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.

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