What trends are driving emerging markets into a bear market?

In Emerging Markets Reached a Bear Market Level we noted the emerging markets index has declined -20%, which is considered to be in bear market territory. The emerging markets index includes 24 countries classified as emerging countries.

To see the country exposure, we examine the iShares MSCI Emerging Markets ETF holdings. China is about 31%, South Korea is about 15%, Taiwan is over 12%, so the top three countries make up 58% of the country exposure. Add India at 10% and the top four countries is a dominant 68% of the exposure. Clearly, we’d expect the drift of these top holdings to dominate the trend.

what countries are emering markets ETF ETFs

Below we see the 2018 price trends of the emerging markets ETF and the top four countries that make up 68% of the emerging markets index ETF exposure. We see that South Korea and China are the primary downtrends that are trending close to the emerging markets index ETF. Taiwan and India have stronger relative momentum.

emerging markets $EEM china $FXI india south korea 2018 trend

To get a better understanding of what is driving the downtrend, we draw the % off high charts to see the drawdowns. From this observation, we can see what is really driving the trend. Of the top four countries in the index, the negative momentum of China and South Korea are driving the trend down. China is down -24% over the past year as South Korea is down -17%.

emerging market ETF trends

Taiwan and India have stronger relative momentum since they have trended up more recently since July. Prior to July, they were trending closer to China and South Korea.

You can probably see why I include the individual countries in my global universe rather than just the broad emerging markets index ETF that includes 24 countries. I want to find potentially profitable price trends, so I increase my opportunity to find them when I give myself more options.

There are 24 countries represented in the MSCI Emerging Markets Index and we’ve looked at the top 4 because they are given 68% of the exposure. That leaves only 32% in the other 20 countries. So, in regard to understanding what is driving the MSCI Emerging Markets Index, viewing the trend of the top holdings is enough to get an idea of the countries driving returns. But, in wanting to go find potentially profitable price trends, I research all the countries trends.

What about the rest of the emerging markets countries? 

Looking at the other 20 countries classified as emerging markets, I’ll divide them into groups. First, we’ll look at the other countries that are down -10% or more year-to-date. Then, I’ll draw a chart of those that are down this year,  but not as much. We’ll end with the few that are positive in 2018.

Emerging markets countries down the most year-to-date include Turkey, South Africa, Indonesia, Brazil, Philippines, Chile, Poland, and Peru. Priced in U.S. dollars, these countries are down between -14% and -52%. Turkey is down the most.

emerging markets countries down 2018 $EEM

Looking at their % off high shows us the drawdown over the past year, which is a different perspective. If you had held one of these ETFs, this is the amount it would be down from its highest price over the past year.

Emerging markets countries down the most 2018

Clearly, these emerging countries are in downtrends and a bear market if we define a bear market as a -20% decline. Keep in mind, these ETFs are foreign stocks priced in U.S. dollars, so to U.S. investors, this is what the trends of these countries look like.

Next, we observe emerging markets countries that are down less than -10% in 2018. Russia, Columbia, Thailand, and Malasia are down between -3% and 8% so far. Their trends are generally down: lower highs and lower lows.

emering markets year to date 2018

We can see the downtrends in a different perspective when we view their drawdowns as a % off high over the past year.

emering market countries percent off high asymmetric risk reward

I saved the best for last. The strongest trending top momentum emerging markets countries so far in 2018 are Mexico, Taiwan, Saudi Arabia, and Qatar. Saudi Arabia was previously classified as a smaller frontier market, but, this summer MSCI announced it will include the MSCI Saudi Arabia Index in the MSCI Emerging Markets Index.

top momentum emerging markets countires 2018

Hearing names like Mexico, Taiwan, Saudi Arabia, and Qatar may highlight home country bias for some investors. Home country bias is the tendency for investors to favor companies from their own countries over those from other countries or regions.

I don’t have a home country bias. I am open to finding potentially profitable price trends in any country around the world. We encourage investors to be open to global trends and not limit their choices, but if our clients don’t want exposure to any specific country, we are able to exclude it in our ASYMMETRY® Managed Portfolios.

While the United States is the single largest economy in the world, according to JP Morgan it accounts for only a small fraction of global GDP and just over 35% of the world’s capital markets. Yet, studies show that U.S. investors have nearly 75% of their investments in U.S.-based assets. As we’ve shown here, there has been a good reason to avoid emerging countries for now, but as we explain in Emerging Markets Reached a Bear Market Level there are times when these countries present strong relative momentum over U.S. stocks.

This is why I tactically shift between global markets based on their directional price trends rather than a fixed buy and hold global asset allocation.

 

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.

 

 

 

 

 

 

Emerging Markets Reached a Bear Market Level, or is it a Continuation of a Secular Bear Market?

Emerging Markets Reached a Bear Market Level, or is it a Continuation of a Secular Bear Market?

An emerging market is a country that has some characteristics of a developed market but does not satisfy standards to be termed a developed market.

The MSCI Emerging Markets Index covers more than 800 securities across large and mid-cap size segments and across style and sector segments in 24 emerging markets. The 24 countries in the index represent 10% of world market capitalization.  The Index is available for a number of regions, market segments/sizes and covers approximately 85% of the free float-adjusted market capitalization in each of the 24 countries.

MSCI uses their MSCI Market Classification Framework to classify countries based on economic development, size and liquidity, and market accessibility criteria.

According to MSCI, it includes countries like Brazil, Chile, Colombia, and Mexico in the Americas. emerging markets in Europe, the Middle East, and Africa are countries like Hungary, Poland, Russia, and Turkey. Asia emerging markets are China, India, Korea, and Taiwan.

MSCI Emerging Markets Index ETF ETFs

Now that we have clarified who the emerging markets countries are, let’s take a look at their price trends.

The MSCI Emerging Markets Index is in a bear market territory, down -20% from its high in January. The investment industry defines a “bear market” as a -20% off its recent high, so we’ll go with it.

emerging markets $EEM #EEM $IEMG

This isn’t the first time Emerging Markets have declined -20% or more since 2009. The downtrend 2015 – 2016 was over -30%.

EEM Emerging Markets $EEM

Looking back to 2007, we see the Emerging Markets Index has never recovered to reach its high in September 2007. It’s still down about -24% from the high 11 years ago.

$EEM Emerging Markets ETF ETFs

So, if we define a “bear market” as -20% off its high, the Emerging Markets Index was in a bear market until January this year and has since reversed back into a bear market again. A bear market that lasts 11 years as this one did is called a “secular bear market“.

emerging markets long term trend secular bear market eem $eem

So, we could say: emerging markets have reentered their secular bear market. Or, maybe it’s just a continuation of a secular bear market if we don’t consider the temporary January 2018 breakout above its 2007 high to have ended the ongoing secular bear market.

The bottom line is, emerging markets countries as an index are trending down. They’ve been in a generally non-trending range for the last decade, though there have been many swings up and down along the way.

It is what it is, but you may now wonder; Why? I pointed out in Trend of the International Stock Market one reason International stocks are 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. But that isn’t the only driver of stocks in these emerging markets countries.

My focus is on the direction of the actual price trends. Any guess anyone has about what is driving the trend is just a narrative. Some guesses are better than others as there are specific return drivers that drive trends, but my decisions are made based on what the trend is now and if it’s more probable the direction will continue or reverse.

Why do I care about the trend of emerging markets?

As the portfolio manager of a global tactical investment program, I make tactical trading and investment decisions across world markets including not only U.S. stocks, bonds, commodities, and currencies, but also international stocks and bonds. My global universe includes developed countries as well as frontier markets and emerging markets.

As emerging markets are down -20% off their high, smaller frontier markets are close behind and larger developed countries are also in a downtrend.

International stock ETF ETFs

Less experienced ETF investors and advisors sometimes ask why I include international markets in my universe, because they’ve only seen these non-trending, weak trending, and down-trending periods the last twelve years.

I include these international markets to make my universe global because there have been periods when these markets provide significantly better trends and momentum over the U.S. stock market. For example, the 2003-2007 bull market.

international emerging markets countries trend following momentum

You can probably see how exposure to these markets added significant alpha to my global tactical portfolio prior to 2008. However, you may also notice their trends weren’t without volatility and declines along the way, so it wasn’t as simple as a buy and hold allocation to them. My Global Tactical Rotation® systems rotate between these markets trying to capture their positive trends rather than a fixed allocation to them.

As seen in the chart above, the relative strength of emerging, frontier, and developed countries were significant over domestic stock indexes in the 2003 to 2007 bull market. It was a trend driven by commodities and countries that produce natural resources.

They will have their opportunity again but for now, this trend isn’t our friend.

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 U.S. stock market was strong in August, but…

August was a strong month for the U.S. stock market, but the broad S&P 500 stock index and leading sectors have reached short-term overbought extremes that often indicate short-term elevated risk.

My focus is to position capital in the primary direction of trends across different time frames, but trends can reach short-term extremes within the primary trend. We can focus only on the bigger trend, or we can try to take advantage of the short-term moves.

To understand where I am coming from for this observation, let’s define trend and extreme.

Trend is a direction that a price is moving, developing, evolving, or changing. A trend is a directional drift, one way or another. When we speak of price trends, the directional drift of a price trend can be up, down, or sideways. When I say a price is trending, it’s drifting up or down. I call sideways oscillation non-trending.

Extreme is reaching a high or the highest degree; very great, furthest from the center or a given point.

Tactical traders can be either directional traders or non-directional. For example, all investors are necessarily directional: they invest in a thing and want its price to go up.

A tactical trader can be directional: buying a stock, bond, commodity, or currency, hoping it will go up with them or they can sell it short hoping it will trend directionally down. They are directional traders, so they necessarily need to define the direction of the trend. Which way is it drifting?

However, not all traders are directional. Volatility traders who trade volatility through listed options or futures are trading movement itself, so when we trade volatility we aren’t concerned at all with the direction of the trend – we just want movement. Volatility traders may have no bias at all regarding the direction, we focus on volatility expansion or volatility contraction.

Trend Following is a directional strategy that requires the portfolio manager to determine the direction of the trend and enters that trend expecting inertia and momentum to continue in that direction. There are more than 300 published academic studies alone that prove that the most recent 3 to 12-month price momentum tends to continue rather than reverse. That doesn’t include the vast research and testing conducted by actual trading firms and hedge fund managers (like mine) that are not published to the public. These methods rely on directional trends to exploit for profit.

Countertrend is another directional strategy that requires the portfolio manager to determine the directional trend. However, my counter-trend system is designed to identify trends that are more likely to reverse and change direction than to continue. It may seem this strategy is the opposite of trend following, and in some ways it is, but countertrend systems are based on different time frames when executed correctly.

For example, a trend-following strategy that has been profitable has necessarily identified existing trends that have continued and trend following profits from the magnitude of those gains.

A counter trend can also be profitable and even combined with a trend following system. A counter trend system identifies reversals when the trend has changed or likely to change. The time frame, then, is different.

For example, while research shows that directional momentum over the recent 3 – 12 months tends to continue for another 12 months or longer, we also observe that trends have lasted 4-5 years tend to reverse and change trend.

You may notice stock market uptrends (bull markets) last about 4-5 years before they reverse into a downtrend (bear market). You may also notice investors and their advisers have a tendency to buy funds with the highest 5-year returns, only to catch the end of the excellent performance. You can probably see how they are “trend following” but using the wrong time frame. We find that trends actually reverse around the time those performance tables look appealing to investors. Counter trend systems aim to get positioned for big reversals in trend to profit from their directional change. Skilled counter trend portfolio managers develop and operate countertrend systems that are proven and quantified to identify and profit from such changes in trend.

We also observe short-term countertrends within the 30-day time frame.  Sometimes short-term extremes result in at least a temporary countertrend move in the opposite direction. These are shorter trend countertrends within an overall primary trend. Of course, countertrend reversals can also become longer trend changes, too.

Back to August, it was a strong month for U.S. stocks, but the broad indexes and leading sectors have reached higher risk levels in the short term.

sector rotation august 2018 stock market returnThe Technology sector reached a short-term overbought extreme in June and again in July and declined about -4% before resuming an uptrend.

The Consumer Discretionary sector where Amazon (AMZN) has a 25.5% weighting reached an overbought extreme in June and declined about -4% before resuming an uptrend.

The Healthcare sector has also shown strong momentum in its trend. It also reached a short-term overbought level, but only declined about -3%. However, by my measure, the Healthcare sector is more overbought than others.

These shorter trend trends are partly driven by investor sentiment. So, investor sentiment measures can be useful secondary confirming indicators to understand the condition of trends. At this point, most investor sentiment readings are only modestly elevated to levels that suggest greed is driving the market trend. Price could keep trending until enthusiasm is exhausted and sellers become dominant.

This is a very short-term observation of current trends. It’s just a near-term insight that we shouldn’t be surprised to see stocks decline at least a few percents in the weeks ahead.

And… it’s September… for those who follow seasonality, September has historically been one of the weakest months for stocks. I don’t make decisions based on seasonality. If stocks decline this month, the cause will be what I highlighted, not because which month it happens to be.

The bottom line is the broad stock indexes are trending up and led by a few strong sectors, but they’ve reached levels that my countertrend momentum systems suggest the risk of at least a temporary decline is elevated.

 

Mike Shell is the Founder, and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios and 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, U.S. Dollar, Emerging Markets, Commodities, and Their Changing Correlations

One of the more interesting global macro market trends right now is the direction of the U.S. Dollar and its impact on other markets.

The chart below is the U.S. Dollar trend year-to-date vs. the Emerging Market Index ETF. Emerging Markets are newly industrialized countries whose economies have not yet reached developed status. As the U.S. Dollar index has gained around 5% in 2018, Emerging Markets have trended down over -7%.

EMERGING MARKETS EEM $EEM #EEM DOLLAR TREND FOLLOWING ASYMMETRIC

At the bottom of the chart, I included the correlation coefficient of the trends between the U.S. Dollar and Emerging Markets. A high correlation value is +1, non-correlated is 0, and a completely negative correlation is -1. The value of -0.90 is a negative correlation relationship between them. As the Dollar is trending up, Emerging Markets is trending down. We don’t need a correlation coefficient equation to determine that since it’s clear by looking at their price trends, the value shows just how negative the relationship has been.

Since Emerging Markets are growing countries, you can probably see how changing trends in currency rates can have an impact on them. For example, countries like China, South Korea, and Thailand are Emerging Markets. If those countries are selling their products to Americans who buy them in U.S. Dollars, a rising Dollar relative to their currency makes their things more expensive for Americans.

Correlation is the relationship or connection between two or more things. In investment management, we use it to measure the degree to which two or more securities move in relation to each other. Correlation is probably one of the most misused equations because professional investors seem to rely on it too much.

Correlation isn’t necessarily causation.

Correlations are ever evolving  – they change over time.

One of the most dangerous investment management mistakes is to assume markets that are supposed to trend independently will always be negatively correlated. A grand example is the failure of diversification among markets that are supposed to trend independent to each other to provide downside risk management in a bear market.

In the chart below, we show the % off high U.S. stocks, Emerging Markets, Developed Countries, and Commodities since June 1999. It shows the drawdowns of these markets from their % off price highs. The October 2007 to March 2009 “Financial Crisis” wasn’t the only time expected non-correlations failed. In the “Tech Wreck” from 2000 to 2003 we also observed international stocks, real estate, and commodities all declined together.

global asset allocation diversification failed 2008

Back to the U.S. Dollar…

An observation is to see something. The action or process of observing something carefully in order to gain information.

Insight is the understanding of a specific cause and effect within a specific context.

What is driving the Dollar up?

Ultimately, supply and demand drives the price trend of everything.

  • If there is enough buying enthusiasm – price goes up.
  • If selling pressure overwhelms buying demand – prices fall.

Beyond this simple economic principle, I believe we have certain key drivers of global market returns. It’s things like the direction of interest rates and inflation. For example, with the Fed raising our interest rates in America, our Dollars have a higher yield for foreign investors. If foreign investors were only earning .50% on their Dollars a year ago and now it’s 1.5%, that may motivate them to buy more Dollars.

Because supply and demand ultimately drives the price trend, I focus on the direction and change of direction of price trends themselves. Correlations are only a secondary observation for me. In fact, though the year-to-date correlation between Emerging Markets and the Dollar is negative, I show below these correlations do indeed change over time. However, though it’s oscillating in degree, we observe there is generally a negative correlation between the Dollar and Emerging Markets – it stays below .50.

changing correlation emerging markets dollar

Below we see that an index ETF of Developed Countries like Japan, the United Kingdom, France, and Germany are also demonstrating a negative correlation with the Dollar, but not as much as Emerging Markets. The iShares MSCI EAFE ETF (EFA) is down about -3% year-to-date with a correlation of -63.

dollar correlation with international stocks ETF ETFs EFA EEM

Another asset class that typically shows a negative trend vs. the Dollar is commodities. The commodities index correlation was negative up until May and has since become more connected.

commodities correlation with dollar

Just like price trends, correlations change and evolve over time. Investors shouldn’t expect them to remain intact when they historically show us they don’t.

It’s interesting to observe how markets interact with each other, but their relationships change because there are different return drivers impacting them.

This is why I don’t constrain myself to beliefs that require fixed causations or correlations. I prefer to be more flexible and unconstrained so I can adapt to changing conditions.

Everything is impermanent – nothing lasts forever.

Mike Shell is the Founder, and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios and 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 ETF Trends

Looking at the broad global markets, U.S. stocks are in a positive trend along with the U.S. Dollar. International stocks, commodities, and foreign currency are trending down.

With the directional trends and momentum being in U.S. stocks, though not without volatility, that has been our focus this year.

International stocks including both developed countries $EFA and emerging markets $EEM are trending down so far in 2018 as the U.S. Dollar $UUP is trending up.

The U.S. Dollar $UUP is trending similar to U.S. stocks $SPY in April.

The dollar has an inverse correlation with foreign currency like the Euro.

With the rising dollar $USD, gold $GLD is trending down even more than the Euro currency $FXE.

So, the overall broad observation of global macro picture is clearly a rising U.S. Dollar and U.S. stocks that are diverging from other markets.

Mike Shell is the Founder, and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios and 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 shows some shifts

Much of the observations I shared last week are continuing to be more apparent this week.  So, in case you missed it, this may be a good time to read them.

Earnings season is tricky for momentum growth stocks

I discussed how earnings season can drive a volatility expansion in stocks, especially high growth momentum stocks. The stock market leaders can become priced for perfection, so we never know how investors will react to their earnings reports. To achieve asymmetric returns from momentum stocks, we need a higher magnitude of positive reactions than adverse reactions over time. On a quarterly basis, it can be tricky. The gains and losses as much as 20% or more in the most leading momentum stocks like Facebook ($FB), Google ($GOOGL), Twitter ($TWTR), Grub ($GRUB), and NetFlix ($NFLX) have since provided a few examples.

Front-running S&P 500 Resistance

In Front-running S&P 500 Resistance I shared an observation that many market technicians incorrectly say support and resistance appear before it actually does. We won’t know if resistance to a price breakout exists until the price actually does pause and reverse. I suggested the S&P 500 may indeed pause and reverse, but not because the index drives the 500 stocks in it, but instead because my momentum indicators suggested the $SPY was reaching a short-term overbought range “So, a pause or reversal, at least some, temporarily, would be reasonable.” As of today, the S&P 500 has paused and reversed a little. We’ll see if it turns down or reserves back up to continue an uptrend.

Asymmetry of Loss: Why Manage Risk?

asymmetry of loss losses asymmetric exponential

In Asymmetry of Loss: Why Manage Risk? I showed a simple table of how losses compound exponentially. When losses become greater than -20%, it becomes more exponential as the gains required to recover the loss are more and more asymmetric.  This simple concept is essential and a cornerstone to understanding portfolio risk management. Buy and hold type passive investors who hold a fixed allocation of stocks and bonds are always fully exposed to market risk. When the market falls and they lose -20%, -30%, -50% or more of their capital, they then face hoping (and needing) the market to go back up 25%, 43%, or 100% or more just to get back to where they were. This can take years of valuable time. Or, it could take a lifetime, or longer. Just because the markets have rebounded after being down for four or five years from their prior highs doesn’t guarantee they will next time. Past performance is no guarantee of future results.

Trend following applied to stocks

In Trend following applied to stocks, the message was short and sweet: gains are produced by being invested in stocks or markets that are trending up and losses are created by stocks trending against us. Investors prefer to be in rising stocks and out of falling stocks. But, as I showed in Earnings season is tricky for momentum growth stocks the trick is giving the big trends enough room to unfold. In fact, applying trend following and momentum methods to stocks is also tricky. It’s a skill that goes beyond just looking at a chart and it’s not just a quantitative model.

Stock market investor optimism rises above the historical average

About two weeks ago,  the measures of investor sentiment showed a lot of optimism about future stocks prices, so we shouldn’t have been surprised to see some stocks fall. When a lot of enthusiasm is already priced in, investors can respond with disappointment when their stocks don’t live up to high expectations.

Much of the momentum and trend following in stocks is driven by an overreaction to the upside that can be accompanied by an overreaction to the downside. A robust portfolio management system factors these things in.

 

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.

Front-running S&P 500 Resistance

The S&P 500 stock index closed just -1% from its all-time high it reached on January 26, 2018, and hasn’t been that high since. It’s been in a drawdown that was as much as -10% and it has taken six months to get back near its high point to break even.

SPY SPX $SPX $SPY S&P 500 STOCK INDEX

Before the madness begins saying “The S&P 500 is at resistance,” I want to point out an observation of the truth. It is one thing to draw a trend line on an index to indicate its direction, quite another to speak of “support” and “resistance” at those levels.

Is the S&P 500 at resistance? 

Depending on which stock charting service or data provider you use, it may appear the S&P 500 ETF (SPY) closed at its prior high. Many market technicians would draw a line like I did below in green and say “the S&P 500 is at resistance.”

S&P 500 stock index at resitance SPY SPX

In technical analysis applied to stock market trends, support and resistance is a concept that the movement of the price of a security will tend to stop and reverse at certain predetermined price levels.

Support is when a price trends down and stalls at a prior low. The reasoning is that investors and traders who didn’t buy the low before (or wish they’d bought more) may have buying interest at that prior low price if it reaches it again.

Resistance is when a price trends up and stalls at a prior high. The reasoning is that investors and traders who didn’t sell the high before (or wish they’d sold short to profit from a price decline) may have the desire to sell at that prior high price if it reaches it again.

Whether everyone trades this way or not, enough may that it becomes a self-fulling prophecy. I believe it works this way on stocks and other securities or markets driven by supply and demand, but an index of stocks?

To assume a market or stock will have support or resistance at some price level (or a derivative of price like a moving average) that hasn’t been reached yet is just a predictive assumption. Support and resistance don’t exist unless it is, which is only known after the fact.

One of the most fascinating logical inconsistencies I see by some technical analysts is the assumption that “support” from buying interest and “resistance” from selling pressure “is” there, already exists, before a price is even reached. Like “SPY will have resistance at $292.” We simply don’t know until the price does indeed reverse after that point is reached.

But, it gets worse.

To believe an index of 500 stocks is hindered by selling pressure at a certain price requires one to believe the price trend is controlled by the index instead of the 500 stocks in it.

Think about that for a moment. Let it sink in. 

  • Do you believe trading the stock index drives the 500 stocks inside the index?

or

  • Do you believe the 500 stocks in the index drive the price of the index?

What you believe is true for you. But, to believe an index of 500 stocks is hindered by selling pressure or buying interest at a certain price requires you believe the price trend is controlled by the index instead of the 500 stocks in it. That’s a significant belief.

To complicate it more. If we want to know the truth, we have to look a little closer.

Is the S&P 500 at resistance? 

As I said, it depends on which stock charting service or data provider we use and how we calculate the data to draw the chart. Recall in the prior chart, I used the SPDRs S&P 500 ETF (SPY) which shows the ETF closed near its prior high. I used Stockcharts.com as the data provider to draw the chart. I’ve been a subscriber of their charting program for 14 years so I can tell you the chart is based on Total Return as the default. That means it includes dividends. But, when we draw the same chart using the S&P 500 index ($SPX) it’s based on the price trend. Below is what a difference that makes. The index isn’t yet at the prior high, the SPY ETF is because the charting service includes dividends.

SPY SPX TOTAL RETURN RESISTANCE

Here is another charting service where I’m showing the S&P 500 ETF (SPY) price return, total return, and the S&P 500 stock index. Only one is at the January high.

spy spx S&P 500 resistance

So, we don’t know if the S&P 500 is at resistance and we won’t know if there exists any “resistance” there at all unless the price does pause and reverse down. It so happens, it just may pause and reverse at this point. Not because more tactical traders are looking at the total return chart of SPY or because the index or ETF drives the 500 stocks in it, but because momentum measures indicate its potentially reaching an “overbought” level. So, a pause or reversal, at least some, temporarily, would be reasonable.

Some may call this charting, others call it technical analysis, statistical analysis, or quantitative analysis. We could even say there is some behavioral finance included since it involves investor behavior and biases like anchoring. Whatever we choose to call it, it’s a visual representation of supply and demand and like most things, it’s based on what we believe to be true.

I’ve been applying charting, pattern recognition, technical analysis, statistical analysis, and quantitative analysis for over twenty years. Before I started developing computerized programs based on quantitative trend systems that apply evidence-based scientific methods, I was able to trade successfully using visual charts. I believe all of it has its usefulness. I’m neither anti-quant or anti-charting. I use both, but for different reasons. I can argue for and against both because neither is perfect. But, combining the skills together has made all the difference for me.

Is the S&P 500 at resistance? 

We’ll see…

 

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.

Earnings season is tricky for momentum growth stocks

Momentum stocks are stocks that show high upside momentum in their price trend. Momentum stocks are trending not only regarding their absolute price gains but also relative strength vs. other stocks or the stock market index.

Momentum stocks are usually high growth stocks. Since momentum stocks are the strongest trending stocks, their trends are often driven by growth in sales and earnings. Growth stocks are companies that are growing earnings at a rate significantly above average. Growth stocks have high increases in earnings per share quarter over quarter, year over year, and may not pay dividends since these companies usually reinvest their strong earnings to accelerate growth.

Now that we have defined what I mean by “momentum stocks,” we can take a look at some examples of momentum stocks and their characteristics like how their prices trend.

Grubhub Inc. ($GRUB) is an online and mobile food-ordering company that connects diners with local restaurants. GrubHub is a great example today of a high momentum growth stock.  GrubHub stock has gained 24% today after smashing Wall Street’s expectations. Earnings grew 92% to 50 cents a share, marking the fifth quarter in a row of accelerating EPS growth. Revenue soared 51% to $239.7 million, a quarterly best.

Grubhub $GRUB GRUB

Before today, GrubHub stock was in a positive trend that developed a flat base since April (highlighted on the chart). GRUB had already gained 60% year to date, but after such as explosive uptrend in momentum, it trended sideways for a while.

It is earnings season, which can be tricky for the highest momentum stocks. Once a stock has already made a big move, it could already have a lot of good news expectations priced in. That concerns some momentum stock traders. In fact, I know some momentum stock traders who exit their stocks before their quarterly earnings announcements. If they had exited GrubHub, they would have missed today’s continuation of its momentum. However, they would avoid the downside of those that trend in the other direction.

I’ve been trading momentum stocks for over two decades. Over the years I’ve observed different regimes of how they act regarding trend strength and volatility. There are periods of volatility expansion and contraction and other periods when momentum is much stronger.

Volatility is how quickly and how far the price spreads out. When price trends are volatile, it’s harder to stick with them because they can move against us. We like upside volatility, but smart investors are loss averse enough to dislike downside volatility that leads to drawdowns. To understand why the smart money is loss averse, read: “Asymmetry of Loss: Why Manage Risk?“.

Strong upward trending stocks are sometimes accompanied by volatility. That’s to be expected because momentum is a kind of volatility expansion. Upward momentum, the kind we like, is an upward expansion in the range of the price – volatility.

That’s good vol.

But, strong trending momentum stocks necessarily may include some bad volatility, too. Bad volatility is the kind investors don’t like – it’s when the price drops, especially if it’s a sharp decline.

I mentioned GrubHub had gained 60% YTD. I like to point out, observe, and understand asymmetries. The asymmetry is the good and the bad, the positive and the negative, I prefer to skew them positively. What I call the Asymmetry® Ratio is a chart of the upside total return vs. the chart of the downside % off high. To achieve the gain for GrubHub, investors would have had to endure its price declines to get it. For GrubHub, the stock has declined -10% to -15% many times over the past year. It has spent much of the time off its high. To have realized all of the gains, investors had to be willing to experience the drawdowns.

grubhub stock GRUB

I point this out because yesterday I wrote “Asymmetry of Loss: Why Manage Risk?” where I discussed the mathematical basis behind the need for me to actively manage the downside risk. To achieve the significant gain, we often have to endure at least some of the drawdowns along the way. The trick is how much, and for me, that depends on many system factors.

Earnings season, when companies are reporting their quarterly earnings, is especially tricky for high momentum stocks because stocks that may be “priced for perfection” may be even more volatile than normal. Accelerating profit growth is attractive to investment managers and institutional investors because increasing profit growth means a company is doing something right and delivering exceptional value to customers. I’m more focused on the direction of the price trend – I like positive momentum. But, earnings are a driver of the price trend for stocks.

Earnings can trend in the other direction, too, or things can happen to cause concern. This information is released in quarterly reports.

Another example of a momentum stock is NetFlix. By my measures, GrubHub is a leading stock in its sector and NetFlix (NFLX) is the leader in its industry group, too, based on its positive momentum and earnings growth. As we see in the chart below, NFLX has gained 88% year to date. That’s astonishing momentum considering the broad stock market measured by the S&P 500 has gained around 5%, and its Consumer Services Sector ETF has gained 11%.

NetFlix NFLX $NFLX

However, NetFlix stock regularly declines as much as -15% as a regular part of its trend. It has fallen over -10% five times in the past year on its way to making huge gains. The latest reason for the decline was information that was released during its quarterly earnings announcement. The stock dropped sharply afterward.

netflix stock risk downside loss

But, as we see in the chart, it’s still within its normal decline that has happened five times the past year.

While some of my other momentum stock trader friends may exit their stocks during the earnings season, I instead focus more on the price trend itself. I predefine my risk in every position, so I determine how much I’ll allow a stock to trend to the downside before I exit. When a stock trends down too far, it’s no longer in a positive trend with the side of momentum we want. To cut losses short, I exit before the damage gets too large.

How much is too much? 

A hint is in the above charts.

If we want to experience a positive trend of a momentum stock, we necessarily have to give it enough room to let it do what it does. When it trends beyond that, it’s time to exit and move on. We can always re-enter it again it if trends back to the right side.

Sure, earnings season can be tricky, but for me, it’s designed into my system. I’m looking for positive Asymmetry® – an asymmetric risk/reward. What we’ve seen above are stocks that may decline as much as -15% as a normal part of their trend when they fall, but have gained over 50% over the same period.

You can probably see how I may be able to create a potentially positive asymmetric risk/reward payoff from such a trend.

 

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

 

 

 

 

 

Asymmetry of Loss: Why Manage Risk?

“The essence of portfolio management is the management of risks, not the management of returns.” —Benjamin Graham

Why actively manage investment risk?

Why not just buy and hold markets and ride through their large drawdowns?

Losses are asymmetric and loss compounds exponentially.

The larger the loss, the more gain is required to recover the loss to get back to breakeven.

The negative asymmetry of loss starts quickly, losses more than -20% decline start to compound against you exponentially and with a greater magnitude the larger the loss is allowed to grow.

If your investment portfolio experiences a -20% loss, it needs a 25% gain to get back the breakeven value it was before the loss.

asymmetry of loss losses asymmetric exponential

At the -30% loss level, you need a 43% gain to get it back.

Diversification is often used as an attempt to manage risk by allocating capital across different markets and assets.

Diversification and asset allocation alone doesn’t achieve the kind of risk management needed to avoid these large declines in value. Global markets can fall together, providing no protection from loss.

For example, global markets all fell during the last two bear markets 2000-2003 and 2007-2009.

global asset allocation diversification failed 2008

It didn’t matter if you had a global allocation portfolio diversified between U.S. stocks, international stocks, commodities, and real estate REITs.

Diversification can fail when you need it most, so there is a regulatory disclosure required: Diversification does not assure a profit or protect against loss.

This is why active risk management to limit downside loss is essential for investment management.

I actively manage loss by knowing the absolute point I’ll exit each individual position and managing my risk level at the portfolio level.

Active risk management, as I use it, applies tactics and systems to actively and dynamically decrease or increase exposure to the potential for loss.

My risk management systems are asymmetric risk management systems. Asymmetric risk management intends to manage risk with the objective of a positive asymmetric risk/reward.

My asymmetric risk management systems are designed to cut losses short, but also protects and manages positions with a profit.

After markets trend up for a while without any significant interruption, investors may become complacent and forget the large damage losses can cause to their capital and their confidence. When investors lose confidence in the markets, they tap-out when their losses are allowed to grow to large.

I prefer to stop the loss before it gets too large. How much is too large depends on the client, but also the math. As seen here, I have a mathematical basis for believing I should actively manage investment risk.

It’s why I’ve been doing it for two decades. Because I understood the math, I knew I had to do it over twenty years ago and developed the systems and tactics that proved to be robust in the devastating bear markets I’ve executed through since then.

 

Mike Shell is the Founder, and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios and 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 following applied to stocks

A stock must be in a positive trend to earn a huge gain…

A stock must be in a downtrend to produce a large loss…

The common factor? the direction of the trend…

That’s what investors like about the concept of trend following.

We want to have capital in trends that are rising and out of trends that are falling.

 

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.

 

 

 

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 interest 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.