I also say:

It doesn’t matter how much the return is if the downside risk is so high you tap out before it’s achieved.

But at this point, you can probably see that the current -10% decline is so far within a “normal correction.”

Though, as I shared in The enthusiasm to sell overwhelmed the desire to buy March 19, 2018, I expect to see more swings (volatility) than last year, and that would be “normal” too.

I define this as a non-trending market. When I factor in how the range of price movement has spread out more than double what it was, I call it a non-trending volatile condition.

Markets decline to a low enough point to attract buying demand. Only time will tell how it all plays out from here.

If you enjoyed this, I encourage you to read “What About the Stock Market Has Changed? A Look at Ten Years of Volatility” 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.

 

What’s going to happen next? continued

The stock market is getting a lot of attention this past week since the global stock market indexes were down as much as -4% for the MSCI EAFE Developed Countries index to the most significant decliner in the U.S. was the NASDAQ (represented below by PowerShares QQQ), which declined over -7%.

I said in What’s going to happen next? on Friday, the most important factor is the stock index is near its prior low in February when it declined -10% sharply. To reemphasize the rest of what I said:

“By my measures, it’s also reached the point of short-term oversold and at the lower price range that I consider is within a “normal” correction.

I know many traders and investors were expecting to see a retest of that low and now they have it. So, I expect to see buying interest next week. If not, look out below… who knows how low it will need to go to attract buying demand.”

As expected, so far today stocks have indeed found some buying demand at the prior low as we see in the chart below. As I suggested, this second low could bring in buyers who were waiting for this retest of the low in February.

Only time will tell how much buying enthusiasm we see from here. It could be enough to eventually drive prices to new highs, and this -10% correction forms a “W” pattern and the correction quickly forgotten.

Or, the buying interest we see now may not be enough to continue a sustainable upward trend.

Ultimately, the price trend of our individual positions is the final arbiter. My decisions are made based on what the price trend is actually doing.

But, I have other quantitative and technical measures that can be a useful guide to update expectations as trends unfold. I look at these trends because I enjoy it and share my observations, so you get a glimpse of how I see trends unfold over time.

This could change any moment, but at this point, I see today’s gains are relatively broad as all the U.S. sectors are positive with Financials, Consumer Discretion, and Technology leading the way. Past performance does not guarantee future results, but Sector strength in the more cyclical Financials, Consumer Discretionary, and Technology leading the way is a good sign.

Getting more technical and quantitative,  I want to update the breadth indicators I shared at the lows on February 9th in Stock Market Analysis of the S&P 500 

At the lows, in February I pointed out the % of stocks in the S&P 500 had shifted from what I consider the “Higher Risk Zone” to the “Lower Risk Zone.” Though that could have been the early stage of a bear market because it could have got much worse, but those stocks instead reversed up from that point. Last weeks downtrend pushed them even deeper in what I consider the “Lower Risk Zone.”

S&P 500 STOCKS BULLISH PERCENT ABOVE MOVING AVERAGE

As we see in the chart above, half of the 500 stocks in the S&P 500 stock index are trending below their own 200 day moving average and half are trending above it. I used the Point & Figure method to clearly express the % of stocks in the S&P 500 that are above their 200 day moving average.

If you think about how long 200 trading days is, it’s about 10 months. If a price is trading above its moving average, it’s considered to be in a positive trend, if it’s trending below the average it is trending down. My trend signals are generated from more robust proprietary systems, so I do not trade using this moving average, but it can be a simple guide to illustrate a trend.

To be precise, at the February low 56% of the 500 stocks were trading in a positive trend after they had reached what I consider a “Higher Risk Zone” in January when most of the stocks, 82%, were in a positive trend. After many stocks trended down, they reversed up to the point that 71% were above their 200-day average during the countertrend. Now that prices have fallen again, even more stocks are in a downtrend.

It may seem a contradiction for this to be potentially bullish because it shows half the stocks have been trending down (and it is), but I’ve been observing this indicator for two decades and what I see in the most simple terms is:

  • When most stocks had already trended up as they had in January when 82% were in positive trends, we are likely to see a countertrend and mean reversion at some point.
  • When most stocks have already trended down to negative trends, we are likely to see a countertrend and mean reversion.

Guess what mean reversion is?

About halfway…

For those who aren’t as mathematically inclined, that would be the 50-yard line. The 50% on the chart above…

Now, keep in mind, it’s only at 51% down from 82% in January. It could go to 5 or 10%, which would take a significant decline from here. But, so far, the ball is on the 50. Which end zone it reaches next will depend on who is stronger; the buyers or the sellers.

If you want more detail and to better understand where I am coming from, revisit what I wrote in February: Stock Market Analysis of the S&P 500.

Risk management is the common characteristic among all the best traders/investors who have lasted over the many significant up and down market cycles of the past decades. I decided I was going to be one of them over two decades ago. No matter how you choose what and when to buy, it is essential to control the size of your potential loss. If you want to learn what I mean by that, read the previous ten or twenty observations I’ve shared here. This is not individual investment advice. The only individuals who get our advice are clients who have an investment management agreement with us. If you have any questions, contact us.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The is no guarantee that any strategy will meet its objective.  Past performance is no guarantee of future results. The observations shared are for general information only and are not intended to provide specific advice or recommendations for any individual.

 

What’s going to happen next?

S&P 500 has declined to the 200-day moving average. I don’t trade the moving average, but include it as a reference for the chart. More importantly, the stock index is also near its low in February.

By my measures, it’s also reached the point of short-term oversold and at the lower price range that I consider is within a “normal” correction.

I know many traders and investors were expecting to see a retest of that low and now they have it. So, I expect to see buying interest next week. If not, look out below… who knows how low it will need to go to attract buying demand.

 

Mike Shell is the founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right.

The is no guarantee that any strategy will meet its objective.  Past performance is no guarantee of future results. The observations shared are for general information only and are not intended to provide specific advice or recommendations for any individual.

Apparently there was more enthusiasm to sell

The U. S. stock market as measured by the S&P 500 declined -2.57%.

The shorter-term investor sentiment measures suggest fear is driving the stock market. That may be a positive signal since investor sentiment gets it wrong at extremes.

I don’t have anything more to share beyond what I wrote earlier this week, which I have reprinted below:

My systems define this as a non-trending market. When I factor in how the range of price movement has spread out more than double what it was, I call it a non-trending volatile condition. It is useful for me to identify the market regime because different trend systems have different results based on the situation. For example, non-trending volatile market conditions can be hostile situations for both passive and trend following strategies. However, countertrend systems like the swings of a non-trending volatile market.

Trend following systems thrive in markets that are trending and smooth. When a market is trending and smooth, the trend following system can earn gains without having to deal with significant adverse price action. When a market trend shifts to non-trending and volatile, the trend following signals can result in whipsaws. A whipsaw is when the price was moving in one direction (and the trend follower buys) but then quickly reverses in the opposite direction (and maybe the trend follower exits with a loss). Even if the trend following system doesn’t enter and exit with a loss, in a non-trending volatile market the trend follower has to deal with the same hostile conditions as a passive investor as the market swings up and down.

My U. S. equity exposure since early February has come from my shorter term countertrend systems. My focus and the focus of my systems isn’t to predict the direction of markets but instead to identify when a market is undergoing a regime change or shifts to a distinct environment. I don’t analyze the markets to try to predict what it will do next. I look at what the market is actually doing and react to it.

 

Mike Shell is the founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter @MikeWShell

The is no guarantee that any strategy will meet its objective.  Past performance is no guarantee of future results.

 

 

The enthusiasm to sell overwhelmed the desire to buy March 19, 2018

The enthusiasm to sell overwhelmed the desire to buy. The S&P 500 stock index closed down -1.42% today. Stocks trended down most of the day and at 2:35pm it was down -2%. As you can see on the chart, it reversed up in the last 90 minutes and closed with positive directional movement. It almost closed above its Volume Weighted Average Price (VWAP).

There are many notable economic reports out this week, so maybe investors are concerned about to the jobs report and the Fed FOMC Meeting. The options market has priced in a 94% chance of a rate hike, so it shouldn’t be a surprise. But, this week is the first FOMC meeting for the new Chairman Powell.

Implied volatility in recent weeks is one of many signals that suggest a volatility regime change. The CBOE Volatility Index® (VIX® Index®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. The VIX® doesn’t seem to want to go back to those prior low levels, so the expectation is higher volatlity.

At this point, the decline today was nothing too abnormal. The stock index is -3.% off it’s high a few weeks ago and -5.4% off its all-time high. However, as you can see below it is within a normal trading range. Speaking of trading range, notice the bands of realized volatility I added to the chart are drifting sideways rather than trending up or down. I see higher lows, but equal highs in the most recent trend and lower highs looking back to January. The VIX is expected volatility, the blue bands are realized volatility.

My systems define this as a non-trending market. When I factor in how the range of price movement has spread out more than double what it was, I call it a non-trending volatile condition. It is useful for me to identify the market regime because different trend systems have different results based on the situation. For example, non-trending volatile market conditions can be hostile situations for both passive and trend following strategies. However, countertrend systems like the swings of a non-trending volatile market.

Trend following systems thrive in markets that are trending and smooth. When a market is trending and smooth, the trend following system can earn gains without having to deal with significant adverse price action. When a market trend shifts to non-trending and volatile, the trend following signals can result in whipsaws. A whipsaw is when the price was moving in one direction (and the trend follower buys) but then quickly reverses in the opposite direction (and maybe the trend follower exits with a loss). Even if the trend following system doesn’t enter and exit with a loss, in a non-trending volatile market the trend follower has to deal with the same hostile conditions as a passive investor as the market swings up and down.

My U. S. equity exposure since early February has come from my shorter term countertrend systems. My focus and the focus of my systems isn’t to predict the direction of markets but instead to identify when a market is undergoing a regime change or shifts to a distinct environment. I don’t analyze the markets to try to predict what it will do next. I look at what the market is actually doing and react to it.

 

Mike Shell is the founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter @MikeWShell

The is no guarantee that any strategy will meet its objective.  Past performance is no guarantee of future results.

 

When I apply different trend systems to ETFs

In my portfolio management, I primarily want to identify trends and get positioned with that trend. As long as there is uncertainty, we’ll see trends. Investor sentiment and expectations underreact to information causing the price to adjust gradually and that’s what produces a trend. The trend following systems I wrote about in My Introduction to Trend Following are designed to buy an asset when its price trend goes up, and sell when its trend goes down, expecting price movements to continue.

We also see the overreaction of investor sentiment and their expectations. After price keeps rising, investors may become overly enthusiastic, which causes prices to overreact and move up to an extreme that matches their sentiment. We saw that the last part of 2017 and it continued in January. We say these markets have become “overbought” and mathematical indicators can signal a countertrend.

We also sometimes see investor sentiment and their expectations plunge as they panic when prices are falling. We say these markets have become “oversold” and mathematical indicators can signal a countertrend. Looking back over the past two months, we may have seen an overreaction on the upside, then an overreaction on the downside. I say that because the stock market very quickly dropped -10%, then recovered most of it a few weeks later.

Someone asked recently “Do you invest and trade in all ETFs and stocks using the same trend system?” The answer is “not necessarily.” As I described above, trend following and countertrend systems are very different. Trend following systems can be multiple time frames, but usually longer trends of at least several months to years. Countertrend moves are normally shorter term as a market may get overbought or oversold, but it doesn’t usually stay that way a long time. For example, the S&P 500 was overbought the last few months of 2017 and that was an anomaly. It was one of the most overbought periods we’ve seen in the stock indexes. So, it was no surprise to see a fast -10% decline.

My point is, different trend systems can be applied to markets. Both trend following and countertrend are trend systems, they just intend to capitalize on a different trend in behavior – overreaction or underreaction.

When I apply my countertrend systems to markets, a great illustration is the high dividend yield market. A great example is the Global X SuperDividend® ETF $SDIV which invests in 100 of the highest dividend yielding equity securities in the world.

Below is a price chart in blue and it’s dividend yield in orange over the past five years. As you can see, the price trend and dividend yield have an inverse correlation. As the price goes up, the dividend yield from that starting point goes down. That is, if we invest in it at higher prices, the dividend yield would have been lower. But, as the price goes down, the dividend yield from that starting point goes up. If we invest in it at lower prices, our future income from dividend yield is higher.

 

For example, I highlighted in green the price was at its low when the yield was also at its highest at 8%. Investors who bought at the lower price earn the higher yield going forward (assuming the stocks in the index continue paying their dividend yields). If we invested in it in 2014 the yield was 6%. High yielding stocks are not without risks. High yielding stocks are often speculative, high-risk investments. These companies can be paying out more than they can support and may reduce their dividends or stop paying dividends at any time, which could have a material adverse effect on the stock price of these companies and the ETFs performance. You can probably see how an ETF that includes 100 of these stocks may be more attractive to gain exposure rather than risking a few individually.

This is an example of when we may use a countertrend system. As I am more inclined to invest in positive trends, this is an example of a situation I may be more willing to buy low. But, I always focus on Total Return. All of my systems include Total Return data that includes the dividend yield, not just the price trend. So as I explain this, keep in mind we still apply my risk management and trend systems but we consider and account for the high yield that makes up its total return.

Below is a chart of the Global X SuperDividend® ETF $SDIV from the low point in 2016 (I highlighted in green above). I charted both the price trend by itself as well as the Total Return which includes dividends. Had someone invested in it at the low, we saw above their yield would be 8% and the impact is evident in the difference. With the dividend yield included, the return was 36% and 18% without it. In other words, the dividend was half the return over this period. The higher the dividend yield at the point of entry, the more it can have an impact on Total Return.

As a special note for our investment management clients who are invested in ASYMMETRY® Global Tactical. We do not reinvest dividends. Instead, we want the cash dividends to go into the cash portion of our portfolio. Since we usually have some positions that generate a monthly yield, it provides the cash balance we need to cover any slippage between trades, investment management costs, as well as provide cash for other investments. I mention this, because any position we hold like this with a high yield may not appear to have as large of a percentage gain since it only represents the price return, not the total return. That is simply because we are using the cash instead of reinvesting the dividends.

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.

 

 

My Introduction to Trend Following

I have noticed more investors are talking about “trend following” these days and more traders and advisors are calling themselves trend followers. As a professional portfolio manager who has been applying trend systems to global markets for two decades, one of the most common questions I get asked is “how did you get started?” Specifically, how my investment strategy, risk management, and trend systems evolved over time. I’ll explain it here, so you know where I am coming from.

Why do you think we learn math by hand before using a machine? We learn to do the math manually because it teaches us the basics before we use a computer. We learn to ask the right questions, turn problems into math formulas, then do the calculations. By working it out manually by hand, we get a feel for the math, an instinct for it. I learned trend following the same way.

What is trend following?

Trend following or trend trading is a trading strategy according to which one should buy an asset when its price trend goes up, and sell when its trend goes down, expecting price movements to continue.”

My first introduction to the term “trend following” was John Murphy‘s Technical Analysis of the Financial Markets: A Comprehensive Guide to Trading Methods and Applications published by New York Institute of Finance in 1999. It was the first book I read clearly dedicated to charting price trends and technical analysis.

In the early 1990’s the first book I read on investment and trading was How to Make Money in Stocks: A Winning System in Good Times and Bad by William J. O’Neil. He described a systematic quantitative approach to screen for stocks with high relative price strength, high earnings growth, and then determine the entry and exit viewing a price chart. O’Neil’s research discovered the best stocks display seven common traits just before they make their biggest gains.  O’Neil calls his strategy the CAN SLIM® Investment System. The CAN SLIM® system for deciding what to buy is based on things like strong earnings growth, which is believed to be the primary driver of a stocks price trend. Once he has screened for this criteria, O’Neil applies trend following to stocks because he requires them to be in a positive trend.

After researching and applying his investment system for years in the late 1990’s, I wanted to create my own system that fit me.  My first interest was to become more advanced in the understanding and identifying directional price trends. Naturally, that was the beginning of my extensive research that began with studying every book I could find on technical analysis and doing every training program I could do.

I went on to read over 500 books covering a broad range of portfolio management topics including trading, technical analysis, and maths like probability and statistics. I wanted to understand how markets interact with each other, what typically drives trends, and what trends look like. Studying price trends naturally led me to investigate investor sentiment, trading psychology, and investor psychology. I have always had a strong interest in math and I think in terms of systems and algorithms, so fifteen years ago I shifted from looking at charts visually to testing and developing trading systems based on price trends.

By 2006, I had already begun testing and developing quantitative computerized trading systems, but I was still also working on the craft of charting and CAN SLIM®. In 2006, I flew out to Santa Monica, CA to attend the first CAN SLIM® Masters Program training with O’Neil and his portfolio managers and passed the exam for the CAN SLIM® Masters certification. I also had become skilled at all kinds of charting including bar charts, point & figure charting, and candlestick charting. I believe becoming a craftsman at all of these different methods provided me with unique skills to understand price trends, how markets interact, and developing computerized trading systems.

I have spent over two decades fully immersed in learning about methods of identifying trends and systems and how to trade them across multiple time frames and multiple markets. My own experience started with basic charting, evolved with more technical analysis tools, then I developed computerized trading systems based on the knowledge and skills I cultivated. Reading books (or writing them) only discovers knowledge. The only way to develop skill is through the intentional practice of actually doing it.

Before I share one of the first things I read on trend following, I want to explain there is more than one way to execute a trend system.  Whether you are an investor who invests in an investment program or a trader who makes the portfolio management decisions in an investment program, you have to choose which fits you and your own beliefs. I can only tell you what I believe. What you believe is true, for you. As I have been successful doing what I do, I can only tell you that the key to success if finding what fits you. Reading information like this is intended to help you decide what you believe and what you don’t believe.

I see tactical traders applying two main methods for trend following. Some of them say they are “rules-based” others say they are “systematic”, but we don’t often see them say they are “discretionary” even if they are. Here is how I see it.

Discretionary trend following trading and investment decisions can include a wide range of operations, but I’m specifically talking about a discretionary trend follower. A discretionary trend follower is someone who looks at a chart, sees the signal, sees that it looks right, and pulls the trigger. The discretionary trend follower may be rules-based and may have a systematic process, but the discretionary trend follower is ultimately making the decision to buy or sell.

Systematic trend following trading and investment decisions apply a set of rules and procedures for trading and investment decisions. To me, a trend follower can be systematic but also be discretionary. A systematic “discretionary” trend follower may be still discretionary but has rules and a process. For example, they look at a chart, see the signal, see that it looks right, and pulls the trigger. Or, a trend follower can be systematic and automated by a computerized trading system that generates the signals. However, when the professional investment industry says “systematic trading” or “systematic trend following” we usually mean more automated and mechanical.

Automated Systematic trend following is necessarily systematic because it’s when we use a computer program to generate the signals automatically. But, a fully systematic trend follower who is automated has a program that not only generates a trend following signal but also generates trade instructions to the broker. A fully mechanical and automated trend following system is computerized to the point that it enters the trades.

I explained these operational methods so you will know where I am coming from as you read about trend following in a technical analysis book. Which of these you believe in is up to you. I believe that either discretionary trend following or systematic with automation can both work. It’s just a matter of which method fits you. There are potential advantages and disadvantages of both and depending on your personal preference, you’ll see them that way. If you are an investor in an investment program, you need to invest with a portfolio manager that fits your preference. If you are a trend following trader, you may lean toward one or the other.

Some traders simply like looking at charts and making their decision that way. They need to see the signal and see that it looks right according to their rules to get the confidence to execute. Others may not be so skilled at seeing the signal on a chart, or maybe they don’t want to spend their time doing it so we can program a computerized system. It seems many new systematic traders weren’t good at discretionary decisions using charts, so their backtesting makes them feel more confident. Only time will tell if these newer systematic traders will be able to follow their automated systems when they invariably don’t perform as they hoped all the time.

Ultimately, it comes down to beliefs and confidence. If you aren’t confident in your ability to see the signal and execute from a chart consistently, then an automated system may help. Some trend followers gain more confidence seeing the signal and pulling the trigger. Those same trend followers would likely have difficulty executing system generated trades.

I often hear things like “our systematic model removes the emotion”, which is far from the truth. Anyone who believes an automated system will remove their emotional issues will eventually experience a whole new set of emotions they may not have felt yet. But, some have a real problem with pulling the trigger, so an automated system may help if they have someone else execute the trades. For example, a professional money management firm like mine has professional traders who execute our trades. But, this still doesn’t assure anyone the trend follower will be able to follow the system through different market conditions.

If someone lacks the self-discipline required to pull the trigger, execute the trades, and follow whatever systems they follow, no method or automation will help. If a trader or investor lacks self-discipline, that issue has to be resolved another way before they’ll find success.

I know at least 100 or so professional investment managers who have been tactical trading including trend following for a decade or a few decades. I’ve seen a range of experiences and outcomes. I can tell you that it isn’t easy. The only people who will say it is are those who aren’t actually doing it. Developing an edge either personally as a discretionary trader or through an automated trading system requires a tremendous amount of knowledge, skills, and self-discipline. Few have it, but some of us do. I believe in human performance because I’ve experienced it first hand. It’s like hockey or Indy racing. Anyone can attempt it, but only the most dedicated will achieve long-term success. Rest assured, discretionary or systematic, it’s still a human endeavor as long as it’s their money.

By now, you may be wondering what I believe and what I do. I do a combination of these. I am Man + Machine. I started charting over two decades ago and applied what I knew to developing computerized systems fifteen years ago. I still enjoy drawing charts like I share here on ASYMMETRY® Observations to see how trends are unfolding. I have several systems that are fully automated that trade all kinds of markets. I’ve learned a lot from just operating them for so long. But ultimately, I use my systems to inform decisions and generate signals and I have the necessary discipline to pull the trigger by sending instructions to my professional traders who execute my trades. That’s what works for me. What works for others may be different. I know where I am sitting right now and it’s where I want to be.

Without further ado, I present one of the first things I read on trend following published in 1999. As you will see, trend following and technical analysis are related. Trend following uses technical indicators like trend lines, moving averages, directional movement, and momentum to generate signals for following trends.

John Murphy is a well-known technical analyst whose books I have read for over two decades. His first book I read was Technical Analysis of the Futures Markets published in 1986 which was charting applied to commodities futures. One of my first introductions to the “trend following” strategy was John Murphy’s Technical Analysis of the Financial Markets published in 1999. I share the following with permission from John Murphy. He starts with the philosophy or rationale of technical analysis, which has an objective of following trends in hopes they will continue. The rest of the book describes many ways to actually identify trends.

Except from Technical Analysis of the Financial Markets:

_______________________

There are three premises on which the technical approach is based:

  • Market action discounts everything.
  • Prices move in trends.
  • History repeats itself.

The statement “market action discounts everything” forms what is probably the cornerstone of technical analysis. Unless the full significance of this first premise is fully understood and accepted, nothing else that follows makes much sense. The technician believes that anything that can possibly affect the price— fundamentally, politically, psychologically, or otherwise— is actually reflected in the price of that market. It follows, therefore, that a study of price action is all that is required.

All the technician is really claiming is that price action should reflect shifts in supply and demand. If demand exceeds supply, prices should rise. If supply exceeds demand, prices should fall.

The technician then turns this statement around to arrive at the conclusion that if prices are rising, for whatever the specific reasons, demand must exceed supply and the fundamentals must be bullish. If prices fall, the fundamentals must be bearish.

Most technicians would probably agree that it is the underlying forces of supply and demand, the economic fundamentals of a market, that cause bull and bear markets. The charts do not in themselves cause markets to move up or down. They simply reflect the bullish or bearish psychology of the marketplace.

As a rule, chartists do not concern themselves with the reasons why prices rise or fall. Very often, in the early stages of a price trend or at critical turning points, no one seems to know exactly why a market is performing a certain way.

While the technical approach may sometimes seem overly simplistic in its claims, the logic behind this first premise— that markets discount everything— becomes more compelling the more market experience one gains.

It follows then that if everything that affects market price is ultimately reflected in market price, then the study of that market price is all that is necessary.

By studying price charts and a host of supporting technical indicators, the chartist in effect lets the market tell him or her which way it is most likely to go. The chartist does not necessarily try to outsmart or outguess the market.

All of the technical tools discussed later on are simply techniques used to aid the chartist in the process of studying market action.

The chartist knows there are reasons why markets go up or down. He or she just doesn’t believe that knowing what those reasons are is necessary in the forecasting process.

Prices Move in Trends

The concept of trend is absolutely essential to the technical approach. Here again, unless one accepts the premise that markets do in fact trend, there’s no point in reading any further.

The whole purpose of charting the price action of a market is to identify trends in early stages of their development for the purpose of trading in the direction of those trends. In fact, most of the techniques used in this approach are trend following in nature, meaning that their intent is to identify and follow existing trends.

There is a corollary to the premise that prices move in trends— a trend in motion is more likely to continue than to reverse. This corollary is, of course, an adaptation of Newton’s first law of motion. Another way to state this corollary is that a trend in motion will continue in the same direction until it reverses.

This is another one of those technical claims that seems almost circular. But the entire trend following approach is predicated on riding an existing trend until it shows signs of reversing.

__________________________

He explained the philosophy or rationale of technical analysis, which has an objective of following trends in hopes they will continue. The rest of the book describes many ways to actually identify trends. As I see it, trend following uses technical indicators to generate signals for following trends.

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.

Asymmetric force was with the buyers

In Asymmetric force direction and size determines a trend, I explained how the net force of all the forces acting on a trend is the force that determines the direction. The force must be asymmetric as to direction and size to change the price and drive a directional trend.

The asymmetric force was with buyers as they dominated the directional trend on Friday.

Friday’s gain helped to push the stock market to a strong week and every sector gained.

The S&P 500 stock index is about -3% from it’s January high and closed slightly above the prior high last week. I consider this a short-term uptrend that will resume it’s longer-term uptrend if it can break into a new high above the January peak.

After declining sharply -10% to -12%, global equity markets are recovering. The good news for U.S. stocks is the Russell 2000 small company index is closest to its prior high. Small company leadership is considered bullish because it suggests equity investors are taking a risk on the smaller more nimble stocks.

As you can see in the chart, the Dow Jones Industrial Average and International Developed Countries (MSCI EAFE Europe, Australasia and Far East) are lagging so far off their lows but still recovering.

So far, so good, but only time will tell if these markets can exceed their old highs and breakout into new highs, or if they discover some resistance force at those levels and reverse back down. As we discussed in Asymmetric force direction and size determines a trend it’s going to depend on the direction and size of the buyers vs. sellers.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.

Asymmetric force direction and size determines trend

In physical science, force is used to describe the motion of a push or pull. Newton’s first law of motion – sometimes referred to as the law of inertia. Newton’s first law of motion is stated as:

“An object at rest stays at rest and an object in motion stays in motion with the same speed and in the same direction unless acted upon by an unbalanced force.” —Newton’s First Law of Motion

Unbalanced force? well well, there’s another asymmetry.

A push or pull is a force. To define a force, we must know its direction and size. It works similar to supply and demand on market prices. If there is enough size in a direction, a price will move in that direction. If there isn’t enough price size in a direction, the price will stay the same.

There are two kinds of forces:

Symmetrical (balanced) forces are equal in size, but opposite in direction. Symmetric forces are balanced, so they lack the direction and size to cause a change a motion. The push and pull are equal and offsets each other. Applying the concept of force to price trends in the market, when balanced forces act on a market price at rest, the market price will not move. When buying enthusiasm and selling pressure are the same, the price will stay the same.

Asymmetrical (unbalanced) forces are not equal and are opposite in direction, so they cause a change in the motion. The size of one directional force is greater than the other, so it’s going to trend in that direction. Some examples of these unbalanced forces can be observed in physical science.

More than one force can be acting at the same time, so the forces are combined into the net force. The net force is the combination of all the forces acting on a trend. The net force determines the direction. If forces are trending in opposite directions, then the net force is the difference between the forces, and it will trend in the direction of the larger force. You can probably see how that is visible in a chart of a price trend.

If buyers are willing to buy more than sellers are willing to sell, the buying pressure is a force that forces up the price until it gets high enough to push sellers to sell.

If sellers are ready to sell more than buyers are willing to buy, the selling pressure is a force that pulls down the price until it gets low enough to pull in buyers to buy.

So, Newton’s first law of motion and inertia is related to Economics 101: When the size of the force of buyers or sellers is larger in one direction, the price will trend. We can observe who is more dominant by simply looking at a price trend chart or quantifying it in a trading system.

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

Investment results are probabilistic, never a sure thing. Past performance is no guarantee of future results.

 

 

Betting on price momentum

“Don’t fight the tape.”

“Make the trend your friend.”

“Cut your losses and let your winners run.”

“These Wall Street maxims all mean the same thing—bet on price momentum. Of all the beliefs on Wall Street, price momentum makes efficient market theorists howl the loudest. The defining principle of their theory is that you cannot use past prices to predict future prices. A stock may triple in a year, but according to efficient market theory, that will not affect next year. Efficient market theorists also hate price momentum because it is independent of all accounting variables. If buying winning stocks works, then stock prices have “memories” and carry useful information about the future direction of a stock.”

James O’Shaughnessy, What Works on Wall Street: A Guide to the Best-Performing Investment Strategies of All Time 1st Edition (1996) 

 

Investment management can take many years of cycles and regimes to understand an edge.

It takes at minimum a full market cycle including both bull/bear markets to declare an edge in an investment management track record.

But we also have different regimes. For example, each bull market can be different as they are driven by unique return drivers. Some are more inflationary from real economic expansion driving up prices. Others are driven by external manipulation, like the Fed intervention.

I’ve been managing ASYMMETRY® Global Tactical for fourteen years. It’s an unconstrained, flexible, adaptable, go-anywhere global tactical program without the limitations of a fixed benchmark. I pursue absolute returns applying dynamic risk management and unconstrained tactical trading decisions across a broad universe of global currency, bonds, stocks, and commodities.

So, I can tell you the bull market 2003-07 was a regime of rising commodities, foreign currency, and international producers of commodities. In this bull market, U.S. equities have dominated. We can see that in the chart below. If your exposure up until 2008 was only U.S. stocks, you would be disappointed as Emerging Markets countries like China and Brazil were much stronger as was commodities. We can also see how those markets have lagged since the low in 2009.

Everything is impermanent, nothing lasts forever, so this too shall change eventually.  Those who believe the next decade will be like the past do not understand the starting point matters, the return drivers, and how markets interact with each other. Past performance is never a guarantee of future results.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

Investment results are probabilistic, never a sure thing. Past performance is no guarantee of future results.

 

Stock pickers market? Sector rotation with stocks for asymmetric reward to risk

After yesterdays 1.1% gain for the S&P 500, it is back in positive territory for the year. It’s been a very volatile start for 2018 with an abnormally strong trend in U.S. stocks late 2017 continued in January only to be wiped out in February. Below is a visual representation, showing the period November 2017 to the low last month. I point that out to show how quickly a trend can change and prior gains of 12% in just a three-month time frame and be erased in a -10% decline over 9 days. Most of the decline was in two days over that period.

With that said, as the broad stock market is lagging in its third month of the year so far, two sectors are leading. Consumer Discretionary (XLY)  and Technology (XLK). At Shell Capital, we monitor global market trends at the broad market level like the S&P 500 which is diversified across 500 stocks that are a part of 10 sectors. These sectors are tradable via ETFs. We can quickly get broad exposure to the overall stock market, or we can get more granular and get exposure to a sector in a low-cost structure with Sector ETFs.  I also monitor the individual stocks inside the sector ETF. When the overall market is in a positive trend, most of the stocks in a sector should be trending up. But, when the overall market has struggled to trend up, like this year-to-date, fewer stocks are trending up inside a sector.

The popular narrative becomes “it’s a stock pickers market.”

I don’t say that myself, I just observe when it is “a stock pickers market” naturally through my daily quantitative research. Here are some examples of my observation.

I pointed out yesterday in Buying demand dominated selling pressure in the stock market that only 32% of the 500 stocks in the S&P 500 are above their 50-day moving average. After yesterdays stock market gain, the participation increased to 40%. The 50-day moving average is a short-term trend indicator, so if 60% of the stocks are below that trend line, we can infer “most stocks are in short-term downtrends.” As of yesterdays close, only 203 (40%) of the S&P 500 are above their 50-day moving average, which means 297 are below it. You can probably see if the price trend continues up, we should see more and more stocks participate in the trend. In fact, if we don’t see more stocks participate, it necessarily means only a few stocks are driving the broad index trend up. I would consider that “a stock pickers market.” Of course, the trick is to see this in advance, or early enough in the stage to capitalize on it. We don’t have to know in advance what’s going to happen next, and we don’t, we just need to observe it soon enough to capture some positive asymmetry (P>L).

I like a visual representation, so here is the chart of the S&P 500 Percent of Stocks Above 50 Day Moving Average. I colored the top part of the chart red and labeled it “Higher Risk Zone” and the lower part green with the label “Lower Risk Zone”. The observation is when 80% of stocks are already trending positive that momentum is a good thing, but as a skilled risk manager, I begin to prepare for change. After most stocks are already trending up, the stock market has been trending up, so a skilled risk manager prepares for a countertrend reversal that is inevitable at some point. As I shared in my observation near the low, Stock Market Analysis of the S&P 500  when nearly all the stocks were already in negative trends as a skilled risk-taker, I look for that to reverse, too.

 

This is only a small glimpse at what I look at for illustration purposes to make the point how I can quantify a “stock pickers market.” After 83% of stocks were already in downtrends I shifted from a risk manager stance to risk-taker mode looking. That is, shifting from a reversal down in January after prices had already trended up to an extreme, to preparing for the decline to end after the stock index quickly dropped -10% and my many indicators were signaling me when and where to pay attention. I shared this to represent that I was not surprised to see certain stocks lead a trend direction when so many had shifted from positive trends to negative trends in a short-term time frame.

This leads me to my main point, which is very simple. A simple way to observe a “stock pickers market” is to see that certain stocks are leading the trend. Because so may stocks were in short-term downtrends, it isn’t a surprise to see a few strong relative strength leaders inside a sector. For example, in the Sector ETF performance table below, two leading sectors are Consumer Discretionary (XLY)  and Technology (XLK). They are up about 6-7% as the broad stock index is up 1.77%. Let’s see what is driving their stronger relative momentum.

Looking inside the Sector for the Leading Stocks 

Reviewing the holdings of the Consumer Discretionary $XLY ETF,  Amazon.com Inc $AMZN is 20.69% of the Consumer Discretionary Sector and has gained +30.28% for the year. A 20% weighting of a stock that has gained 30% results in a 6% contribution to the portfolio return. That is, this one large position has contributed 100% of the sectors return year-to-date. There are 84 stocks in the ETF. This doesn’t mean the other 83 stocks are flat with no price change. Instead, some of them were also positive for the year and some are negative. So far this year, they have offset each other. Some stocks in the sector have gained more than Amazon, but it makes the simple example because it’s exposure is the largest at 20%. Netflix $NFLX, for example, is the sector ETFs biggest gainer up 64%, but it’s 4.63% of the portfolio. However, because it’s gain is so strong this year its contribution at the portfolio level is still significant at 3% of the 5.66% YTD gain in the sector ETF. That is an extreme example. Why is it extreme? Let’s look at price charts of the year-to-date price trend, then the drawdown, which expresses the ASYMMETRY® ratio. The ASYMMETRY® ratio is a ratio between profit and loss, upside vs. downside, or drawdown vs. total return.

First, we observe the price trend for 2018 of the Consumer Discretionary Sector ETF $XLY, Netflix $NFLX, and Amazon $AMZN. The divergence is clear. But, you may notice they all had a drawdown a few weeks ago. All to often I see the upside presented, but not enough about the path we would have to endure to achieve it. To get a complete picture of asymmetric reward to risk, we want to see the drawdown, too, so we understand the ASYMMETRY® ratio.

Those are some big impressive short-term gains in those stocks. Clearly, this past performance may not be an indication of future results.  Too bad we can’t just know for sure in advance which is going to trend up with such velocity.  We can’t catch every trend, but if we look in the right way we may find some. In order to take a position in them, we’d have to be willing to experience some downside risk, too. As a portfolio manager, I decide how much my risk is in my positions and at the portfolio level by predefining when I’ll exit a losing position. But, to understand how much downside is possible in stocks like this and the sector ETF, I can examine the historical drawdown. We’ve seen a drawdown in the stock market already this year. Below we see the Consumer Sector ETF drawdown was about -8% a few weeks ago. Amazon wasn’t more, even though it’s gain is much more than the sector. That’s what I’m calling positive asymmetry and good looking asymmetric reward to risk in regard to the trend dynamics. Netflix declined -13%, but its gain is much higher. This is what leading stocks are supposed to look like. They have their risk and they could decline a lot more than the market if investors lose their enthusiasm for them, but we can manage that risk with our exit and drawdown controls.

I often say that it doesn’t matter how much the return is if the risk and volatility are so high you tap out before it is achieved. To better understand that, I want to show two more charts of these stocks. Below is what the YTD price change looked like at the February low. If investors watch their holdings closely and have emotional reactions, you can see how this would be viewed as “I was up 45% and now only 30%.” Many investors (and professional advisors) have difficulty holding on to strong trends when they experience every move.

One more chart to illustrate how it doesn’t matter how much the return is if the risk and volatility are so high you tap out before it is achieved. I don’t believe we can just buy and hold and reach our objective of asymmetric reward to risk. I believe risk must be managed, directed and controlled. To make the point, below are the historical drawdowns that have been -60% to -90% in these three. It doesn’t matter how much the return is if the risk and volatility are so high you tap out before it is achieved! To extract positive asymmetric reward to risk, we must necessarily do something different than buy and hold.

This may make you wonder: Why buy a sector ETF if you can buy the strongest stocks?

The divergence isn’t normally this wide. In a trending market, more of the other stocks would normally be participating in a trend. This is why I first explained that in an upward trending market we normally see the majority of stocks eventually trending together. When that is true, the sector ETF provides good exposure and limits the selection risk of just one or two stocks. Make no mistake, individual stocks are riskier. Individual stocks are more subject to negative news like disappointing earnings reports, negative product outlook, or key executives leaving the company, etc. So, individual stocks are more volatile and subject to trend in much wider swings both up and down. But for me, I apply the same risk management systems to predefine my risk at the point of entry drawdown controls as the trend unfolds in the stock, up or down.

Yes, it’s been a “stock pickers market” so far and that trend may continue. It just means that fewer stocks are leading the way for now and in a healthy trend more stocks will participate if the short-term uptrend continues to make higher highs and higher lows. As a tactical portfolio manager, my focus is on what seems to offer the positive ASYMMETRY® of a positive asymmetric reward to risk.

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

Investment results are probabilistic, never a sure thing. Past performance is no guarantee of future results.

Buying demand dominated selling pressure in the stock market

Past performance is no guarantee of future results and that was the case today. After last weeks Selling pressure overwhelms buying demand for stocks for the third day in a row the enthusiasm to buy overwhelmed the desire to sell. Market prices are driven by simple Economics 101: when buying enthusiasm overwhelms sellers, prices rise. The S&P 500 gained 1.16% today and seems to have found some buying support at the prior range I highlighted in green.

stock market florida investment advisor

Sector breadth was strong with Utilities, Real Estate, and Financials leading the way.

Sector rotation trend following

We don’t just invest and trade in U.S. stocks and sectors, I look for trends globally across the world. Though the Global ETF Trends monitor below shows many international countries were in the green, the good ole USA was one of the biggest gainers today.

global tactical asset allocation trend following global tactical rotation

Back to the U.S. stock market, in the chart below, I added Kelner Channels to illustrate a few things.

Keltner Channels are volatility-based envelopes set above and below an exponential moving average. This indicator is similar to Bollinger Bands, which use the standard deviation to set the bands. Instead of using the standard deviation, Keltner Channels use the Average True Range (ATR) to set channel distance.

Kelner Channels show the range of volatility has spread out and got wider since the stock market price trend trended above the upper channel in January, suggesting its uptrend was abnormal.  Since then, the trend reversed down and again traded outside the range of the Kelner Channel on the downside. It’s a good example of how the market can overreact on both the upside and downside.

stock market trading range ATR

In the chart above, I also include the Relative Strength Index, which is on its 50-yard line. You can see how it was reading “overbought” in January (and had been for months), then after that extreme it became oversold. This kind of price action presented us with an opportunity to turn on the swing trading systems. My countertrend systems signaled short-term entries in several stocks and ETFs very near the low prices.

I pointed out in Stock Market Analysis of the S&P 500 on February 9th near the lows the breadth of the stock market was oversold at a lower risk. Market analysis is best used as a weight of the evidence. You can probably see how these different indicators signaled a countertrend move was possible and this time that has happened so far. I say this time because it’s always probabilistic, never a sure thing. If the stock market were going to trend down -50% over a two year period it would start off this way being “oversold” and look “washed out”, only to get worse as it swings up and down on it’s way to a lower low. During times like this, a skilled swing trader or countertrend systems can help to generate profits as price trends swing up and down.

Below is an updated chart of the percent of stocks in the S&P 500 that are trading above their 50-day moving average. 12% more stocks are trading above their 50-day moving average after today, bringing it to 32%. I point this out because it gives us an idea of how many stocks are still left to trend back up. That is, based on this breadth indicator, there is room for stocks to keep trending up if buyers continue their enthusiasm. This is the opposite of the condition in the last months of 2017 and January when 80% or more stocks were already in positive trends. To revisit this concept I encourage you to read Stock Market Analysis of the S&P 500. 

SPX S&P 500 stocks above the 50 day moving average SPY

The bottom line is, the supply and demand for the stock market seems to be shifting back in control of buyers for now. Only time will tell if it continues in the days and weeks ahead. This is just a quick market analysis to look at what is going on, not investment advice. Our investment management and advice are only offered through an investment management agreement. If you want investment management or advice, contact us.

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

Investment results are probabilistic, never a sure thing. Past performance is no guarantee of future results.

Selling pressure overwhelms buying demand for stocks for the third day in a row

Well, I guess by saying on Tuesday I’m planning to write a comment when the stock index closes up or down 1% or more I’ve turned myself into a regular ole Mark Twain.

If you’ve ever read the “about” page, I poke some fun:

Mark Twain’s mother once said:
“I only wish Mark had spent more time making money rather than just writing about it”.

I go on to say:

Today there is no shortage of writings about the capital markets and portfolio management. Many who write about money and the management of it provide no evidence to suggest their beliefs are useful. That is, they do a lot of talking and writing, a lot less doing. We are left to wonder if they have good results. The author of ASYMMETRY® Observations is no Mark Twain.

Ok, so March isn’t getting off to the best start so far. The stock market as measured by the S&P 500 closed down -1.45% today. Below is the intraday chart. This index was down most of the day, but it did trend up off of its low after 2PM.

stock market spx spy march 1 2018

Zooming out to a few months instead of intraday, the SPY didn’t care at all that I drew that black line to show the prior low. It traded right below it. Of course, we don’t own this index at Shell Capital, so I am just sharing this as an observation.

stock market index asymmetry

We can get more granular by looking at the individual sector changes instead of the broader S&P 500 index that includes some of them all. Below, I show that the Utility sector was the only sector in the green (barely), which is no surprise since it has been the laggard for a while.

sector trend rotation march 2018

We can drill down even more into the sectors and see the ETF subsectors. Here we see some shades of green.

sector trend following

Next, we could look at stocks within the sectors, but that’s enough detail for now.

I will add that today was a global market decline as several other countries stock markets participated. Japan declined more while Mexico, Peru, and Egypt gained. The emerging markets index which includes Mexico only declined -0.19% today.

global ETF trend outlook march 2018

Finally, below is the same table of bar charts I used earlier in February Global Market Trends, but this one is only the past three days. The U.S. stock market has declined the past three days, so I wanted to see what other markets have done over the same period. Let’s just say that a diversified portfolio of global asset allocation wouldn’t have helped since many markets are down like commodities and international markets.

global asset allocation trend

If you haven’t read February Global Market Trends I encourage you to. Near the end, I discussed if an investor should pay too much attention to daily market swings. My purpose of writing this is to summarize what happened and that is always necessarily in the past. The future may be different.

How does this affect us at Shell Capital? I predefine my risk by knowing in advance when I’ll exit my positions if they decline. I do it to control my risk in each position and for drawdown control at the portfolio level. So, I respond accordingly.

If this keeps up, it looks like I’ll be eating dinner at my desk every evening, typing away like Mark Twain 🙂

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

Investment results are probabilistic, never a sure thing. Past performance is no guarantee of future results.

February Global Market Trends

After a very positive January for U.S. and international stocks, in February it only took 10 days for the S&P 500 to decline -12% intraday and a -10% drawdown based on closing price.

stock market decline drawdown februrary 2018

Yet, February ended with the S&P 500 only down -3.5% after that -12% intra-month drawdown.  For the month, International (MSCI EAFE) and Emerging Markets declined the most viewing the below board based indexes. The U.S. Dollar gained 1.8%.

global market returns february 2018 loss drawdown

Next, we view February global market returns relative to the S&P 500 stock index by holding it constant. This visual shows us how much markets gained/lost net of the S&P 500, Though in the absolute trend table above I showed bonds declined in absolute return, they gained relative to the S&P 500,

global market trend returns relative to spx spy S&P 500

Of course, one month isn’t a trend. In fact, I’m going to explain how this is an intentional logical inconsistency. Speaking of one time period in isolation, be it a month, year, or series of years is just an arbitrary time frame. What’s worse is viewing just the result over a time frame, like the month of February above, in just a table format.

A return stream is precisely that; a stream. A return stream is a continuous price trend in a continuous specified direction. Continuous is forming an unbroken whole; without interruption. So, I like to view return streams as price trends on a chart so I can see how the trend really unfolded over the period. Observed as a visual price trend, we see both the good and the bad of the price action along the way. You can probably see how it does that better than a simple performance table, monthly return % of the period or the bar chart above.

stock market decline februrary 2018

In the chart above, we see how much the price trends of those markets declined along the way before closing the month yesterday. I wrote about the short-term risk reversal in Stock Market Analysis of the S&P 500 suggesting it may reverse back up at least temporarily and retrace some loss and it did.

Now, what is essential about looking at performance data and trends is what the investor experiences. Investors experience what they choose to experience. For example, suppose and the investor is fully invested in the stock market, they could experience the month one of three ways.

  • If the investor only looks at his or her month-end statement, they would experience either the month end “-3.5%”.
  • If the investor watches their account or market indexes closely every day, they experienced every daily move and the full -12% decline and then some recovery.
  • Some may not pay any attention at all either because they are disinterested or they have an investment manager they trust to manage their risk-taking and risk management for them.

Investors and traders get to choose what time frame they watch things. I’ve always observed that “watching it too closely” can lead to emotional mistakes for many. For me, I’m paying attention and may zoom in and pay more attention when trends get more volatile or seem to reach an extreme. But, I’m a tactical portfolio manager, it’s what I do. I can view short term or long term trends alike with self-discipline. I have an edge that has been quantified by a long track record of 14 years in the current portfolio I manage.

I said this recently on Twitter:

If the investor doesn’t like to see such losses like those experienced in many markets in February, they may choose to instead not be fully invested in stocks all the time. That’s what I do. I’m not invested in any specific market all the time. My exposure to risk and return increases and decreases over time based on trends and my risk systems. I intentionally increase and decrease my exposure to the possibility of loss and gain. I’m also unconstrained so I can do it across any global market like bonds, currency, stocks, commodities, or alternatives like REITs, inverse (shorting), or volatility.

According to the American Association of Individual Investors, the decline was so quick most individual investors didn’t seem to respond:

Majority of Investors Avoided Taking Action in Recent Market Correction

“This week’s Sentiment Survey special question asked AAII members what portfolio action, if any, they took in response to the recent market correction. The majority of respondents (62%) said they didn’t make any change or only made a small change. Many of these respondents described themselves as being focused on the long term, viewing this month’s correction as being only temporary in nature or not severe enough to warrant any action. A few of these respondents described the correction as lasting too short of a time for them to take advantage of it. Nearly 33% respondents said they took advantage of the decline to buy stocks or funds. Some said they took advantage of the reduced prices to either add to current positions or buy new holdings. Just 7% of respondents said they sold stocks during the correction. A small number of respondents said they sold some positions and then bought new positions.”

I say investors should find and do what helps them, not make it worse. Know yourself, know your risk, and know your risk tolerance. That’s what we do.

So, that is what happened during the month of February, and a little asymmetric observation to go with it.

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

Investment results are probabilistic, never a sure thing. Past performance is no guarantee of future results.

Selling pressure overcomes buying demand for second day in U.S. stock market

When popular market indexes gain or lose 1% or more in a day, we’ll try to take the time to comment on it here. Go figure I said that yesterday, now I’m writing about it two days in a row.

Much like yesterday in Stock market indexes lost some buying enthusiasm for the day the S&P 500 stock index closed down 1.01% today. The SPY traded most of the day above yesterdays close, then broke below that level after 3PM. Like yesterday, the last trades were downside volume, which is selling pressure.

But, the above chart is the intraday price trend of what happened in a single day, today. We aren’t making decisions for such a short time frame. I only show the day to discuss today’s action. So far, it isn’t anything too unusual, but that could change.

What’s more important is a bigger picture. The chart below is still only two months, so not the big picture, but since the stock indexes are in a correction the last several weeks, I’m zooming in to see the detail. Two down days of -1% or more is evidence of some selling pressure and distribution, but so far it isn’t a change or trend direction. If the trend declines below the prior low, which I marked with the black line, then I wouldn’t be surprised to see if fall further. In other words, it should get some buying demand (support) at that level. If it doesn’t, we may see further downside. The reversal back up from the February 9th low could be coming to an end and set the stage for a retest of the low. Only time will tell. We’ll see. I don’t have a position in this, but the S&P 500 is a widely followed index we use as a market proxy.

I predefine my risk by knowing in advance when I’ll exit my positions if they decline. I do it to control my risk in each position and for drawdown control at the portfolio level.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

Investment results are probabilistic, never a sure thing. Past performance is no guarantee of future results.

 

 

The most important rule of trading is to play great defense, not great offense.

It is fascinating to read Market Wizards: Interviews With Top Traders published in 1989 again and see how much the portfolio management strategy of another ole boy from Tennessee is nearly identical to my own. I read the book the first time in the early 1990’s so it may have had an impact on me as a young tactical trader as I evolved over time.

“The most important rule of trading is to play great defense, not great offense. Every day I assume every position I have is wrong. I know where my stop risk points are going to be. I do that so I can define my maximum possible drawdown. Hopefully, I spend the rest of the day enjoying positions that are going in my direction. If they are going against me, then I have a game plan for getting out.”

Paul Tudor Jones in Market Wizards: Interviews With Top Traders (p. 123). Wiley. Kindle Edition. Schwager, Jack D..

 

Stock market indexes lost some buying enthusiasm for the day

Buying enthusiasm reversed from positive to selling pressure today after the first hour. I observed notable selling volume at the close, which was the opposite of what I pointed out last Thursday.The S&P 500 Stock Index was down -1.27% for the day.

 

I’ll also share that volume increased sharply during the -10% decline in the S&P 500 Stock Index earlier this month. No surprise, it was selling pressure after many months of buying enthusiasm, just an observation…

 

So far, the S&P 500 Stock Index has regained approximately half of its -10% loss earlier this month and is now up 2.64% for the year.

Since I pointed out that the stocks inside the S&P 500 has dropped to a much lower risk zone in Stock Market Analysis of the S&P 500, the % of stocks in the index above their 50 day moving average increased from only 14% in a positive trend to 55%. Today, 18% fewer stocks are above their 50-day moving averages.

S&P 500 percent of stocks above 50 day moving average Feb 2018

None of this is yet suggesting a change of trend, but when stock popular stock indexes gain or lose more than 1% or so my plan is to update it here.

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

Investment results are probabilistic, never a sure thing. Past performance is no guarantee of future results.

Stock Market Analysis of the S&P 500

There are many parts to a complete risk management system. One part is monitoring and measuring the risk of the overall markets. Market risk analysis may involve observing risk gauges like price momentum, market breadth, investor sentiment, P/E valuation, and fund flows.

Stock market breadth is useful for market analysis to better understand internal conditions. For trading decisions, I focus individual trends. As I shared last week, when breadth reaches such extremes (high or low) it may point attention in the right direction.

I start with a Point & Figure chart of the % of stocks in the S&P 500 index that are trading above their 50-day moving averages. Only 14% of the 500 stocks were trending above their 50 day moving average, signaling the internal trend weakness of the stocks inside an index.

S&P 500 % OF STOCKS ABOVE 50 DAY MOVING AVERAGE

I color the high zone as “Higher Risk” because, after 84% of stocks in the S&P 500 stock market index are already above their 50 day moving average nearly all of them are already trending up – think “upside exhaustion”, eventually it will reverse. It was a “warning shot across the bow”.

I color the low area as “Lower Risk” because, after 86% of stocks in the S&P 500 stock market index are already below their 50 day moving average nearly all of them have already trended down – think “downside washout”, eventually it will reverse. But, 50 day is a short-term trend, so…

Since the 50 day moving average just signals a short-term trend, let’s also consider the % of stocks above and below the longer term 200-day moving average. With a longer time frame, we’ll see more lag.

SPY $SPX #SPX S&P 500 STOCK MARKET % OF STOCKS ABOVE 200 DAY MOVING AVERAGE

As we see above, 82% of S&P 500 stocks were above their 200 day two weeks ago. After the -10% or so S&P 500 decline, only 56% were still trending above. With the lag in the 200 day, we aren’t surprised to see fewer stocks dropped below the 200 day since they had more distance to fall to reach it.

The longer time frame creates more lag in the signal simply because the 200 day is using 400% more data points than the 50 – it’s going to be slower. We call that “lag”.

What do these internal breadth indicators suggest? It’s a measure of trend direction “participation” of the stocks in the S&P 500. As we saw, the 50 SMA is washed out, but since 50 SMA is short-term, it could stay that way if prices keep falling. The 200 SMA is more important.

What do these internal breadth indicators suggest?

It’s a measure of trend direction “participation” of the stocks in the S&P 500 index. The % of stocks above the 200 SMA dropped to where they did in the recent past and reversed up… but… I’ve been observing breadth for nearly 3 decades, so I’ve seen how low it “can” go.

As I lengthen the time on the chart, I show you the “real” lower risk zone is in the teens like the 50, for the 200. Only time will tell if it stops here, as it has the past two years, or goes lower.

S&P 500 $SPX $SPX Bulllish percent of stocks above 200 day moving average

The bottom line is, market breadth is “washed out” in the short-term and about halfway there on a longer term view – if it is to go lower. So, while this is evidence enough to expect to see at least a short-term reversal back up, there is also plenty of room to see the S&P 500 stock index drop another -10% or more as only half of the stocks are yet below their 200-day averages. What it does next is simply a matter of buying demand outweighing the desire to sell. 

As I’ve said, there are many parts to a complete risk management system. The above is just an observation and example of “market analysis” using breadth.

Next, let’s take a look at the S&P 500 price trend to explore buying demand vs. selling pressure. 

S&P 500 stock index tapped the 200-day moving average intraday in oversold territory. I highlighted in green it’s a zone of about 8 months of prior trading range. Support occurs after prices fall; buyers may become more inclined to buy and sellers become less inclined to sell. So far, that is what we are observing. The stock index declined about -12% and reached an “oversold” level on the momentum oscillator and is above the 200-day moving average used for standard trend following.

S&P 500 oversold
Looking even closer, I’ll point out the trading volume has been heavier on positive days and relatively lighter on down days. I circled the heaviest volume below. The biggest volume in the S&P 500 SPY ETF wasn’t on the down days, it was on the days it closed positive: last Tuesday and Friday. This is an overly simplistic analysis of the volume and price as I could go into more detail and separate up volume vs. down volume, but my objective is an educational overview of the big picture.
S&P 500 $SPY $SPX trend following asymmetry asymmetric
Finally, I’ll get a little more technical into the details.
In the candlestick chart below, I circled in blue a Doji cross & long shadow in Friday’s trading. Doji is when the open and the close is nearly the same and suggests indecision, a tug-of-war, between buyers and sellers. It’s when the price moves above and below the opening, but closes near the opening price.
$SPY $SPX stock market
The long lower shadow on Friday and short upper shadow indicated that sellers dominated during the first part of Friday, driving prices lower. But then it closed positive. So, it “could” suggest at least some short-term capitulation, especially if today’s gain holds. We’ll see.

Risk management is the common characteristic among all the best traders/investors who have lasted over the many important up and down market cycles of the past decades. I decided I was going to be one of them over two decades ago. No matter how you decide what and when to buy, it is essential to control the size of your potential loss. If you want to learn what I mean by that, read the prior ten or twenty observations I’ve shared here. This is not individual investment advice. If you need individual advice, contact us.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

Investment results are probabilistic, never a sure thing. Past performance is no guarantee of future results.

Asset Class Returns are Driven by Sector Exposure

The popular U. S. stock indexes closed in the red for the year Monday, erasing their big starting gains in January. As I mentioned many times; quick gains can be lost even faster. The financial news has mostly been quoting the Dow Jones Industrial Average because it had gained the most year-to-date. It had gained over 7% in January, but lost that gain, and then some, in two days. After just a few days, the Dow Jones dropped -14% in the futures market and -8% on a closing basis. That was enough to wipe out recent gains and mark the index down nearly -2% for the year.

I discussed the market risk in our portfolio commentary for our investment management clients, and we were positioned for it. I also explained it in In remembrance of euphoria: Whatever happened to Stuart and Mr. P? and In the final stages of a bull market. So, it should have been no surprise.

But, when I looked at the asset class performance table, I saw some interesting divergence. Large Cap Growth is still outperforming Small Value. As most of the U.S. equity asset classes were in the red, Large Growth remained positive on the year. I thought I would share a look as to why.

I am a tactical portfolio manager, so my focus is on finding trends and shifting to the trends I want and avoiding those I don’t. That’s a lot different than “asset allocation.” Financial advisors who create asset allocation models for their investment clients normally allocate into funds in the asset class style box. This is also typical with 401(k) plans. They offer funds that provide broad exposure to an asset class style box, rather than the individual stock market sectors I prefer to focus on. So, we often hear style box asset classes quoted like “Large Growth is beating Small Value” or “Large Caps ard leading Small Caps.”

According to Morningstar:

The Morningstar Style Box is a nine-square grid that provides a graphical representation of the “investment style” of stocks and mutual funds. For stocks and stock funds, it classifies securities according to market capitalization (the vertical axis) and growth and value factors (the horizontal axis).

Below is a recent performance for the equity markets. As you see, U.S. Large Growth was leading with a 2.89% gain year-to-date, Small Value was down -4.83%.  When we observe such a divergence, it makes us curious what is causing it.

 

To understand what is driving the return, we take a look inside to see “what is different.” Below is the sector exposure breakdown of Large-Cap Growth.  We can understand the sector exposure of the iShares Morningstar Large-Cap Growth ETF. Clearly, the big standout is heavy exposure to Information Technology. The other two larger exposures are Consumer Discretionary and Health Care.

Large Growth Stocks Outperform Small

Next, we observe the sector exposure of the Small Value asset class. We can see the sector exposure in the holdings of iShares Morningstar Small-Cap Value ETF.

The Small Value index has 22% exposure to Financials since many financial sector stocks are smaller companies. The other top sector exposures are Industrials, Consumer Discretionary, Real Estate, and Energy.

Small Value Stocks Underperforming Why are

What is different?

Clearly, the single largest difference is that Large Growth is very heavily exposed to the trend in Technology sector. Technology is 50% of Large Growth while it’s only 8% of Small Value. On the other hand, Financials is only 5% of Large Growth but its the largest exposure in Small Value at 22% of the index.

Stock market asset class returns are driven by their sector exposure. Recently, the Tech sector has been one of the mightiest trends, so it’s helped Large Growth also appear more dominant over equity styles that hold less of it. I would preferably look inside and find out what return driver is causing the difference, then get exposure to that trend in momentum.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

Investment results are probabilistic, never a sure thing. Past performance is no guarantee of future results.

In the final stages of a bull market

In the final stages of a bull market, we normally see a parabolic move to the upside, a final blowoff that gets in the last investors. Buying demand is the response of investor euphoria like I pointed out last week.

An indication of a parabolic move is seen in price channels and confirmed with momentum oscillators. Only time will tell if this is it, but in the chart, I highlight the S&P 500 stock index broke out above an upper moving average channel.

spy spx trend

Price trends usually peak with volatile swings up and down before a larger leg down. Some swing tighter than others, but there is normally a period of “indecision” that precedes an intermediate trend change or drawdown. A drawdown is a decline in the value of an investment or market below its all-time high. Below is the period leading up to the -15% drawdown in the stock index late 2015 – 2016. In the green box, I show the price trend entered a period of swings up and down before breaking an upward trend, drifting more sideways, then a-15% decline.

 

spy eem stock market

Next is the swings in the S&P 500 entered into what became a -18% decline in 2011. My point here is that larger legs down don’t necessarily happen all at once, there are indecisive swings that eventually fall apart.

spy 2011 decline

The top in 2007 presented much larger swings and of course ended up declining -56% over nearly two years afterward. I believe these swings up and down before a larger trend unfolds is indecision among traders and investors. Again, my point here is that larger legs down don’t necessarily happen all at once, we instead observe indecisive swings that eventually fall apart.

spy spx 2007 stock market top

Lastly, here is the 1999 – 2000 peak that also presented wings like the previous peaks. The stock market trend broke above a simple channel a few times before entering a -50% bear market.

stock market top 1999

The current trend just recently stretched above the channel and at the same time, was very overbought for months as measured by the momentum oscillators. This happened at the same time bullish investor sentiment measures was reaching record highs and volatility at historical lows. However, as seen in observations above, the U.S. stock market could just now be entering into a phase of swings up and down that could last for months or years, or it could fall apart sooner. Either way, I make this point for situational awareness.

As a portfolio manager, I don’t need to know for sure what’s going to happen next.  I just know what I’ll do next as trends unfold.

Only time will tell if this is the early stages of an end of an aged bull market or just an interruption of a euphoric “melt up”. We don’t need to know when a major top is in. It doesn’t require an ON/OFF switch. When a big bear market does come, it will be made up of many swings up and down along the way over many months. People will crave to be in, out, in out, in, out, as it all unfolds.  Adaptability is essential: the consistent willingness and ability to alter attitudes, thoughts, and behaviors to appropriately respond to actual or anticipated change in the environment.

Clearly, it’s the swings we have to be prepared for… if we want to avoid a loss trap.  In a loss trap, investors get caught in a loss and have a hard time getting out. When they lose more than they can afford or more than their risk tolerance, they are prone to tap out after large declines. To avoid the loss trap, know your risk tolerance and actively manage risk within that tolerance.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

Investment results are probabilistic, never a sure thing. Past performance is no guarantee of future results.

 

In remembrance of euphoria: Whatever happened to Stuart and Mr. P?

I have recently found myself reminiscing about the late 1990’s – specifically the grand euphoric year of 1999. If you aren’t sure why then maybe you aren’t paying attention. Sometimes not paying attention is a good thing if it prevents you from following a herd off a cliff.

The four most expensive words in the English language are “this time it’s different.” – John Templeton

Lately, I’ve been reminiscing about the tech stock bubble, the .com’s, and how the Nasdaq QQQ replaced the Dow Jones Industrial Average as the favorite index by 1999. Then there were all the infamous statements like “you don’t understand the New Economy”. We’ve been talking about the funny commercials from the baby trader to the college-age guy helping the mature executive start trading online, to “Be Bullish”.

Do you remember Stuart and Mr. P? Back in 1999, there were traditional “stockbrokers” who were registered with a brokerage firm, who bought and sold stocks, bonds, and options for individual and institutional clients. If you were a stockbroker back then, like I was, you probably remember it well. Online trading was the beginning of the end for the traditional “stockbroker” firms earning a $200 commission to buy or sell 100 shares. The great thing about the evolution of online trading is it lowered trading costs dramatically. For someone like me who wanted to be a tactical money manager anyway, that was a great thing. I embraced it and went on to start my investment management company. But the point of this observation is the investor sentiment in 1999. The video below is amazing to watch 20 years later. But what fascinates me the most is how it reminds me of today; different subjects, same sentiment.

Watch:

 

That may remind you of some of the things we hear today.

Those type of commercials flooded the financial news and evening news channels in 1999. To be sure, below is a WSJ article printed about the “Let’s Light This Candle” ad on December 7, 1999. I’ll tell ya what… that’s about as close to the top as you can get.

So, I wondered, what happened to Stuart and Mr. P? 

Stuart was helping Mr. P buy Kmart stock online. Kmart was then one of America’s leading discount retailers. The Kmart Corporation was the second largest U.S. discount retailer and major competitor to Walmart. Kmart filed for Chapter 11 bankruptcy protection in January 2002. Just two years after Stuart helped Mr. P buy shares online it filed for the largest ever retail bankruptcyKmart was later bought by Sears, which is now a failing company. At least Mr. P was wise enough to only buy 100 shares, young Stuart wanted him to buy 500 shares! They had no position size method to determine how much to buy based on risk, which would include a predefined exit. It is unlikely Mr. P had a predefined exit in place to exit the stock to cut the loss short. During that time, investors were only thinking about what to buy. They rarely considered how and when to exit a stock with a small loss to avoid a larger loss. After such a strong bull market, who is thinking about the risk of loss?

For those of us who remember, in the late 1990’s most investors weren’t just buying the largest retailers – they were buying technology. In hindsight, that period is now referred to as the “tech boom” or “tech bubble”. That’s because almost everyone wanted to buy tech stocks. Literally, even the most conservative seniors were cashing out bank CD’s to buy tech stock.  And… I’m not even going to get into the .com stocks, most of which no longer exist from that time.

Whether you remember the trend as my friends and I do or not, we can use historical price charts to see what happened. Below is the Technology Select Sector SPDR® ETF  since its inception 12/16/1998 to today. I’m starting with the full history to see the initial gain, before the waterfall decline. The Technology Select Sector SPDR® Fund seeks to:

“Provide precise exposure to companies from technology hardware, storage, and peripherals; software; diversified telecommunication services; communications equipment; semiconductors and semiconductor equipment; internet software and services; IT services; electronic equipment, instruments, and components; and wireless telecommunication services.”

Those were the most popular sectors, aside from the actual Internet stocks.

Below is what happened from December 9, 1999, when WSJ printed the article about the ad because it was so interesting and popular, to now. After nearly 20 years an investor buying the diversified tech sector would have just recently realized a profit, assuming they held on for 19 years.

Here is what that -80% drawdown looked like that lasted 19 years.

“Those who cannot remember the past are condemned to repeat it. “

George Santayana

 

This is a kickoff of a series of articles on this topic I have in queue on current global market conditions. Stay tuned…

Mike Shell is the founder of Shell Capital Management, LLC, a registered investment manager and portfolio manager of ASYMMETRY® Global Tactical.

All Eyes are Now on the Potential Government Shutdown

If the U. S. Government shuts down, it will be the 19th time. Looking at the table below, it doesn’t seem a big deal. The table shows the 18 prior government shutdowns going back to 1976. It lists the start and end date of the shutdown and the gain or loss for the S&P 500 stock index. The average is only a -0.60% loss from beginning to end of the shutdown.

But, here are some considerations: 
1. It is too small of a sample size to draw a statistically significant inference. Basic probability needs 30 data points.
2. It only shows the gain/loss from beginning and end of the shutdown.
3. It doesn’t show what happened before and after those dates. Was there more movement/drawdown before or after?
4. It doesn’t show what happened in between the start and end date so it may have been worse.
5. It doesn’t consider market stage at the time of shutdown. Was it overvalued and overbought? Or was it undervalued and oversold?

The truth is; anything can happen.
We don’t know for sure how it will play out. With such a small sample size of prior events and without factoring in the market conditions at the time, what it did in the past doesn’t provide us with a good expectation.

The current condition: if the government shuts down this time:
1. It will be when the U.S. stock market is at the second most expensive fundamental valuation, ever.
2. When investor and advisor bullish sentiment has reached record highs, at this point a contrary indicator.
3. As recent momentum indicators are at the highest levels ever seen before, at this point a contrary indicator.

My solution? always be prepared that anything can happen.
I know how much risk I’m willing to take given the possible outcomes and define my risk by knowing when I’ll hedge or exit.

 

Mike Shell is the founder of Shell Capital and the Portfolio Manager of ASYMMETRY® Global Tactical.

Counting down to the New Year

Doesn’t it seem the years are flying by?

It’s partially just math. It’s asymmetric!

We perceive that time seems to pass faster as we age because, at four years old, a year was 25% of our life. At 40 a year is only 2.5% of our life. The older we get, we perceive the years go by faster because each year is relatively less of our life.

Maybe we can’t control time, but we can make each year BETTER!

Or… maybe we can control our time?

As we get older, we tend to become more stable, so life can become routine. The more familiar we become with our day-to-day activities, the faster the days seem to pass by.

Want to slow down time? and have more fun?

Change things up! Create new experiences! Do new things!

Industrial Sector Pulling Back as RSI Suggested it Could

In “Resolving Conflicts with Relative Strength” I discussed the conflict between high Relative Strength (a trend that is gaining more than others) and a high RSI (a trend that is considered overbought). I used the Industrial Select Sector SPDR ETF as an example. It has taken about five weeks, but the point can be seen clearly now.

Below is part of what I said on September 27, 2017, and following that I’ll share an update.

When I see the chart below, I think:

“The trend is up, it has moved up fast enough to be overbought in the short term, so it may pull back some and then the trend may resume to the upside”.

That chart was about five weeks ago. Below is an update on the trend in the U.S. Industrial sector. Since the sector got “overbought” based on a RSI reading over 70, the trend continued up (green highlight) and has since trended down about -3%. At this point, it is trading around the same price it was when it first became overbought. Now, it is getting closer to being “oversold” on a short-term basis.

So, as the Industrial sector was one of the strongest sector trends a few weeks ago, it also appeared overbought on a short-term basis. It is now drifting down to what may become a better entry point in what has otherwise been a strong directional trend.

We’ll see how it unfolds.

Black Monday: Huge Losses a Reminder of Risk

30 years ago today, global stock markets collapsed. The U.S. stock market represented by the S&P 500 had gained over 35% year-to-date. Investors were likely optimistic. It only took a single day to erase the gain.

The loss on Black Monday was -31.5%. Notice that a -31.5% decline more than erased a 35%+ gain. In fact, after the index had gained over 35% for the year, it was down nearly -9% after a -31% decline.

 

As I explain in Asymmetric Nature of Losses and Loss Aversion, losses are asymmetric. Losses compound exponentially, which is what makes risk management and the pursue of drawdown control worthwhile.

Below we see it in action. It only took a decline of -31% to erase over 60% of a 100% gain since 1984. The S&P 500 stock index had gained over 100% since 1984. The -31% decline brought the gain all the way down to 37%. Losses are very asymmetric.

Black Monday is talked about as a single one-day event, but really it wasn’t. Several weeks of weakness led up to a big down day. But, it would have taken a rather tight risk management system to have exited.

Looking even closer, the % off high chart shows the stock index was about -7% off its price high for several weeks before the crash. So, a drawdown control and risk management system trading this index would have had to exit because of this trend.

It doesn’t have to happen in a single day to erase a lot of gains.

Let’s remember this one.

And more recently, this one.

Today is a reminder that markets are risky and they necessarily require risk management.

 

 

Asymmetry in Income Taxes

It seems we hear more about “inequity” in recent years, like income inequality. Income inequality refers to the extent to which income is distributed in an uneven manner among a population. That shouldn’t be a surprise since our efforts are asymmetric. We don’t hear much about the asymmetry in the effort. That is, some try harder and work harder than others, and take bigger risks, which leads to the asymmetry in income.

Regardless of the cause, the progressive U.S. tax system aims to balance it out to spread the wealth.

In “A closer look at who does (and doesn’t) pay U.S. income tax” Pew Research finds that:

…taxpayers with incomes of $200,000 or more paid well over half (58.8%) of federal income taxes, though they accounted for only 4.5% of all returns filed (6.8% of all taxable returns).

By contrast, taxpayers with incomes below $30,000 filed nearly 44% of all returns but paid just 1.4% of all federal income tax – in fact, two-thirds of the nearly 66 million returns filed by people in that lowest income tier owed no tax at all.

Read the full story at: “A closer look at who does (and doesn’t) pay U.S. income tax

What do wealthy people do differently?

This morning a financial planner who knows we are the investment manager to wealthy families asked me a great question:

“What do wealthy people do differently?”

I thought I would just sit here and write it out. These are my own observations over a few decades.

First, let’s define “wealthy”.

I’m going to define “wealthy” as someone who has already achieved “freedom”. Notice I said “freedom”, not just “financial freedom”. I’ve asked thousands of people over the past two decades “what is important about money to you?”. Ultimately, the question leads to one single word: “freedom”. So, there doesn’t seem to be a need to add “financial” in front of “freedom”. But, that isn’t to say you can’t have plenty of money without much freedom. You could say “Some people have far more money than they ever need but they still don’t enjoy their freedom because they keep working for more”. You may consider that person is still getting what they want. Some people just want to produce, and they never stop. They are still free. They have the freedom to keep doing what they love doing. In fact, some wealthy people are driven to create more wealth for a charity. No matter what our goals are in life, traveling, relaxing, time with family and friends, helping others, having enough capital to do what we want seems essential.

Having enough money to do what we want, when we want, seems to be the primary goal of most of us.

So, I define “wealthy” as someone who has already achieved “freedom”, regardless how he or she chooses to enjoy his or her freedom.

What do these people do differently than those who haven’t accumulated enough capital to say they are “wealthy”?

1. They save and invest money. The first thing that I have observed is that they simply save part of their income and invest it.

a. Save: They save it because they don’t spend more than they should. They save a large amount of themselves to use later. Even if they earn $X a year, they don’t the most they can for their home or carts. For example, a person earning $1 million a year may live in a $1 million neighborhood and a neighbor who earns $200,000 a year. Who do you think will be “wealthy”? One is stretched, the other is saving.

b. Invest: People who achieve “freedom” and the “wealthy” status don’t stop and just saving money in a bank account, they invest it. Wealthy people take the time to invest their money. Most of them invest with an investment manager who is fully committed to investment management.

2. Wealthy people care about their money. I know a lot of wealthy people, and I know just as many who aren’t. Those who are wealthy save and invest money, those who don’t spend it. As investment management clients, wealthy families are the first to complete forms, etc. as needed because they care about their money. They also appreciate investment managers who are on top of things as they would be.

3. Wealthy people are focused on that ONE thing they do best. Just like the book The ONE Thing: The Surprisingly Simple Truth Behind Extraordinary Results says: they are focused. If they are a Physician, they focus on being a great Physician. If they own a company, they focus on their business. If they are a country music artist, they focus on being the best they can be. If they are an engineer, that’s their focus. They do what they do best and they find other people to do the things they don’t want to do like lawn maintenance or whatever. If you want to earn more money to save and invest, focus on what earns you the most and pay others for the things you aren’t so great at or don’t want to do.

4. They take some risks and manage their risk. To achieve wealth, we have to be both risk-takers and risk managers. If we take no risks in life, we’ll have no chance of reward. Not graduating from college has some risks, but so does attending. Who we marry, how we title our assets, how we insure our assets, and how we manage our assets all have risks and the potential for reward. Wealthy people tend to take risks in that one thing they are best at. They go “all in”. But wealthy people also direct and control their risks. They try to take good risks that are worth taking. It doesn’t matter how much wealth we accumulate if we aren’t able to keep it. For example, many people can remember how much wealth they created on paper up to 2000 only to see it cut in half. They did it again up to 2007 through 2009, and it took years to break even. Wealthy people know to realize a real profit, you have to take a profit. To avoid a large loss, we have to cut losses off at some point. Proper planning and risk management are essential.

5. Everything is relative, but yet it isn’t to them. I know business owners as well as Physicians who I consider wealthy as well as musicians, and athletes. But, you don’t have to earn $500,000 a year all your life to become wealthy. You don’t have to earn it all in a short time, either. I know people who have a total $500,000 invested who are wealthy. They have “enough”, for them. Depending on the lifestyle, others may not become wealthy until they have over $5 million if they spend a few hundred thousand a year traveling, etc. I also know families with several hundred million. Everything is relative, but wealthy people don’t compare their wealth and assets to others. They aren’t “keeping up with the Joneses”. People who do that often have large debts because they buy things they can’t afford with money they don’t have. Or, they save and invest less.  Wealthy people don’t buy a new car or house because their friend does, or compare their investment account to others. Wealthy people may be more introverted when it comes to personal finance – their focus is on their own family needs.

What do the wealthy do differently? They discover how much capital they need to enable the freedom to do what they want when they want, whatever that may be. Income alone, or the neighborhood we live in, or the cars we drive, or memberships don’t signal that we are wealthy. Some wealthy people are still operating their business, practice,  or “working”. A distinction is that they want to and they could choose to do something else with their time if they want. Wealthy families have saved and invested enough money to have achieved freedom. To do that, they focus on the thing they do best. They delegate the other stuff to someone else. They care about accumulating and managing their money and managing their risks. They appreciate investment managers and wealth managers who help them do it.

Resolving Conflicts with Relative Strength

In “Relative Strength can be a source of conflict for Tactical Traders” I explained how two different momentum indicators are in conflict with each other and can lead to conflict in tactical trading decisions. Tactical traders may use many different indicators and methods to determine whether to enter, hold, or exit a position. If we look at two conflicting indicators like this, we have to avoid becoming conflicted ourselves.

To avoid the conflicts, define clearly what they are and how to use them. To do that, I’m going to mix up a bowl of Physics and Psychology.

The indicators essentially represent the same thing. They apply a different algorithm, but both are momentum measures that determine the speed of change in price movements. A key difference is that the basic Relative Strength I used is a simple price change over a period. That simple Relative Strength algorithm simply compares the price change over a period to determine which trends are stronger and which are weaker. Tactical Traders using this method of Relative Strength expect the stronger trends will continue to be stronger and the weaker trends will continue to be weaker. A trend in motion is expected to continue in that direction until some inertia comes along and changes it. You may recognize this from Physics:

Newton’s first law of motion states that “An object at rest stays at rest and an object in motion stays in motion with the same speed and in the same direction unless acted upon by an unbalanced force.” Objects tend to “keep on doing what they’re doing.” In fact, it is the natural tendency of objects to resist changes in their state of motion. This tendency to resist changes in their state of motion is described as inertia.

Inertia: the resistance an object has to a change in its state of motion.

We can say the same about investor behavior and beliefs when we look at confirmation bias.

Confirmation bias is the tendency to search for, interpret, favor, and recall information in a way that confirms one’s preexisting beliefs or hypotheses.

That psychological bias is similar to the physics law of motion;

“Objects tend to keep on doing what they’re doing. In fact, it is the natural tendency of objects to resist changes in their state of motion.”

Investor and trader behavior and Confirmation Bias seems to agree with the first law of motion.

You can probably see how we may develop our beliefs because of our environment. If we observe over time the natural tendency of objects to resist changes in their state of motion then we may expect a trend to continue.

It gets more interesting. According to The Physics Classroom:

Newton’s conception of inertia stood in direct opposition to more popular conceptions about motion. The dominant thought prior to Newton’s day was that it was the natural tendency of objects to come to a rest position. Moving objects, so it was believed, would eventually stop moving; a force was necessary to keep an object moving. But if left to itself, a moving object would eventually come to rest and an object at rest would stay at rest; thus, the idea that dominated people’s thinking for nearly 2000 years prior to Newton was that it was the natural tendency of all objects to assume a rest position.

So, up until Newton’s first law of motion, people believed trends would eventually end instead of continue. In that same way, some people look for and expect recent price trends to change rather than continue.

We have discovered two different beliefs.

  • A trend in motion will stay in motion with the same speed and direction (unless acted upon by an unbalanced force).
  • A trend will eventually stop moving (a force is necessary to keep an object moving).

A Tactical Trader using Relative Strength based on the rate of change assumes that trend speed and direction will continue into the future. This is more in agreement with Newton’s first law.

A Tactical Trader using the Relative Strength Indicator, an oscillator,  assumes that trend speed and direction will oscillate between a range. If it reaches “oversold” it may reverse back up and if it reaches “overbought” it may reverse back down. This is more like the Physics beliefs prior to Newton’s first law when they expected a trend or motion to change.

To avoid conflicts between these two concepts and indicators, I define them separately as Trend Following and Countertrend.

Trend Following systems are methods that aim to buy securities that are rising and sell securities that are declining. Trend following is directional – it focuses on the direction of prices. Not all measures of Relative Strength are directional, but the one I used is. I simply ranked the sectors based on their price change over 3 months. That is an absolute ranking, but also a relative ranking. I may require the price change to be positive to enter a position. Some Relative Strength methods are only relative, so they don’t require a positive trend. They may enter the sectors that have the better price change over the period even if it’s negative.

Countertrend systems aim to bet against the recent price trend for the purpose of pursuing a capital gain or for hedging. In a strongly rising market, a countertrend strategy may believe the price is more likely to reverse. For example, the RSI is “overbought.” In a  declining market, a countertrend strategy may indicate the trend is likely to reverse back up. For example, RSI is “oversold.” The risk is, an oversold market can keep trending lower and an overbought market may keep trending up!

I believe there are directional trends that are more likely to continue than to reverse – so I apply Trend Following to them. That necessarily means I believe investors may underreact to new information causing the price trend to drift gradually over time to match supply and demand.

I also believe that trends can reach an extreme, especially in the short run, by overreacting to information or extremes in sentiments like fear and greed. Because I have observed trends reaching an extreme, I may apply overbought and oversold methods for countertrend trading.

When I see the chart below, I think:

“The trend is up, it has moved up fast enough to be overbought in the short term, so it may pull back some and then the trend may resume to the upside”.

I combine the two, rather than them necessarily being in conflict with each other. I believe the high RSI number is confirming the strong trend, but I also believe it suggests it may not be the best entry point if you care about entering a position that may decline a few percent after you enter it.

So, I believe both of these systems can be applied at different times depending on the market state of the trend type. When a price trend is oscillating up and down over time but not necessarily making a major new high or low, a Countertrend method may capture profits from those swings. When a trend is moving up or down for a prolonged period that same Countertrend system may catch some of the profits and miss some as well. That is because it expects the trend to reverse at certain points and it doesn’t. However, a Trend Following system may better capture the overall trend when it keeps trending. But, none of them are perfect. If a Trend Following system captures the bigger trend it also means it will likely participate in a drawdown when the trend does end. If the Trend Following algorithm is loose enough to ride the trend without whipsaws, it will also be loose enough to lose some gains when the trend does change to the other direction.

If Tactical Traders and investors have useful definitions like these and can apply these different methods to different types of markets, with the right mindset and expectations we can avoid the conflicts.

Relative Strength can be a source of conflict for Tactical Traders

Relative Strength can be a source of conflict for Tactical Traders. I was talking to another tactical trader who manages a hedge fund. He said:

“Industrials are a leading sector, but it’s overbought”.

Relative Strength is a simple measurement to determine which stock, sector, or market has trended up the most over a period of time.  For example, when we rank U.S. sectors over a period of 3 months to see which sectors have been trending the strongest, we see sectors like Financials, Energy, Materials, and Industrials have been the leaders over the past three months. Of course, past performance doesn’t necessarily indicate it will continue into the future. As with any trend indicator, Relative Strength is always looking at the past, never the unknowable future.

To see a different visual, below is how those same sectors appear in a line chart over the past 3 months. We observe that most of the sectors have trended in a wide range over the past few months.

 

When ranked by Relative Strength, the Industrial Sector is a leader compared to other sectors and its directional trend can also be seen in its price chart.

No, wait.

Now that I’ve pulled the chart up: The Industrial sector is overbought right now based on the Relative Strength Index. I highlighted the indicator over 70 with the red line.

So, one “Relative Strength” indicator says it’s in a strong relative trend, the other suggests its “overbought”.

These two indicators sound the same, but they are different, but also the same. It depends on what you think it represents. Both of them actually represent the same thing, but the expectation from them is the opposite.

Relative Strength as I used above, is just a simple comparison of the price trends over the past 3 months, or whatever time frame you want to use.

The Relative Strength Index is a momentum oscillator that measures the speed and change of price movements. That doesn’t sound much different than Relative Strength. The equation is different. The way it is used is different. RSI oscillates between zero and 100. The default time frame is only 14 days. Without writing a book on it, I’ll share that RSI is intended to capture the shorter term swings in a price trend. Since it’s using 14 days, it’s assuming a cycle of 28 days.

When the RSI exceeds 70 it’s considered “overbought” because, mathematically, it has moved a little too far, too fast. When it gets “overbought” it’s expected to either drift sideways for some time or reverse back down. We may indeed observe the price trend stalling at overbought levels. The trouble is, it isn’t perfect. A strong trending price with a lot of inertia can continue trending up and just get more and more overbought. I find that investors who pay a lot of attention to it are concerned their profit will be erased, so they are looking to take profits when it appears overbought.

When the RSI declines below 30 it’s considered “oversold” because, mathematically, it has moved down a little too far, too fast. When it gets “oversold” it’s expected to either drift sideways for some time or reverse back up. We may indeed observe the price trend stalling at oversold levels. The trouble is, a waterfall declining price trend with a lot of inertia like panic can continue trending down and just get more and more oversold. Buying oversold markets, sectors, or stocks can lead to profits, but it’s like catching a falling knife. When I buy oversold markets, I focus on the high dividend yield positions whos yield gets higher as the price falls.

Tactical traders use many different indicators and methods to determine whether to enter, hold, or exit a position. If we look at two conflicting indicators like this, we have to avoid becoming conflicted ourselves. Many tactical traders may experience Confirmation Bias, looking for an indicator that agrees with what they already believe.

So, let’s look at that chart again. On the one hand, it’s trending up! On the other hand, it’s overbought! Will the trend continue or will it reverse down?

We don’t know, but different tactical traders use different methods to enter, hold, and exit positions. I know tactical traders who use only Relative Strength. I know others who mainly use RSI. They are buying and selling each other’s positions and both of them could be profitable overall. If you don’t like to enter a position that may decline in the weeks ahead you may want to avoid high RSI “overbought” markets if you believe they may decline in the short term. If you are a trend following purist who loves to buy new breakouts you’ll ignore the RSI and instead realize a high RSI indicators a strong trend and go for it. Said another way: do you fear missing a trend or fear losing money short term.

It’s easy to say “Don’t get conflicted and biased!” but another to shed more light on the conflict.

Tomorrow I’m going to share with you how I see it.

Stay tuned.

Read Part 2: Resolving Conflicts with Relative Strength

FANG Stocks were the Leaders but now the Laggards

The so-called “FANG” stocks are Facebook (FB), Amazon (AMZN), Netflix (NFLX), and Google (GOOG). These are some of the most talked about stocks in the market the last several years.

If you notice, every bull market has some catchy phrase or acronym the media likes to focus on.

The Nifty 50 was a group of 50 stocks that were most favored by institutional investors in the 1960s and 1970s. Companies in this group were usually characterized by consistent earnings growth and high P/E ratios. Examples of nifty-50 stocks were companies like IBM,  Coca-Cola, and General Electric. The list also included companies that have been had challenges the past decade, like Xerox and Polaroid.

The FANG stocks are popular for good reason. They are some of the best companies in the world. I say that based on the things or services they provide, but also their earnings growth. Earnings growth is the key driver of a stock price. For example, the Investors’ Business Daily shows a EPS Rating of 98, which means NFLX EPS growth rate is above 98% of other stocks. The RS rating is relative strength and means the stock has outperformance 93% of other stocks.

However, in recent months these stocks have shifted from market leaders to laggards. As the overall market has been flat recently, these stocks have declined -5% or so.

We’ll see if they continue to drift down or reverse back up.