Technical analysis of the stock trend and volatility

Just yesterday I shared the observation in The value of technical analysis of stock market trends that the stock indexes were in a tight range the past month and we’d likely see a breakout, up or down.

I didn’t mention possible macroeconomic or geopolitical factors, I just pointed it out saying the market does what it does., and something or someone gets the blame.

Today, the stock market has shifted from being positive after the open, shaking off news of China imposing new tariffs on the U.S., to a waterfall decline down -2% at this point. Below is the up-close trend of today’s action so far.

Some probably believe the stock market is falling because of the new China Tariffs on the U.S, Trump Tweet about China, Jackson Hole Comments, or The Federal Reserve.

The reality is, it’s just the market, doing what it does.

I focus on that. The price trend and volatility.

Here is the trend looking at the tight range I observed yesterday. As you can see, the price is still within the range, but it’s trending toward the lower range.

DOW STOCK MARKET DOWN DAY TRUMP CHINA

In the meantime, the CBOE S&P 500 Volatility Index (VIX) has spiked up 25% today on the new enthusiasm for expected future volatility.

Wikipedia defines Technical Analysis as:

In finance, technical analysis is an analysis methodology for forecasting the direction of prices through the study of past market data, primarily price and volume.

By that definition, what I’m sharing here isn’t Technical Analysis, I guess.

Investopedia defines it as:

Technical analysis is a popular trading method that analyzes past price action, usually on charts, to help predict future price movements in financial markets.

But, I am analyzing past price action on charts, but not necessarily to predict future price movements.

I’ll just call it charting.

I hope you find it helpful.

Let’s see how it closes. 

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

The value of technical analysis of stock market trends

Someone asked; how do you use technical analysis (charting) as an investment manager?

I’ll share a simple and succinct example.

Below is a chart of a popular stock market index. What do you see when you look at it?

I see an overall uptrend based on this time frame, which is only year-to-date.

I see it’s experiencing a normal-looking interruption in the short term, so far.

As such, I’m looking for signs of which direction it’s going to move, by observing which direction it does move.

Without adding a single “technical indicator” for statistical or quantitative analysis, I see the stock market using this proxy has been drifting generally sideways since February.

spy spx ytd trend following

However, it has made higher highs and higher lows, so it’s a confirmed uptrend.

Looking closer, are shorter term, I see the green highlighted area is also in a non-trending state, bound by a range. I’m looking for it to break out; up or down.

setting stop loss for stocks

If it breaks down, I will look for it to pause around the red line I drew, because it’s the prior low as well as an area of trading before that. I would expect to see some support here, where buyer demand could overcome selling pressure.

If it doesn’t, I’d say:

Look out below!

Do I trade-off this? Nope.

Am I telling you to? Nope.

But, if I wanted to trade off it, I could. This is an index and the index is an unmanaged index and cannot be invested in directly. But, for educational purposes, assume I could enter here. Before I did, I would decide my exit would be at least a break below the red line. Using that area as an exit to say “the trend has changed from higher lows to lower lows, which is down, I’ll exit if it stays below the line.

Of course, the same strategy can be applied quantitatively into a computerized trading system. I could create an algorithm that defines the red line as an equation and create a computer program that would alert me to its penetration.

This is a succinct and simple glimpse into concepts of how I created my systems.

I hope you find it useful.

I developed skills at charting before I created quantitative systems. If someone doesn’t believe in either method, they probably lack the knowledge and skill to know better.

Let me know if we can help!

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Your technical analysis is no match for Trump Tweets!

Someone texted me this image this morning.

Trump Tweets market reaction to trump tweet

Now that’s funny right there; I don’t care who you are!

But seriously though, many people like to blame others for their reality. Most of the time, the market does what it does, and something or someone always gets the blame for it – besides them.

It’s an easy way for them to be right. It wasn’t them and their risk exposure that was wrong, it was someone else like the President, or the Fed, or the machines.

I ignore the nonsense and focus on price trends. I focus on the facts.

Yes, I call it technical analysis of price trends, as it has been called for decades.

But, just like we are now seeing trading firms call computerized quantitative trading systems more trendy names like “artificial intelligence” and “machine learning” or “pattern recognition”, others have renamed technical analysis “quantitative analysis”

The trend seems to be driven by those who write research papers, books, and such.

To be sure, an example is a disclosure I saw in an SEC Form ADV registration document. In Methods of Analysis, Investment Strategies, and Risk of Investment Loss, the first lists: Quantitative analysis and Fundamental analysis, but not Technical analysis. I’m going to fictitiously call this firm “QUANT”.

QUANT will primarily utilize Quantitative analysis but may also use other analysis methods, including Fundamental analysis as needed.

Quantitative analysis involves the analysis of past market data; primarily price and volume.

Fundamental analysis involves the analysis of financial statements, the general financial health of companies, and/or the analysis of management or competitive advantages.

Investment Strategies QUANT will utilize long term trading and short term trading strategies.

Under Material Risks Involved, it goes on to say:

Methods of Analysis

Quantitative analysis attempts to predict a future stock price or direction based on market trends. The assumption is that the market follows discernible patterns and if these patterns can be identified then a prediction can be made. The risk is that markets do not always follow patterns and relying solely on this method may not work long term.

Fundamental analysis (I’m skipping this irrelevant part for brevity)

Investment Strategies

Long term trading is designed to capture market rates of both return and risk. Frequent trading, when done, can affect investment performance, particularly through increased brokerage and other transaction costs and taxes.

Short term trading generally holds greater risk and clients should be aware that there is a material risk of loss using any of those strategies.

Investing in securities involves a risk of loss clients should be prepared to bear.

What’s the big deal?

It isn’t a big deal, but, let’s change a single word to see what happens.

Let’s replace “Quantitative” with “Technical” and see if it fits the same.

Technical analysis attempts to predict a future stock price or direction based on market trends. The assumption is that the market follows discernible patterns and if these patterns can be identified then a prediction can be made. The risk is that markets do not always follow patterns and relying solely on this method may not work long term.

Yes, that’s the definition used for Technical analysis.

The point is, they just didn’t want to call it “Technical analysis” because “Quantitative analysis is more trendy in modern times.

But, it’s the same.

I don’t debate others hoping to change their minds, but instead, I do mull over what others believe to see how it may be in conflict with what I believe. By doing that, it allows me to question my own beliefs to see if there is enough evidence to change what I believe. I do that to combat what we are all more prone to do, which is seek out information that confirms what we already believe and ignore information that says it isn’t true. Humans have the tendency to interpret new evidence as confirmation of one’s existing beliefs or theories. If we want to gain new knowledge, we have to consider we may be wrong and apply a scientific approach to discover new knowledge.

Confirmation bias is the tendency to search for, interpret, favor, and recall information in a way that affirms one’s prior beliefs or hypotheses. It is a type of cognitive bias and a systematic error of inductive reasoning.

We have to be careful of looking for information that reinforces what we already believe, without considering what could be wrong about our beliefs.

It’s reverse-engineering.

I try to break it to see if it will break and what makes it break.

…and speaking of Technical Analysis, Long Term U.S. Treasury Bond ETF TLT has been in a volatility expansion, on the upside. Demand has driven its price momentum up to levels historically seen during larger stock market declines. The price is now outside the upper price channel. You can probably observe what it typically does afterward.

technical analysis of TLT $TLT trend following

Technical Analysis of the S&P 500 index price trend: it looks to me like we’re about to observe a breakout in one direction or the other. The last time, in May, the breakout was to the downside. This time may be different. See the first image above for risk disclosure of what may go wrong — or at least who may be blamed for it 🙂

technical analysis of the stock market spx

Technical Analysis of VIX: the volatility expansion has now contracted from 25 to 15. So, the options market now expects the range to be within 15% instead of 25%.

We’ll see if vol expectations continue to drift down, or spike back up.

Ps. I didn’t provide any evidence of my political beliefs. If anyone took anything from the above as a sway one way of the other, they are joking themselves as I am joking with them. I focus on the facts. We can’t blame any single thing or any one person on the direction of stock market trends and if anyone does so, they are joking themselves.

We can say the same for calling Technical analysis Quantitative analysis, believing by changing the word, it means something different.

It doesn’t.

I say believe and do whatever creates asymmetric investment returns for you.

But as Larry the Cable Guy says:

Now that’s funny right there; I don’t care who you are!

 

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Investor fear has been driving the stock market down

I like to observe the return drivers of price trends. Though I primarily focus on the direction of the price trend and volatility, I also consider what drives the price trend.

Yesterday I suggested the stock market was at a point of pause and possible reversal back up in The stock market is holding its breadth… for now.  I shared some examples of how the percent of stocks in a positive trend had declined to a point that could indicate the selling in the near term could be drying up.

So far, today’s sharp reversal up seems to confirm at least a short term low.

Up until today, the S&P 500 stock index was down about -6% off its high. In May it dropped -8% before reversing back up to a new high. I express these drawdowns in the % off high chart below. This is year-to-date, since January 1.

Just for reference, this -6% decline looks more similar to May when I expand the time frame to 1 year instead of just year-to-date. We also see the October to December waterfall decline was a much deeper -20%.

Of course, if you look close enough, the pattern prior to the much steeper and deeper part of that fall looks similar to now, with the price trend testing the prior low, recovering, then falling sharply another -10%. I’m not pointing this out to say it will happen again, but instead that it’s always a possibility, so risk management is essential.

What is driving this decline?

Fear.

It’s that simple.

Some are afraid of another recession signaled by an inverted yield curve, others of the Trump Tweets, others by the Fed lowering interest rates or not doing it fast enough. I’ve heard some hedge funds are afraid China will invade Hong Kong, others are concerned of the China tariffs. Some people probably wake up afraid and fear everything that can possibly happen, as such, they experience it as if it did.

I prefer to face my fears and do something about them.

Investors have reached an extreme level of fear in the past few weeks as evidenced by the -6% decline in the stock index. We can also see this reflected in the investor sentiment poll. The AII Sentiment Survey shows optimism is at an unusually low level and pessimism is at an unusually high level for the 2nd consecutive week.

investor sentiment extreme trading

Such extreme levels of investor sentiment often proceed trend reversals. So, these extreme fear measures along with the breadth measures I shared yesterday, I’m not surprised to see the stock market reverse up sharply today.

Another interesting measure is the Fear & Greed Index, which is a combination of multiple sentiment indicators believed to measure investor sentiment. The Fear & Greed Index has reached the “Extreme Fear” level, so by this measure, fear is driving prices.

fear greed index

Over time, we can see how the Fear & Greed Index has oscillated up and down, swinging from fear to greed and back to fear again. I highlight the current level has reached the low point it typically does before it reverses up again, with the exceptions of the sharp panics in 2018.

advisor money manager using fear greed index extreme behavior

I have my own proprietary investor sentiment models, but here I share some that are simple and publicly available. I’m not suggesting you trade-off of these, as I don’t, either, but instead use them to help modify your investor behavior. For example, rather than use these indicators to signal offense or defense, investors may use them to alert them to their own herding behavior. Most of the time, we are better off being fearful when others are greedy and greedy when others are fearful.

These measures aren’t quite robust enough to be timing indicators by themselves, my signals are coming from other systems and I’m using these to illustrate what’s driving it.

Over the past 12 months, as of right now the stock index is up 2.48%. That’s including today’s 1.5% gain.

Only time will tell if it holds the line, but as I’ve zoomed in to a 3-month time frame, we can see the first line of support that needs to hold.

We are long and strong at this point, so;

Giddy up!

 

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

The stock market is holding its breadth… for now

The stocks in the S&P 500 index that are above their 50 day moving average has stopped at the same level it reversed in May. The percent of stocks in up or downtrends is a measure of breadth, which means how actively stocks are participating in uptrends and downtrends. 

spx percent of stock above 50 day moving average

At 30% of stocks above their short term trend line isn’t nearly as washed-out as they were last December, we’ll see if this is the end of the selling pressure.

The percent of stocks above their 200 day moving average is at 54%, also around the same level as the May correction.

spx stocks above 200 day moving average asymmetric risk reward

But, notice that is nowhere near the December washout, which as an asymmetric risk-reward opportunity.

Of course, nothing is more important than the actual price trend itself. In the really short term, today paused at the low two weeks ago. If this line doesn’t hold, the next one is the May low. So, we shouldn’t be really surprised to see it fall to that level.

spx spy trend following

So far this stock index is -6% off it’s high, a normal correction within an ongoing uptrend.

So, if this is just a normal pullback within an ongoing uptrend, we should soon see the enthusiasm to buy overwhelm the desire to sell. Otherwise, the stock market will obviously fall some more, and that would still be within a normal decline.

Fortunately, I anticipated this volatility and some decline and shifted to defensive stocks and some bonds to help avoid some of the declines. I also had some hedges early on that helped offset the initial losses in long exposure.

I hear there’s a lot of noise and many geopolitical themes getting the blame, but it’s really just the market, doing what it does. Something and someone always gets the blame. If you believe that’s the real driver, you aren’t paying enough attention to my observations.

We’ll see how it all unfolds from here.

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

 

Argentina stock market loss is a reminder of single country ETF risk

If we looked at the MSCI Argentina ETF on July 4th, its gains year to date were astonishing.

Below is a chart of both iShares MSCI Argentina & Global Exposure ETF (AGT) and Global X MSCI Argentina ETF (ARGT) price trend from January 1st to July 4th.

The Global X MSCI Argentina ETF (ARGT) invests in among the largest and most liquid securities with exposure to Argentina. Both of the ETFs intend to track the MSCI All Argentina 25/50 Index.

On the iShares MSCI Argentina and Global Exposure ETF website, iShares highlights the theme:

Why AGT? Currently, the second-largest economy in South America, Argentina has recently implemented policies to make its market friendlier to foreign investors (World Bank. Based on 2015 GDP)

However, International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks often are heightened for investments in emerging/developing markets or in concentrations of single countries.

Yesterday, the ETF priced in U.S. dollars dropped -24%. Just like that, in a single day, most of its year-to-date gain evaporated.

 at Bloomberg reports “Argentina’s 48% Stock Rout Second-Biggest in Past 70 Years” and;

  • Only Sri Lanka has suffered a worse single-day drop since 1950
  •  South America nation endured similar one-day sell-off in 2002

Single countries can be subject to the possibility of substantial volatility and loss of value due to adverse political events.

Argentina’s peso also fell -15% after a surprising primary election outcome. CNN says It seems investors how populists could replace the country’s current, business-friendly government.

Bloomberg goes on to say:

“That marked the second-biggest one-day rout on any of the 94 stock exchanges tracked by Bloomberg going back to 1950. Sri Lanka’s bourse tumbled more than 60% in June 1989 as the nation was engulfed in a civil war.”

The top 5 shows 1-day percent declines from -36% to -62%:

Global X MSCI Argentina ETF AGT ARGT

 

You can probably see why I say we must actively manage the possibility of loss through tactical risk management methods. Tactical risk management methods may include predefined exits, hedging, and position size control. Of the 40 or so single country ETFs I include in my global universe of ETFs, it necessarily requires the realization that any single country can result in a loss like Argentina.

 

I built my risk management systems with the possibility of these enormous losses in mind, so we can probably be more prepared than those with no plan to direct and control the exposure to the possibility of loss.

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Falling stock price creates an asymmetric return for investors seeking high income from dividend yield

The demand for retirement expertise is strong and getting stronger. In my career over more than two decades, I’m not only observing an aging client base but also a noticeable increase in the number of people over fifty looking for income from their investments.

I don’t always call it “retirement” as it’s really “freedom.”

I don’t necessarily call it “financial freedom” because freedom is freedom, and it’s hard to have it without the financial part squared away.

As my wife Christi and I are rapidly approaching 50 ourselves with seemingly more momentum we’re noticing we are around more and more friends who are looking forward to the shift from “working for a living” to their money working for them.

I call it “getting off the treadmill,” and not everyone wants to get off the treadmill, but when you are ready to, you need a plan.

We create plans for getting off the treadmill and more importantly, staying off it.

But that isn’t my topic today. Today we have a simple topic relative to retirement income portfolio management. That’s what most call it. I just think of it as replacing earned income from working or running a business with passive income from not having to physically “do” things to get money income.

As an active investment manager, I’m not otherwise a fan of anything passive. There is nothing about what I’m going to share here that is passive for me, but it is for investors who want to get a check and go enjoy doing whatever it is they want to do with their time.

Here we go.

The word “correlation” is a statistical term that is grossly overused in the investment industry, but there may be no better true example than the negative correlation between price and yield (or interest rate.)

When the price of a stock or bond that is paying dividend or interest FALLS, its yield from that starting point RISES.

Conversely, when the price of a stock or bond that is paying dividend or interest RISES, it’s yield FALLS from that starting point.

It’s an inverse correlation and the one time when I switch from a trend-following strategy to a countertrend strategy.

If I want high income, I necessarily aim to buy low and sell high through the trend cycles.

I’ll share a very straightforward example, but I’ve removed the name of the fund. This ETF is one I actually own and since my mission here isn’t to make recommendations to people I don’t know or promote a position I have in my ASYMMETRY® High Income Yield portfolio, we’ll just leave off the name. Instead, let’s focus on the price and yield trends.

One advantage of falling stock prices is as price falls, the dividend yield rises from that new price. In the example below, the blue line is the price trend over the past five years. The orange line is its dividend yield. You can see when the price declines, the yield from that staring point rises.

retirement income high yield portfolio

If we buy it after it falls, our yield percentage is based on what price we buy it. Of course, that’s assuming all its holdings continue to pay their dividends/interest. This isn’t risk-free, so I add some risk management techniques to the overall strategy.

The bottom line is, when we look at the blue line above, that’s the price, and it has declined to the lowest point in five years. However, the orange line, which is the dividend yield on this ETF is at an all-time high.

If it’s high income we want from our savings, we want to buy after the price falls, then may sell, or hedge, to reduce exposure after the price trends up to an extreme.

When we buy high yielding assets at lower prices, the dividend payment is higher from that starting point as long as the companies we invest in keep paying their dividends. In this example, this one ETF alone invests in over 100 of the highest dividend-yielding equity securities around the world.

One of the primary risks of high dividend-yielding securities is rising interest rates. Over more than a decade, we’ve seen the central banks drive interest rates from one extreme to another. As the chart of the Prime Rate shows, they lowered rates from 8% in 2007 all the way to 3.25% and kept it at that historically extreme low level. Starting in 2016, the Federal Reserve started raising interest rates. By last year, the Prime Rate had reached 5.5%. The Fed recently lowered the rate to 5.25%.

Economic data now suggests the Fed may continue to lower interest rates.

So, instead of a rising interest rate environment, we may see a falling interest rate environment.

The bad news is; if the Fed keeps lowering rates, historically, the Fed has lowered rates to ward off recession or when it sees substantial risks of a downturn.

The good news is, these falling prices are creating an opportunity for investors who want to build a high-income portfolio through dividend yield and interest.

Of course, if that sounds like you, you don’t want to wait until it happens to get started. If you look closely at the chart again, there are seasons and cycles to increase and decrease exposure.

retirement income high yield portfolio

What we are seeing now is a new opportunity to add exposure.

I’m not saying to randomly go pick high yielding dividend stocks or ETFs. Like any investment, it isn’t risk-free. Investing always involves risk, including the possible loss of principal. High yielding stocks are often speculative, high-risk investments. So, portfolio management requires actively managing the risk along with diversification. Some high dividend 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 Fund’s performance. International investments additionally involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume.

The bottom line is; there is no free lunch. If we want the potential for return, we have to be willing to take the risks we are willing to take, and tactically manage or hedge the risks we want to limit.

As with most things in life, timing is everything. We don’t have to get the timing perfect, just good enough to result in asymmetric risk/reward.

Right now, I see interesting asymmetric risk/reward setups in some of these securities we use to build our high-income portfolio. That is, the potential for future capital gain from price appreciation and high income from the dividend yield seems more elevated than the downside risk.

Of course, if I predetermine my downside risk as I do, I can skew the payoff asymmetrically.

For example, in the case above, this fund of 100 stocks is yielding about 10% from this price. If I invest in it today, the future expected return from the dividends alone would be approximately 10% a year from now, and it pays monthly. You can probably see how attractive that sounds to someone who wants to live off their capital. Let’s see a simple example of the possibility of asymmetry.

Price Falls: As its price has already fallen sharply and its yield has increased to nearly 10%, I may believe it won’t drop a lot more. However, even though it may be oversold, I could predetermine an exit of only -5% below the current price. If it falls -5% after I buy it, I could sell it and take the loss and move on. But, these positions are unique. It isn’t just about the price trend. As price falls, its income-generating potential is increasing. So, a falling price actually increases the future asymmetric risk/reward payoff potential.

Price Stays the Same: If the price stays the same for a year, we will earn about 10% from the dividends. If I only risked 5% on the position and it trended up instead of down and stayed the same for a year, our asymmetric risk/reward is 2:1. I risked 5% to earn 10%.

Price Trends Up: The best outcome is I buy it, and the price goes up, and we also earn the 10% income from the yield. If the price gained 10% and the yield paid 10%, the total return would be 20%. If I risked 5% to earn 20%, the asymmetric payoff is 4:1.

You can probably see why I call this strategy ASYMMETRY® High Income Yield.

Questions? feel free to email me. 

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

 

 

All investors are market timers

All investors are market timers.

It isn’t just tactical traders.

I’ve been hearing more about “market timing” recently from some investment advisors saying they aren’t market timers.

But they are.

We all are.

And timing is everything. Like it or not.

I start off with general definitions of market timing from a Google search.

According to Wikipedia:

Market timing is the strategy of making buying or selling 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.”

This definition indicates “by attempting to predict future market price movements” is what draws the distinction of “market timing.”

Next is Investopedia:

“What Is Market Timing?

Market timing is a type of investment or trading strategy. It is the act of moving in and out of a financial market or switching between asset classes based on predictive methods. These predictive tools include following technical indicators or economic data, to gauge how the market is going to move.

So, it seems the distinction they make for “market timing” is a prediction.

Yet, everyone must necessarily make a prediction about the future to invest or trade.

For the passive indexers who buy and hold index funds, they necessarily make a prediction those funds past performance will resemble future results. They assume the stock and bond markets will have a positive return over the long term. The truth is, that is not a certainty, but a prediction on their part. In fact, choosing a time to rebalance their asset allocation is market timing, too, especially if they do it in response to price trend changes.

For value investors who actively look to add stocks they believe have been undervalued by the market, and/or trade for less than their intrinsic values, they are necessary market timing. When they sell a stock that has reached full value, they are timing the exit. It’s market timing. Some may even reduce or hedge overall stock exposure when the broad stock indexes are overvalued, which is also a timing decision. The more aggressive value investors, such as a value hedge fund, may use leverage to buy more stocks after their prices fall in a bear market. It’s market timing.

For momentum investors. it’s about following the historical trend. Momentum investing is a system of buying stocks or other securities that have had high returns over the past three to twelve months, and selling those that have had poor returns over the same period. It’s market timing as it assumes on average they’ll achieve more gains from the positive trends than losses from the negative trends. Extrapolating the recent past into the future is necessarily market timing.

What about non-directional trading strategies like certain options spreads and volatility trading? They still require and entry and an exit and timing the trade. Being invested in the stock market, buy the way, is explicitly short volatility, so when volatility expands stocks usually fall.

I want to be long volatility when it’s rising and short or out when it isn’t. I want to be in an options positions that on average result in asymmetry: more profit, less loss.

For example, an options straddle is a non-directional trading strategy that incorporates buying a call option and a put option on the same stock or ETF with the same strike and the same expiration. With a non-directional trade, we may have a two in three chance of making money because we can profit if the stock moves up or down. It requires movement, which is a prediction of the price expanding and timing it. It’s market timing.

Rather than trying to debate against “market timing” it seems more useful to admit we are all doing it in all we do, one way or another.

I embraced that long ago, and for me, I realize timing is everything.

But that doesn’t mean it always has to be perfect timing, either.

Asymmetry results from the average gains overwhelming the average losses, so the timing could have no edge if the profit-taking and loss cutting systems are robust.

All investors are market timers. The market timers who make the biggest riskiest bet are the passive index asset allocators who make no attempt to manage their risk, assuming past performance is indicative of future results.

Past performance is no 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.

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Global Asset Allocation hasn’t done any better

I’ve been hearing of how different active management strategies haven’t performed as well as the S&P 500 stock index the past five years. I can’t say it’s a big surprise since the SPX has been well into an overvalued level since 2013.

iShares Global Asset Allocation ETFs are an interesting example for GAA. Each of them has a percent in stocks and a percent in bonds. According to iShares:

Each iShares Core Allocation Fund offers exposure to U.S. stocks, international stocks, and bonds at fixed weights and holds an underlying portfolio of iShares Core Funds Investors can choose the portfolio that aligns with their specific risk considerations like investment time horizon; for example, those with longer investment time horizons may consider the iShares Core Aggressive Allocation ETF.

Each ETF has a fixed allocation to stocks and bonds.

ishares global allocation ETF

So, the difference between them as they go from conservative to aggressive is what percent is in stocks vs. bonds. iShares Core Allocation brochure says these ETFs harness the experience of BlackRock and the efficiency of iShares ETFs to get a broad mix of bonds and global stocks. BlackRock is the largest asset manager in the world, so if it’s global allocation you want, I’m guessing these may be hard to beat. I’ve not invested in them nor do I recommend them, but I think they make for a good example of what can or can’t be accomplished with Global Asset Allocation.

Global Asset Allocation hasn’t done much better than alternative strategies. Over the past five years, the total return for the most aggressive ETF is 31%. Simple math says that’s around 6% over five years.

So, by this measure, Global Asset Allocation doesn’t come close to putting 100% of your money into a stock index fund. Below we see the SPY, for example, has doubled the iShares aggressive allocation and tripled the conservative allocation.

But, who invests all their money in the stock index all the time?

I don’t believe I know anyone who does.

Why?

A picture is worth a thousand words. The stock index has declined over -50% twice since 1999, so it could certainly do it again.

Next, we compare the S&P 500 which is fully invested in stocks all the time to their conservative allocation in terms of % off high to observe historical drawdowns. Clearly, there is a huge difference in the downside risk as well as the upside reward. For a conservative investor who can’t handle -50% drawdowns or more than, say -20%, investing all their money in something that declines that much isn’t an option.

When the valuation level is so expensive, it increases the possibility a big bear market may happen again.

The Shiller PE Ratio for example, is the second-highest it’s ever been. In fact, the only two times it was higher was Black Tuesday before the largest crash in American history and the 1995-99 bubble. This has also been the longest economic expansion in U.S. history.

Shiller PE Ratio

So, we shouldn’t be surprised to see another bear market and recession in the years ahead. However, my main point here is these higher valuation levels suggest higher risk levels, so many active management strategies have probably taken less risk in the past five years.

But, it doesn’t seem Global Asset Allocation from the largest asset manager in the world hasn’t done any better.

May as well be honest and realistic about it.

Not convinced?

Think you or your investment advisor can do better than iShares managed by BlackRock at Global Asset Allocation?

Ok, I’ve added four more well known Global Asset Allocation funds. To keep the chart clean, I’m only comparing them to the top-performing iShares ETF, which of course is the most aggressive since it’s a bull market.

None of these funds have achieved a better result. The two best known active global allocation funds, BlackRock Global Allocation, and PIMCO All Asset have achieved a total return of only 15% the past five years.

The past five years have been very unusual. It’s a period of the longest economic expansion in U.S. history and the longest bull market.

It isn’t going to last forever.

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Small stocks are still lagging

The chart is the price trend of the Russell 2000 Index, which is a small-cap stock market index compared to the S&P 500, the stock market index based on the market capitalizations of 500 large companies. Small-cap stocks have been lagging over the past year.

Smaller stocks lagging behind larger companies is more typical in the late stage of a bull market and economic expansion.

Looking back over three years, we see smaller stocks were leading on the upside during the uptrend. That hasn’t been the case recently.

This divergence may be an early sign of a regime change.

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

The volatility expansion is here…

Since I mentioned it a week ago, volatility has indeed expanded.

In fact, it’s increased 32% today alone.

Implied volatility as observed by the VIX has almost doubled the level it was a week ago.

The Fear & Greed Index is now at the “Extreme Fear” level. VIX is one of the signals it uses to measure the degree of investor panic.

how to use fear greed index

Clearly, the options market has now priced in more expected movement in the range of prices. When I mentioned it a week ago, it implied a 12% range, now it’s 23%.

The S&P 500 stock index is down 3.35% today.

stock market 2019

We’ll see if this is enough panic selling today to drive prices low enough to attract new buying demand.

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Charting and technical analysis of the stock market trend

I usually share more of my observations of the stock market trend when the shit hits the fan. The truth is, I enjoy volatility expansions more than the quiet, calm trends. There isn’t as much for me to talk about when the trends are calm and quiet.

I also try to point out, in advance, when I believe we may see a volaltity expansion like we are now. You shouldn’t expect it from me as I’m ultimately an investment manager, not a Mark Twain, so my own tactical trading decisions are my priority. Also, what I share here doesn’t necessarily represent what I am trading in our managed portfolios. In fact, I usually try to avoid mentioning any symbol, stock, ETF, etc. that I may be trading or invested in. As such, use my observations at your own risk as it is not investment advice. With that said…

Here is the one year chart of the S&P 500 with some basic technical analysis applied. The blue trend line I drew overhead is where we would have expected to see “resistance become support,” but it hasn’t. So, there wasn’t enough buying demand to overcome selling pressure today. Based purely on quantitative measures as I’ve shared over the past week, it isn’t a surprise to see a volatility expansion and price trends widen out.

stock market momentum and support resistence

I marked how the current decline relates to the past two. This one has turned down rather sharply and quickly as of today. The SPX stock index is down about -6% from it’s high of which nearly half of the loss is today.

I now expect we’ll see some buying interest step in… at least temporarily. Only time will tell if this becomes a waterfall decline like we saw October to December, or worse.

I haven’t mentioned any news items that could be used as catalysts. Last week it was the Fed and employment, today it’s China, Hong Kong, and Trump tweets. Contrary to what most people probably believe, the range of prices broadening out and price trends falling is something I thought we may see as a normal quantitative reaction. Whatever may get the blame, it’s just the market, doing what it does. I can assure you of only one thing: I’ve heard a wide variation of reasons today from different levels of people. On the financial news, it’s one thing, from global macro hedge fund managers, it’s another. For example, one mentioned the Chinese PLA army is building on the Hong Kong border…

“May you live in interesting times” 

Ironically, it is an English expression purported to be a translation of a traditional Chinese curse.

In the meantime, my short term momentum systems are showing the broad stock index reaching its lower range of probabilities, so we “should” see it retrace up at some point, at least temporarily. Of course, there is always a chance of a waterfall decline the moves much deeper than a normal range of probabilities. In fact, we have already seen that now if you look at the chart. The price trend has moved below the “normal range of the market” as measured by the lower band.

We’ll see how it all unfolds.

If you want to follow along, sign up on the right to get automatic emails immediately when I share a new observation. 


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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Measuring the volatility expansion

To no surprise, we are observing a volatility expansion.

I say it isn’t a surprise, because I shared my observation on July 28th in Is volatility setting up for an expansion? the following:

I’m not going to be surprised if we see a VIX volatility expansion this week along with the range of stock prices spreading out.

There are plenty of potential catalysts that could drive volatility and uncertainty higher for those who need a story driving it.

This morning, the CBOE Volatility Index® (VIX® Index®) is trending 20% to 21.20, which is its long term historical average. As I pointed out before, it was at 12 when I pointed out the possibility of a volatility expansion. I didn’t expect to see it just because it was at a low level of 12, but instead because there was no shortage of potential catalyst that could cause prices to spread out into a wide range from indecision.

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. Since its introduction in 1993, theVIX®Index has been considered by many to be the world’s premier barometer of investor sentiment and market volatility.

The VIX has gained 76% since I shared the observation.

Is there a way to trade this volatility? Yes, there is, and it’s easier said than done. Tactical traders can trade VIX options, futures, ETFs, or the ETN. I share the below chart for informational purposes only. It’s the iPath® Series B S&P 500® VIX Short-Term FuturesTMETN charted along with the VIX index and does not necessarily represent any position I have taken. As you can see, it has gained 27% over the past week as the VIX gained 76%, but past performance is not necessarily indicative of future results. In fact, trading the VXX is very tricky and timing is everything.

A deep dive into VXX and long volatility ETFs is beyond the scope of my mission here as I just want to show a simple example of “long volatility” for asymmetric hedging. The succinct reason the VXX didn’t track the VIX index perfectly is because he Index offers exposure to a daily rolling long position in the first and second month VIX futures contracts and reflects market participants’ views of the future direction of the VIX index at the time of expiration of the VIX futures contracts comprising the Index. Owning the ETNs is not the same as owning interests in the index components included in the Index or a security directly linked to the performance of the Index. For additional information including the risks associated with VXX and ETNs, please see the VXX prospectus. The bottom line is, to successfully trade the VXX is beyond simply trading its price trend, it also requires understanding its roll yield issues and the VIX term structure.

While CBOE Volatility Index® (VIX® Index®) is a measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices, I use other measures to observe actual, realized, historical volatility.

Below is the S&P 500 stock index with bands of standard deviation. As you can see, the red arrow shows the price has spread out below the lower volatility band. These volatility bands normally contain the range of price, until it doesn’t. In this case, the volaltity is measured by the standard deviation, so this is a simple observation of the standard deviation shortfall. A price trend can and does trend beyond its normal range.

Bollinger Bands Volatility Expansion SPX $SPY $SPX

In the next chart, I use channels that represent a band of the average true range. In this case, the average true range is adapting more responsive by spreading out faster, so the SPX price trend is still within its lower channel as the price trends down.

Keltner Channels ATR SPX $SPX volatility expansion

The bottom line is, we’re seeing a volatility expansion as I suspected we could.

We’ll see where it goes from here…

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

 

“THEY KNOW NOTHING!”

Today marks the 12 year anniversary of the Jim Cramer character on CBNC having his now-famous emotional breakdown on live TV. It’s worth listening to once a year to reflect on the extreme level of panic going on this day 12 years ago.

So, I have shared it below.

I was cool as a fan that day… my risk management methods were robust and I had developed the discipline to execute through it. Avoiding the waterfall declines and panic level losses has been the highlight of my experience so far.

I believe we’ll see another period like this and the next time, it could even be worse.

I also managed through the 2000-03 period well, too, by simply observing bonds were trending up as stocks were trending down, so I shifted from stocks to bonds.

As such, I’m prepared and as ready as I’ve ever been, and hopefully, my past experience of operating through the last two major bear markets will continue to compound my skill and discipline.

 

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Why we don’t necessarily need the stock market to go up

Yesterday I mentioned in “Volatility continues to expand, and stocks are falling” some hedging positions such as gold, long-term treasuries, or long volatility or short stock indexes have helped offset some of the stock market loss. I thought I would share a few examples for informational purposes. None of these ETFs necessarily reflect any position my investment management firm currently has.

The first is gold and the long term U.S. Treasury. They are both in uptrends and made meaningful gains yesterday.

I like to observe and understand return drivers and how markets interact with each other. You may notice in the year-to-date chart above gold and long-term U.S. treasuries seem to be correlated. That is, they are trending in a similar pattern, which makes us wonder if they are driven by the same global macro return drivers.

Over a one-year period, the two appear interconnected most of the time.

I’m not a huge fan of correlation as it’s used in finance to measure how trends interact. But, many investment managers use it, so I’ll share some observations here.

Correlation is defined as a measure of the linear relationship between two quantitative variables, for example, a price trend. When the values of one variable decrease as the values of another increase to form an inverse relationship, this is known as a negative correlation. When two markets trend closely together, they are considered correlated.

When markets trend disconnected from each other, they are considered non-correlated. When markets trend the opposite of each other they are considered negatively correlated. In the chart below, I added the correlation coefficient on the bottom, which cycles up and down, but shows a relatively high degree of correlation quantified. I like to see it visually in the charts, but I also have computer systems that determine it quantitatively with the equation.

I don’t often like to get into such math here, but… bare with me.

Next, we observe the 3-year time frame. Gold and treasuries have been highly correlated most of the time. It appears these two markets may be inspired by the same return drivers at times.

Over five years, the price trends look similar much of the time. You may notice the correlation isn’t so accurate. For example, the correlation is very low early 2018, but both of the price trends were down, they just zigged and zagged differently. The volatility through off the correlation number.

It doesn’t require any advanced math to see in this price trend to see the value of exposure to gold and treasuries could have added (at times) to a stock portfolio over the past year. For example, as the stock index fell last year, gold and treasuries trended up. As stocks have been weaker lately, their trends are breaking out to the upside. I say “at times” because it isn’t always true; timing is everything. You may be surprised to see gold has gained more the past year than stocks. A lot more, in fact. The stock index has gained less than 5%, gold 17% and treasuries 12%.

Many investors are probably too stock-centric as they compare their investment returns to stock indexes that are 100% invested, all the time.

My point here is that there are many other markets from which we can look for trends. The U.S. stock market has had a great year in 2019, up over 10%, but over the past full year, not so much.

You can probably see why I prefer my global, tactical, unconstrained approach better.

By having a global universe, I can look for trends in the U.S. and globally.

By being tactical, I can increase/decrease my exposures based on my expected asymmetric risk/reward.

Being unconstrained, I can look for trends across all markets and apply different systems like trend following and countertrend, and across different time frames, long or short.

We don’t necessarily need the stock market to go up if we can define the direction of trends and actively manage their risk.  It also helps to observe and understand how markets interact with each other.

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Volatility continues to expand, and stocks are falling

In Is volatility setting up for an expansion? I suggested we may see a volatility expansion from the VIX at 12. The CBOE Volatility Index VIX has since gained 40% and the longer-dated 3-month VIX also implies a 20% higher volatility.

Today the VIX was down over -10% at one point and then reversed up to close in the green by 11%.

VIX VOLATILITY EXPANSION

Investors should expect to observe more movement in stock prices as they are now spreading out in a wider range. The stock indexes have turned down into a normal pullback, down about -2.4% off their highs.

I mostly share observations of broad indexes to make general statements about their trend. Here is the NASDAQ and S&P 500 % off high over the past year to see how much they’ve reclined recently relative to prior losses.

Some hedging positions such as gold, long-term treasuries, or long volatility or short stock indexes have helped offset some of the stock market loss.

We’ll see how it goes from here…

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Asymmetry vs. Convexity

Convexity captures the asymmetry in the connection between bond prices and changes in interest rates.

Duration only captures one aspect of the relationship between bond prices and interest rate changes. For more significant interest rate trends, the correlation between the change in rates, and the change in bond prices is asymmetric.

The bond price decrease resulting from a substantial interest rate increase will typically be less than the price increase resulting from an interest rate decline of the same magnitude.

This asymmetry arises from the convex payoff pattern shown by the solid curved line in the chart below.

asymmetry vs convexity

It plots the relationship between the yield of a bond and its price.

The dashed line estimates the consequence of a change in yield on the price of the bond.

This convex pattern also means a portion of the interest rate move continues uncaptured by duration.

Duration is a measure of interest rate risk and is mathematically derived from the slope of the dashed line.

The curved line represents convexity.

Convexity is a measure of the degree of the curve in the correlation between bond prices and bond yields.

Convexity captures the asymmetry.

Now we’re seeing some volatility expansion

I suggested in Is volatility setting up for an expansion? we may see volatility increase.

Sure enough, implied volatility, as measured by the VIX, has trended up from 12.16 to 15.30, which implies the expected volatility over the next 30 days has examined from about 12% to 15%.

VIX

The bands around the price trend below use a measure of realized historical volatility (standard deviation) over the past 20 days. As the realized volatility has contracted, it signals the range of prices spreading out has been narrow. This is an uptrending, quiet, market condition. When I see one market condition like this I’m alert for it changing.

bollinger band spx

In the next chart, we observe another channel of volatility around the stock index measured with average true range (ATR) and it has been a tighter band. The stock index price has also been pushing the upper boundary since the beginning of the year.

spx atr channel position sizing

Periods of low and contracting volatility are often followed by periods of higher and expanding volatility.

On the other hand, here we see the realized volaltity of implied volatility has reached its upper band, so if it remains within a normal range, it may remain inside the band. However, it can certainly spike up if the market expects higher movement.

vix volatilty of volatlity

So, Semper Gumby, always flexible.

This uptrend could change.

I know when I’ll exit all my positions if they trend down enough to cut my losses short. I also know what percent of drawdown that would lead to if all of my positions decline together. If I wanted, I could tighten it up to reduce the drawdown if prices fall more. Or, I could hedge with a short index position or go long volatility.

You can probably see how everyone decides what they get from the market.

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Is volatility setting up for an expansion?

I’m not going to be surprised if we see a VIX volatility expansion this week along with the range of stock prices spreading out.

There are plenty of potential catalysts that could drive volatility and uncertainty higher for those who need a story driving it.

According to Bloomberg:

As Fed officials begin their discussions on Tuesday they will have some more data with which to assess the economy. Personal income, pending home sales and consumer confidence statistics are all due that morning. Then on Thursday, the ISM manufacturing report is expected to show industry is stabilizing and continuing to expand. Friday’s trade data will be pored over for evidence that the skirmish with China is having an effect. Also next week, the Treasury will say on Wednesday how much money it needs to borrow amid rising budget deficits.

For me, the driver of a volatility expansion $VIX will just seem like a normal countertrend from a historically very low point. As vol has contracted into the 12’s it is at the low level of its cyclical range. This is when I start looking for a reversal.

VIX $VIX #VIX VOLATILITY EXPANSION JULY 2019

VIX futures are at a 9.86% contango, so the roll yield is a little steep. That is, the September VIX future is about 10% higher in price than the August VIX price. The difference in the price creates a roll yield those traders who are short VIX options or futures hope to earn.

vix-futures-term-structu

Those of us more focused on the directional trend, especially countertrends, will be more alert to see volatility expand from here. The trouble is, the contango creates a headwind for the ETFs and ETNs we may want to enter long at some point. That’s because they may invest in both the front month and second month, so as they roll forward through time they are selling the lower-priced august to buy more of the higher-priced September. This negative roll yield is why the VIX based ETFs trend down over the long term. To trade them successfully, timing is important, but it’s also not so simple.

The next chart is the S&P 500 stock index with Bollinger Bands around the price trend set at two standard deviations from its 20 day moving average. While the VIX is an implied volatility index based on how the options market has priced options of the S&P 500 index stocks, these bands are measures of realized volatility. Actual volatility has also contracted recently.

bollinger bands realized volatility

Periods of low and contracting volatility are often followed by periods of higher and expanding volatility.

Let’s see how it goes…

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

 

Trend following: no system will adapt perfectly to all conditions all the time.

I just came across this Wall Street Journal article about trend following as I was searching for something.

Jan 9, 2019 – Trendfollowing investment strategies—a computer-based way of … Trendfollowing algorithms turn bearish at swiftest pace since 2008 as …

 

Below that headline, when I clicked on it, was:

“Trend-following algorithms turn bearish at swiftest pace since 2008 as machines steer more trades”

Clearly, since publication January 9th it wasn’t a productive signal from trend-following if we look at the S&P 500 stock index and mark the date of the article as I did with the green highlight below.

trend following performance 2019 stocks stock market

The last several years has been more challenging for trend following systems and investment managers applying the strategy. The challenge is more an issue for less experienced portfolio managers and their investors if they’ve never operated through periods when trends and volatility is more hostile for the strategy.

Trend following performed well during late 2007 to early 2009 period. Most investment managers executing the strategy were CTA’s applying it to futures contracts as “Managed Futures”, though a few of us were doing it with stocks and a global universe of ETFs.

This performance during the crash gave trend following a reputation of being a risk management strategy, or at least a crisis risk hedge. While trend following does have the potential to capitalize on sustained trends and avoid or profit from downtrends, periods of changing trends can be more of a challenge. It depends on the time frame we apply and how we use the signals from trend-following indicators.

According to CME about trend following:

“Trend following systems aim to identify and exploit sustained capital flows across asset classes as markets move back out of and into equilibrium, often after prolonged imbalances. Other CTA styles thrive on volatility and choppy price action that accompanies these flows, as well as a variety of other market phenomena.”

They go on to say:

“The market conditions that have traditionally been difficult for CTAs employing trend following strategies have been those in which there is no follow through on trends, such that prices are mean-reverting. As a result, many CTAs incorporated additional strategies in an effort to capture these types of market characteristics as a complement to their trend following.”

Trend following trading systems are primarily expected to prosper most during periods of strong, clear, and sustained price trends. Some market conditions may be difficult for these strategies. We’ve observed most trend-following strategies have experienced somewhat hostile conditions over the past five years.

A price trend is a price that drifts in one direction or another. Volatility refers to the day-to-day range in price swings. A market condition can be trending or non-trending, volatile or smooth. A condition of strong, clear, sustained, price trends with low volatility may be a more pleasant experience that is easier to stick with. Just the opposite is a market condition with no clear directional price trend that is very volatile in its day-to-day price swings. If the time frame doesn’t match up well, these trend following systems will get whipsawed as they enter a trend just before it reverses back down, or it exits a trend at a low price before it reverses up.

Volatile market conditions are typically hostile conditions for both passive and active strategies. A risk management objective may be to reduce exposure to volatility during these periods. Even a condition of strong, clear, and sustained price trends may be so volatile in its day-to-day range that it may shake us out of otherwise profitable positions. On the other hand, a smooth, clear, sustained price trend may be easier to stick with, but volatility is sometimes low at the end of a sustained trend as investors are complacent just before it reverses.

Although we’ve observed most trend-following and momentum strategies have experienced somewhat unfriendly conditions over the past five years, those of us who have applied them over many market cycles for two decades or more know the systems don’t always match the trends perfectly. However, we have confidence over enough market cycles and trends these methods can be robust and result in asymmetric returns. Sometimes the asymmetric returns are achieved by avoiding large losses as my own systems did 2007 to 2009 and other times by exposure that results in relative outperformance and alpha as I saw 2005 to 2008.

Investment programs can be designed to fit different market conditions, but no system will adapt perfectly to all conditions all the time. An expectation of perfection may be a risk to the investor’s capital if it causes the investor to abandon a good program during a losing streak or drawdown. What investors should focus on is what results the investment manager has achieved over long periods of full market cycles.

For me, I have known that no system will adapt perfectly to all conditions all the time, so I manage my systems to get closer to what I want. I have automated systems that we operated mechanically. That is, the computerized trading programs generate signals and trades that can be executed systematically without any thought or oversight if we wanted. However, I’ve been operating dozens of these systems for 16 years now and was a chartist for years before that. I’ve learned how the systems operated having observed thousands of their signals in real-time in real life. From that, along with already having some skill at charting price trends, I’ve developed intuition about when my systems may be in hostile conditions. As such, in my primary portfolio, I play a shell game with them – pun intended. That is, I observe market conditions such as trend direction, momentum, and volatility expansion and contraction and decide which system to apply, when. The variations are based on trend following vs. countertrend, trend time frames shorter-term to longer-term, and different equations and algorithms to define the trend. These systems are also applied to different universes of markets like individual stocks, sector ETFs, international, bonds, etc.

Back to the WSJ article:

Computer Models to Investors- Short Everything WSJ Trend Following article

Fortunately, I didn’t follow that trend.

For example, the chart below is the period leading up to the date of the Wall Street Journal article “Computer Models to Investors: Short Everything” so we know how the stock index looked at the time.

trend following sell signal 2019

Charting the trend another way, here is the same index and time frame, but past on its % off high, which is the drawdown. We observe the stock market index declined nearly -20% from October 2018 to January 2019 and then recovered about 7% of the loss by the date WSJ published the article.

stock market drawdown decline 2018

If an investment manager had gone short as the article suggested trend-following models signaled, they would be down about -17% since. Of course, those models could have signaled to reverse from short to long before now.

Fortunately, I didn’t follow that trend. I participated in the last 2018 downtrend more than I prefer, but I’ve since captured the gains in 2019 to make up for it. It’s because in late December I was buying when others were fearful. I increased exposure at lower prices and have held it since. I applied my countertrend strategy, not my trend following strategy. How did I know to do that? I didn’t know for sure, but my analysis suggested a high probability of an asymmetric entry as I shared in An exhaustive analysis of the U.S. stock market and then later in a following An exhaustive stock market analysis… continued. 

I sometimes share my observations of market conditions here, but I always write them for myself. Having done this for over two decades now, I don’t underestimate the edge gained from the ability to revisit what I really observed and believed at the time and how it all unfolded. As I suggested in Investors follow the trend after the fact, count on it, 

ALL TIME NEW HIGH STOCK MARKET STOCKS 2019

Here we are seven months later and investor sentiment has changed dramatically from absolute panic last December to optimistic and that’s driving prices higher. Investors see headlines of the stock indexes finally reaching all-time new highs again, which probably reinforces their optimism the higher it trends.

So, most trend-following models have already signaled “buy” and be participating in the uptrend. Again, no system will adapt perfectly to all conditions all the time. An expectation of perfection may be a risk to the investor’s capital if their expectations and ego cause them to abandon a good investment program during a losing streak or drawdown.

Self-discipline and persistence seem to be required by all strategies.

We’ll see how it all unfolds from here…

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm.. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Investors follow the trend after the fact, count on it.

Whatever is popular in personal financial planning and investment management today will not be in the near future.

People believe and do the wrong things at the wrong time without a reasonable estimate of where trends are in different cycles.

Example: In 2007, everyone believed a house was an excellent investment.

Today younger generations believe the opposite.

The truth: Timing is everything.

Example: I see a lot of talk on Twitter, etc. about “low fees” referring to index ETFs. We sure didn’t hear that at the lows of 2008 – 2009 when those low fee index funds were getting crushed.

Investors wished they had tactical risk management or hedge funds that actually hedged or traded long/short. After the fact, they would have gladly paid a 2% management fee plus 20% of profits to have avoided the crash in their investment accounts.

I tactically trade low fee index ETFs, so I like them to be efficient, too, but I observe other financial advisors put too much focus on it. If your only value proposition is “low fee” you may be in the wrong profession. I’d rather achieve something over full market cycles and get compensated adequately for it.

Another recent example is after 2008 up until 2013, investors and advisers wanted tactical risk management (after-the-fact). Then, after the stock market kept trending up post-2013, they have become more and more complacent about risk.

This when a sage investor monitors and observes the big picture, preparing for the next cycle and change in trend.

I operated through these periods by observing these cycles and trends and noticing when the crowd reaches extremes.

But, this time has been different.

We are now witnessing the longest bull market in stocks and economic expansion in U.S. history.

What you need to know today is this too shall pass. When cycles reach an extreme, they usually swing the other way just as intense.

In 2013, the stock market reached what is considered an expensive valuation level. The S&P 500 was trading at 20 times earnings per share. As such, many active investment managers dialed back their stock risk exposures. But, the stock market kept trending up, and expensive has only gotten more expensive. Maybe it’s justified in a low inflationary period? Nevertheless, it’s considered a much higher risk state for fundamental investors.

You can see the expensive valuation of the stock index in the Shiller PE chart below. There were only two times it was this high or higher.

shiller pe ratio 2019

It is what it is. The valuation level as measured by Shiller PE is well into what is considered a higher risk zone in what is now the longest bull market and economic expansion in U.S. history.

shiller pe ratio 2019 average high low

At extremes, I prepare for the other way.

This one has taken much longer and stretched higher, so maybe its reversal will be uglier.

I’m not saying I’m bearish on the stock market at this moment, but instead pointing out the big picture risk longer term that I’m prepared to deal with.

People are attracted to things after the fact. What is fashionable today will be tomorrows despised. What is hated today will be tomorrows cool.

It will all happen after the fact.

Count on it.

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm.. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

 

 

A few observations on Global Macro and Trend Following

A few observations on #GlobalMacro and #TrendFollowing

As I see it, trend following can be global macro and global macro can be trend following. I call my primary strategy “global tactical,” which is an unconstrained, go-anywhere combination of them both and multiple strategies.

There is no way to predict the future direction of the stock market with macroeconomics. There are far too many variables and the variability of those variables change and evolve. The way to deal with it is to simply evolve with the changing trends and direct and control risk.

For me, it’s about Man + Machine. I apply my proprietary tactical trading systems and methods to a global opportunity set of markets to find potentially profitable price trends. Though my computerized trading systems are systematic, I use their signals at my discretion.

I believe my edge in developing my systems and methods began by first developing skill at charting price trends and trading them successfully. If I had started out just testing systems, I’d only have data mined without the understanding I have of trends and how markets interact.

Without the experience of charting market trends starting in the 90’s I probably would have overfitted backtested systems as it seems others have. A healthy dose of charting skill and experience helped me to avoid systems that relied on trends that seemed unlikely to repeat.

For example, if one had developed a backtested system in 2000 without experience charting those prior trends in real-time, they’d have focused on NASDAQ stocks like Technology. The walk forward would have been a disaster. We can say the same for those who backtested post-2008.

All portfolio management investment decision-making is very challenging as we never know for sure what’s going to happen next. The best we can do is apply robust systems and methods based on a positive mathematical expectation and a dose of skilled intuition that comes with experience.

As such, ALL systems and methods are going to have conditions that are hostile to the strategy and periods you aren’t thrilled with the outcome. For me, self-discipline comes with knowledge, skill, and experience. I am fully committed, steadfast, and persistent in what I do.

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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. All information provided is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Happy Birthday, America!

People sleep peacefully in their beds at night only because rough men stand ready to do violence on their behalf.

land of the free because of the brave

Independence Day is a federal holiday in the United States commemorating the Declaration of Independence of the United States on July 4, 1776. The Continental Congress declared that the thirteen American colonies were no longer subject to the monarch of Britain and were now united, free, and independent states.

Happy 4th of July! May we all enjoy our freedoms and independence today and forever.

Semper Fi,

Mike Shell

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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. All information provided is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

 

 

Logical Inconsistency?

One of the most widely quoted words of wisdom from legendary investor Warren Buffet is,

 

“Rule No. 1: Never lose money.

Rule No. 2: Don’t forget rule No.1.”

 

But.. is it a logical inconsistency?

Warren Buffet Rule number 1 lose money BRK $BRK Berkshire Hathaway

Logical Insonconsinecy:

When multiple statements are given which contradict one another.

These may be given together or may be separated in time. Sometimes the contradictions are rather subtle and are difficult to spot. At other times, they are obvious. If you have enough authority, then you may be able to carry this off.

 

For me, actively managing risk for drawdown control is essential to “not lose money.”

 

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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. All information provided is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

 

Will the stock market hold the line? or do we keep hedging risk? and opportunity for high income yield

The U.S. stock indexes declined -6.84% for the large-cap S&500, -11% for mid caps, and about -19% for small-cap stocks mostly in the single month of May.

asymmetric risk reward stock market

Since June 1st, however, these same stock indexes have started to trend back up.

stock market asymmetry

Over the past 3 months, momentum has turned negative for the stock indexes.

momnetum stocks 3 month

My strategy was to hedge off some of this downside risk. I then removed my hedges for a profit. It doesn’t always work out that way. A hedge position isn’t necessarily intended to be profitable through the entry and exit, but instead, the objective is to hedge off some of the downsides of long positions. Sometimes I hold them too long and lose their gains, other times I exit and realize a profit, and then there are times I exit them too soon with a profit but miss an even large profit. It ain’t perfect, nor does it need to be, and I’m okay with it.

My stock market observation yesterday, which I shared on Twitter, was:

This double bottom could be a likely short-term low if the holds the line… my guess is it’s more likely than not. If it breaks down further from here, though, it probably gets ugly like when it didn’t hold last December…

SPY $SPY buy signal countertrend trend following

So far, so good… as marked with a simple trend line.

SPY INVESTMENT MANAGER TACTICALA week ago the AAII Sentiment Survey showed an unusually high level of Pessimism and optimism at an unusually low level… signals to stalk the market for good risk/reward setups on the buy side.

behavioral finance economics investor sentmiment advisor

I exited my hedges a few days ago and increase my exposure to stocks. However, I did this at the same time my momentum and systematic trend following systems shifted from stocks to bonds or cash. So, my entries are based on signals from my countertrend and high-income yield systems. As prices fall in high yielding ETFs, their dividend yield increases.

Global X SuperDividend™ US ETF (DIV) is an interesting example. This is not investment advice for anyone to buy this ETF as I only provide advice and portfolio management to clients via an executed contract. It is useless to know what I would buy if you don’t know how much I would buy and when I would sell. With that said, the chart of Global X SuperDividend™ US ETF (DIV) shows as the price (blue line) declined to a double bottom, the dividend yield has increased to 7.6%. So, if I entered it here, it would be expected to yield 7.6% going forward. I am only using this for informational purposes, so I’m not including all the variables and risks it may not which can be found here.

The point is, you can see how as price falls in a high yielding asset, it’s yield rises.

Global X SuperDividend™ US ETF (DIV)

I have recently made my ASYMMETRY® High Income Yield Portfolio available to clients who seek high income from their portfolio and are willing to accept fluctuation in the balance. Up until now, I had been testing this strategy with my own capital. The portfolio focuses on asymmetric risk/reward opportunities for high-income yield and also adds an asymmetric hedging system to help with downside risk management. For more information on the strategy, contact me.

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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. All information provided is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Stock market reaching an interesting point but I hedged some risk a week ago

Stock market indexes are reaching a point they should find some buying interest if it exists. We’ll soon find out if they can hold the line, or see more selling pressure…

stock market asymmetry

My short term momentum indicators are reaching oversold at the same time the S&P 500 is testing the support area in green above as well as the 200 day moving average.

At the same time, the Long Term Treasury ETF is pushing on its upper band and becoming more likely to reverse back down within its average range. I sold a position for a small profit in TLT that was short term hedge.

TLT ASYMMETRY HEDGE $TLT ASYMMETRIC

My other hedges, which are much more asymmetric than TLT, remain in place to hedge off some market risk until the selling pressure seems to be drying up. My hedging isn’t necessarily intended to result in a profit if the stock market falls, but instead of offset losses in other positions we want to continue to hold. Although sometimes the payoff in the hedge is large enough I realize the profit while it’s there. However, if I took profits too soon every time we wouldn’t have the exposure for hedging purposes in larger waterfall declines. At this point, we have open profits in our remaining hedges.

We’ll see how it all unfolds…

 

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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. All information provided is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

 

Remembering the other wall

As we approach the Memorial Day weekend, someone reminded me today of a statement made by President Ronald Reagan on June 12, 1987:

“Mr. Gorbachev – tear down this wall”

I had enlisted in the U.S. Marines and would enter training a year later. So,  for the first time in my life, I was paying attention to world events.

It’s probably hard for most people to conceive, but young men and women joining the U.S. Marines were hoping for the opportunity to fight the Communist Party of the Soviet Union after high school. #TheFewTheProud

But here we are 30 years later and we probably have as many who would rather fight for it. #ComingApart

Socialism and communism

The Difference Between Communism and Socialism

“Communism and socialism are economic and political structures that promote equality and seek to eliminate social classes. The two are interchangeable in some ways, but different in others.In a communist society, the working class owns everything, and everyone works toward the same communal goal. There are no wealthy or poor people — all are equal, and the community distributes what it produces based only on need. Nothing is obtained by working more than what is required. Communism frequently results in low production, mass poverty and limited advancement. Poverty spread so widely in the Soviet Union in the 1980s that its citizens revolted. Like communism, socialism’s main focus is on equality (symmetry). But workers earn wages they can spend as they choose, while the government, not citizens, owns and operates the means for production. Workers receive what they need to produce and survive, but there’s no incentive to achieve more, leaving little motivation. Some countries have adopted aspects of socialism. The United Kingdom provides basic needs like healthcare to everyone regardless of their time or effort at work. In the U.S., welfare and the public education system are a form of socialism. Both are the opposite of capitalism, where limitations don’t exist and reward comes to those who go beyond the minimum. In capitalist societies, owners are allowed to keep the excess production they earn. And competition occurs naturally, which fosters advancement. Capitalism tends to create asymmetry between the wealthiest citizens and the poorest, however, with the wealthiest owning the majority of the nation’s resources.”

 

 

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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. All information provided is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Protecting the Flock is Asymmetric

Memorial Day is a federal holiday in the United States for remembering the people who died while serving in the U. S. military.

Memorial Day

Source: United States Marine Corps

How many American military have died in war

Protecting the flock is asymmetric, so we need to be reminded. Less than 1% of Americans serve in the military. Out of a nation of 320 million people, 1.3 million Americans are on active duty military according to the Department of Defense. In comparison, 12% of the population served during World War II.

what percent of Americans serve in military

Source: How many Americans have died in U.S. wars?

Since fewer families are impacted by war, there seems to be a disconnect in the situational awareness of what is going on in the world.

On Memorial Day, remember it wasn’t just one who gave his life for us. It was over 1.1 million and counting…

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The normal noise of the market?

We shouldn’t be surprised to see stock prices pull back closer to their average true range in the days ahead. Such a pullback or stall would be normal.

Below I highlight the strong momentum Technology sector XLK ETF as an example of stock prices in some sectors finally reaching their prior highs. In addition to the price trend reaching a point of potential overhead resistance at the prior high, we observe this trend is also outside the upper volatility band of average true range.

TECH SECTOR MOMENTUM XLK $XLK $IYW

Most of the time, we should expect to see a price trend stay within this range. If a price trend breaks out of the range higher or lower, it can be evidence of a trend change. In this case, the short term trend has been up since January, the intermediate trend has been sideways, non-trending and volatile since last September. Sine the short term trend has been an uptrend since January, I view the upside breakout above the volatility band a signal the trend may be more likely to pull back within the channel range.

The broad stock market S&P 500 index ETF SPY doesn’t look a lot different than the Technology sector, except it’s about -2% away from reaching its September 2018 high.

stock market SPY $SPY

The bottom line is, looking at the directional price trends they are up in the short term but reaching a point they could see some resistance from the prior highs. At the same time, my momentum systems suggest the trends are reaching an overbought level and the price and expanded outside their average true range channel.

A small short-term pullback in stock prices from here would be within the range I consider normal noise of the market.

 

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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. All information provided is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Giddy up…

As expected, the U.S. stock market declined briefly, then found enough buying enthusiasm to drive prices to a new breakout above the March high.

As I concluded in Strong stock market momentum was accompanied by broad participation:

“…though we shouldn’t be surprised to see short term weakness, we could suppose the longer term trend still has room to run.”

As we see in the chart below, while the U.S. stock market is trending with absolute momentum, the strongest relative momentum has been in other countries around the globe.

global macro asymmetric risk reward .jpg

Though my short term momentum systems signaled weeks ago the current uptrend may become exhausted and it did, the reversal back up and continuation since then appears bullish.

At this point, it appears some global stock markets are in uptrends and may have more room to run. For asymmetric risk/reward, I cut my losses short and let the winners run on.

Giddy up…

 

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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. All information provided is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Going with the flow

We can’t stop the current or the obstacles, but we can train, prepare, and manage the risks for protection and then go with the flow.

global macro tactical momentum trend following asymmetric risk reward

I focus on the things I can control, then enjoy the ride as it all unfolds. 

The picture source is back where I come from: Ocoee River, Tennessee.

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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. All information provided is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

What has changed? Global trends, volatility expansion and contraction, plus some rising interest rates

My focus is: What has changed? if I see no change in the direction of the trend of volatility, then we just go with the flow.

Realized (historical) and implied volatility (VIX) has settled down on the and it’s reflected in a Bollinger Bands contraction.

Periods of low volatility are often followed by periods of high volatility.

The empirical evidence is observed visually in this chart.

SPY SPX VOLATILITY MOMENTUM TREND

Volatility trends in cycles up and down, so they oscillate between high and low levels and can reach extreme highs and extreme lows. I believe volatility expansions are driven by indecision and vol contractions are driven by complacency decisiveness.

Small-cap stocks have been leading the way trending with momentum, but they’ve also declined a little more the past few days. Like the S&P 500 the Russell 2000 is showing contracting volatility after a big volatility expansion.

small cap momentum RUT IWM trend following system

Gold has been trending up gradually. I focus on the rate of change and momentum. However, recently Gold has declined sharp enough to indicate a short term volatility expansion.

gold gld $GLD

Emerging Markets has less of a rate of change than the higher momentum U.S. stocks, but volatility is also contracted.

EMERGING MARKETS TREND MOMENTUM

After a killer uptrend and momentum expansion last 2018 when stocks were falling, the Long Term Treasury ETF (TLT) has settled down into a non-trending period. It’s dropped below the volatility band, so maybe it will reverse up again. TLT is an example of a non-trending low vol condition, so we’ll expect a breakout from this range at some point.

TLT LONG TERM TREASURY HEDGE ASYMMETRIC RISK REWARD

Wanna see an example of an uptrend with low volatility? ETFs like SHV is a short-term  U.S. Treasury bond ETF with remaining maturities between one month and one year. It’s smooth, but with low risk, comes low potential reward. However, it’s a good example of a defensive position when it’s time for Risk-Off. It’s also probably a competitor to bank CDs and money markets.

SHV SHORT TREASURIES TREND VOLATITLIY MOMENTUM YIELD

Before you get too excited, here is the growth of $10,000 invested in the iShares Short Treasury Bond ETF (SHV) 10 years ago! With interest rates so low driving down the yield, it only grew to $10,380 because the interest rate was so low. 

shv

The good news for low-risk savers who invested their money in Treasury Bonds, their interest rates are trending up, so the yield is increased to nearly 2%.

Yield on Short-Term U.S. Treasury ETFs
That’s also good news for active risk managers like myself who increase and decrease exposure to the possibility of loss. Now, when I shift to defense and rotate from stocks to safer cash-like investments, we’ll actually earn some yield as wait for trends to improve. As you can see in the charts above, any defensive exposure intended to avoid risk temporarily didn’t earn the yield the past decade we did before. Unless we used higher yielding riskier positions for defense, it reduced our total return the past decade so look forward to getting that edge back.

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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. All information provided is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Welcome to March! A review of global asset allocation and global markets

In the first two months of 2019 global asset allocation has gained 4% to 8.6%. I use the iShares Core Global Allocation ETFs as a proxy instead of indexes since the ETFs are real world performance including costs. The four different allocations below represent different exposure to global stocks vs. bonds.

global asset allocation ETF ETFs asymmetric risk reward .jpg

I’m not advising anyone to buy or sell these ETFs, but instead using them as an example for what a broadly diversified global asset allocation portfolio looks like. Most financial advisors build some type of global asset allocation for their clients and try to match it with their risk tolerance. The more aggressive clients get more stocks and the most conservative clients get more bonds. Of course, this is just asset allocation, so the allocations are mostly fixed and do not change based on market risk/reward. This is very different than what I do, which is focus on asymmetric risk/reward by increasing and decreasing exposure to risk/reward based on my calculations of risk levels and the potential for reward. So, my system is global, but it’s tactical rotation rather than fixed allocation.

The iShares Core Allocation Funds track the S&P Target Risk Indexes. So, BlackRock is the portfolio manager managing the ETF and they are tracking S&P Target Risk Indexes. Here is their description:

S&P Dow Jones Indices’ Target Risk series comprises multi-asset class indices that correspond to a particular risk level. Each index is fully investable, with varying levels of exposure to equities and fixed income and are intended to represent stock and bond allocations across a risk spectrum from conservative to aggressive.

In other words, they each provide varying allocations to bonds and stocks. The Conservative model is more bonds, the Aggressive model is more stocks.

S&P Target Risk Conservative Index. The index seeks to emphasize exposure to fixed income, in order to produce a current income stream and avoid excessive volatility of returns. Equities are included to protect long-term purchasing power.

S&P Target Risk Moderate Index. The index seeks to provide significant exposure to fixed income, while also providing increased opportunity for capital growth through equities.

S&P Target Risk Growth Index. The index seeks to provide increased exposure to equities, while also using some fixed income exposure to dampen risk.

S&P Target Risk Aggressive Index. The index seeks to emphasize exposure to equities, maximizing opportunities for long-term capital accumulation. It may include small allocations in fixed income to enhance portfolio efficiency.

Below is an example of the S&P Target Risk Index allocations and the underlying ETFs they invest in. Notice their differences is 10% to 20% allocation between stocks and bonds.

Global Allocation Index Construction

These ETFs offer low-cost exposure to global asset allocation with varying levels of “risk,” which really means varying levels of allocations to bonds. I say they are “low-cost” because these ETFs only charge 0.25% including the ETFs they are invested in. Most financial advisors probably charge 1% for similar global asset allocation, not including trade commissions and the ETF or fund fees they invest in. Even the lowest fee advisors charge at least 0.25% plus the trade commissions and the fund fees they invest in. With these ETFs, investors who want long-only exposure all the time to global stock and bond market risk/return, they can get it in one low-cost ETF. However, they do come with the risks of being fully invested, all the time. These ETFs do not provide any absolute risk management.

As an unconstrained, go-anywhere, absolute return manager who does apply active risk management, I’m unconstrained from a fixed benchmark, so I don’t intend to track or “beat” a benchmark. I operate with the limitations of a fixed benchmark. My objective is to create as much total return I can within a given amount of downside risk so investors don’t tap out trying to achieve it. It doesn’t matter how much the return is if inveestors tap out during drawdowns before it’s achieved. However, I consider global asset allocation that “base rate.” If I didn’t think I could create better asymmetric risk/reward than these ETFs I wouldn’t bother doing what I do. I would just be passive and take the beatings in bear markets. If we can’t tolerate the beatings, we would invest in the more conservative ETF. I intend to create ASYMMETRY® and win by not losing, and that necessarily requires robust risk management systems and tactics.

Now that we know what they are, below are their total returns including dividends looking back over time. (To see the full history in the prospectus click: iShares)

In the chart below, we see the global asset allocation ETFs are attempting to get back to their September 2018 high. While the S&P 500 stock index is still down about -4% from its September 2018 high, the bonds in these ETFs helped reduce their drawdowns, so they have also recovered their losses better.

global tactical asset allocation asymmetric risk reward

To be sure, below are the drawdowns. The iShares Core Conservative ETF is only 30% stocks and 70% bonds, so it had a smaller drawdown and has recovered from it already. I added the S&P 500 in this chart with is 100% stocks to show how during this correction, the exposure to bonds helped offset losses in stocks. Diversification does not guarantee a profit or protect against a loss in a declining market. Sometimes diversification and even the broadest global asset allocation fails like it did in 2008.

GLOBAL TACTICAL ASSET ALLOCATION ASYMMETRIC RISK REWARD DRAWDOWN

We can look inside the ETF to see their exposures. Below we see the iShares Core Moderate ETF which is 60% stocks and 40% bonds largest holding is the iShares Core Total USD Bond Market ETF (IUSB) at 50% of the fund.

iShares Core Moderate Allocation ETF

Below is the 1-year total return chart including dividends for its largest holding. It has gained a total return of 2.9% the past year. All of the gains were this year.

iShares Core Total USD Bond Market ETF (IUSB)

Next, I added the other two largest holdings iShares Core S&P 500 ETF (IVV) and iShares Core MSCI International Developed Markets ETF (IDEV). The weakness was worse in international stocks. 

GLOBAL ASSEST ALLOCATION ADVISORS TACTICAL

No total return chart is complete without also looking at its drawdowns. The combination of the total return chart and the drawdown is what I call the ASYMMETRY® Ratio. The ASYMMETRY® Ratio is the total return divided by the risk it took to achieve it. I prefer more total return, less downside drawdown.

global tactical asset allocation drawdown risk management

The point is, global stocks and bonds have recovered much of the losses. As we would expect so has global asset allocation. The only issue now is the short term risk has become elevated by my measures, so we’ll see how the next few weeks unfold.

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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. All information provided is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Strong stock market momentum was accompanied by broad participation

Not only has the broad stock market indexes like the S&P 500 advanced sharply with great momentum since late December 2018, but its breadth has also been impressive.

The percent of stocks trading above their 50 day moving averages shows about 92% of stocks are in short term uptrends. This advance not only confirmed the price trend momentum but suggests participation has been broad. More stocks are above their 50-day moving averages that late 2017.

percent of stocks above the 50 day moving average trend following asymmetric risk reward

The downside is we are necessarily observing only the past and the past doesn’t assure future performance. In fact, once 92% of stocks are already in shorter-term uptrends, we can start to wonder at what point the buying enthusiasm is exhausted. That is, indicators like this may be observed for signs of an inflection point.

percent of stocks above 200 day moving average trend following

However, the percent of stocks above their 200 day moving averages is at 63%. So applying that same line of thinking, though we shouldn’t be surprised to see short term weakness, we could suppose the longer term trend still has room to run.

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.

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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. All information provided is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Putting my short-term technical analysis tactician hat on and hedging off equity risk

I’m dialing in to look at shorter-term technical analysis as my risk management systems are suggesting a risk of a stock market decline is becoming elevated.

tactician technical analysis analyst tactical manager trader

Zooming in to shorter time frames, the U.S. stock market advance appears to be becoming exhausted.

The chart below is the SPDR® S&P® 500 ETF, yesterday on a 5-minute chart. Now that’s zooming in! I’m not a day trader, but I’m monitoring the trend for signs of buying exhaustion and/or selling pressure to potentially take over. Yesterday this index ETF was up nearly .75% in the morning, then you can see it drifted down to close well below its VWAP for the day.

SPY VWAP MOMENTUM RELATIVE STRENGTH TREND FOLLOWING

The next chart shows the SPY trend going back for about six months. The recent stock advance has been impressive and I’m sure glad we participated in it, but I’m now applying some situational awareness. The strong momentum since the late December 2018 low could be becoming exhausted and may find some resistance for higher prices, at least temporarily.

SPY

As a tactician, since we had heavy exposure to stocks, I’ve been gradually reducing exposure and today started hedged off some equity risk to offset some of my market risks. I did that as opposed to taking large profits and realizing taxable gains. Fortunately, we took advantage of last years volaltity and made the best of it by executing significant tax loss harvesting. This time I decided to hedge some of our gains rather than realize them.

I may be wrong, but my risk management systems are elevated for at least a short term exhaustion, so I expect we’ll see some selling pressure overwhelm buying at some point from here. If it doesn’t, then it’s a good sign the momentum may be here to stay a while, but I’ll probably still wait for a reversal down to add more exposure in my tactically managed portfolio. My objective is asymmetric risk/reward, and from this starting point, I see more potential for downside than upside for stocks. My systems aren’t always right, but the magnitude of the gains are larger than the losses when it’s wrong. I call it ASYMMETRY®.

 

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management solely to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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. All information provided is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

U.S. Stock Market Update

Last week in What’s going to happen next for the U.S. stock market? I shared an observation the U.S. stock index had reached a point I expect to see at least a stall. So far, that’s mostly what we’ve seen the last week.

stock market momentum

The stock index has reached a point that a stall or reversal is even more possible now. As we see in the above chart, the uptrend has been strong and sharp. Volatility, how wide the price spreads out, has also narrowed. After prices trend up, volatility tends to shift from expansion to contraction and that’s about when a trend becomes more likely to change, at least temporarily.

My momentum systems also suggest the velocity of the uptrend has reached a point the short term trend is becoming more susceptible to stall or reverse.

Otherwise, the short term trend has been strong and rising. The longer-term trend as seen in the chart is defined as sideways using a smoothing trend-following indicator like the 200-day moving average. Notice the blue line is virtually sideways and barely adapted to the -20% drawdown. The S&P 500 is now above its average of the past 200 days. However, notice it crossed above it three times October through December before reversing down sharply.

So, I define the current S&P 500 trend and condition as follows:

From this starting point, I expect the asymmetric risk/reward from here may be limited. I’m glad we participated in this recent trend, but we are positioned more carefully short-term at this stage.

However, if the current short term uptrend continues with high momentum, it would be very bullish for the longer term and may negate the likelihood that this could be the end of a decade long bull market. If this is an aged bull market ending, we’ll see swings up and down as it shifts. If the nearly -20% decline was enough, we’ll see new highs in the weeks or months ahead.

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.

Mike Shell and Shell Capital Management, LLC provides investment advice and portfolio management solely to clients with a signed and executed agreement. The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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 presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

What’s going to happen next for the U.S. stock market?

The U.S. stock market is reaching a point it may stall at least temporarily.

stock market momentum asymmetric risk reward

The percent of stocks in the S&P 500 index that are above their 50 day moving average has increased to 85%, which I consider a higher risk level in the short term.

$SPXA50R S&P 500 Percent of Stocks Above 50 Day Moving Average

The S&P 500 bullish percent is just over midfield, but it’s usually less responsive than the stocks above their 50 day. That’s because the Bullish Percent is based on Point & Figure buy signals and their default requires around a 10% gain to generate a buy signal.

$BPSPX bullish percent risk indicator

So, I wouldn’t be surprised to see U.S. stocks stall or countertrend reversal down at least temporarily.

From a longer-term observation, the U.S. stock market has recovered just over half the decline from last September. Only time will tell if this is the early stage of a long bear market if it recovers to an all-time new high.

I just make tactical decisions based on the current trends, the likelihood of countertrends, and volatility. We’ve been positioned very well so far in 2019 and capitalized on the panic selling late December.

 

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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 presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

 

 

Asymmetry and the inverted yield curve

A global macro indicator that’s been talked about a lot lately is the risk of an inverted yield curve. An inverted yield curve is an asymmetry when the short-term interest rate is higher than the long term interest rate. In normal conditions, the yield on long term bonds should be higher as a premium for the longer maturity. For example, we expect to pay a higher interest rate for a 30-year mortgage than a 15-year mortgage. The same is true for government bonds. In normal conditions, investors should expect to earn a higher yield and return from longer maturities and borrowers should expect to pay more for longer-term loans.

The normal term structure is the 3-month interest rate is much lower than the long-term 30-year interest rate. We plot the term structure on a graph for a visual representation of the trend. A yield curve can be observed in different trends and slopes. For example, an inverted yield curve is a descending slope that is asymmetric as the yield on longer-term maturities declines at a progressively slower rate of change. Inverted yield curves are rare and abnormal, so it signals something is changing. An inverted yield curve may signal a decline in economic activity, inflation, or a recession.

Below is what an inverted yield curve looks like as it inverted December 2006. The horizontal line on the left chart is the yield curve showing the shorter term bond yield on the left was higher than the long bond rate on the right. The chart on the right is the S&P 500 with a red line marking the date of the yield curve inversion. A year later, the stock market started a decline of over -56%.

yield curve inverted 2006
Next is the inverted yield curve in August 2000 when the yield curve was more accurate as to timing. The broad stock market declined -50% after the yield curve inverted.
yield curve inverted August 2000
So far, the normal yield curve, 3 month vs 30 year, has not inverted. The long-term interest rate is higher than the short-term rate.
yield curve inverstion inverted 2018 asymmetry
Below is the current yield curve compared to August 2000. We see a significant difference in the spread and slope. Short term interest rates like what we earn at the bank or from a money market were over 5% in 2000. Today, they’ve finally increased to over 2%.
inverted yield curve 2000 compared to now
Next is the 2006 inverted yield curve compared to now. The arrows show the difference between the current slope and the inverted yield curve then.
inverted yield curve 2006 compared to now

 

For the yield curve to invert and shift to negative asymmetry, the short-term interest rate will have to increase higher than the longer-term interest rate. Or, the long-term interest rate decrease below the short term. Either way that hasn’t happened yet.

What could cause an inverted yield curve? The end of the yield curve could drive it if investors believe interest rates will be lower in the future. If investors believe long term rates will decrease it may increase demand for longer-term bonds, which consequently lowers yields.

We don’t have to know in advance of what may cause the yield curve to become inverted. We only need to observe that it does. If it does, I would expect a recession. However, the U.S. stock market is the leading indicator for a recession, so we’ll know to expect a recession if the stock market trends down lower than the December low.

Next, I’ll share some observations of leading economic indicators. For me, it doesn’t help with tactical investment decisions, but since the economy is a big global macro topic lately, it’s a good time to review its indicators.

The yield curve hasn’t inverted like it did in December 2006 and August 2000. The yield curve doesn’t suggest a recession anytime soon.

 

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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 presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

 

Asymmetry in the CBOE Index Put/Call Ratio suggests hedging

I pointed out yesterday the Stock market internals are signaling an inflection point. On a short term basis, some internal indicators are suggesting the stock market is at a point I expect to see a more significant breakout in one direction or another. That may sound like a symmetrical statement, but it’s the result of a symmetrical point that I consider midfield. From here, I look for signals of which direction the momentum shifts.

The asymmetry in the CBOE Index Put/Call Ratio suggests an increase in hedging yesterday. In the chart below, we see the Put/Call Ratio on Index options is at the high end of its range. I believe index options are used more for hedging by large institutions like hedge funds and pensions than for speculation by smaller individuals. I must not be the only one who recently hedged market risk. 

cboe index put:call ratio asymmetric hedging

Looking back over the full history, we see the current asymmetry of 1.55 puts to calls is a level that shows the asymmetry is on the upper range. When it gets too extreme, it can signal an overly pessimistic position.

cboe index put call long term history asymmetric hedge

The CBOE Equity Put/Call Ratio which I believe is more of a measure of individual investor speculation remains at a normal level at this point. That is, we normally see the Equity Put/Call Ratio below 1 as it indicators more (speculative) call volume than put volume.

equity put call ratio asymmetric risk reward hedging

However, when the Equity Put/Call Ratio spiked up to an extreme in late December I thought it was a good indicator of panic. That turned out to be the case as it marked the low so far.

From here, I’m looking for signs of which direction the momentum is shifting. The CBOE Index Put/Call Ratio seems to suggest professional investors like me are more concerned about hedging against downside loss. They may be like me, setting on capital gains I prefer to hold (let the winners run!) so adding a hedge can help offset a loss of value. Yet, if we see a continuation up in the recent uptrend we simply take a smaller loss on the hedges that we can tax deduct.

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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 presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Stock market internals are signaling an inflection point

Indicators of the internal strength of the market measure the breadth of the market trend using the number of individual stocks participating in a move.

On December 24, 2018, I shared my observation in An exhaustive stock market analysis… continued that the stock market was washed out since most stocks had fallen. This gave us a signal the selling may have been exhausted and we could look for signs the prices had reached a low enough level to attract buying interest.

That’s exactly what we’ve seen since.

But, what is the current state of the stock market and those indicators?

The percent of the S&P 500 stocks above their 200 day moving average is a longer-term indicator since the lag is 200 days. It takes more time for more stocks to trend above this longer moving average, so by the time they all do, it may be a better long term indicator of a higher risk level. The thinking is once most stocks are already above their longer trend line, it could be closer to the end of the trend and visa versa. In the chart below, we see the only 10% of stocks were in a positive trend at the December low and today it’s closer to midfield. I consider this to be within a normal range. It shows us the current uptrend could have plenty of room to keep trending up before this breadth indicator would suggest longer-term buying exhaustion.

percent of stocks above 200 day moving average asymmetric

However, it’s possible this is the early stage of a bigger bear market. If it is, we’ll see swings up and down to eventually lower highs and lower lows. In that scenario, we’ll see the shorter term indicators reach extreme highs and extreme lows as bear market trends historically unfold as cycles.

The percent of the S&P 500 stocks above their 50 day moving average is a shorter term indicator. Here we see most stocks were participating in the uptrend and have trended above their short term 50-day moving average. In fact, by this measure, we should be surprised to see at least a short term decline in stocks. Price trends don’t often trend straight up, they are more like a stair step as they pause along the way.

percent of stocks above 50 day moving average asymmetric

The NYSE Bullish Percent is another breadth indicator showing the percent of stocks trading on the NYSE stock exchange that is in a positive trend. Specifically, it’s the percent on a Point & Figure buy signal. The NYSE listed stocks are mostly larger companies so we can see the 40% range is about midfield like the % of stocks above their 200 day. No extreme here. New buy signals are expanding when the indicator is rising.

nyse bullish percent asymmetric risk reward 2019

I don’t see any extreme level in the S&P 500 Bullish Percent, either, so there is plenty of room for trends in either direction.

s&p 500 bullish percent asymmetric risk reward

Record High Percent is a breadth indicator that confirms when new highs outnumber new lows and when new highs are expanding. Record High Percent is new 52-week highs divided by the sum of new 52-week highs plus new 52-week lows. When the indicator is above 50, new highs outnumber new lows. New highs are expanding when the index is above 50 and rising. We can see visually this is a faster moving breadth indicator, so it reaches extremes faster and more often.

record high percent

Overall, since the most recent low on December 24th, the breadth indicators suggest there has been broad participation in the uptrend, and the trend may have entered a stage where we could see some short term momentum and buying interest wane. However, the longer term indicators signal there is plenty of room for a continuation of the recent uptrend if it doesn’t instead reverse down to a lower low.

These midfield levels are harder to read since they don’t get so extreme the probability is high of a reversal. In the price trend between the extremes, I prefer to ride the trend and maybe hedge.

For tactical traders and risk managers, this is probably a good time to reduce exposure or hedge off some downside risk and get more neutral in the short term to see how it all unfolds.

asymmetric risk reward trend following

In fact, all of the above is just confirming what I see in the above price trend of the S&P 500. It’s oscillating around the line where there could exist some prior resistance, or it could become support. It’s at an inflection point.

We’re seeing some pause around the level and we’ll soon see what direction supply and demand drive it next.

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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 presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Feeling and Doing the Right Thing at the Right Time

Last week I shared the observation that VIX Implied Volatility is Settling Down. The VIX Index is a  measure of the market’s expectation of future volatility, so the market is pricing in less volatility from here.

However, looking over the past five years, we can apply the 200-day simple moving average to the VIX to see vol oscillate between low vol regimes and a volatility expansion. Currently, it’s still somewhat a volatility expansion in comparison to recent periods, though the 17.80 level is below the long term average of 20. Everything is relative and evolving, so it depends on how we look at it.

vix volatility expansion regime change

Growing up on a small farm in East Tennessee I learned to “make hay while the sun shines.” Disasters happen if we try to make hay all the time or at the wrong time. I know many investors have a passive, all in, all the time approach, but I also saw farmers try to make hay in harsh weather. We have a better experience if we plan to make hay when the sun is shining rather than during a thunderstorm.

I believe the timing is everything.

Markets, especially stocks, are not normally distributed. We observe waterfall declines far beyond what is seen within a normal bell curve. These “tail risks” shock investors and cause panic selling. As panic selling drives prices lower, it results in more panic selling. Unfortunately, most investors natural inclination is to do the wrong thing at the wrong time. So, we see them getting too optimistic at peaks like January 2018 and then panic at lower prices like December 2018.

investor-emotion-market-cycles-fear-hope-greed1

If I am to have better results, I must necessarily be seeing, believing, and doing something very different than most people. In fact, what I’m doing should appear wrong to them when I’m doing it. So, to do the right thing overall, I must necessarily appear wrong to most when I’m doing it. That’s what I do, and I’m not afraid to do it. I just do what I do, over and over, and if someone doesn’t like it, they don’t have to ride in our boat.

I occasionally share a glimpse of the many indicators that generate signals that help to inform me. Most of these indicators I share aren’t actual trade signals to buy or sell, but instead, I use them for situational awareness. I don’t want to be one of the people in the above chart. I prefer to instead reverse it. If I’m going to experience any feelings, I want to feel greed when others are in a panic and feel fear when others are euphoric. That’s how I roll at the extremes. More often, we are in a period between those extremes when I just want to be along for the ride.

In several observations recently like An exhaustive analysis of the U.S. stock market on December 23rd, I covered the Put/Call Ratios and other indicators because they had spiked to extreme levels. In some cases, like the CBOE Total Put/Call Ratio spiked to 1.82 in late December, which is its highest put volume over call volume ratio ever.

A put-call ratio of 1 signals symmetry: the number of buyers of calls is the same as the number of buyers for puts. However, since most individual stock investors buy calls rather than puts the ratio of 1 is not an accurate level to gauge investor sentiment. The long term average put-call ratio of 0.7 for the Equity Put/Call Ratio is the base level I apply. Currently, the Equity Put/Call Ratio is back down to 0.54, which indicates a bullish investor sentiment. A falling Put/Call ratio below its longer-term average suggests a bullish sentiment because options traders are buying a lot more calls than puts. In fact, it’s a little extreme on the bullish side now. I wouldn’t be surprised to see the stock market decline some and this level trend back up.

equity put call ratio asymmetric risk reward

The Index Put/Call Ratio is often greater than one because the S&P 500 index options are commonly used by professional investment managers to hedge market risk. At 0.99 I consider this to signal there isn’t a lot of hedging right now so I wouldn’t be surprised to see stocks pull back some and the ratio trend up more. It isn’t an extreme bullish sentiment, but maybe a little complacent.

cboe index put:call ratio aymmetric risk reward

So, in just about four weeks we’ve seen the sentiment of investors swing from one extreme back within a more normal range. I can’t say the current levels are extreme enough to be any significant signal, but they are drifting that way.  Investors currently see this is a “risk on” regime, so we’ll go with the flow until it changes. By these measures and others, we are seeing them approach a level to become more aware of an elevating potential for a counter-trend.

The good news is, none of this has to be perfect. Asymmetric risk-reward doesn’t require a 100% win ratio, it’s about the average gain exceeding the average loss. For me, it’s more about magnitude than probability.

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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 presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

If fund flow doesn’t show up in price, does it really matter? 

“If a tree falls in a forest and no one is around to hear it, does it make a sound?”

It’s a philosophical thought experiment that raises questions about perception and observation.

Is sound only sound if someone hears it?

Can something exist without being perceived?

Some investment managers focus on fund flows to understand how large institutional investors are positioning their capital. If I paid attention to it, I would probably focus more on the trend for extremes rather than the level or direction of flows. I believe the crowd does the wrong thing at the wrong time and that includes most professional investors and portfolio managers. So, I expect it would be a contrary indicator that I could quantify to be true. After money flows out of funds at an extreme, it’s probably a good time to buy their shares.

Fund flow is the net of all the cash inflows and outflows in and out of a fund or asset class. In the last few months of 2018, we heard a lot about capital flowing out of high yield bonds.

Below is the fund flows of high yield funds tracked by Lipper.

high yield fund flow hyg jnk

We can see how it matches the price trend of the SPDR® Bloomberg Barclays High Yield Bond ETF.

price trend shows fund flow of etf

We don’t have to look at an actual fund flow calculation to understand the supply and demand of the fund.

If something doesn’t show up in price, does it really matter?

Would the fund flow matter if it wasn’t enough to drive the price trend?

My answer is “No.” So, I skip the fund flow and focus on the price trend.

The price trend is ultimately all that matters and I don’t need to follow fund flows to see the asymmetry in supply and demand.

If enough money is flowing into a fund or group of funds, it’s going to drive the price up. If it doesn’t eventually drive the price up, why would we buy it?

Eventually, all strategies are trend following. To earn a profit, we need the price to rise.

Well, when it comes to high yielding markets like high yield bonds there is the exception. Since it pays a yield, the price could stay flat for years and we would still earn a return. In fact, I like to tactically buy yield when it’s high and that necessarily means when the price has fallen. For example, as the High Yield ETF declined in price, its yield increased to 6%.

high yield income investment strategy

If we had bought it at the lower price, we would expect to earn about 6% from that point forward. Now its price has trended up, the yield if we invested today is down to 5.65%.

However, since my focus is on Total Return (Price + Yield) I could say there is still some element of trend following.

We see it when we compare the three-year price only chart to the Total Return. When we observe based on price alone, the trend is down. When we factor in the dividend yield, it’s an uptrend.

high yield trading momentum system trend following

It’s all a matter of perception and observation.

For useful insight, perception and observation need to be complete.

 

 

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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 presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

The Stock Market Trend Update: Clearing the Line

The stock market started last year with a sharp gain. By the end of January 2018, the S&P 500 stock index was up 8% and bullish investor sentiment followed it. Then, it declined -10% in February quickly. After retesting the February low in April, it started to trend back up. By the end of September, the stock market was at an all-time high again, and up nearly 11% for the year.

2018 stock market decline

For a broader observation, I included the VIX CBOE Implied Volatility Index below the SPX price trend chart below. As the stock index price trend fell, the VIX spiked up. As the price trend trended back up, implied/expected volatility measured by the VIX declined to a historical extreme low of 12. It developed into a quiet trending uptrend. It was the kind of condition that trend following systems are designed to exploit. It’s also the kind of condition that drives more exposure to risk from volatility targeting strategies that increase exposure as volatility evaporates and decrease exposure to loss when volatility expands.

spx stock market decline 2018 vix volatility expansion

Then came October.

The month of October has a bad reputation with some investors because they remember the crash of October 1987. However, September is more often the down month. The average return in October is positive historically, despite the record declines of -19.7% in 1929 and -21.5% in 1987. Based on history, October has a higher probability of a gain than a loss.

From October through December, the S&P 500 commenced to falling nearly -20%.  The month of December going into Christmas Eve was especially brutal with panic selling driving a waterfall decline.

2018 stock market crash fourth quarter .jpg

As I shared several times here, eventually those who want to sell have sold and new buying demand steps in when prices reach a low enough point to drive their enthusiasm to buy. After the waterfall decline, that’s exactly what we’ve seen since the beginning of January. Those who added or increase their exposure have been rewarded, those who decreased their exposure are probably feeling the fear of missing out. The S&P 500 has gained about 13% since the low on December 24th and nearly 6% year to date in 2019.

stock market spy spx gain since 2018 low

Getting technical, I like to see a visual of the price trend and define it with trend lines for observation. Below we see the same line I wrote about in Will the stock market hold the line? in November as potential support (that wasn’t) came back into play as potential resistance (that isn’t.) Support and resistance is only a “potential” unless it actually is. The SPX has cleared the line and is trending above that prior price level that held twice and broke badly the third time.

spx technical analysis trend line asymmetric

The stock market is up sharply today after this breakout, expected volatility VIX is decreasing, and we see an expansion in breadth and momentum.

While the stock market has reached a point we may see at least a temporary decline, it is instead trending up at this point. The driver could be those who panicked at the lows now becoming overwhelmed by the fear of missing out. It could also be the same volatility targeting programs that sold into the volatility expansion now reentering as volatility is decreasing. So, this trend could run longer than many expect it to if it’s driven by enough buying demand.

We’ll see if it holds the line again. But, Semper Gumby: last year started out this way, too.

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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 presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

VIX Implied Volatility is Settling Down

The CBOE VIX is settling down again after getting after it last year.

The VIX is designed to measure the 30-day expected volatility of the U.S. stock market, derived from real-time, mid-quote prices of S&P 500® Index call and put options.

The VIX Index is a  measure of the market’s expectation of future volatility, so the market is pricing in less volatility from here.

vix $vix #vix term structure asymmetric hedge

VXV calculates based on a 3-month measure instead of VIX’s 1-month measure. The chart gives us an observation of term structure. Typically, we expect longer dated options like the 3-month to be higher than 1-month because they offer “insurance” for a more extended period. If the 1-month is higher than the 3-month, it means near term implied volatility has spiked, so the market is probably buying the protection of options. Right now the 1-month is lower than the 3-month, so the term structure is back to its normal contango.

By the way, anyone trading volatility or hedging with the VXX ETN should be aware that VXX is maturing on January 30th, 2019. Barclays has created a replacement with iPath® Series B S&P 500® VIX Short-Term FuturesTM ETN (VXXB).

Speaking of CBOE, it will be interesting to see the outcome of the earnings report on February 8th and if the volatility last year improves their profitability.  Blow is an interesting observation of the stock. The stock has declined -31% since its high last February. The orange line is the forward PE Ratio, with the stocks price over its earnings per share “predicted” by analysts. Keep in mind, analyst estimates are often wrong. Their expectations are no sure thing. The red line is the trailing 12 months earnings per share (EPS). The gap down in Forward P/E corresponding to the trailing twelve month EPS is an interesting observation.

cboe earnings report eps

The Forward P/E Ratio can signal analyst sentiment of a stock. If the forward P/E ratio is higher than the current P/E ratio, it indicates decreased expected earnings. A Forward P/E ratio less than the current P/E means expected increased earnings. Charting them below, it doesn’t appear the analyst are overly optimistic about the EPS report. But, what if they’re wrong?

cboe pe eps earnings research stock

We’ll soon learn if options and futures trading in VIX results in profits for CBOE in a volatility expansion. Over the past year, that hasn’t been the case, so maybe it’s time?

cboe earnings from vix optoins trading

We’ll see.

Only time will tell if VIX implied volatility continues to contract and the CBOE stock trends up or down. But, if any company that should profit from directional movement up or down and a volatility expansion, it’s the CBOE. Analysts can get the CBOE stock wrong and the market can get the future volatility wrong,

Let’s see how it unfolds.

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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 presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Uncharted Territory

Uncharted Territory is trending on @Twitter as the government shutdown becomes the longest in U.S. history.

Everything about the future is always uncharted territory.

Uncharted is unexplored or unknown. To chart is to map, so uncharted is not yet on the map.

The future is always uncertain, so we must deal with uncharted territory.

uncharted territory

Uncharted Territory should not be confused with unchartERed, which means lacking a charter.

The charter, in this case, is something that authorizes someone to work in a specific role.

So, unchartered is unauthorized. It isn’t unchartered territory it’s uncharted territory.

Considering the future is unknowable since it doesn’t exist yet.

We are always in uncharted territory.

We can draw our charts and maps, but future events aren’t like physical places.

We deal with the certainty of uncertainty It’s all we have, so we may as well embrace it.

I don’t know what’s going to happen next to make tactical decisions that result in asymmetric risk/reward. I only need my average gains to be larger than my losses.

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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 presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

FAANG Stocks and Momentum Trends

Markets trend in cycles and trends come and go like seasons from spring to summer to fall to winter. I like to observe a range of price trends and behavioral trends from short term to very long term secular trends.

In the 1960s and 1970s, it was the Nifty 50. The Nifty 50 were 50 stocks institutional investors admired.

The Nifty 50 stocks got their reputation during the bull market of the 1960s and early 1970s. They were considered “one-decision” stocks because investors were told they could buy and hold the shares forever. Nifty 50 stocks included IBM, General Electric (GE), and Coca-Cola (KO). Some of the Nifty 50 have had problems the past decade, like Xerox and Polaroid. More recently, we can add General Electric to not so nifty list.

The secular bear market of the 1970s started with the 1973–74 stock market crash and lasted until 1982.  Valuations of the Nifty 50 fell to low levels along with the rest of the stock market. Most of the Nifty 50 lagged the stock market indexes and then they weren’t so popular afterward. Trends can be fads and come and go, but the one thing we see driving fads in the stock market is their actual price trend. Stocks are loved at all-time highs, not so much after they decline.

Below are three of the better Nifty Fifty stocks. Buying and holding the stocks would require tremendous patience and acceptance of volatility and large drawdowns.  Coca-Cola had the best momentum overall. But, who could have held through the drawdown from the late 1990s that lasted a decade? How about Xerox?

nifty 50 ko ibm ge

Below are the % off high drawedowns of these “Blue Chips.” A -50% more decline that lasts for years is something an investor would have to tolerate more than once to own the stocks long term. This is why buy and hold investing doesn’t work for most investors. 

fifty 50 stock asymmetry ratio

Then in the 1990s, it was the tech stocks especially those involved in the Internet. More specifically, the “.com” stocks was a whole new level of popularity and euphoria. The overall stock market reached its highest valuation levels, ever. Most of the .com stocks no longer exist. Some of the technology stocks involved in building the infrastructure still do, like Cisco (CSCO), Microsoft (MSFT), Oracle (ORCL), and Qualcomm (QCOM). But, many of the momentum stocks of the 1990s aren’t around to see their charts.

tech stocks

If investors only focused on is the right side of the chart, those several thousand percent gains look exciting. But, in the real world, even a -20% decline in the stock indexes as we saw in 2018 causes investor fear and panic selling. The investors holding the above stocks would probably need to be asleep at the wheel to have held them long term.

Looking at the total return alone isn’t sufficient, so I like to observe what I call the ASYMMETRY® Ratio, which is the total return chart above along with the drawdown. The ASYMMETRY® Ratio gives us a full picture of the asymmetric risk-reward if there is one. Clearly, the downside drawdowns were brutal by any measure. Maybe even more brutal than the Nifty 50.

1990s momentum tech stocks

Those are the momentum trends of the past.

Today we have the FAANG stocks. It stated as FANG and has since extended to FAANG. The FAANG stocks are Facebook (FB), Apple (AAPL), Amazon (AMZN), Netflix (NFLX), and Google (GOOG). They have been some of the most popular momentum stocks and for good reason. These are some of todays greatest companies. Who can imagine Netflix going away today? Who could have imaged online Netflix taking out Blockbuster? Who can imagine Amazon eventually taking out Netflix? What if Walmart (WMT) or Target (TGT) figure out a way to compete with both? The reality is, there is probably some small company out there we don’t know about that will be the next big winner. We don’t have to attempt to find the needle in the haystack, we can just focus on the price trends and they’ll show up eventually.

I shared my observations in FANG Stocks were the Leaders but now the Laggards so I won’t rehash it. My mission here is a short term update.

So far in 2019, all of the FAANG stocks are trending up except for Apple (AAPL). Only one of the FAANG stocks have had stronger momentum than the First Trust Dow Jones Internet ETF (FDN) which is a more diversified version of FAANG type internet industry stocks. The clear leader has been Netflix (NFLX).  Here is a chart over the past month:

faang stocks fb aapl amzn nflx goog momentum asymmetric risk reward

The ASYMMETRY® Ratio looking at the total return vs. % off high drawdown gives us a better picture of asymmetric risk-reward. Below is their total returns over the past year.

fang faang stock momentum fb aapl amzn nflx goog

The FAANG stocks clearly have their downside risks and all of them are in drawdowns as we see below. However, they are recovering and the diversification of the ETF helped reduce its drawdown relative to the individual stocks.

 

faang stock asymetric risk reward momentum drawdown

We’ll see if the FAANG stocks resume their prior momentum we’ve seen over the past several years.

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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 presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

A Tale of Three Vols

I know, you’re thinking this is about the Tennessee Vols.

Nope.

Different vol.

I’m not talking about Tennessee Volunteers, I’m talking about the volatility of the stock market.

Someone asked:

“With the S&P 500 is up 3.43% on Friday, volatility is up, way up. So, why is the VIX down -16%? “

The short answer is the CBOE Volatility Index (VIX) is volatility implied by S&P 500 options prices, so it’s expected future volatility, not actual or realized historical volatility. In fact, the VIX is an estimate of volatility for the next 30 days. Part of the price of S&P 500 options is an estimate of how volatile the S&P 500 will be between now and the option’s expiration date.  This estimate is not directly observed but is implied by how much buyers are willing to pay for options.  If the market has been volatile as it has been recently, option premiums will increase with the volatility expansion. When the stock market is calm and smooth like it was in 2017, options prices will decrease as a volatility contraction. So, the VIX is implied volatility, not historical realized volatility.

Since investors tend to extrapolate the recent past into the future, they usually expect recent calm markets to continue and violent swings to persist. However, we’ve experienced nearly a year of a high volatility regime with the S&P 500 swinging up and down in a range as high as 20%. However, we’ve now seen two high volume up days and the second is considered to be an upward follow-through day. Such a thrust seems to have the options market expecting lower volatility over at least the next month. That’s how I see it. Others may believe its a reaction to the economic news. It is what it is.

What is perplexing to those not familiar with VIX movement is it decreased so dramatically as the price actually gained a lot. Volatility actually expanded, but to the upside, and implied volatility evaporated. That doesn’t sound like a volatility gauge.

Another issue is not all volatile calculations really measure upside and downside vol the same way. Below is the S&P 500 index.

  • The first chart in the next window below the price trend is an average true range (ATR) of the price over the past 14 days.
  • The second chart is the VIX.
  • The chart in the last window is the standard deviation.

spx spy vix $spx $spy $vix atr volatility asymmetric

A few observations:

  1. The price of the S&P 500 has increased sharply the past two weeks.
  2. The VIX is trending down sharply and so is the standard deviation.
  3. The average true range isn’t trending down. It has stayed about the same.

As the price has spiked up, historical volatility as measured by standard deviation is trending down sharply and so is implied volatility. The only measure actually accounting for this wide range of prices (up in this case) is the average true range.

You may be wondering why?

Standard deviation a statistical model that measures the volatility of a price trend. The calculation assumes that two standard deviations should contain 95% of the price data.

The average true range includes the total “true” range of the price trend by comparing highs, lows, and closes, and compares the price change over different days to account for gaps up and down in price.

As you can see, the average true range of price appears to more accurately reflect the volatility as prices spread out. The standard deviation is recovering from the large deviations as the average true range is reflecting remaining day to day volatility.

What does it matter, anyway?

Volatility measures may be used to create indicators for trading signals. For example, in the chart, I added channels above and below the price trend that are 2 times the standard deviation. These bands are expected to include about 95% of price action.

spx spy $spx $spy atr sd vix volatility asymmetric

There are two ways it may be used for tactical trading.

A trend following system may use them to identify a breakout because moves outside the price range are rare. A trend following system expects such strong momentum will continue.

  • When the price breaks out the upside, a trend follower may buy, expecting the momentum of the price will keep trending up.
  • If the price breaks out to the downside, the trend following system may sell (short), expecting the downside momentum to continue.

A countertrend system does just the opposite.

  • If the channel is reached on the upside, the countertrend system will sell, expecting the price will reverse back down within the range.
  • If the price falls to the lower channel, the countertrend system will buy, expecting the price is more likely to trend back up within the range.

I’m just sharing this as an observation to answer a question. We could test these signals to see their results as a system to quantify which one may have a better asymmetric risk/reward. But, for this purpose, we can see how these three volatility indicators are similar or different.

I could have titled this observation “A Tale of 4 Vols” since we can observe the distinctions between “lower volatility” and “higher volatility” by simply looking at the price trend. Over the past two years, we’ve certainly observed a period of low vol change into high vol. I call it a volatility expansion and though, for me, using the VIX and other indicators signaled the possible change, the price trend itself is the final arbiter.

trend following stocks stock market asymmetric risk reward

By the way, what about the other vol? The Tennessee Vol? Why do they call Tennessee the “Volunteer State” and the Tennessee Volunteers?

Appalachian Magazine shares the story:

“The proclamation went out from Nashville that the federal government needed 2,600 volunteers to assist in the war with Mexico… Within a week’s time, more than 30,000 Tennesseans responded to the call to arms.  And it was from this overwhelming show of patriotism that the State of Tennessee not only assisted in winning the outright sovereignty of the State of Texas, but also in securing its lasting title as The Volunteer State.”

So, there you have it.

I guess I could have titled this observation “A Tale of Five Vols.” You can probably see how observations can spread out to a wider range and become more volatile. It’s even true for the topic of volatility.

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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 presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Stock Market Update

After gaining over 6% since the low on Christmas Eve, the S&P 500 declined -2.45% today. We can expect a wider range of prices in a volatility expansion after a -20% decline.

spx january 3 2019

I say it’s a volatility expansion because implied volatility is relatively elevated at 25.45, implying a 25% range of prices is implied by options prices on the S&P 500 stocks.

vix volatility expansion

Looking over its full history, we’ve seen the VIX trend higher, but it’s relatively elevated. Its long-term average is about 20. But, for mean reversing indicators like the VIX, the average doesn’t mean much since it doesn’t stay there.

vix long term history

Another way I define a volatility expansion is realized volatility. The VIX is expected volatility implied by options prices, realized volatility is actual historical volatility. In the chart below I added an average true range over the past 14 days above the S&P 500 stock index price trend. We can see how volatility expanded as the price trend fell. Prices tend to spread out in a wider range in a downtrend. We can see this in the chart. There was a regime change from a low volatility uptrend to a downtrend with volatility expansion.

atr volatilty expansion realized vol asymmetric risk reward

The CBOE Put Call Ratios spiked up today. Zooming in to a 30 day period, we see the Index Put Call Ratio is about where it was at the lows in December. I believe the Index Put Call Ratio is a better indication of extremes in fear of lower prices because index options are mostly traded by professionals and used for hedging. The Equity Put Call Ratio is options on individual stocks and more non-professionals and tends to be more speculative. I explained it in Investor Sentiment into the New Year 2019. 

put call ratio january 2019

To get a longer view below is the past five years of the Put Call Ratios. They’ve been higher in 2015, but are clearly at elevated levels. It indicates the put volume on index options is 155% more than call volume, which suggests hedging or speculative bets the index will decline.

put call ratio peaks past years 2018

Prices decline until the selling pressure is exhausted. Selling pressure is exhausted after those who want to sell have sold, which pushes prices down to a low enough point to attract buyers. To get an indication of when prices have trended down far enough to exhaust sellers and attract buyers, I look at the price trend itself as well as extremes investor sentiment and breadth. Below is the percent of stocks in the S&P 500 below their 200 day moving average. The percent of stocks above their 200 day moving average reversed back down… only 14% are in a positive uptrend. There are currently 505 stocks in the S&P 500. Of the 18 that are above their 50 day moving average, two are because they are being bought out Celgene CELG and Redhat RHT. Some of the others are kind of recession stocks like auto parts, discount store, and a gold stock: AZO ORLY DLTR NEM.

percent of stocks above 200 day moving average $spx $spy spx

The percent of S&P 500 stocks above their 50 day moving average reverses back down… only 3% are in an uptrend…

percent of stocks above 50 day how to use it spx

The stock market is approaching oversold levels again but may get more oversold before reversing back up.

One advantage of falling stock prices is as price falls, the dividend yield rises from that new price. This is not a recommendation to buy or sell any security, but below is the price trend and dividend yield the Global X SuperDividend® ETF (SDIV). It invests in 100 of the highest dividend yielding equity securities in the world. We can observe as the price trends down, the dividend yield trends up. That is, if we buy high yielding assets at lower prices, the dividend payment is higher from that starting point assuming the companies keep paying their dividends. Below we can see how this ETF yield has increased to 9% as its price has fallen -35% off its high.

high yield income strategy sdiv dividend etfLike any investment, it isn’t risk-free. Investing always involves risk, including the possible loss of principal. 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 Fund’s performance. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. The bottom line is; there is no free lunch. If we want the potential for return, we have to take risks.

If this is the early stage of a larger decline, it will unfold with many up and down swings along the way. It will get overbought/oversold over and over and sometimes stay that way longer. I shared it in An exhaustive stock market analysis… continued. 

Emotional undisciplined investors, traders, and portfolios managers will be destroyed in a volatility expansion. They’ll swing from the fear of missing out to the fear of losing money as the stock market swings up and down.

Self-discipline and emotional fortitude are essential to be an investment manager.

We’ll see how it all unfolds from here.

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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 presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

 

Investor Sentiment into the New Year 2019

Investor sentiment measures may be used as contrarian indicators. We expect the market to do the opposite of what the indicators are saying when they reach an extreme level of bullish/greed/optimism or bearish/fear/pessimism.  Identifying extreme levels of positive or negative sentiment may give us an indicator of the direction the stock market is likely to trend next.

I observe when sentiment reaches overly optimistic levels like it did late 2017 into January 2018, the stock market trend trends down or at least sideways afterward. In reverse, after investor sentiment becomes extremely pessimistic, the stock market tends to trend back up.

Although extreme investor sentiment may be used as a contrarian indicator, I do not base my investment or tactical trading decisions on it by itself. I use investor sentiment measures and indicators to indicate and confirm my other signals of a potential trend change. For example, when bullish investor sentiment is rising from a lower level but not yet reached an extreme high, it’s just confirming trend following. However, when bullish sentiment reaches an extreme it warns me to be prepared for a potential countertrend. All those who want to buy may have bought, so buying enthusiasm may be exhausted. That’s what I observed in January 2018. After prices fall investor sentiment shifts to bearish and they fear more loss. Once the level of fear reaches an extreme it begins to suggest those who want to sell have sold and we could see selling become exhausted and a selling climax.

We have two types of investor sentiment measures: Polls and indicators.

Investor sentiment polls actually survey investors to ask them what they believe about the market. The AAII Investor Sentiment Survey has become a widely followed measure of the mood of individual investors. Since 1987, AAII members have been answering the same simple question each week:

“Do you feel the direction of the market over the next six months will be up (bullish), no change (neutral) or down (bearish)?”

The results are then consolidated into the AAII Investor Sentiment Survey, which offers us some insight into the mood of individual investors.

Bearish investor sentiment is negatively correlated with stock market index returns. Below I created a chart of the S&P 500 stock index with an overlay of the % bearish investor sentiment. On the bottom, I added the correlation between the S&P 500 and the % bearish investor sentiment. We can visually see there is a negative correlation between investors getting more bearish as stock prices fall. For example, few investors were bearish in 2014 into 2015 until the stock index fell -12% in August 2015, then the % of bearish investors spiked up. We also saw the % of bearish investors extremely low in January 2018 as the stock index reached an all-time high. After the stock index declined -20% at the end of 2018 we saw the % of bearish investors spike up again. As we enter 2019, the % of bearish investors is at a historical extreme high level so we may be observing a selling climax as the desire to sell gets exhausted.

Bearish Investor Sentiment is Negatively Correlated with Stock Index Returns

Bullish investor sentiment is positively correlated with stock index returns, except after stock prices fall, then investors lose their optimism. In the chart below, we see the % of bullish investors trending up along with stocks 2014 into 2015, but then as prices fell late 2015 into 2016 they lose their optimism for stocks. We saw another spike to an extreme level of bullishness late 2017 into 2018 as the stock index reached all-time highs. The % of bullish investors declined with great momentum after prices fell sharply. As we enter 2019, the % of bullish investors is very low, leaving much room for the desire to buy to take over.

Bullish Investor Sentiment is Positively Correlated with Stock Index Returns

Investor sentiment surveys like AAII are useful tools to get an idea of extreme sentiment levels when selling pressure or buying enthusiasm may be becoming exhausted. However, their potential weakness is they are ultimately just polls asking people what they believe, not what they are actually doing. Regardless, they do seem to have enough accuracy to be used as a guide to confirm other indicators.

As I’ve observed extreme levels of investor sentiment and participation in the 2018 downtrend in global markets, I’ve shared these indicators several times. As we saw in the investor sentiment survey, the VIX spiked in 2015, then spiked again but to a lower high in 2016 as the stock index fell. The VIX spiked again in February 2018 as the S&P 500 quickly declined -10%. After prices trended back up implied volatility contracted all the way to the low level of 12. The stock index started to decline again, so the VIX once again indicated a volatility expansion. As we enter 2019, the CBOE S&P 500 Volatility Index VIX is at 25.42, just over its long-term average of 20. The VIX implies an expected volatility range of 25% over the next 30 days.

VIX VXX VXXB 2018 VOLATILITY EXPANSION TRADING INVESTMENT ADVISOR.jpg

I’ve shared several observations the past few months of the Put/Call Ratio. The Put/Call Ratio is a range bound indicator that swings above and below 1, so reveals a shifting preference between put volume to call volume. When the level is high, it indicates high put volume. Since puts are used for hedging or bearish trades, I consider it a contrary indicator at extremely high levels.

The Equity Put/Call Ratio measures the put and call volume on equities, leaving out indexes. The Equity Put/Call Ratio spiked to a high level of put volume when it reached 1.13 on December 21, 2018, as the stock index was declining. The high Equity Put/Call indicated options trading volume was much higher for protective puts than call volume. The Equity Put/Call Ratio is considered to be mostly non-professional traders who tend to be more bullish, so it keeps call volume relatively high and the ratio low. Its high level has so far turned out to be a reliable short-term indicator of a short-term low in stocks. As we enter 2019, the Equity Put/Call Ratio is at .60, which is at a normal range. We normally see more call volume than put volume in the Equity Put/Call Ratio, so the ratio is its normal level as you can see in the chart.

equity put call ratio 2018 spx spy

The CBOE Index Put/Call Ratio is applied to index options without equity options. We believe professional traders and portfolio managers mostly use index options for hedging or directional positions. The total volume of the Index Put/Call Ratio is asymmetric toward puts for hedging purposes. As we can observe in the chart below, the current level at the beginning of 2019 is 1.09 dropping about 35% from it’s December peak at 1.67.

INDEX PUT CALL RATIO CBOE 2018

We can visually see the tendency in Index Put/Call is around 1 as the Equity Put/Call Ratio is around 0.60. Equity Put/Call Ratio has a more optimistic/bullish tendency as individual stock options are used more for bullish bets as index options are used more as for hedging.

The CBOE Total Put/Call Ratio combines both equity and index options to create a range bound oscillator that swings above and below 1. With the Total Put/Call Ratio, I believe the put bias in index options is offset by the call bias in equity options. The Total Put/Call Ratio spiked to its highest ever reading of 1.82 on December 20, 2018, as the stock index was entering the -20% “bear market” level. I consider a level above 1.20 to be bullish as it indicates an extreme in put volume over call volume. A reading below 0.70 is more bearish since there is an asymmetry between call volume over put volume. Above 1.20 is an elevated put trading volume. As a bet that stock prices will fall or hedge against them, buying put options is a bearish sentiment. Of course, some of the volume could have been traders selling puts which are a very speculative bullish bet, but since I pointed it out the stock indexes reversed up sharply, so I believe it turned out to be a reliable short-term indicator of a short-term low in stocks. As we enter 2019, the Total Put/Call Ratio is at .98 which is still high. We usually see more call volume than put volume, so the ratio is typically well below 1 as you can see in the chart.

total put call ratio spx comparison

There is no better indicator of a shift in investor sentiment than price action. No one believes that any more than me. The direction of the price trend is the final arbiter, and I’ve believed it over two decades. Any indicator that is a derivative of price or non-price trend economic data has the potential to stray far from the reality of the price trend. The price trend determines the value and the outcome of a position. As we enter 2019, the S&P 500 stock index has declined -20% off it’s September high and after a sharp reversal up since December 24th, it’s currently in a short-term downtrend, but at a level, the countertrend back up may continue.

spy spx stock index 2018 bear market

Even if you don’t observe investor sentiment measures as an indicator or trade signal, it’s still useful to observe the extremes to help avoid becoming overly bullish or overly bearish and part of the herd. The herd tends to be wrong at extremes, and most investors tend to do the wrong thing at the wrong time. If I am to create better results, I must necessarily do the opposite of most investors.

As a tactical investment manager, I identify changes in price trends, inter-market relationships, investor sentiment, and market conditions aiming for better risk-adjusted returns. My objective is asymmetric investment returns, so I necessarily focus on asymmetric risk/reward positions, and that includes focusing on asymmetries between bullish and bearish investor sentiment.

 

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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 presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

To Know Where You’re Going, Look at Where You’ve Been: The 2018 Year in Review

I write my observations of trends and market conditions every day, though I only share some of them on ASYMMETRY® Observations. The advantage of writing observations as we see them is we can go back and read what we observed in real time.

The best “year in review” is to reread these observations in the order they were written to see how global directional trends and volatility expansions and contractions unfolded in real time. Reviewing our actual observations removes the hindsight bias we have today, looking back with perfect hindsight of what happened only after the fact.

It’s one thing to think back and write about what you observed over the past year, it’s another to revisit what you observed as you saw it. It’s even another to review what you actually did in response to what you observed.

Mark Twain’s mother once said:

“I only wish Mark had spent more time making money rather than just writing about it.”

I don’t take the time to share every observation I have because I am no Mark Twain. I am fully committed to doing it, not just writing about it. Writing about observations of directional trends and volatility is secondary to making tactical trading decisions and active risk management for me. I see no use in observing markets and writing about it if I do nothing about it.

The first observation I shared this year was on January 18th. The topic may sound familiar today. From there, I observed conditions to suggested we could have been seeing the final stages of a bull market, a trend change to a non-trending indecisive period, and a volatility expansion. If you want to understand what in the world is going on, I encourage you to read these observations and think about how it all played out over the year.

JANUARY 2018

All Eyes are Now on the Potential Government Shutdown

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

FEBRUARY 2018

In the final stages of a bull market

Asset Class Returns are Driven by Sector Exposure

Stock Market Analysis of the S&P 500

Stock market indexes lost some buying enthusiasm for the day

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

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

February Global Market Trends

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

Buying demand dominated selling pressure in the stock market

Asymmetric Volatility

MARCH 2018

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

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

Asymmetric force direction and size determines trend

Asymmetric force was with the buyers

My Introduction to Trend Following

When I apply different trend systems to ETFs

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

Apparently there was more enthusiasm to sell

What’s going to happen next?

What’s going to happen next? continued

APRIL 2018

Is this correction and volatility normal?

Global Market Trends

MAY 2018

Is the economy, stupid?

JUNE 2018

Growth Stocks have Stronger Momentum than Value in 2018

Sector Trends are Driving Equity Returns

Trend Analysis of the Stock Market

Trend of the International Stock Market

Interest Rate Trend and Rate Sensitive Sector Stocks

Expected Volatility Stays Elevated in 2018

Sector ETF Changes: Indexes aren’t so passive

Commodities are trending with better momentum than stocks

Investor sentiment gets more bearish

Is it a stock pickers market?

JULY 2018

2nd Quarter 2018 Global Investment Markets Review

Global Stock and Bond Market Trends 2Q 2018

Stock market investor optimism rises above historical average

Trend following applied to stocks

Asymmetry of Loss: Why Manage Risk?

Earnings season is tricky for momentum growth stocks

Front-running S&P 500 Resistance

The week in review shows some shifts

AUGUST 2018

Global Market ETF Trends

Global Market Trends, U.S. Dollar, Emerging Markets, Commodities, and Their Changing Correlations

The Big Picture Stock and Bond Market Valuation and Outlook

SEPTEMBER 2018

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

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

What trends are driving emerging markets into a bear market?

VIX level shows market’s expectation of future volatility

Rising Interest Rate Impact on Real Estate and Home Construction

The Trend in Interest Rates and the Impact on the Economy and Stock Market

OCTOBER 2018

Stanley Druckenmiller on his use of Technical Analysis and Instinct

Here comes the volatility expansion

Intermarket trends change over the past two weeks

The volatility expansion continues like tropical storm Michael that could become a hurricane

Divergence in Global Asset Allocation

The Stock Market Trend

U. S. Sector Trends

Observations of the stock market decline and volatility expansion

The stock market trends up with momentum

Observations of the stock market downtrend

NOVEMBER 2018

The stock market is swinging its way to an inflection point

Divergence in the Advance-Decline Line May be Bullish

Pattern Recognition: Is the S&P 500 Forming a Head and Shoulders Bottom?

Momentum stocks need to find some buying interest

Will the stock market hold the line?

The Death Cross on the S&P 500

DECEMBER 2018

Stock Market Observations

What’s going to happen next for the stock market?

Global asset allocation takes a beating in 2018

The stock market has reached a short-term extreme as investor sentiment indicates fear

An exhaustive analysis of the U.S. stock market

An exhaustive stock market analysis… continued

Keep in mind, even if I see what could be the final stages of a bull market unfold, it doesn’t mean I try to just exit near the stock market peak and sit in cash for years. For me, it isn’t a simple ON/OFF switch. The highlight of my performance history has probably been my execution through bear markets. I’ve historically operated through them by being a tactical risk manager/risk taker, which means I increase and decrease exposure to the possibility of risk/reward with an objective of asymmetric risk/reward. I can’t assure anyone I’ll do as well in the future as I’ve done in the past, but I do know I’m even better prepared now than I was then. Being as prepared as possible and well-honed on situational awareness is the best I can do.

I’m looking forward to sharing more observations as we enter 2019 as global market conditions appear to be setting up for some trends to avoid, some to participate in, and some interesting trends to write about. To follow along, enter your email address on the top right of this website and follow me on Twitter.

HAPPY NEW YEAR! 

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell 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 presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

 

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