Here comes the volatility expansion, but is the coronavirus outbreak in China to blame?

The Dow Jones Industrial Average is down 460 points and headlines mostly blame the coronavirus outbreak in China as it spreads around the world.

A few headlines this morning:

Stocks Tumble Around the World on Virus Jitters

China Deaths Jump as Measures Fail to Slow Spread of Virus

What’s Being Done to Limit the Spread of the China Virus

Millions Left Worried, Angry and Isolated After Wuhan Lockdown

Stocks Drop on Coronavirus Fears

The Dow industrials fell about 400 points as detection of coronavirus in new patients in the U.S., Australia and France led to escalating concerns about the containment and potential economic impact.

People love a good story, so the narrative gets the blame for falling prices.

As I shared in What’s the stock market going to do next? and Periods of low volatility are often followed by volatility expansions, it’s really just the market, doing what it does.

The stock market is declining simply because it was priced for perfection. You can see in the chart below, as the price trend of the S&P 500 stock index trended up the past several months, its volatility, or the range of prices, was tight.

Who doesn’t love a quiet uptrend?

It was a nice quiet uptrend, suggesting investors were complacently enjoying the ride. I was to until it reached an extreme, then I hedged off some risk, then reduced the possibility of loss completely by taking profits and shifting to short term U.S. Treasuries.

This time, I was just a little early with my hedging, but that was ok. The higher stocks trended up and more volaltity contracted, the more likely the trend would reverse down and volatility expands.

That’s what we’re seeing now.

volatlity expansion spx spy dia vix

While an SPX at 3200 is a ‘normal’ range for the market to move, I wouldn’t be surprised to see the price trend decline to the blue line I marked on the chart.

Of course, as I said in Now, THIS is what a stock market top looks like!, it could be an even larger peak, too.

Anything is possible, which is why we necessarily need to actively direct and control the possibility of loss for asymmetric risk-reward.

I don’t believe this price decline is driven by the coronavirus outbreak in China as it spreads around the world. I think it’s just the market, doing what it does, as I’ve shared the past several weeks. Some catalyst gets the blame for it.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

What could go wrong

Investors, including millionaires and fund managers, are really bullish.

According to E-Trade Financial:

“In Q4 of last year, even as stocks gained, millionaires were cautious and possibly worried about a repeat of the plunge in the fourth quarter of 2018. Now 76% of these wealthy investors grade the U.S. economy highly, and there has been a 16% increase in investors who expect the market to rise by as much as 5% this quarter, according to an E-Trade Financial quarterly survey provided exclusively to CNBC.”

Then, Bank of America Merrill Lynch’s regular survey of global fund managers:

“The FOMO — fear of missing out — market did not come out of nowhere.

Last November, Bank of America Merrill Lynch’s regular survey of global fund managers found that global fund managers’ cash levels posted their largest decline since President Donald Trump’s 2016 election as investors rushed to take on risk.”

After reading that, I thought: With everyone so bullish, what could go wrong? 

Place tongue in cheek image here.

Following up with my reaction over the weekend to Barron’s cover in Now, THIS is what a stock market top looks like!, I finally got around to reading the article “Ready or Not, Here Comes Dow 30,000.”

Barron’s said:

“Investors are responding to a set of conditions- low interest rates, muted inflation, and massive cash returns from U.S. companies – that make putting money into stocks the rational thing they can do.”

So, the reach for yield drives the stock market because:

“Some 80% of companies in the index cash-return yields higher than treasuries.”

Below I compare the S&P 500 stock index ETF dividend yield to the 10 year Treasury rate. By this measure, the 10 year is 1.84%, which is 0.14% more than the SPY.

10 year treasury yield compared to S&P stock index yield

However, since the Treasury yield curve is relatively flat, the one-month Treasury is 1.54%, so there isn’t much of a spread or premium between the interest rate earned for just one month over 10 years.

10 year treasury yield compared to S&P stock index yield

Moving on to “What Can Go Wrong” they say rising bond yields are a risk to equities.

Of course, rising prices (inflation) is a driver of rising bond yields.

So, inflation may be the driver of a longer-term downtrend in stocks if these markets interact this way.

Since 2012, the Federal Reserve has targeted a 2% inflation rate for the US economy and may make changes to monetary policy if inflation is not within that range. So far, the FED has been successful ‘on average’, but there have been some uptrends in inflation.

US INFLATION RATE DRIVES BOND YIELD PRICE

Next, I added the high and low inflation rate since 2012 and highlight above 2% in yellow. 

inflation rate drives bond yield price high low

By and large, inflation cycles within a range. With the current inflation rate at 2.29%, which is a little higher than the Fed 2% target, I suppose global macro traders should pay attention to the trend and rate of change of inflation. 

What could go wrong?

There are always many things that can cause a market to fall. We’ve got a U.S. Presidential election this year, an impeachment, now

A quick glance at headlines shows:

BREAKING NEWS

CDC expected to announce first US case of deadly Wuhan coronavirus

Changes to impeachment rules

So, there are always many things that could go wrong and be regarded as a catalyst for falling prices, but I focus on the direction of the price trend, momentum, volatility, and sentiment as my guide.

The direction of the price trend is always the final arbiter.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

 

How low can implied volatility VIX go?

Volatility measures the frequency and magnitude of changes, both up and down, that we experience over a certain period of time.

When we speak of volatility in the financial markets, we necessarily mean the magnitude of price movements, both up and down, over time.

So, volatility is how quickly and how far a price trend spreads out.

The more dramatic the price swings, the higher the level of volatility.

Volatility can be measured using actual historical price changes (realized volatility) or it can be a measure of expected future volatility that is implied by option prices.

The VIX Index is a measure of expected future volatility.

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

When the VIX is low, a lower level of volaltity is implied, or priced in, to the options. When the VIX is high, expected volaltity is high.

Recently, the implied volatility index VIX has been very low at times. As seen below, I added the low of the past year to the chart, which was 11.54, which is lower than today.

VIX record low volatility expansion contraction

But, the long term average VIX level is 19 and the lowest level the VIX has reached since its inception was 9.14 reached late 2018.

VIX long term average low and high level

To put the 9.14 level into perspective, here is the past three years and how low the VIX was in 2018 as complacency set in.

VIX lowest level 2018

Can stocks keep trending up and implied volatility drift lower?

Absolutely.

But, what happened after it did?

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

 

 

Now, THIS is what a stock market top looks like!

Stock Market Risk is Elevated

I walked out the front door this morning with a cup of coffee to take the pup out and pick up my weekly Barron’s in the driveway.

When I got inside, I opened it up and BEHOLD! 

Barrons cover signal indicator

Gracing the cover of Barron’s is:

“Dow 30,000 THE MARKET’S BIG RUN: Why stocks could vault past the milestone”

I haven’t read the article, as the cover is signal enough for me.

The Magazine cover indicator says that the cover story on the major business magazines is often a contrary indicator.

I’m sure they made a great case for higher stock prices.

The trend is your friend until it ends.

Markets can remain irrational longer than you expect, but there are times when markets overreact and the probability of a trend reversal becomes more and more likely.

This looks like one of those times.

I searched for other headlines:

Dow 30,000 Barron's

I found a few.

barron's dow 30,000 melt up won't stop

And as a friend on Twitter pointed out, it’s way ahead of schedule. In 2017 Barron’s said :

“Next Stop Dow 30,000” and followed with “the Dow could surpass 30,000 by the year 2025.”

dow 30,000 2017 barron's call

So far, Barron’s was right on that prediction. Below is the Dow price trend since the cover in 2017. But, consider the Dow is near 30,000 five years earlier than expected. 

dow performance barron's 2017 30,000 call to 2020

Notwithstanding the Dow is only about 2% from 30,000, the articles are calling for more uptrend. Sure, it’s possible this calm uptrend will continue to drift up without a volatility expansion, but it’s become much less likely as I see it.

I love me some good quiet uptrends, but all good things eventually come to an end.

In the case of equity market trends, these calm uptrends usually end when the majority least expect it.

That seems to be the case now.

Right now, the Dow Jones Industrial Average is signaling the higher likelihood of a volatility expansion. I say this because the Dow price trend has drifted above its average true range volatility channel and the Bollinger Band® lines plotted two standard deviations away from a 20-day simple moving average. These volatility measures visually illustrate volatility expansions and contractions and signal when a price trend moves outside it’s “normal” range. I call it “the normal noise of the market.” Periods of low volatility are often followed by volatility expansions.

dow 30,000 trend

My observations this week seem especially important because risk levels have become more elevated, yet individual investor sentiment is extremely optimistic.

As I’ve had very high exposure to stocks, I have now taken profits in our managed portfolios.

It’s a good time to evaluate portfolio risk levels for exposure to the possibility of loss and determine if you are comfortable with it. 

For more information on my observations that risk is becoming elevated, read:

You probably want to invest in stocks

Investor sentiment is dialed up with stock trends

Is gold a good buy right now?

What’s the stock market going to do next?

Questions, comments, need help? email me here.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

The week in review

The observations I shared this week, in case you missed them. 

My observations this week seem especially important because risk levels have become more elevated, yet individual investor sentiment is extremely optimistic. It’s a good time to evaluate portfolio risk levels for exposure to the possibility of loss.

You probably want to invest in stocks

Investor sentiment is dialed up with stock trends

Is gold a good buy right now?

What’s the stock market going to do next?

What’s the stock market going to do next?

Last week, I ended “You probably want to invest in stocks” with: Is it a good time to buy stocks? That’s my next observation as I’ll share the big picture.

As promised, here is my observation and insight on the big picture as well as the short term possibilities.

THE BIG PICTURE 

First, I start with the big picture.

The S&P 500 is trading at 31.8 x earnings per share according to the Shiller PE Ratio which is the second-highest valuation level it has been in 150 years. Only in 1999 did the stock index trade at a higher multiple times earnings.

Shiller PE ratio for the S&P 500

This price-earnings ratio is based on average inflation-adjusted earnings from the previous 10 years, known as the Cyclically Adjusted PE Ratio (CAPE Ratio), Shiller PE Ratio, or PE 10.

What is the P/E 10 and how is it calculated?

  1. Look at the yearly earning of the S&P 500 for each of the past ten years.
  2. Adjust these earnings for inflation, using the CPI (ie: quote each earnings figure in 2020 dollars)
  3. Average these values (ie: add them up and divide by ten), giving us e10.
  4. Then take the current Price of the S&P 500 and divide by e10.

The bottom line is, the stock market valuation has been expensive for a while now. The only time I factor in the price-earnings ratio is in the big picture. Although it isn’t a good timing indicator, it is considered a measure of the margin of safety for many investors and at this elevated level, there is no margin of safety by this measure.

As such, risk seems high in the big picture, which suggests investors should access their exposure to the possibility of loss in stocks and stock funds to be prepared for a trend reversal.

WHY MANAGE THE POSSIBILITY OF LOSS? WHY NOW?

That’s about as far as I go with “fundamental valuation” as quantitatively, I know to focus more on the direction of trends, momentum, and volatility.

So, let’s take a look.

STOCK MARKET MOMENTUM SEEMS STRETCHED.

I love me some up trends and momentum, but… sometimes all the gains come in a short period… and that’s what we’ve seen the past three months.

SPX SPY TREND AVERAGE LEVEL PAST YEAR

Just for fun, I included the average level of the S&P 500 (SPX) in the chart to show what level would be “mean reversion” if it happened. I don’t expect it to drop the low, but it’s interesting to see, nevertheless.

Next, I include the relative strength of SPX which measures the velocity of the price trend recently.

S&P relative strength momentum asymmetic returns

I highlighted the upper area red because when relative strength is really high, it often results in a price decline. Think of it as a “too far, too fast” indicator, but like all signals, it’s imperfect.

I highlighted the lower level as green because when prices fall so far, so fast that its relative strength is this low, the trend eventually reverses back up. It’s a measure of selling exhaustion.

Looking at the same data, but from a different angle, here you can see the correlation between the higher and lower relative strength levels and what happened next with the price trend.

SPX SPY RSI RELATIVE STRENGTH

In observing relative strength daily for over two decades now, in my observations, this level of relative strength suggests this is in the high-risk zone.

But, quantitative analysis of price trends is best observed through different confirming indicators.

THE WEIGHT OF THE EVIDENCE 

For the sake of brevity, I’ll skip too much of a detailed definition, but the percent of S&P 500 stocks trading above their 200 day moving average is a measure of market breadth. Market breadth shows us what percent of stocks are participating in the trend. Right now, 87% of the S&P 500 stocks are trading in longer-term uptrends as defined by the 200-day moving average.

percent of stocks above 200 day moving average SPX SPY

The high participation in the trend is a good thing until it reaches higher levels and extremes, then I start wondering where the next buying enthusiasm is going to come from. I start looking for the buying pressure to dry up. The red line I drew marks the three peak levels over the past year for reference.

In case you are wondering, here is how high the current level is relative to the past fifteen years.

investment trading offense and defense risk management

It’s up there.

I analyze markets as to the direction of the trends, momentum, volaltity and investor sentiment.

VOLATILITY LEVEL AND DIRECTION 

When it comes to volatility, I look at both the direction and rate of change in volatility, but also the level. I also split volatility into two completely different parts: implied (expected) volatility and realized (historical) volatility.

Starting with implied volatility, the VIX is extremely low again at 12.19. As we see in this long term chart, volatility cycles up and down over time, but it doesn’t really “revert to the mean.” To illustrate it, I included the long term average of 19.

VIX $VIX LONG TERM AVERAGE OF THE VIX

The bottom line is, implied volatility, which is the expected volatility as implied by options prices shows a very low expected range of prices over the next 30 days. That’s positive until it isn’t.

At such low levels in implied volatility, we should expect to see another volatility expansion.

Next is the historical volatility on the S&P 500 index, which is the 30 Day Rolling Volatility. Here we calculate 30 Day Rolling Volatility as Standard Deviation of the last 30 percentage changes in Total Return Price * Square-root of 252 then multiplying the standard deviation by the square root of 252 to return an annualized measure. 252 is the number of trading days in a year.

I’m sure you needed to hear that. I won’t do it again.

S&P 500 spx spy historical realized volatility expansion

I drew a red line over its history to highlight the current level. Historically, it’s on the low end. Volatility is commonly used as a measure of a security’s riskiness. Typically investors view a high volatility as high risk.

However, the opposite is true.

Volatility decreases over time as price trends up and by the time the price peaks, investors so confident the trend will continue they become very complacent. When volatility is extremely low as it is now, it’s when the risk of a price decline increases.

The opposite is also true. When volatile expands to a high level, it does so because prices have fallen and investors are indecisive, causing the range of stock prices to spread out. Prices spreading out is volatility and we see it spike at stock market lows.

What’s going to happen next?

The trend is up, it’s a quiet uptrend as volatility is contracting, and most stocks are trending up.

Everything is good until it isn’t.

KNOW YOUR RISK LEVEL AND RISK TOLERANCE. 

Everything is impermanent, nothing lasts forever, so this too shall pass and by my measures, it’s getting closer.

So, I implemented my drawdown control and took profits on stocks today.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

Investor sentiment is dialed up with stock trends

I believe there are many factors that drive stock prices and one of them is investor sentiment. However, enthusiasm and panic can also reach extremes, which drives the opposite trend.

When investors are extremely bullish they help drives up as long as they keep buying stocks. But, at some point, their buying enthusiasm or capacity to buy gets exhausted and the buying pressure dries up. We saw this in rare form in 2017 as investor sentiment was excessively bullish as prices kept trending up. In the chart below I show the breakout after a very volatile period (yellow) and a smooth uptrend in 2017 (green line), but then it was interpreted sharply early 2018 and then corrected even more by the end of ’18.

trend following breaktout uptrend 2017 crash 2018 asymmetic returns risk reward

In fact, as an example of the challenge of this period, if we had applied a trend following system that entered the breakout above the 2015-16 trading range and but didn’t exit at some point in the uptrend, this stock index declined all the way back to the breakout entry point. SPX trading trend following breaktout uptrend 2017 crash 2018 asymmetic returns risk reward

We can say the same for buy and hold; if someone held stocks over this period the end of 2018 they were looking back three years without much capital gain. So, the point in time investors decide to do their lookback makes all the difference.

Back to investor sentiment…

Another observation about investor sentiment is after prices trend up, investors get more and more optimistic about prices trending up, so the trend and momentum itself attract stock buying enthusiasm. At major bull market peaks, like in 1999, it brings out the masses. I remember grandmothers cashing out bank CD’s wanting to buy stocks then.

The same applies on the downside. After prices fall, investors become more and more afraid of deeper losses in their portfolio, which results in more selling pressure.

Everyone has an uncle point, it can either be predefined like mine is, or you can find out the hard day after your losses get large enough you tap out at lower prices. 

Since I shared my observations of investor sentiment in You probably want to invest in stocks last week, the CNN Fear & Greed Index, made up of 7 investor sentiment indicators, remains dialed up to “Extreme Greed”, so investors and the market seem to be optimistic about up-trending stock prices.

Fear and Greed Index

In fact, based on the historical trend cycle of the CNN Fear & Greed Index the market seems to be as optimistic about up-trending stock prices as it’s been in years. Only late 2017 did we see as much enthusiasm.

Fear and Greed over time

Who remembers how that turned out?

2018 Drawdown in stocks loss

On sentiment indicator, I noted last week that wasn’t as bullish as others were the AAII Individual Investor Sentiment Survey. That changed this week.

US Investor Sentiment, % Bull-Bear Spread is at 14.33%, compared to 3.17% last week and 9.09% last year. This is higher than the long term average of 7.72%. investor sentiment chart bull bear spread

So, individual investors are bullish, according to AAII.

What’s driving all this enthusiasm for the stock market?

The trend is up, and here is a chart of the S&P 500 market capitalization showing the value of the stocks in the index based on the current price.

S&P 500 market capitalization cap history

Most investors follow trends whether they realize it or not. Trend following can be a good thing as long as the trend continues. It’s when the trends change we find out who’s who.

You can probably see why I believe it is essential to actively manage investment risk and apply robust drawdown controls to avoid the bad ending. For me, it’s a combination of predetermined exits to cut losses short and asymmetric hedging.

 



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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

You probably want to invest in stocks

You probably want to invest in stocks right now, I bet.

If you are already invested in stocks, you probably want to be more aggressive in investing in stocks. Maybe it’s selling bonds to buy more stocks, or investing that extra cash, or something really aggressive like adding leverage or buying more risky stocks.

I believe this because investor sentiment is dialed up and 2020 started out about as enthusiastic as it gets. Well, and we’re getting calls from people wanting to invest.

fear greed index

The Fear & Greed Index is driven by seven different investor sentiment indicators. If you’re an investor, I encourage you to use it as a gauge for your own enthusiasm and panic.  When you feel one way or another about the future direction of the stock market, check the indicator to see what emotion is driving the stock market now.

Avoiding costly mistakes is essential in money management, so if we can help you avoid buying too high and then tapping out at the lows, that’s an edge. That’s the behavioral counseling we do; investor behavior modification. It’s one of the main observations I share here. If nothing else, I hope I can help you avoid making costly emotional decisions as many investors do.

The Options Speculation Index measures speculative call buying as a % of total option activity. Right now, it shows the options market bought to open 21.6 million speculative call options, the most ever, according to SentimentTrader. The previous record was 19.7 million during the week of Jan 26, 2018. The total bullish/bearish volume was the most since March 2000. This is extreme.

options speculation index

Investors sentiment trend to follow price trends, so investors or trend followers.

After prices trend up, investors get more bullish, expecting the gains to continue.

After prices trend down, investors get more bearish, expecting the losses to continue.

So, it isn’t a surprise to see this level of enthusiasm, considering the stock index is at an all-time high.

stocks stock market at all time high

The AAII Investor Sentiment Survey is a another gauge that offers insight into the mood of individual investors. Each week, AAII asks its members a simple question: Do they feel the direction of the stock market over the next six months will be up (bullish), no change (neutral) or down (bearish)? They refer to this question as the AAII Sentiment Survey. Since they started polling members in 1987, our survey has provided insight into the moods of individual investors.

aaii investor sentiment

Pessimism among individual investors about the short-term direction of the stock market is at a six-week high. The latest AAII Sentiment Survey also shows lower levels of bullish and neutral sentiment. Below is a chart I drew of the % Bearish sentiment from the survey with a line marketing its long-time average. Investors are not bearish, as the level is at its long term average. So, this gauge doesn’t match the Extreme Greed of the Fear & Greed Index. 

US Investor Sentiment, % BEARISH

The % Bullish is actually below average by this measure. Bullish sentiment, expectations that stock prices will rise over the next six months, fell 4.1 percentage points to 33.1%. The historical average is 38.0%. Optimism has been below this average during 41 out of the last 52 weeks.

US Investor Sentiment % Bullish

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, fell 3.9 percentage points to 37.0%. Even with the drop, neutral sentiment is the expectation that is above its average of 31.5% for the 33rd time in 34 weeks.

 

investor sentiment for trading

AAII guesses:

The killing of Iranian general Qasem Soleimani likely influenced this week’s results. Several respondents brought up the conflict with Iran and tensions in the Middle East. Also affecting sentiment are the trade agreement between the U.S. and China, Washington politics, earnings growth, the economy, valuations and the stock market’s recent record highs.

This week’s special question asked AAII members: what you think will most influence the direction of stock prices in 2020?

Approximately 39% of respondents believe that geopolitical events will have the most influence on stock prices in 2020.

Individual investors have a lot of opinions based on news:

Unsurprisingly, the ongoing conflicts with Iran and China are named specifically. Domestic politics are also named by many respondents, with 26% stating that the outcome of the November elections will most likely influence the market. Additionally, 18% of respondents from this survey believe that earnings performance will sway the stock market and 17% say that the Federal Reserve’s policy and a low-interest-rate environment will have the biggest influence on how the stock market will move in 2020.”

Here is a sampling of the responses:

“The economy and earnings. And maybe an end to some of the trade wars.”

“The Fed will need to continue to lower rates and will probably need to continue its easing to maintain liquidity in overnight lending.”

“Strong business cycle in the U.S. and better trade agreements with China.”

“Earnings versus forecasts.”

“Conflict in the Persian Gulf and the 2020 election will increase uncertainty.”

In my opinion, these individual investors focus on the wrong things. The direction, momentum, and volatility of the price trend are all the matters. The direction of the price trend is the final arbiter. 

Is the AAII Sentiment Survey a Contrarian Indicator?

To learn more about the survey and the opinion of Charles Rotblut, who is vice president at AAII and editor of the AAII Journal on the matter, read the article by the same name: Is the AAII Sentiment Survey a Contrarian Indicator? 

Here are his conclusions in sentiment insights and as its role as a potential contrarian indicator for market direction.

“As the data shows, extraordinarily low levels of optimism have consistently preceded larger-than-average six- and 12-month gains in the S&P 500.”

It goes on to add:

“Sentiment is not a flawless contrarian indicator, however. Though unusual, bullish and bearish sentiment readings above or below one standard deviation from their historical average have a mixed record of signaling market direction. Extraordinarily high bullish sentiment and extraordinarily low bearish sentiment (two standard deviations away from the average) have generally worked well, with the exception of two notable periods.”

“It will be many years before we know whether the periods of 2003–2004 and November 2007–February 2009 were mere blemishes on the survey’s record as a contrarian indicator or a sign that both optimism and pessimism can remain at high levels for an extended period of time. I tend to think the latter will be the case, given long-term market history.”

Two important conclusions:

The failure of sentiment to work perfectly highlights two important points. Though correlations between sentiment levels and market direction have appeared in the past, the AAII Sentiment Survey does not predict future market direction. Overly optimistic and pessimistic investor attitudes are characteristics of market tops and bottoms, but they do not cause stock prices to change direction. Rather, it is changes in expectations of future earnings and economic and valuation trends that move stock prices. The timing of such changes has proven to be difficult to predict with accuracy.

This leads to my second concluding point: Never rely on a single indicator when forecasting market direction. Rather, consider a variety of factors—including prevailing valuations, economic data, Federal Reserve policy, government policies and other prevailing macro trends—and allow for a large margin of error in your forecast.:

As the saying attributed to John Maynard Keynes goes, “the market can stay irrational longer than you can stay solvent.”

As many studies like Dalbar show; individual investors have difficulty achieving good results over the long term, so they must be focused and doing the wrong things.

“Since 1994, DALBAR’s Quantitative Analysis of Investor Behavior (QAIB) has measured the effects of investor decisions to buy, sell and switch into and out of mutual funds over short and long-term timeframes. These effects are measured from the perspective of the investor and do not represent the performance of the investments themselves. The results consistently show that the average investor earns less – in many cases, much less – than mutual fund performance reports would suggest.”

None of the global macro news items they listed can possibly be predicted, so it is futile. So, if investors using this type of information for investment decision making, you can probably see how they may end up “switching in and out of mutual funds” at the wrong time.

By focusing on the price trend and its statistical possibilities and actively managing risk and drawdown, I believe we stack the odds in our favor by focusing our resources on the few things we can control.

Is it a good time to buy stocks? That’s my next observation as I’ll share the big picture.

Got questions? need help? Send me an email 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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

Is gold a good buy right now?

Individual investors seem to get sucked in after prices trend up.

I’ve had two friends ask this week if it’s a good time to buy gold.

Of course, they as after gold at a new high over the past year.

^SPX_IGPUSD_chart

 Although looking at the gold price since 1980, it hasn’t reached the high it did about seven years ago.

is gold a good buy right now

The fact the price is still below the peak price it reached late 2011 is an observation of the downside risk of investing in gold. Since the 2011 gold rush, the gold price gradually trended down over -40%.

gold asymmetric risk reward asymmetry ratio

Part my ASYMMETRY® investment strategy is to consider what I call the ASYMMETRY® Ratio, which is the total return over a period vs. the downside risk it took to achieve the return. My objective is asymmetric risk-reward, so we want asymmetric risk-reward profiles whereby the total return is multiples greater than the drawdown we have to experience to achieve it. The Asymmetry® Ratio is a ratio between profit and loss, upside vs. downside, or drawdown vs. total return. The bottom line is, it doesn’t matter how much the potential return is if the possibility of loss is so high you tap out before its achieved. So, we necessarily have to understand the asymmetric risk reward.

Is gold a good buy right now?

It depends on many factors, such as the personal objectives and portfolio management system.

If it’s someone just thinking of buying it arbitrarily as one said “because the stock market looks risky”, gold doesn’t necessarily look any less risky when I compare the trends.

gold vs stocks safe haven

If buying gold is part of a trend following trading system with risk management, then maybe the system enters it and uses the prior price low as an exit. In that case, the “risk” is defined by the difference between the current price and the prior low, which is 7% lower, rather than risking it all.

is gold a buy

The exit, not the entry, always determines the outcome.

What I mean is, it doesn’t so much matter when we buy something because we never know for sure in advance if it will go up or trend down. So, it’s what we do after we buy something that determines the outcome. And, if you just buy and hold without a predefined exit, then you’re risking it all.

You can probably see why I predetermine my loss in advance, should a price trend down. I want to cut it short, rather than risk it all. So, my risk is determined by my exit point, not what I’ve invested in.

Beyond that, gold has strong momentum as evidenced in the chart, but looks overbought in the short term, so it may pull back some. If I wanted to buy it (I don’t at this time nor do we own it) I would decide my exit based on the risk I’m willing to accept and let it rip.

We never know the outcome in advance, so I don’t focus on trying to be right all the time. I instead focus on how much money I’m willing to put on the table to 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.Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

 

 

Volatility is expanding, a little

To no surprise, the CBOE S&P 500 Volatility Index that represents the market’s expectation of 30-day forward-looking volatility, is trending up. 

VIX VOLATILITY EXPANSION ASYMMETRIC RETURNS

So far, it isn’t much of a volatility expansion, but it’s elevated somewhat higher than it was. At around 15, the VIX is also well below its long term average of 18.23, although it hasn’t historically been drawn to the 18-20 level, anyway. The average is skewed by the spikes in volatility; volatility expansion. 

VIX is at a current level of 14.82, an increase of 0.80 or 5.71%% from the previous market day.

Here are the 50 and 200-day moving average values for VIX.

VIX MOVING AVERAGE

As I shared over the weekend, and it was quoted in today’s MarketWatch article “U.S.-Iran tensions will spark increased volatility — here’s how to play stocks, fund manager says“:

“So, on a short-term basis, the stock indexes have had a nice uptrend since October, with low volatility, so we shouldn’t be surprised to see it reverse to a short-term downtrend and a volatility expansion.

“For those who were looking for a ‘catalyst’ to drive a volatility expansion, now they have it.”

I was referring to the U.S. conflict with Iran, of course. 

The VIX index value is derived from the price inputs of the S&P 500 index options, it provides an indication of market risk and investors’ sentiments. VIX measures the implied ‘expected’ volatility of the US stock market. So, many market strategists use the VIX as a gauge for how fearful, uncertain, or how complacent the markets are. The VIX index tends to rise when the market drops and vice versa. During the 2008-2009 bear market, the VIX trended up as high as 80.86. Although the VIX cannot be invested in directly, securities like ETFs and derivatives based on it may provide the potential for an asymmetric hedge. For example, over the past year when the S&P 500 stock index was down -1% or more on the day, some of the ETFs based on long volatility spiked 10% or more. Volatility is difficult to time right, but when we do the payoff can be asymmetric. An asymmetric payoff is achieved when the risk-reward is asymmetric: maybe we risk 1% to achieve a payoff of 5%. Since long volatility has the potential for big spikes when volatility expands, it’s asymmetric payoff doesn’t require the tactical trader and risk manager to be as ‘right’ and accurate. So, the probability of winning can be lower, but the net pay off over time is an asymmetric risk-reward.

You can probably see why I pay attention to volatility and volatility expansions.

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

 

 

How will the conflict with Iran impact global equity markets?

On December 30th someone tweeted the headline:

IRAN WARNS U.S. ITS MIDDLE EAST DOMINANCE IS OVER AFTER NAVAL DRILLS WITH RUSSIA, CHINA

I replied and shared the link to the Newsweek article about the threat from Iran:

According to the NPR timeline of Iran events, it started a few days sooner.

Friday, Dec. 27: Attack near Kirkuk

Militia group Kataib Hezbollah attacks the K1 military base near the Iraqi city of Kirkuk with rockets, killing an American contractor and wounding several American and Iraqi personnel. Kataib Hezbollah has ties to Iran. It has denied orchestrating the attack.

In response:

Sunday, Dec. 29: Trump orders some airstrikes

Tuesday, Dec. 31: Embassy compound stormed

On Tuesday morning, Iraqi supporters of Kataib Hezbollah begin storming the U.S. embassy in Baghdad. The violence escalates, with militia members attempting to enter the embassy, starting fires and damaging the outside and a reception area of the embassy.

The conflict in Iran escalates:

Thursday, Jan. 2: Esper’s warning; Soleimani killed

Esper gives a statement emphasizing that the U.S. “will not accept continued attacks against our personnel & forces in the region.” He also sends a message to U.S. allies to “stand together” against Iran.

U.S. Marines are deployed:

Thousands of Marines Head to Middle East on Navy Ship as Iran Pledges Retaliation

A Navy amphibious assault ship with thousands of Marines on board will skip a planned training exercise in Africa to instead head toward the Middle East as tensions there spike.

Now, infantry from the U.S. Army:

750 soldiers with 82nd Airborne headed for CENTCOM, additional 4,000 troops expected to deploy as Iran tensions mount“At the direction of the Commander in Chief, I have authorized the deployment of an infantry battalion from the Immediate Response Force (IRF) of the 82nd Airborne Division to the U.S. Central Command area of operations in response to recent events in Iraq,” Secretary of Defense Mark Esper said Tuesday evening in a written statement.

Just like that, we go from a relatively peaceful time to what may become another war in the middle east if Iran doesn’t stand down.For some of us, these things hit closer to home when we know those being deployed. But, you don’t sign up to be a U.S. Marine or Army Ranger expecting to get through your tour without deployment and the possibility of combat. As Americans, we are fortunate for our Sheepdogs yearning for a righteous battle: On Sheep, Wolves and Sheepdogs.

How will the conflict with Iran impact U.S. and global equity markets?

I don’t know.

Neither does anyone else.

But I do have an idea, and it’s pretty obvious it isn’t positive news, though we never know for sure how the world markets will react to any news.

Although I am regarded as a “global macro” investment manager, I don’t focus so much on the “macro” as in “macroeconomics” as I do the direction of price trends and their volatility.

Economic indicators, as well as fundamental evaluations, have the potential to be very wrong and stay wrong. If you believe ABC stock is cheap at $50, you really believe it cheap as it falls -50% to $25 and then what if it drops to $5? Not my cup of tea.

That dog don’t hunt.

I focus instead on directional price trends.

The concept is very simple:

  • If I’m long an asset that is trending up, it’s good.
  • If I’m out of assets that are trending down, it’s good.
  • Or, if I’m short assets that are trending down with the potential to earn a profit from the downtrend, it’s good.

It’s easier said than done, so it isn’t so simple to operate. For example, what time frame is a trend? Why one time frame over another? It all has to be quantified to determine what is most robust.

And you know what? that changes, too.

It’s not as simple as running a backtest to determine the best signals, parameters, and time frame to apply them to and then expecting the future will be just like the past. Past performance doesn’t always indicate future results. So, this requires work. It also requires me to keep it real.

I’ve been pointing out for a few weeks that a volatility expansion seems imminent. Since I first observed it, the S&P 500 index had a minor decline of 2-4% before continuing its uptrend. The U.S. equity market has been bullish. But, here we are again. The price trend has drifted above its average true range channel. A price trending above its average true range is positive, but when it stays above it, it can also result in mean reversion. That is, the price may drift back toward the middle of the volatility channel like it did early December.

spx spy ATR volatilty expansion asymmetric

So, on a short term basis, the stock indexes have had a nice uptrend since October with low volatility, so we shouldn’t be surprised to see it reverse to a short term downtrend and a volatility expansion.

For those who were looking for a “catalyst” to drive a volatility expansion, now they have it.

We don’t know what’s going to happen next in Iran, but what I do know is exactly how I’ll respond to changing price trends.

I predetermine my exits in advance to cut losses short.

I predefined my risk and know how much risk exposure I have at any time.

Since I do this for all of my positions, I know how much risk I have accepted in each individual position, but I also know how much portfolio risk I have for drawdown control.

As a simple example, if I had 15 positions across global markets and each of them has their own individual exit points where I would sell to reduce exposure, then I can use the summation of that risk at the portfolio level to predetermine a drawdown limit. Of course, any hedging positions such as a short S&P position, reduce the portfolio risk of the longs, too. And, not all of these global positions are necessarily driven by the same return drivers, so they may not all be correlated. So, they may not all trend up or down together. For example, when the S&P 500 stock index has had a down day of -1% or more the past fifteen years, the Long Term U.S. Treasury has gained an average of 0.80% on the same day. An even more asymmetric example is on the same day the stock index fell -1% or more, the long volatility index-based ETFs may have gained 5% to 15% on the same day.

It’s times like this when my process and systems become more obviously necessary.

For everyone else, there’s buy and hold with no limit to their downside loss.

That dog don’t hunt, for me. 

Let’s hope for peace in the middle east, but if they don’t want peace, Godspeed to our Troops as they enter and embrace the unknowable. 

Semper Fidelis.

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

Why invest globally?

Why invest in international markets? someone asked.

Go back to 2007 and it was more obvious. I remember just the opposite questioned posed then; why not invest it all in Emerging Markets? Of course, that was after this:

emerging markets eem $eem trend following asymmetric

Emerging markets were the dominant trend from 2003 to 2007. As the chart shows, it wasn’t even close: 358% for the MSCI Emerging Markets Index vs. 76% for the S&P 500 U.S. stock index.

emerging markets outperform

The MSCI Emerging Markets Index represents securities that are headquartered in emerging markets countries. An emerging market is considered a country that has not yet become developed because of economic characteristics. These countries tend to present a unique investment opportunity because of the nature of their growth potentials.

However, emerging countries aren’t without risk. MSCI Emerging Markets Index has had three notable drawdowns greater than 50% in 1998, 2001, and 2008.

emerging markets eem drawdowns

Back in 2007, when someone asked me “why not invest it all in Emerging Markets” I guessed it was likely the end. Even though the person was born in a foreign country and did business globally, the enthusiasm was a sign. Doing business around the world doesn’t make someone a global investment expert. As this investor did indeed invest their money in Emerging Markets as he confirmed when I saw him a few years later, the timing was terrible. In fact, based on the MSCI Emerging Markets Index chart since 2007 it sill is.

emerging markets since 2007

As we see the full history below, although international stock markets like Emerging Markets can have periods of drawdowns and otherwise non-trending times, there are still potentially profitable price trends that may be captured with a robust tactical method. I’ve avoided EM for a while now for obvious reasons.

msci emerging markets index history

Then, there are developed international markets. The MSCI EAFE Index tracks large-cap and mid-cap companies in developed countries around the world. The index primarily covers the Europe, Australasia, and the Far East regions. This index is used as an important international benchmark. The index has had large drawdowns in 2003 and 2009, which were largely due to recessionary periods. As you can see in the chart, the performance was similar to Emerging Markets. However, the gains on the upside weren’t as much.

msci eafe international markets

You can probably see why investors aren’t talking about these international stocks the last several years. We won’t hear about it until after they trend up a lot and make headlines and magazine covers. I’m a global tactical manager, but I’ve avoided EM and DM for many years now for obvious reasons, unlike global asset allocation which invests in it all the time.

I’m unconstrained and tactical, so I shift between markets based on trends and countertrends, rather than allocating to them for constant exposure to the risk-reward.

The chart above doesn’t exhibit asymmetric risk-reward by itself, but my special weapons and tactics aim to extract it from what is there.

More recently, I’ve mostly focused in high dividend yield global stocks. But, there will come a time when this market are the place to be and when they do, I have 30 other countries outside the United States in my universe.

Have a question or comment? shoot me an email below:

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

Asymmetry in yield spreads, inverted yield curve warning shot, and unemployment

The 10-2 Treasury Yield Spread is the difference between the 10-year treasury rate and the 2-year treasury rate.

A 10-2 treasury spread that approaches zero indicates a “flattening” yield curve. A flattening yield curve is when the shorter-term interest rate (2 years) is the same as longer-term interest rate (10 year).

Although many people mistakenly promote symmetry and balance as a good thing when it comes to investment management, this is another of many instances where asymmetry is preferred over symmetry.

If we balance our profit and loss, we make no progress.

So, I prefer profits over losses and profit greater than loss.

If we balance our risk and reward, we are left with no change.

So, I prefer asymmetry over symmetry: more reward, less risk, or asymmetric risk-reward.

Getting this wrong can be one of the biggest mistakes of your life. If you balance your portfolio, you’ll have periods of gains, but they may be followed by periods of losses and the losses are just enough to remove the gains. Asymmetric returns are achieved by capturing more of the good, less of the bad.

In the chart below, we can see the yield spread went negative in August. Since then, it has trended back up. The Yield Spread has become more asymmetric.

A negative 10-2 yield spread is historically considered a precursor to a recessionary period. So, symmetry is the first signal of an issue, then it turns negative. That’s why we saw these inverted yield curve headlines in August. Since yield curve inversions are scares, they get significant attention in the financial press.

inverted yield curve

Typically, long-term bonds have higher yields than short-term bonds. An inverted yield curve is seen as an indicator of an impending recession. A negative 10-2 spread predicted every recession from 1955 to 2018 but occurred 6-24 months before the recession happened, so the inverted yield curve is a leading indicator that signals far in advance. The gray area labels recessions. You can see the Yield Spread drops to a low level before the recession.

Although it isn’t currently inverted, we should take note it did invert briefly, and the spread is on the low range of its cycle historically We can see in the chart the inversion doesn’t necessarily stay flat or inverted for long. The signal, then, is the symmetry then the inversion.

The slope of the yield curve oscillates up and down with the state of the economy. The upward-sloping yield curve is observed when the economy is growing. When investors expect a recession, they also expect falling interest rates. The belief of the market that interest rates are going to fall drives the inversion. When the yield curve inverts, it’s because investors have low confidence in the economy over the near term. So, it’s an indicator of investor sentiment and behavior. Here is a visual of the historical rates between the 2 and 10 year. The 10 year should be materially higher as a reward for tying money up longer as is the case most of the time.

The 10-2 spread reached a high of 2.91% in 2011, and went as low as -2.41% in 1980. The good news is the 10-2 spread flattened to zero last September but has since spread back out.

Only time will tell if the inversion in 2019 will precede a recession. All we know now is it’s a warning shot across the bow to pay attention to other leading economic indicators that precede the next stage of the business cycle.

But, the rate of change in interest rates is probably the most important leading indicator. Falling interest rates result in a lower cost of capital and liquidity for both consumers and businesses. When money is cheaper, we’re more likely to spend. We should be more inclined to buy a new $100,000 car at 2% than 4%. When interest rates rise, as they are now, we know the economy will eventually slow down as it costs more to borrow money to fund business projects or personal spending. As interest rates rise, people spend less. Since the cost of the loan literally rises, this happens whether they know what they are doing or not, since rising rates also means people and businesses can afford less debt. When rates rise, payments rise, so the amount they can borrow, which is based on income, reduces spending.

The yield curve inversion doesn’t automatically mean a recession is in the near future.

Employment is essential, too. The U.S. Unemployment Rate is about as low as it’s ever been.

As with all cycles, it isn’t the extremely low level of the cycle we should focus on, but what’s more likely to happen next. It should be no surprise that low unemployment precedes recessions.

For me, the directional trend of the stock market will be my primary guide for the economy but I monitor many trends for situational awareness of what is going on.

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

 

What I’m reading into the new year

“Those who forget the past are doomed to repeat it”

One of the advantages of writing observations in real-time is the ability to go back and read them with perfect hindsight.

We know that global asset allocations of varying mixes of stocks and bonds have had a strong year in 2019.

global tactical asset allocation performance 2019 asymmetric return

Most of the gains were achieved in the first four months. Here are the return streams through May 1, 2019, for different targeted allocations.

Since May 1st, global asset allocation portfolios experienced much more volatility and less capital gain.

How did such a great year for stocks and bonds begin?

At the end of a year like this, I like to reflect on this time a year ago, especially since the market state is so radically different between now and then.

If we want to learn from the past and our experiences, it’s essential to revisit things from time to time.

A year ago, we celebrated Christmas with a stunning waterfall decline in stocks.

Today, we’ve enjoyed an equally stunning guiser in gains.

So, what has changed?

To gain an understanding, here is what I’m reading into the new year.

December 17, 2019:

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

December 20, 2019:

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

December 23, 2019:

An exhaustive analysis of the U.S. stock market

December 24, 2019:

An exhaustive stock market analysis… continued

January 1, 2019:

Investor Sentiment into the New Year 2019

If you read all of them, you’ll be surprised how much you learn about market trends,  behavior, volatility, and internals.

MERRY CHRISTMAS!

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

 

 

 

 

 

Global Asset Allocation had a strong year in 2019, but…

People don’t usually invest all their money in equities, even though the stock market is mostly what we talk about. Large institutional investors like pensions and endowments don’t invest all their capital in the stock market, either. Instead, they invest in allocation to stocks and bonds globally diversified across world markets.

One of my favorite examples of the stock and bond part of this global asset allocation is the S&P Dow Jones Indices’ Target Risk index series.

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.

global asset allocation ETF ETFs ishares S&P target risk

For example, after a positive year for stocks and bonds, most investors will pay more attention to the one that gained the most. After stocks outperform bonds, the best gains are naturally going to be the global allocation that held the most stock exposure.

The S&P Target Risk Aggressive® Index is one of four multi-asset class indices that compose the S&P Target Risk Series. The S&P Target Risk Aggressive Index emphasizes exposure to equities, maximizing opportunities for long-term capital accumulation. It may include small allocations to fixed income to enhance portfolio efficiency. In a positive year like 2019, it was the clear winner on the upside. The aggressive allocation gained 19% so far in 2019. On the other end of the spectrum, even the conservative allocation gained 10%.

But, risk isn’t a knob.

Asset allocators don’t get to dial it up or down, and it always work out the way they want.

The reward isn’t a knob, either.

Just because a portfolio is dialed up with risk to “aggressive” doesn’t mean you get the reward from it.

That’s especially true in the short term. Had you believed risk and reward is a knob you turn to get what you want in January a year ago, you could have experienced the aggressive allocation resulted in the more aggressive loss.

The conservative model lost the least, but that isn’t a sure thing, either. In global asset allocation, conservative means more allocation to bonds for fixed income. If bonds fall and stocks rise, the conservative model could lose money and the more stock weighted aggressive could gain.

Diversification is often presented by advisors as a risk management strategy that mixes a wide variety of investments within a portfolio. But, diversification does not assure a profit or protect against loss. The outcome of asset allocation is driven by the exposure to stocks vs. bonds and their gain and loss.

That’s not what I do.

A global asset allocation of exposures that otherwise remain static is very different from dynamic exposures that change based on asymmetric risk-reward driving tactical decisions.

My outcome is decided by my tactical increase and decreases in exposure to risk-reward as I focus on asymmetric risk-reward. I believe there is a time for offense and a  time for  defense.

But, for everyone else, there’s global asset allocation. It’s what most people do. They allocate capital, I rotate capital. I rotate, rather than allocate.

If I were going to invest in static, long-only, fully invested all the time global asset allocation, it would look like these S&P Target Risk indexes. When it comes to a simple allocation of capital, who’s going to do it better than S&P? Many advisors are charging their clients 0.50% to 1% for a simple asset allocation like this. I personally believe the risk of a disaster is so high it makes the unmanaged risk imprudent, so we don’t offer fixed, long-only, fully invested all the time global asset allocation at Shell Capital. If we did, we’d probably manage billions because investors want “market returns” until they are big losses. We could also spend our time selling instead of analyzing. But we would constantly be apologizing for market behavior instead of embracing up and downtrends. In my opinion, it’s a difficult business model, but it’s still the easiest for financial advisors. They allocate to the funds, rebalance routinely, maybe do some tax-loss harvesting, and write a commentary about what the market did that lead to their results. Admittedly, it’s a lot easier than tactical portfolio management. When the market doesn’t do what they wanted, it’s the market’s fault. In 2008, they said let’s  “hunker down.”

From my perspective, the investment advisory firms with the largest assets under management tend to be asset allocation firms. They advise clients to invest in global asset allocation models similar to these. Since they aren’t doing constant research and making tactical trading decisions, their time is freed up for the golf course, where they meet more and more clients.

Why do I think it’s a challenging advisory business model?

Global asset allocation doesn’t give me what I want, nor does it give our clients what they want. We want active risk management. We want a point in which we’ll reduce our exposure to loss and maybe even reverse it so as prices fall we profit from it. Sure, like global asset allocation, tactical portfolio management does not assure a profit or guarantee protection against a loss, either. But, like any other action in life vs. inaction, it’s an attempt, which to me, is better than no attempt at all.

What I know is this: global markets can and do all fall together in times of crisis when investors who held their losses too long keep tapping out as prices fall.

global asset allocation diversification failed 2008

Even the most respected global allocation funds participated in the waterfall decline enough to tap out most investors I know if they had invested in them – we didn’t.

I know some advisors and media have been criticizing the “hedge fund” side of the investment industry for years now because total returns haven’t been as high as the past. I don’t think passive indexing advisors have all that much to speak about themselves. Even the most aggressive index allocation that assumes no fees is a 26% gain in the past three years. That’s not an average gain, it’s a gain in capital.

More importantly, those numbers haven’t changed over the past 5 years. So, the past 5 years haven’t been so outstanding for anyone, especially factoring in the volatility.

In fact, it’s caused by volaltity. Volatility eats away at compounding capital positively.

Speaking of volatility, it’s the downside volatility we don’t like. Here are the historical drawdowns of these indexes since they launched in 2011.

If you look close, to get the return of global asset allocation, you’d have to hold through declines of -10% to -20% routinely. In a big bear market will be worse, which hasn’t happened since these indexes weRE made available.

That’s why I believe even a passive global asset allocation is a risky business and not an investment model I’m willing to offer. If people we know want global asset allocation, we show them a way to get it without us. We only offer what we believe is of value.

I can’t imagine what it would be like in 2011 when these global allocations were falling and all we can say is “Hopefully it stops falling?”

But, what if it doesn’t?

What if it keeps falling?

I believe everyone has a tap-out point. We can either determine it in advance or find out the hard way. The tap-out point will be tested over and over with global asset allocation.

But, 2019 wasn’t one of those years, so everyone has something to celebrate this year.

When the wind is blowing, we can let out the sail and enjoy the ride.

When the wind stops blowing, we have to row, not sail, or risk sinking.

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

After a strong year like 2019, investors should prepare for what could be the opposite in 2020 and it doesn’t seem they are

After nearly a -20% waterfall decline last October through December, in “An exhaustive analysis of the U.S. stock market” a year ago today I wrote:

“Someday in the future, stock investors will be giddy again and completely forget about how they feel right now.”

Sure enough, that’s what happened. Individual investors as gauged by the AAII Investor Sentiment Survey capitulated a year ago and have since then oscillated their enthusiasm for stocks sharply as a result of the stock price action. In the chart below we see the stock index with the bullish investor sentiment below it. Investor sentiment clearly oscillates up and down as investors swing from fear and greed, but right now they are bullish.

I also note the bullish sentiment evaporated during every market dip this year. The stock market has memory because its investors do so after such a fall a year ago investors were quick to react (emotionally at least) to every sign of another drop.

It looks like we’re ringing in the new year with high optimism in the stock market.

The Fear & Greed Index, which includes seven different investor sentiment indicators, is dialed up to the “Extreme Greed” level again as people are probably hopeful recent gainst will continue.

CNN FEAR GREED INDEX TRADING ASYMMETRIC

The last time this fear and greed gauge was this high was the end of 2017.

CNN FEAR GREED INDEX HISTORY BACKTESTED

The stock market has gained even more in 2019 than it did in 2017, but this year follows a waterfall decline.

After a strong year like 2019, I suggest investors prepare for what could be the opposite in the period ahead.

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

Reminiscences of a December to remember

What a difference a year makes.

A year ago, global equity markets were in a waterfall decline that started in October 2018.

The S&P 500 stock index declined by nearly -20% and the MSCI ACWI Index fell -18%. The MSCI ACWI Index is MSCI’s flagship global equity index is designed to represent the performance of the full opportunity set of large- and mid-cap stocks across 23 developed and 26 emerging markets.

A financial advisor I know said:

“This is the worst Christmas of my life!”

I think he was serious.

After a euphoric period for stocks in 2017, it shouldn’t have been such a surprise if we are prepared for the trend to swing the other way, as it does.

I’m not sure of professionals in other industries experience the same level of trauma as a financial advisor. Most of my clients are Physicians and owners of companies, and as much as I know about their work, I can’t think of a similar scenario for facing a shock. It’s like a Physician or Dentist having all their patients really sick at the same time. So, I get it. In fact, it’s why we do what we do with active risk management and investor behavior modification.

The good news is, the markets didn’t get any sicker. Instead, Christmas Eve was the low, which, of course, we only know for sure in hindsight. But, as I shared on this date late year in “An exhaustive analysis of the U.S. stock market” the probably was in favor of reversal back up was high, so a year ago today was an asymmetric risk-reward setup and I traded it accordingly.

Investment management is probabilistic, never a sure thing. 

Asymmetric risk-reward is the probability of the payoff vs. a loss, but more importantly the size of the potential payoff relative to the possibility of loss. For example, if we believe there is a 70% chance of a downtrend in a stock index that’s an asymmetric probably, but only an asymmetric payoff if the magnitude of the fall is greater than the magnitude of a possible gain. If we believe there is a 70% chance of a -5% decline, but a 30% chance of a +20% gain, the asymmetry is -3.5% on the downside and +6% on the upside, for a positive 2.5% expectation. Even though the upside was less probable, the expected payoff made it the better bet.

A year ago today, I shared this observation:

The bottom line is the stock market could certainly be entering another big bear market. It’s long overdue as this bull is very aged and overvalued. Even if it is, it will include swings up and down along the way. That’s the challenge for all strategies that trade or invest in stocks. For buy and hold investors, it’s a challenge as stocks swing up and down and they have full exposure all the time and unlimited downside risk. For tactical traders, the swings are a challenge as we increase and decrease our exposure to risk and reward and none of our methods are perfect. The key, for me, in dealing with it is to hold the lowest risk, highest potential reward exposure. Barring we don’t see some waterfall decline, most of the market is at a point we should see a countertrend move up at least temporarily. If prices keep trending down, I’m guessing the upswing that does come will be just as sharp.

After prices have fallen, I start looking for signs of a potential countertrend and it could come at any time.

Someday in the future, stock investors will be giddy again and completely forget about how they feel right now. But for now, the trend is down, but the sentiment and breadth are at such extremes we should be alert to see at least a short-term reversal in the days ahead.

The next day, on December 24, 2018, in “An exhaustive stock market analysis… continued” I shared:

After prices have declined, I look for indications that selling pressure may be getting more exhausted and driving prices to a low enough point to attract buying demand. That’s what it takes to reverse the trend.

I’ve been here before. I’ve executed through these hostile conditions as a tactical operator. The more hostile it gets, the more focused in the zone I get. After the stock market has already declined, I start looking for this kind of panic selling and extreme levels for a countertrend. We’re seeing those levels now. Sure, it could get worse, but we have reached a point that lower prices are more and more likely to result in a reversal back up.

Sure enough, those dates marked the low. Not because of the date or seasonality, but because of the stock market had gotten so washed out the selling pressure was exhausted. As I pointed out in the observations; those who wanted to sell had sold and eventually that panic selling dries up.

By May these indexes had recovered from their nearly -20% declines, so if you tapped out near the low, you missed out on the recovery.

It doesn’t always work out this way. All -50% bear markets begin with a -10%, -20%, and -30% decline that continues to swing up and down on the way to the final low. A year ago was the worst stock market drop in a decade, but it could have gotten worse. If it had, it would have likely rebounded to retrace some of the loss, then resumed the downtrend again. An example is January 2000 to March 2001, which was a -20% decline and only the beginning of a much deeper, longer, bear market.

Those of use who operated in the bear market from 2000 to 2003 know how it unfolded. In the next chart, I added the NASDAQ Composite since by 2000, most investors were largely in NASDAQ listed tech and internet stocks. For them, it was a bloodbath.

This is why I believe it’s essential to actively – manage- risk. Active risk management goes way beyond diversification and asset allocation to having predefined exits for every holding to stop the loss should it trend down and/or hedging.

Buy and hold indexes? Only if you have the stomach for it. You’d have to be willing to lose more after you’ve lost a lot, be very patient holding those losses and be able to afford the loss in capital to buy and hold indexes.

Here’s why:

After the S&P 500 peaked in late 1999 it didn’t see the same level for eight years. In April 2007 it finally recovered the loss. We can’t say the same for the NASDAQ. It was still down -41%.

In fact, the truth about buy and hold is this experience.

Oh, did I forget the dividends? The total return index isn’t much better; it’s -45% vs. -53% without dividends.

So, I’m not making light of a waterfall decline and certainly a year ago could have been the beginning of a much longer and deeper waterfall. Surely we’ll see one again someday in the future, so you had better know how to tactically shift and actively manage risk if you want to try to avoid it.

One more chart before I digress and get back to this past year. The NASDAQ was in a massive bear market for 15 years. It didn’t reach its 2000 level again until the end of 2015.

You can ask any stock investor you know who invested in the late 1990s if they didn’t hold mostly technology stocks by 2000. Here’s an image of the top 15 Nasdaq companies when the index peaked in 2000.

Top 15 Nasdaq companies when the index peaked in 2000

Many of these stocks don’t exist anymore.

Here is what Pensions & Investments wrote about it in 2015:

With the Nasdaq composite eclipsing 5,000 for the first time since March 2000, P&I took a look at the makeup of the index the last time it was over 5,000. According to Nasdaq, on the day the index peaked (March 10, 2000), the combined valuation for composite companies was about $6.6 trillion. At the opening Monday, the combined valuation of firms was $7.6 trillion.

Among the largest 15 companies in the index back in 2000, only four remain in the top 15 today: Microsoft, Cisco, Intel and Qualcomm.

Over the entire 781-week period, only Qualcomm and Microsoft stocks had positive returns — up 1.54% and 1.34% annually, respectively. Cisco’s stock had a cumulative return of -52.5% (-4.8% annually) and Intel was down 24.63% (-1.9% annually).

The composition of the Nasdaq Composite index has changed dramatically. In 2000, technology companies dominated its makeup by number of companies (64.9%), compared to 43.22% today. In 2000, telecom firms were the second-largest (11.8%), but only account for 0.83% of the index today. Consumer services (20.9%) and health care (16.2%) are the second- and third-largest industries by number of firms in the index today.

The point is; markets are dynamic. No matter how incredible the innovation and the craze for it, or how bad the waterfall decline, these things do pass.

That’s where I believe we can have an edge.

We don’t have to participate all in, all the time.

And, even if we don’t fully participate in an uptrend, it may be worth it if we avoided the downtrend. The math is still in our favor as we don’t need to capture as much gain if we avoid some loss.

“Those who cannot learn from history are doomed to repeat it.” –George Santayana

When the stock market is trending up with low volatility this time of year as it is now, it’s a good time to reflect on the past when things are in the opposite state. Of course, that is after being prepared for a reversal of the trend. This time last year was an astonishing time by any measure because of the speed of the drop in stock prices.

Rather than rehash it, I suggest reading these as I am this week:

An exhaustive analysis of the U.S. stock market” and “An exhaustive stock market analysis… continued“.

I think you’ll be surprised at what you learn from such commentary written in real-time in the heat of the battle at a time like this when the markets are quietly trending into the new year.

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

 

Trump impeachment, Trump tweets, stock market trends, trend following, and volatility

When Donald Trump was elected the President of the United States the headlines read like this one from MarketWatch:

Dow futures plunge 750 points as Trump takes key battleground states

Stock markets are not handling Election Night well.

Futures for the Dow Jones Industrial Average plunged as Republican presidential nominee Donald Trump’s lead widened in the presidential race against Democratic rival Hillary Clinton.

And CNN:

Wall Street welcomes Trump with a bang – Business – CNN.com

Nov 9, 2016 – An overnight panic in global markets evaporated as Wall Street gave an … Trump’s election would bring about a plunge in the stock market. … “The selloff last night was an hysterical reaction,” 

Since then I’ve heard a lot of hedge fund type investment managers who operate investment strategies that include risk management, hedging, or trend following complain about the hostile conditions. Some of them blame it on algorithms, but it seems most of them blame it on Trump’s tweets. One trader recently said:

“Trump completely screwed me over these past two years by rocking the markets with constant vol spikes. Had we had a reasonable president, I probably would have made a lot more money.”

To that, I replied:

“Well, ya know, “everyone gets what they want from the market” and personal responsibly (respond-ability) is the foundation of good results. SPX has gained 58% with declining vol since the last election.”

stock market since trump election

Sure enough, after the “plunge” headlines that probably shocked a lot of individual investors out of the stock market who weren’t already out, the S&P 500 went on to deliver an even more surprising total return since then. I also pointed out volatility as measured by standard deviations has somewhat declined since then.

Who knew?

No one!

Who believed the stock index would gain so much over a period of geopolitical instability and vol spikes?

I don’t know anyone. Well, except those who buy and hold. Periods like this are favorable to those who buy and hold. That is if they can hold through the drawdowns, volatility, and news headlines, which ain’t easy. Don’t forget, that would be the same investors who held through a -56% loss in the S&P 500 that took many years to recover from. Most people can’t do it, because when they’re down -50% they don’t know if the losses are over or will get even worse.

It only takes once.

So, the essential element is knowing your risk tolerance.

Standard deviation, a measure of historical volatility has declined, but that trend doesn’t reflect what real people deal with; drawdowns in their account values. Below are drawdowns in the stock index since the 2016 election. The first year as abnormally quiet, and then we’ve observed two very sharp waterfall declines.

stock market volatility trump tweets

My trader friend goes on to say:

“Yeah 2017 was phenomenal. This year, however, was absolute misery if you weren’t a buy-and-holder. Basically, any sort of “market goes up, quickly shocks down, then continues right back up again” just makes any sort of momentum/trend-follower system look like an idiot.”

To that I replied:

“It didn’t seem too bad to me. The S&P Trend Allocator index tracks the performance of a systematic trend strategy allocating between the S&P 500 and cash, based on price trends. If the SPX is observed to be in a positive trend, its allocated to the SPX therwise, it is allocated to cash.”

S&P trend following index

As seen in the chart, the S&P 500 recovered from the -20% loss at the end of last year and made an even higher gain. The blue line is the S&P Trend Allocation index, a trend following model applied to the S&P 500 stock index that exits when the index falls. This index cannot be invested in directly, but it shows us the results of the model. You can see it was in cash in January because of the big decline in late 2018. It finally got back in synch with the S&P 500 around March, but it “missed out” on the sharp recover over those first three months. This is the cost of active risk management with a trend following system. If you want to avoid big losses, this is the price you pay.

In the chart, I also included the S&P Target Risk Moderate Index, which is a global asset allocation of 60% stocks and 40% bonds. It was smoother in 2019, but the bonds, too, offset gains. So, for those who say “I’ll put most of my money in stocks, but not all of it” that’s about what it would have looked like. However, indexes don’t include fees and expenses.

Next, I expand the time frame back to about three years to the inception of the S&P Trend Allocator index to see it’s risk-reward. Yes, it achieved less total return and its trend following strategy exits a little late, resulting in missing some of the price trend recoveries, but in a major decline it would potentially pay off. 

S&P trend allocation etf portfolio

Here is a comparison of the downside drawdowns where we can see the red line trend model missed half of the drawdown late 2018. For that peace of mind, it didn’t capture all of the 2019 recovery.

S&P trend allocator trend following risk management drawdown

The S&P Trend Allocator index is a very simple trend-following model. Though I have similar systems, this isn’t what I do. My systems include many more parts, different parameters, and apply trend following and countertrend in an unconstrained way to a global opportunity set of markets.  To me, the issue with the S&P Trend Allocator index is its symmetrical trading system; it enters and exits with the same method. Mine are an asymmetrical trading system: entering the trend one way, exiting another. I believe trends waterfall down faster than they drift up, so my strategy is more focused on those beliefs. 

We’ve had a great year in 2019 in regard to risk-adjusted returns because I’ve been more focused on countertrend moves along with some trend following. I believe everyone gets what they want from the market. Most investors can’t tolerate large losses of 100% stocks all the time, so they need active risk management. If we miss those big down moves, we don’t have the asymmetry of losses working against us as we compound capital over the long-term.

If you make investment decisions based on elections and politics, you’re probably going to be surprised over and over.

If your investment strategy doesn’t account for volatility, no matter what causes it, you may be doing the wrong thing at the wrong time.

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

 

 

Is Santa Claus coming to town?

A Santa Claus Rally refers to the tendency for the stock market to trend up in the last week of December into the New Year. Several theories exist for its existence, including holiday shopping, enthusiasm fueled by the holiday spirit, and professional investment managers adjusting portfolios before going on vacation.

From the look of today’s price action, Santa came early. For me, it’s all about math and the status of the trend. U.S. stocks continue their uptrend with a volatility expansion.

volatlity expansion

How much more momentum the uptrend will have may be near exhaustion.

Considering the price trend of the stock index is already trended above the top end of the range, it will take a strong thrust of buying enthusiasm to drive it more than 1-2% higher from here.

So, this may be about it for 2019 gains for this broad index.

Only time will tell…

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

The challenge of backtesting and systematic trading and how to get past it

I’m going to make this observation a challenge of my brevity because this is a topic I could write a book on if I sat still long enough. So, this is by no means going to be an exhaustive observation on the topic of trading system design, testing, and operation.

There are two kinds of traders; discretionary and systematic. I’m using the word “trading” because it means both buying and selling. To me, an investor is someone who buys and may never sell. For example, our clients are investors because they invest in our investment program and I do the buying and selling (trading.)

Discretionary trading relies on the skill, knowledge, experience, control, emotional intelligence, and discipline of the portfolio manager. If we make a decision as a human instead of operating a computer program that systematizes the decision, it’s discretionary.

Systematic trading is operating methodically according to a fixed plan (algorithm) that is designed to achieve a profit by entering and exiting markets trading on an exchange. Systematic is rules-based, so it’s a “system” for decision making. As such, the portfolio manager doesn’t look at a price trend chart to figure out what to do next but instead runs the computer program to get the buy or sell signal.

Automated, by the way, is an even more systematic program where the program sends the signal to the trade desk or broker for execution automatically without any intervention or supervision from the portfolio manager.  So, automated is a more advanced operation of systematic.

Discretionary can be rules-based and systematic, but for this purpose, I draw the binary distinction between the two. A chartist is an example of discretionary and a systematic trader runs a computer program to get the buy and sell signals to execute without interference.

By nature, mathematical, quantitative, systematic, and automatic methods to trading advance themselves to computerized testing. When done correctly, backtesting can add enormous value to an overall trading strategy. A property tested quantitative system can validate a strategy to determine its probability for generating asymmetric risk/reward or even a profit. So, the scientific method of testing makes the system verifiable; would it have worked in the past, or not? I could go on, but I’ll leave it there. The bottom line is, the advantage of applying a scientific systems testing process is to verify what it would have done had we been operating it in the past.

Of course, this is necessarily always done with perfect hindsight! So, we must necessarily be realistic with ourselves. For example, I can create a custom investment program for investment advisors and high net worth families to match their risk/reward objectives. Below is an example of a quantitative trading system applied to a fixed list of securities for an investor whose objective is absolute returns. The blue line is the hypothetical system as tested over the period 2000 – 2007. It may not seem impressive by the minimal profit over the period. but it’s better than the orange line and didn’t decline nearly as much as a stock index from 2000 – 2003. At the time, an absolute return investor would have appreciated its risk management benefit.

asymmetric trading system to 2007

Next is the return stream through the end of 2009. The system’s tactical risk management methods worked by reducing the drawdown in comparison to the orange line, an alternative I’m comparing to just for illustration. Absolute return strategy isn’t relative return, so they have no benchmark to play the horse race with.

asymmetric trading system through bear market

Once again, over this period of nine years, I’m guessing some may be thinking; my objective is to earn a profit and this isn’t’ much profit at all!

Well, sometimes we do need to consider that everything is relative. To see what I mean, the next chart of the returns streams I made the orange line a U.S. stock index. You can see the drawdowns are much more for the stock index.

relative return strategy

To be sure, here is the same period, but a drawdown chart. The stock index declined twice -50% or more. The blue line, which is the system, had drawdowns of around -15% or less.

asymmetric trading drawdown

So, with the stock index, most investors probably tap out near the lows after they are down -40% or -50% and are afraid to ‘get back in’ until well after prices have trended back up.

I don’t know how to handle such a tap out situation. There is no right answer to deal with it; when do you ever get back in?

Do you feel better prices fall another -20%?

Or do you wait for a +20% advance?

If you tap out after fearing more losses, when do you ever reenter? After you fear missing out?

Probably.

It isn’t a situation with a good answer, because we never know what’s going to happen next.

My answer is to avoid the drawdown in the first place.

I instead prefer to actively manage my risk and apply drawdown control systems designed to limit the drawdowns.

By the way, the scenarios I described are discretionary decisions. More than anything, discretionary trading must master themselves to develop skill and discipline. 

The inability to execute decisions in the heat of the battle is the basis for the failure of the discretionary trader. Imagine what it would be like in a losing streak when entry and exits result in losses over and over for months or years.

But, systematic isn’t immune. The inability to follow a strategy with discipline is the basis for the failure of the systematic trader.

Some quantitative systems traders mistakingly proclaim their systems and models “remove the emotion from the equation” which is a sign of inexperience or lack of the mindset of a skilled operator. I feel my feelings like everyone else, except I feel the right feeling at the right time. I programmed myself to embrace the emotions and make it an edge.

The blue line is the full return stream of our hypothetical trading system example.

asymmetric trading system risk reward

If you compare it to the orange system you probably feel disappointed and unimpressed with the return post-2013.

But the difference is you may have stayed with it with9ut tapping out at the low.

Mic drop … THUMP!

But right now you’re thinking; what have you done for me lately?

If so, you would have never achieved any of this performance as most investors don’t according to studies from agencies like Dalbar. Investors tend to do the wrong thing at the wrong time. If they are real with themselves, they see what they’ve done long term.

In this example, the same system that avoided the tap out level drawdowns is the same one that has obviously taken on less exposure to loss the past five years.

To achieve it’s long term results over these full market cycles, you’d have to stick to the system.

Otherwise, you’d find yourself sitting there in a panic trying to figure out what’s going to happen next, you’ll never know the answer, and you’ll try to figure out what to do.

So, systems trading isn’t necessarily any easier. Systems don’t always work as there are hostile conditions for every system or simply periods when they don’t do as well.

A hint; markets cycle through different types of regimes. What works well with today’s backtest is unlikely to work well into the future. If the future isn’t like the past, the results won’t be the same. What does work best in the next cycle is often what doesn’t’ test so well over the prior four or five years, so investment advisors who sell backtested performance are likely to constantly disappoint. Who would buy a mediocre backtest? The incentive is strong to produce the over-optimized backtests.

Here is an example that looked great during the 2008-2009 crash as it made money, but…

overfitted trading system symmetry

You can probably see why they don’t work out as expected.  An over-optimized backtest that’s overfitted to the past can be much worse than the charts above.

At the end of the day, we always create our own results. Even if you invest with an asset manager, you still create your own results. So, be honest with yourself about it.

You decide the outcome one way or another. Be sure you’re confident in what you’re doing. For me, it started with exhaustive quantitative testing and improved with two decades of doing.

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

Stock market volatility, participation in the trend, REITs, and MLPs

The U.S. stock market as measured by the S&P 500 index reached reaches a new high, so volatility remains subdued. After prices trend up, investors become increasingly more confident and confident is reflected by a tight range in price. I saw this because the possible is also true; when investors and traders are indecisive, we see a more sideways volatile trend as the buying and selling pressure tries to decide in which direction to position capital. We observe this contracting volatility in the chart below. I colored the volatility band around the price based on an average true range to highlight its trend and range. The line on the top is the past 14-day average true range of the SPX showing historical volatility remains very low.

spx spy trading trend following

For a different perspective to see who historical vola.tiy is negatively correlated with the price trend, I drew the charts together below. When the stock market trends up, realized historical volatility as measured by and an average of the past 14-day true range of moment typically trends down.  As the stock market loses value, volatility increases. Volatility trading for an asymmetric hedge can result in a larger asymmetric payoff than the price itself.

spx negative correlation with atr volatility vix

As the SPX price trend is up, most of the stocks it tracks are in longer-term uptrends as evidenced by the below chart of the percent of S&P 500 stocks above their 200 day moving average. Right now, 77% are trending up which is the upper end of the breadth recent cycle I marked with the line. Breadth indicates participation in a trend up or down. The more stocks are trending up, the more healthy an uptrend. However, these measures reach extends at their high and low extremes in the cycle.  While 77% of the S&P 500 stocks in uptrends are positive at some point the buying enthusiasm is exhausted and it’s usually signaled by high readings.

spx percent stocks above 200 day moving average

I’m not asserting this foretells a big down move, but instead, it’s situational awareness that the risk level is elevated.

Next, is the shorter-term trends. The percent of stocks above their 50 days moving averages has been sideways since mid-October. Currently, 73% of stocks are in short term uptrends. So, by this measure, they haven’t yet reached the recent cycle high in July.

spx percent of stocks above 50 day

I sorted the S&P stocks to see which were below their 50 day to look for a pattern. Sure enough, I see one; it’s mostly REITs (Real Estate Investment Trusts) which is no surprise since REITs have been weak recently. We don’t own any of the stocks. 

quantitative analysis of technical indicators.png

The Dow Jones REIT Index is designed to measure all publicly traded real estate investment trusts in the Dow Jones U.S. stock universe classified as Equity REITs according to the S&P Dow Jones Indices REIT Industry Classification Hierarchy. These companies are REITs that primarily own and operate income-producing real estate. Based on the observation above, it is no surprise to see this index of 175 real estate stocks is below its 50 day moving average, but is above the 200-day moving average and is oversold today. My relative strength systems that signal asymmetric rate of change suggest REITs are near a short term low.

REIT

This reminds me of another high dividend-yield sector. In Alerian MLP Index is diverging from crude and reaching new lows on November 20th I point out this same trend system suggested a countertrend rally was probable and sure enough, it gained 7% since then. Here is the updated chart of the Alerian MLP Index.

MLP ALERIAN OIL GAS ENERGY MLPS AMJ

REITs may not play out so well, but, what is, is.

The trend is your friend until the end when it bends. So far, this uptrend hasn’t since October has done little but drift up aside from the -3% dip last month and a volatility expansion that was little more than a blip.

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

Keeping the mind right with investor sentiment indicators

Investors oscillate between the fear of missing out and the fear of losing money.

After their portfolio trends up, they extrapolate recent gains into the future.

After their portfolio falls, they extrapolate recent loss into the future, expecting the damage to continue.

Investors mostly follow the trend, and this extrapolation bias helps to drive price trends.

Of course, not every investor follows the trend. Some are more fearful all the time, others are more optimistic, but I believe most oscillate between the fear of missing out and the fear of losing money.

The fear of missing out happens when they hear the stock market has made significant gains, and they don’t have the same exposure to it. Not enough exposure could mean 100% exposure to stocks, or it could mean leverage for aggressive investors and traders. The fear of missing out sucks them in, often at the wrong time. They’ll almost always feel this way after the fact when it’s too late.

As Walter Deemer says:

“When The Time Comes To Buy, You Won’t Want To” 

The fear of losing money happens when the investment portfolio is falling, and investors extrapolate the losses into a fear of losing more money. Since not all of us are trend followers, some will fear loss after significant gains, expecting a countertrend.

Regardless of whether an investor’s behavior is more driven by trend-following or countertrend expectations, they all seem to oscillate between the fear of missing out and the fear of losing money.

We quantify this investor sentiment into indicators that may be used as signals. Two examples are the Fear & Greed Index and the AAAI Investor Sentiment Survey.

The AAII Asset Allocation Survey turned bullish again last month, with investors saying they have more capital allocated to stocks.

AAII allocation survey bullish

However, neutral investor sentiment is at the upper end of its historical range, suggesting investors are indecisive. They’ll turn bullish if stocks continue to trend up. They’ll get bearish if stocks trend down.

neutral investor sentiment at uppper end of range AAII

Instead of polling the AAII members to crowdsource by for their opinions, the Fear & Greed Index gauges sentiment from seven different indicators.  The Fear & Greed Index had shifted down from Extreme Greed to a more moderate Greed back to Extreme Greed. Again, following the price trend as stocks fell, so did their enthusiasm.

fear and greed index

Below is a visual of the Fear and Greed over time. You can probably see some evidence of my observation that investors oscillate between greed and fear in cycles. Although most of this data is in the middle of the chart, it also reaches extremes. It’s the extremes I pay attention to as both a countertrend signal and also to help investment management clients with behavior modification. Most of the time I want to follow the trend, but at the extremes is when I may deviate from the crowd.

fear and greed index over time

It isn’t enough to be a successful investment manager, we also have to help clients modify their behavior. Most people simply tend to do the wrong thing and the wrong time, and I believe the edge is avoiding that enough so that my average gains far exceed my average losses – that’s ASYMMETRY®. But, even if we create consistently upward sloping asymmetric investment returns, it isn’t enough without keeping the mind right.

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

Is the volatility expansion over?

Using the S&P 500 stock index as a proxy for the stock market, today we saw a modest uptick. It’s now back within a normal range. Realized volatility as measured by the average true range of the past 14 days has trended up. Volatility isn’t directional, so a volatility expansion involves but down and up days.

spx trading

Implied volatility of the S&P 500 stocks had a sharp move up and settled back down some today. Applying the same realized volatility measures to the VIX is a view of the realized vol of implied vol. Yesterday may turn out to have been a good time to exit long volatility positions, or maybe it explodes from here.

ViX #VIX $VIX volatility trading asymmetric

The VIX futures term structure closed 10% contango. The December VIX futures are 10% lower priced than January. The curve is flatter beyond February.

vix-futures-term-structu

This contango creates a headwind for VIX ETFs that roll each day as they sell the January futures at a lower price and buy the February at a 10% higher price. It’s why the VIX exchange-traded funds and notes trend dow long term. So, they aren’t suitable for anyone to hold for long.

VIX may stay within the range and the stock market trend back up.

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The use of this website is subject to its terms and conditions.

What really drives stock prices down?

What really drives stock prices? The price of stocks, just like groceries, is driven by supply and demand of people “the market” buying and selling. What drives stock prices and the stock market really is no more complicated than that.

Unless you make it more complicated, then it is for you.

What drives stock prices? It is probably one of the most asked questions we get.  It’s also one of the best questions, so I’ll share my observation of it as succinct as I can.

Many investors seem to believe stock prices, and therefore, the stock market is driven by the news of the day because they see the headlines. The press tries to construct a story of the cause and effect. But, if we look at the news headlines on any day, we observe vastly conflicting narratives and reasons for a stock market directional move. 

To be sure, here are the headlines I found online today. According to headlines, recent price action and volatility are driven by everything from Trump’s talk on a China trade deal to an overvalued stock market to factory data to the fear of missing out.

what drives stock prices

The answer is, “all of the above” drives the stock market.

The news is newly received or noteworthy information, especially about recent or relevant events. However, none of us can say which specific news actually drives stock prices. 

If you really want to know what drives stock prices, it’s just the market, doing what it does.

All information and news have the potential to drive stock prices, as does investor sentiment. The price of stocks, just like groceries, is driven by supply and demand of people buying and selling. When emotion gets imbalanced, prices trend. Yes, there’s another asymmetry!

When supply and demand are symmetrical, the price stays the same.

When supply and demand are asymmetrical, the price trends in the direction of the most pressure and enthusiasm.

After yesterday’s close, I saw someone ask, “Why did the stock market do so bad today?”

I’m guessing he saw a headline like this:

what drives the stock market causes stocks to go up and down

However, a Dow decline of -0.96% isn’t a significant drop, but if you anchor to the “-268 point drop” as most do, it may sound worse, to you.

I focus on the % change to normalize the movement. Normalizing with the percent change adjusts the values measured on different scales to a notionally standard scale. For example, the “-268 point drop” is one thing from an absolute level of 27,783, but a very different situation when the Dow was at 10,000. At today’s level of 27,783, it’s only -0.96%, but the same point drop when the index was 10,000 is -2.68%, nearly three times the single-day loss.

A -1% single-day decline in the stock index isn’t a lot by historical standards. If it feels like it is, the investor should either better inform themselves of market history or have little to no exposure to the stock market. I’ll help with the former below.

First, here are the stats. I’ll continue to use the Dow Jones Industrial Average index data.

So far, in 2019, the Dow has declined -1% or more on 18 days. When it declined -1% or more in a single day, the average drop that day was -1.7%. So, a -1% drop isn’t uncommon. It’s well within a normal range for a down day. I count about 231 trading days so far in 2019, excluding holidays, so 18 of those days falling -1% or more is nearly 10% of the days. And remember, the average drop those days was -1.7%, yesterday was only -1%.

Oh, and the worst day so far in 2019 was -3%, so it could be three times worse!

When we extend the lookback period to this time last year, the Dow declined -1% or more on 26 days. When it declined -1% or more in a single day, the average drop that day was -1.87%. Again, a -1% drop isn’t uncommon. Last December was a very volatile month.

2018 was more volatile than 2019, so far. In 2018, the Dow declined more than -1% on 35 days, and when it did, the average drop was -2%, and the worst day was -4.6%.

Investors tend to anchor to the recent past and extrapolate it into the future. That is, humans tend to expect what is happening now to continue. After a volatile 2018, most investors probably expected a volatile 2019. For many, the down days and downtrends in 2018 were a shocker after an abnormally quiet 2017. In 2017, the stock market trended up with little downside. We only saw 4 down days of -1% or more, and the average down day was only 1.3%, and the worse was 1.7%. You can probably see how many were stunned last year.

This may make you wonder when investor fear drives down stock prices, what is a “normal” down day?

It depends on the time frame and the market state over that time frame. Over the past three years, the Dow declined 57 days more than -1%, and the average down day was -1.9%, and the worst was -4.6%. That’s nearly 700 data points, so the sample size is likely enough to say we should expect a -2% down day is going to happen, and a -5% is possible.

To expand the sample size, I wondered how many -1% or more down days I’ve dealt with since I started managing our primary portfolio in May 2005. In the last fourteen years, the Dow has dropped -1% or more 427 days, and an average decline was -1.8%, and the worst down day was -9.4%! You can probably see why a -1% down day from my perspective isn’t a big deal, and the statistics of the data also confirms it’s well within a typical down day.

Of course, the trouble is larger downtrends being with down days. So, the investor’s concern isn’t just a single down day, but instead a series of down days, which is a downtrend. Before moving on to what drives stock prices and the stock market, let’s look at the downtrends.

Over the past year, the Dow Jones has declined more than -5% twice and -20% once starting last December. All of these downtrends include -1% down days. So, I’m not saying they don’t matter, but instead, the single -1% down day isn’t by itself significant.

Expanding the lookback period to the past 10 years, we see many downtrends of -5% or more. But, within those downtrends, there was only one -5.4% down day, but 245 down days over -1% with an average loss of -1.6%. Downtrends include these down days.

Next, we look all the way back to the beginning of the index data to observe its historical downside. The 1926 era Great Depression was by far the worst when the Dow Jones Industrial Average fell over -75%. It makes the 2007-09 period when it fell -50% look tame.

Clearly, if you invest in the stock market, you should expect to experience drops of -5% a few times a year, and -10% maybe once a year, and -20% or more at least every market cycle. If all you do is buy and hold stocks or stock funds, expect to experience a -50% because if history is a guide, it has happened before, so it could happen again.

You can probably see Why we row, not sail.

To understand what drives stock prices and how much of a loss is considered a large loss, we have to know the history. I hope I’ve shared it in a helpful way.

If there’s anything I hope individual investors get from my observations, it’s a better understanding of the risks of investing. The rewards of investing are well advertised, but the risks are what matters the most when our focus is asymmetric risk/reward. When prices of positions are trending in our favor increasing our investment account value, our concern isn’t that we are making too much money. Our interest is not giving up all the profit, which is a risk management function.

The exit, not the entry, always determines the outcome.

If you want to know what really caused the decline, I shared my opinion in a single chart that I believe sums it up best. It was good enough to make it in The Daily Shot in the Wall Street Journal. As the stock index has trended up quietly in recent weeks, volatility had contracted, as seen in the chart. As I shared, “Periods of low volatility are often followed by volatility expansions.”

Mike Shell Wall Street Journal WSJ

A few weeks ago, I also observed investor sentiment had reached an extremely optimistic level as stated in Investor sentiment signals greed is driving stocks as the U.S. stock market reaches short term risk of a pullback.

Now that stock prices have fallen two days in a row, we’ll start to see the pendulum swing from extreme greed to a middle ground. If the stock market drops a lot more, investor sentiment will become fearful, just in time for a reversal back up again.

Some favor stories, others favor data and charts, I’m a math guy, so I prefer the data and visually seeing it in charts. I’m lucky to be able to write.

What we have here isn’t a failure to communicate, the news is everywhere. I think it’s a misunderstanding of what really drives stock prices down. It’s the desire and enthusiasm to sell.

Stock price trends, just like groceries, are driven by supply and demand of people buying and selling. When sentiment gets imbalanced, prices trend in the direction that has the most force and momentum.

Yes, it’s another asymmetry! Without the asymmetry, prices would stay the same.

In the spirit of ASYMMETRY® and asymmetric risk-reward payoffs, I’m naturally trying to get the most reward from my observations by helping as many people as possible, so share it! And enter your email on the right to get immediate notices of new ASYMMETRY® Observations. We do not sell or use your email address in any other way. Also, follow me on Twitter: @MikeWShell

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The use of this website is subject to its terms and conditions.

A volatility expansion seems imminent

On November 16th, about two weeks ago, I shared an observation in “Periods of low volatility are often followed by volatility expansions” that implied and realized volatility had reached such a low level we should expect to see a volatility expansion.

I also pointed out investor sentiment had been reaching excessive optimism. The type of excessive optimism we normally see when less-skilled investors have an urge to buy stocks instead of a hedge or sell them to reduce risk.

It was plenty early, as expected, which is better than being late.

When I share these observations, the intent is to highlight an extreme trend or cycle I expect to shift the other direction. In this case, I saw the range of prices was getting tight, suggesting to me there was little indecision in the market, which also implies confidence and complacency.  I say this, having been monitoring these market dynamics daily and professionally for over two decades.

The chart I included showing the S&P 500 price trend peaking at the upper band of its range and its average true range at what I consider an extreme low go included in MarketWatch, then Barron’s, and then today The Daily Shot in the Wall Street Journal.

Mike Shell Wall Street Journal WSJ

Since that chart is now two weeks old, here’s an update. The S&P 500 has trended down about -1.2% the past two sessions and its price is back inside the volatility bands. However, notice the bands have contracted since October, so I say again: Periods of low volatility are usually followed by volatility expansions.

volatllity expansion vix asymmetric december 2019

So, stay tuned, a volatility expansion with at least a minor price correction seems imminent.

Prepare yourself accordingly.

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 in Florida, Tennessee, and Texas focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The use of this website is subject to its terms and conditions.

The full interview

The full interview

Last week I had an interview with Barbara Kollmeyer, Senior Editor & Reporter, at MarketWatch: The Wall Street Journal Digital Network. It was then featured in Barrons this morning as “Investors Are Ignoring Two Major Risks to Stocks, Warns Fund Manager.

It sparked some inbound questions, so I’m sharing the full interview below. I don’t always do interviews, but when I do, I prefer them in writing, so my words aren’t misinterpreted or taken out of context. Barbara asked some great questions. She also did a great job getting straight to the point and picking out what is probably the most important part for her audience of an otherwise much more broad conversation. For those who want more information and have questions, I hope you enjoy it and find it helpful.

Can you briefly explain an asymmetric portfolio, and how that has helped your clients ride out major stock market corrections? 

I’ve been managing ASYMMETRY® Global Tactical for fifteen years now. I designed it to be a complete portfolio, all in one account. That is, I actively trade a global universe of stocks, bonds, and alternatives like volatility. The investment objective is a positive asymmetric return profile that fits within our client’s tolerance for risk and the desired return over a full market cycle. An asymmetric return profile means I want to actively control my downside risk while trying to capture as much of the upside I can. I believe traditional asset allocation and diversification is not enough; a smoother return profile for clients requires drawdown controls such as risk management and hedging. The hallmark of my track record has been how we got through the 2008-09 period and overall consistency. By focusing on asymmetric risk-reward, which is mainly a focus on cutting losses short and managing portfolio risk, we’ve been able to provide risk-adjusted returns to fit clients’ sensitivity for risk. So, my focus is providing asymmetric, risk-adjusted returns over full market cycles of uptrends and downtrends.

What is your biggest market call right now? How do you make money in 2020?  

Periods of low volatility are followed by volatility expansions. In the short run, investor sentiment is very optimistic, which has helped drive the stock market a higher risk level of correction. I like uptrends, until the end when they bend, so I apply trend following systems. However, even an upward price trend has counter swings up and down along the way that can reach extremes. So, I also monitor for these potential countertrend signals to help smooth out the risk-reward more asymmetrically. At the moment, I’m prepared for a possible downswing that seems likely in the months ahead. As for 2020, I think we’ll see a volatility expansion off the recent calm state. The driver of a volatility expansion may be the U.S. election and other geological issues. I’ll trade the price swings and volatility.

You talk about how the stock market hasn’t made any progress in the last two years? Why is that and what will change it? 

In the last two years, the stock index dropped -5 to -10% three times, which is normal, but also -20% this time last year. Until recently, when stocks started trending up, and volatility contracting, the stock indexes made little progress going back to the end of 2017. I define the period as counter trending and volatile. I believe the stock market made little upward progress because 2017 was an abnormally smooth uptrend with a 20% gain in the S&P 500 index with no drawdowns of more than 3-4%. Investors became euphoric as prices trended up and drove it to an extreme overbought level on the upside. Since then, I think we’ve seen all that excessive optimism get worked off as extreme cycles tend to swing the other way. I warned about this extensively two years ago. As to what may change it from a counter trending state to an uptrend, we see it try to trend up now, but it seems there are some headwinds such as slow earnings, relatively high valuation, and political issues. Although the market can climb a wall of worry, I’m prepared for the worst.

If we can call this the longest bull market ever, what stops it? 

Yes, this is the longest bull market in American history. In 2007 I was warning of a 73-74 type bear market, and that’s what we saw. As I said in 2007, before the waterfall decline, something will get the blame for it, but it will just be the market, doing what it does. I believed the stock market was at a cyclical peak within a long term secular bear market that started in 2000. Currently, this is a very aged old bull market. It reached the second-highest valuation level in 150 years measured by Shiller PE Ratio. The only two times it was this high was Black Tuesday in October 1929 what is now known as The Wall Street Crash of 1929 and the Great Crash. In 2017 Shiller PE was higher at 33 than its 1929 peak of 30. The second period was when it hit 44 in December 1999. More experienced investors today may remember what happened next. It’s now known as the dot-com bubble, and it popped with stock indexes dropping over -50%. I don’t use PE ratios for trading or investment decisions, but my understanding of it has helped me be aware of the big picture. I’m not suggesting we will see another big crash like those that followed these high valuation periods, but instead, investors need to be aware of the risk that it could unfold the same. 

What’s the biggest risk investors are ignoring right now? Do you feel that they rely too much on ETFs? 

The biggest risk investors seem to be ignoring right now is the high valuation and age of this bull market and the risks it poses for the long run. It doesn’t have to fall just because it’s been trending up over a decade, but the valuation and expected return from this starting point are pretty simple. For example, the current dividend yield is now less than 2%, the PE is 30, and earnings growth is lower than decades ago. The long term expected return is a summation of these, so when we add it up, it’s maybe 4-5% from this starting point. That’s half the 10% historical return investors are told to expect, which is the average since 1924 commonly seen on a brokers wall. In 1924, the dividend yield was 5%, PE was only 10 allowing a lot of room to expand, and earnings growth was higher than it has been recently. This is the one thing I think investors need to be aware of. It’s also why I do what I do. I think we need to row, not sail, to get the results we want.

I don’t believe investors necessarily rely too much on ETFs, and I was an early ETF investor myself. I started trading ETFs two decades ago, when there were just a few, such as sectors. Passive indexing may become a market risk and lead to less price discovery, but overall, I view ETFs as a great way to gain efficient exposure to return streams. Now, if all investors do is buy and hold them, I think that will be a significant risk eventually as it was before.

What’s your favorite chart right now and why? 

My favorite chart right now is the VIX, because it has trended down to the 12 range. As you can see in the chart, when implied volatility gets this low, we eventually see a volatility expansion.

VIX $VIX #VIX implied volatility mean reversion countertrend expansion trading asymmetric

So, I’m prepared for it as it both signals to me the opportunity for a lower cost asymmetric hedge and maybe profit from rising volatility. Asymmetric risk-reward is achieved by a lower-risk entry where the risk is predefined and limited, but the payoff is higher. An asymmetric payoff, for example, is when I risk $1 and earn $2. Asymmetric risk-reward, for me, is defined by how I structure to trade, not what I invest in. But some things have a higher likelihood of trending, which can create asymmetry. Of course, as with all indexes, the VIX is not something you can invest in directly. In fact, since the VIX is a mathematical calculation, you can’t even buy a basket of the securities inside the index to mimic the VIX. Instead, the only way investors can access the VIX is through futures contracts, options, or exchange-traded funds. So, we can go “long volatility” in several different ways.

Another chart I think is worth a mention is the Alerian MLP Index. The Alerian MLP Index is a gauge of energy infrastructure Master Limited Partnerships (MLPs) whose constituents earn the majority of their cash flow from midstream activities involving energy commodities.

MLP ENERGY CRUDE OIL DIVERSION

An asymmetric global macro trend been noticing recently it has trended down to a lower low that 2016 while WTI Crude Oil Spot Price is much higher than it was then. It’s an interesting divergence. Alerian MLP Index is an index, so it cannot be invested in directly but its price chart itself an example of an asymmetric risk-reward if it reverses back up. But, the current downtrend could keep trending down much lower than anyone believes it can. As such, it is essential to predetermine risk in advance. There are many things that could drive MLP prices lower, including trade deals, or lack thereof.

Barrons link: Investors Are Ignoring Two Major Risks to Stocks, Warns Fund Manager

In the spirit of ASYMMETRY® and asymmetric risk-reward payoffs, I’m naturally trying to get the most reward for the efforts as possible, so share 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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The use of this website is subject to its terms and conditions.

 

 

An interview with yours truly: Investors are ignoring two major risks to stocks, warns fund manager

I don’t always do interviews with the media, but when I do, it’s with authors I enjoy reading.

In fact, I haven’t granted a major media interview since Forbes with Kata Stalter in 2012 “Using Price Trends to Maximize Profits.” Hard to believe that was seven years ago!

Yesterday I was interviewed by Barbara Kollmeyer, who is an editor for MarketWatch in Madrid and we follow each other on Twitter. She picked out what I think is the most important thing to share with individual investors right now: this is a late-stage economic expansion and an aged bull market in stocks, so people should be prepared. Readers of ASYMMETRY® Observations will find it familiar, although I’ve lately been writing more about the short term trend.

The interview:

Investors are ignoring two major risks to stocks, warns fund manager

 

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The use of this website is subject to its terms and conditions.

Alerian MLP Index is diverging from crude and reaching new lows

The Alerian MLP Index is an interesting trend. It’s down -61% since inception. The Alerian MLP Index is a gauge of energy infrastructure Master Limited Partnerships (MLPs) whose constituents earn the majority of their cash flow from midstream activities involving energy commodities. We’ve been noticing recently it has trended down to a lower low that 2016 while WTI Crude Oil Spot Price is much higher than it was then.

It’s an interesting divergence and may be an example of an asymmetric risk-reward if it reverses back up from this relatively low level. In theory, after such a downtrend further downside could be limited and the potential for upside greater. Of course, The Alerian MLP Index is an index, so it cannot be invested indirectly. I’m using it only as an example. The index could keep trending down much lower than anyone believes it can.

It is always essential to predetermine risk in advance. There are many things that could drive MLP prices lower, including trade deals, or lack thereof.

It will be fascinating to see how this trend unfolds and what it may be signaling about the global macro environment.

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The use of this website is subject to its terms and conditions.

 

 

TEN WAYS TO LOSE MONEY IN WALL STREET

TEN WAYS TO LOSE MONEY IN WALL STREET

The Market Cynic from Art of Contrary Thinking originally published 1954.

After many hours of toil and deep thought I have compiled a dependable guide for stock traders. I shall not attempt to explain or qualify these precepts, realizing that my readers will doubtless follow them regardless of any advice to the contrary.

1) Put your trust in board-room gossip.

2) Believe everything you hear, especially tips.

3) If you don’t know, guess.

4) Follow the public.

5) Be impatient.

6) Greedily hang on for the top eighth.

7) Trade on thin margins.

8) Hold to your opinion, right or wrong.

9) Never stay out of the market.

10) Accept small profits and large losses.

Neill, Humphrey Bancroft. Art of Contrary Thinking (p. 19). Caxton Press.

 

By and large, the stock market is correlated with consumer sentiment

I’ve shared some observations about investor sentiment this past week as sentient indicators and surveys have reached an extreme level of optimism.

When sentiment reaches an extreme, we should prepare for it to swing the other way, at least temporarily.

Why?

Because that’s what it does. Most financial and economic data cycles up and down, swinging like a pendulum as investors oscillate between fear and greed. Or, as I like to put it: oscillating between the fear of missing out and the fear of losing money.

What about consumer sentiment?

The US Index of Consumer Sentiment is another sentiment survey, but it measures consumers instead of specifically investor sentiment about the stock market trend. The US Index of Consumer Sentiment (ICS), as provided by University of Michigan, tracks consumer sentiment in the US, based on surveys on random samples of US households. The index aids in measuring consumer sentiments in personal finances, business conditions, among other topics. Historically, the index displays pessimism in consumers’ confidence during recessionary periods, and increased consumer confidence in expansionary periods.

US Index of Consumer Sentiment is at a current level of 95.70, an increase of 0.20 or 0.21% from last month. This is a decrease of 1.80 or 1.85% from last year and is higher than the long term average of 86.64.

US consumer sentiment is near the top of its historical range going back decades. There are only two times since its inception the level was high than it is now, such as the euphoric bubble of the late 1990s.

Consumer sentiment has been trending up the past decade until 2015 and has been drifting sideways at the historical peak range the past four years.

The art of contrary thinking suggests when everyone thinks alike, everyone is likely to be wrong. However, in recent years the crowd has been right. For example, US GDP (Gross Domestic Product) is the total value of goods produced and services provided in the US. It is an indicator to analyze the health of the US economy. GDP is calculated as the sum of Private Consumption, Gross Investment, Government Spending, and Net Exports. Two-quarters of consecutive negative real GDP growth is considered a recession. GDP is also used by the Fed (FOMC) as a gauge to make their interest rate decisions. In the post World War II boom years, US GDP grew as high as 26.80% in a year, but by the late 20th century 2-7% nominal growth was more the norm.

US GDP is at a current level of 21.53 trillion as of September, up from 21.34 trillion in the last quarter. This represents a quarterly annualized growth rate of 3.48%, compared to a long term average annualized growth rate of 6.26%. Although it shows the US economy has grown less than the long term average, the United States is now a developed country and long past the emerging country stage pre-WWII boom years. So, in the chart below we observe a correlation between consumer sentiment and GDP. Up until recently, they are trending in the same direction, but keep in mind GDP doesn’t necessarily have an upside limitation, while the consumer sentiment is a survey that can be more range-bound. Sentiment surveys tend to oscillate up and down in response to changing economic conditions.

Another note about GDP before I get a thousand emails from my economics friends and other global macro funds managers, US Real GDP Growth is measured as the year over year change in the Gross Domestic Product in the US adjusted for inflation. To make my point and keep it simple, I used the base GDP.

So, how does overall consumer sentiment correlate with the stock market trend and how do they interact with each other?

Below we chart the US Index of Consumer Sentiment overlayed with the S&P 500 price trend for general visual observation. By looking at the lines, we can observe they are correlated. Up to 2000, the stock market and consumer sentiment trended up. The stock market and consumer sentiment trended down from 2000 to 2003 or so.

But, from around 2003 to 2008 it would appear consumer sentiment was non-trending as it drifted sideways as the stock market trended up, however, the sentiment was just staying at its peak level. When I highlight the peak range below, it’s more obvious that sentiment remains at a high level for years and occasionally swings down. Americans are mostly optimistic about America! and we should be.

consumer sentiment correlation with the stock market intermarket analysis

Continuing to review the trends, the period from 2007 on is correlated again to the downside as stocks and consumer sentiment dropped sharply. Recall this stock index declined -56% from October 2007 to March 2009 and then took four years to reach its 2007 high again in 2013. We can see the bottom chart above is the correlation coefficient of these two data. Although the correlation oscillates up and down, it has remained in the upper range signaling it is more correlated that not.

The larger declines in consumer sentiment are related to recessions. We’ve only had two recessions since 1991. The 1990s was the longest period of economic growth in American history. The collapse of the speculative dot-com bubble, a fall in business outlays and investments, and the September 11th attacks, brought the decade of growth to an end. Notwithstanding these major shocks, the recession was relatively brief and shallow compared to the one we would see seven years later. I marked the recessions in gray to show how they fit into the big picture.

“As a general rule, it is foolish to do just what other people are doing, because there are almost sure to be too many people doing the same thing.”

William Stanley Jevons (1 September 1835 – 13 August 1882) was an English economist and logician. Irving Fisher described Jevons’s book A General Mathematical Theory of Political Economy (1862) as the start of the mathematical method in economics.

This is really about human behavior.  Emotions and sentiment rise and fall with events.

To be a successful investor over the long term, we must necessarily believe, feel, and do differently than the masses at the extremes. So, I monitor the extremes to see when they change. At the extremes, I hope to be doing the opposite of what our investment management clients and everyone else believe I should be doing. 

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The use of this website is subject to its terms and conditions.

The week in review

The week in review.

Periods of low volatility are often followed by volatility expansions

I like uptrends, until the end when they bend.

This uptrend in U.S. stocks hasn’t seemed ready to bend, but we are observing signs a reversal down could be soon. I’m not necessarily talking about a market crash of -50%, but instead a decline of around -5% or so that we typically see a few times a year as we’ve seen twice this year.

The “long term” investors may wonder why it matters?

All big waterfall declines begin with smaller downtrends. Few stay “long term” investors after large declines. After -30% declines or more, most anyone’s financial plans become negatively impacted. It’s especially true since we don’t know how long it will take to recover and there is no guarantee it will.

So, as a tactical risk manager, I necessarily prepare and apply situational awareness. If we want to manage our drawdowns, we want to do it sooner than later. Everyone is always giddy at all-time highs, then regretful if they don’t derisk or hedge after a downtrend.

Below is an example of a measure of realized volatility charted with the stock index. The top line is the 20-day average true range of the S&P 500 (SPX) and the lower is its price trend. I marked it up to show the average true range indicates a volaltity contraction like we’ve seen twice this year. The point is it preceded a volatility expansion and price declines.  I also added the blue bands around the price trend that reflect two times the average true range of the price trend. When the price trend moves outside this volatility band, I consider it simply outside its recently normal range. As you can see, it can stay outside its range for a while, but the price trend mostly oscillates inside this range. When it swings outside the range, it means reverts or swings the other way.

Average True Range ATR use in portfolio management trading volatlity

We can say the same for expected volatility, as measured by the CBOE Volatility Index, which measures implied volatility on the S&P 500 stocks. The VIX has declined to the 12 level, the low level of its historical range.

VIX $VIX #VIX IMPLIED VOLATLITY

Periods of low volatility are often followed by volatility expansions.

The SPX trend can trend higher, and volaltity can drift lower, but in the short run, it’s a good time to check thy risk.

Investment management is all about probabilities and possibilities, so you can probably see the direction is most probable, though anything is possible.

Why does any of this matter? read Why we row, not sail.

For an update, see A volatility expansion seems imminent

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The use of this website is subject to its terms and conditions.

Can an optimistic investor sentiment measured by the AAII Investor Sentiment Survey trend higher?

Someone asked:

Can an optimistic investor sentiment in AAII Investor Sentiment Survey trend higher?

Another commented:

The AAII Investor Sentiment Survey is just over its long term average, so it has room to run.

Of course, bullish investor sentiment can trend higher. That is especially true when looking at just one survey measure like the AAII Investor Sentiment Survey.

Below I charted the Investor Sentiment, % Bearish and % Bullish using the AAII Investor Sentiment Survey data. Looking at the extremes, the end of 2017 was the highest % Bullish and the lowest % Bearish. If you recall, it was a very euphoric period with stocks trending up.

For another less noisy visual of this observation, I then chart the % Bullish – Bearish Spread. When it’s higher, more investors taking the survey are bullish. When it’s lower, more are bearish.

The peak optimism is clearly shown at the end of 2017 after the stock market had trended up with abnormally low volatility.

The peak cycle in pessimism was last December 2018, after stock prices had a waterfall decline.

To be sure, next, we overlay the % Bull-Bear Spread over the S&P 500 stock index. We can see visually the % Bullish reached an extremely high level in the last month of 2017 as the stock index trended up.  But, what happened afterward? aaii investor sentiment survey research backtesting

We see its lowest level over the period was the end of 2018 as stocks were in a waterfall decline.

The key is; what happened after the extreme level of bullishness?

It continued for a while, but I warned about it on January 24, 2018:

By the way, this past year is vastly different than the low volatility period I highlighted above. I was pointing out the stock index hadn’t dropped more than -4% in over a year and that was an unusually quiet condition. This past year has been more normal-looking from that perspective, with tow -5% – 7% drops after the waterfall.

Below is the trend from 2015 to 2018 to put it into perspective. Preceding 2017 were those two declines in 2015 and 2016. The beginning of which was considered a “flash crash.”

After stocks reached the second low, the trend up became smoother and smoother. Oh yeah, another blast from the past; I pointed that out, too, in November 2017.

Below is the trend from the January 26, 2018 peak through December 2018. The S&P 500 stropped -18% and more like -20% from the recovery high in October 2018 before the waterfall decline.

Here is the trend from January 1, 2017, to December 25, 2018. It’s what happened after the euphoric period. It was all but wiped out just a few months.

Can the investor sentiment get even more optimistic and drive stock prices even higher? Of course, it can! It has before! The Bull-Bear Spread is elevated, but not at its historical extremes.

But the AAII Investor Sentiment Survey isn’t necessarily a timing indicator by itself. It’s just a gauge. But, when combined with other observations I’ve discussed this week, the weight of the evidence suggests it’s a better time to reduce risk and hedge than to take on new risks as these surveys show investors are doing.

Those who forget the past are doomed to repeat it. 

Those who learn from the past have the potential to gain an edge from it.  

Have a great weekend!

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The use of this website is subject to its terms and conditions.

Investor optimism is reaching extremes

Ok, so this isn’t anything new. I just discussed it last week in “Investor sentiment signals greed is driving stocks as the U.S. stock market reaches short term risk of a pullback.” The sentiment indicators keep confirming the same signal: that investors are very optimistic about future gains.

It’s the kind of sentiment we often see before a decline.

The Fear & Greed Index is a simple combination of seven different indicators that are considered investor behavior measures. It includes the Put/Call Ratio, the net new 52 week highs and lows, stock price breadth, market momentum, the yield spread between junk bonds and investment-grade, and market volatility.  It’s a useful gauge to monitor against your own sentiment and behavior. The Fear & Greed gauge remains at a high level, signaling “Extreme Greed” and excessive optimism.

Fear & Greed Index What emotion is driving the market now?

Just as the stock market cycles up and down over time, so does investor sentiment. In fact, I believe investor sentiment oscillating between fear and greed is what drives stocks in the short run.

We measure this investor behavior with these different indicators. For example, the number of stocks hitting 52-week highs exceeds the number hitting lows and is at the upper end of its range, indicating extreme greed. The S&P 500 is 4.90% above its 125-day average is another above the average than has been typical during the last two years and rapid increases like this often indicate extreme greed.

The Put/Call Ratio shows during the last five trading days, volume in put options has lagged volume in call options by 50.13% as investors make bullish bets in their portfolios. This is among the lowest levels of put buying seen during the last two years, indicating extreme greed on the part of investors.

Stocks have outperformed bonds by 4.50 percentage points during the last 20 trading days. According to the Fear & Greed Index, this is close to the strongest performance for stocks relative to bonds in the past two years and indicates investors are rotating into stocks from the relative safety of bonds.

Junk bond demand shows investors in low-quality junk bonds are accepting only 1.84% in additional yield over safer investment-grade corporate bonds. This spread is down from recent levels and indicates that investors are pursuing higher risk strategies.

Investors tend to feel the wrong feeling at the wrong time as they oscillate between the fear of missing out and the fear of losing money.

Another useful gauge I follow is the AAII Sentiment Survey. Since 1987, AAII members have been answering the same simple question each week. The results are compiled into the AAII Investor Sentiment Survey, which provides insight into the mood of individual investors. Today’s AAII Sentiment Survey shows Investors are optimistic again. Optimism is above 40% on back-to-back weeks for the first time since August 2018.

AAII Investor Sentiment Survey

The investor misbehavior of thinking, feeling, and doing the wrong thing at the wrong time doesn’t just include individual investors, but also many professional investment managers.

‘Fear of missing out’ triggers huge fund manager shift from cash to stocks,

The latest Bank of America Merrill Lynch investment fund managers survey shows fund manager cash levels are lowest in six years  and

“Investors are experiencing Fomo—the fear of missing out—which has prompted a wave of optimism and jump in exposure to equities and cyclicals,”

According to ‘Fear of missing out’ triggers huge fund manager shift from cash to stocks, Bank of America Merrill Lynch says:

The survey of 230 managers running $700 billion of assets found cash levels dropped 0.8 percentage points to 4.2%, the biggest monthly drop since Nov. 2016 and the lowest cash balance since June 2013.

Like individual investors, many investment managers also oscillate between the fear of missing out and the fear of losing money. This may be especially true for relative return mutual fund type active managers who aim to beat an index benchmark. If they are underperforming their index after an uptrend, they may feel the fear of missing out and increase their exposure. If they lose as much or more on the downside, they may tap out after the fact to avoid further losses.

An objective of absolute returns necessarily requires seeing, believing, and doing things differently as an independent thinker.

As investors seem to be taking on more risk, I see indications that stocks may be near a point of buying exhaustion. Keep in mind, these investor sentiment surveys are on a lag. It was probably this very optimism that pushed stocks to this higher level.

If there is enough enthusiasm left to keep driving prices higher, the uptrend will continue as long as optimism prevails. If instead these indicators and surveys are a signal of buying exhaustion, we’ll see prices fall at some point from here.

I focus on these extremes in investor sentiment.

So, it may be a good time to reduce or hedge off some risk.

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The use of this website is subject to its terms and conditions.

Active management and tactical allocation isn’t the only method with “strategy risk” as global asset allocation can get off track, too

Most investors, individual and institutional, apply some kind of asset allocation method to a portfolio mix of cash, bonds, and stocks. The most diversified also invest internationally,  so their portfolio is global. The most common method is strategic asset allocation, which allocates capital to funds that represent different parts of the stock and bond markets based on some prediction of future exected returns or historical returns along with variance. There isn’t much skill to it unless you can predict the future better than others.

That’s Global Asset Allocation and it’s especially what large institutional investors like pensions and endowments do.

Since around 2002, most financial advisors have adopted it as well. I say 2002 because that was when I remember even the large Wall Street brokers like J.P. Morgan and Merrill Lynch starting to teach their financial advisors to use Modern Portfolio Theory to create Global Asset Allocation portfolios. Although in many cases, these investment brokers and banks don’t necessarily allow their brokerage salespeople to create their own models, instead, they sell models the firm creates. After all, financial advisors at a brokerage firm or investment bank aren’t analysts or portfolio managers, their job is to sell the firms’ products and services. So, most individual investors who have a financial advisor at a large brokerage firm probably find themselves in some kind of Global Asset Allocation.

In The stock market has made little progress in the past two years which is a hostile condition for trend following I pointed out the U.S. equity market has made little progress in the past two years. I also showed a simple example of how and why it’s a hostile condition for trend following methods.

The past two years haven’t been any better for allocation to global stocks and bonds, no matter how you sliced it.

To illustrate this observation, we use the S&P Target Risk Index Series. Below is the chart of all four “target risk” allocations between global stocks, bonds, and cash.

An index isn’t a physical basket of securities, but a mathematical construct that describes the market. So, we can’t invest directly in an index. But we can invest in securities like ETFs that track indexes and which provide exposure to the markets they reflect. In the case of S&P Target Risk, BlackRock iShares has ETFs that aim to track each of the four indexes.

The S&P Target Risk series of indices comprises multi asset class indices that correspond to a particular risk level. They measure risk level based on exposure to cash and bonds (for lower expected risk) to stocks for higher risk and expected return. So, the four indices each measure the performance of specific allocations to equities and fixed income. Each index has 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.

Something unique about these indices is each index is composed of exchange traded funds (ETFs), rather than an index allocation to other mathematical indices.

Again, the indices represent stock-bond allocations across a risk spectrum from conservative to aggressive. The assigned risk level of the index (conservative, moderate, growth, and aggressive) depends on the allocation to fixed income.

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.

We can refer to Index Construction for details on each index’s allocation to equity and fixed income.

Index Construction Target Risk S&P global asset allocation index

The short version is there is a 10% to 20% difference between the allocation between bonds and stocks.

So, how has Global Asset Allocation performed in this very volatile two years that’s had a hard time gaining enough momentum to stay at new highs?

The Aggressive allocation participated in the downside but not the upside.

Active management or tactical allocation isn’t the only method with “strategy risk” as sometimes asset allocation can get off track. 

I don’t offer this kind of asset allocation that allocates capital to fixed buckets of stocks and bonds and then rebalances them periodically. As a tactical portfolio manager, instead of allocating to markets, I rotate between them based on asymmetric risk-reward. We don’t want to have too much exposure to falling markets and we prefer to focus on up trending markets. So, I prefer to limit my downside by predefining my risk and the upside takes care of itself as we let profits run. For me and our clients, our portfolio a replacement to this kind of asset allocation. Frankly, if I didn’t think I could achieve a better asymmetric risk-reward profile over full market cycles including drawdown control that we are better willing and able to tolerate, I wouldn’t bother doing what I do. If you can’t beat ’em, join ’em. But, from what I’ve seen so far, many investors in global asset allocation tapped out in the last bear market as both stocks and bonds experienced waterfall declines. Do you know what didn’t? cash and shorts.

To me, that’s tactical.

The bottom line is, all investments and investment strategies involve risk, including the potential loss of principal an investor must be willing to bear. Which one is right anyone is a function of their personal preferences toward someone actively making decisions or passively holding exposure to market risk, their risk tolerance for drawdowns, and their desire to pursue asymmetric risk-reward. None of it is a sure thing.

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The use of this website is subject to its terms and conditions.

The stock market has made little progress in the past two years which is a hostile condition for trend following

Until the recent breakout to new highs, the stock and bond markets have made little progress in the past two years. Below are the price trend and total return chart of the S&P 500 stock index (SPX). The price trend of SPX has trended in a range of 20% to 30% since the first of 2018, but until this month, it had made very little progress.

The price return through today is 7.45%, and the total return, including dividends, is 11.38%. At the end of October, it was only 5.73% and 9.5%.

So, this has been a long non-trending volatile period similar to 2015 and 2016. From January 2015 to November 2016, the percent change of the SPX was near zero. Finally, in December, it trended up and broke out to a new uptrend. Still, over two years, the price trend change was only 8.74%.

I define market trends as volatile and non-volatile, trending, and non-trending. When we understand the current condition, it helps with tactical decisions of which type of system to focus on.

When markets are trending, and quiet, directional trend following systems enjoy the ride.

When a market gets choppy and volatile, the trend following systems have difficulty as they may exit the lows only to miss out on the price trend reversal back up. Then, by the time they reenter, the trend reverses back own again. A straightforward observation is the 200-day moving average, which got whipsawed several times in the 2015 to 2016 period.

I don’t trade moving averages. But, if we did over this period by entering the signal above the moving average and entered/exited at the close the day it was crossed, we’d have experienced these whipsaws. Of course, just thinking back to the past isn’t nearly as exciting as experiencing market action in real-time.

But, applying the moving average would have resulted in approximately -2.2% in 2015 vs. a small gain of 1.25% in the SPX.

In 2016 executing the signals resulted in a gain of 8% vs. 12 for the SPX.

Only looking at the upside leaves out the downside we have to experience to achieve it. Below are the drawdowns of this method applied to the stock index (blue line) vs. the stock index itself (red line.) This simplified example using a moving average for trend following missed most of the first decline with a drawdown of only -3% when the SPX dropped -8%, but then it participated in the next decline. Also notice it took a while to regain exposure, so it “missed out” of the sharp uptrend reversal April 2016 to July.

moving average drawdown whipsaw risk

When it’s one sharp declined after an uptrend, trend following methods usually exit and avoid some loss. It’s when the price swings up and down over a period we see the whipsaws of non-profitable entries and exits.

Over the past two decades, I’ve spent a lot more time and resources studying what causes entry and exit systems to fail than data mining for those that were historically successful. My heavy emphasis on what doesn’t work helped me to discover what does. Of course, this isn’t an example of a method that doesn’t work just because it didn’t achieve a perfect result of a hostile period. The other side of its results over this period was the smaller drawdown. To many investors, it’s worth missing some upside if the downside is limited.

If we want to manage the downside loss, we must be willing to miss some upside gain as there is no free lunch in active risk management.

These periods that are hostile for some methods signaled for me to have other weapons in the arsenal. For example, while trend following methods can do well in trending, non-volatile markets by catching the trend and riding it to the end, my countertrend systems are shorter-term and aim to enter and exit the swings. So, my countertrend systems actually consider the swings a friendly condition as they want to enter the shorter term countertrends down and exit to take a profit after it trends up.

Applying both of these systems is a bit of a shell game. But hey, that’s my name, so it may as well be my game. I say it’s a shell game because trend following and countertrend systems are in direct conflict with each other, so we necessarily need to decide which to use, when. It’s another tactical decision. It requires me to determine which market condition we’re observing and then apply the method that seems to best fit the situation. Nothing is ever perfect, and it’s far from easy, but when executed well, we have the potential to take advantage of different conditions. Or, more importantly, to avoid the hostile conditions of the single strategy.

It’s all easier said than done.

I have spent much effort in developing systems and skills for the execution of them. I am well aware of the challenges I face. But, I embrace the challenges, accept them, and deal with them.

By the way, the same 200-day moving average trend following method once again had its share of whipsaws since the beginning of 2018.

So, anyone applying trend following like this is happy to see the new breakout and hoping it will continue. If it doesn’t, the moving average exit signal is about -6% below the current price, so it would result in a -6% drawdown if the price falls from this point.

My countertrend systems, on the other hand, are signaling a short-term exit for this same stock index and entries on sectors like Utilities and Real Estate. You can see why in the chart.

They are in an overall uptrend, but their prices have dropped recently, offering a potentially asymmetric risk/reward if the uptrend resumes back up. That is, the downside is limited by predefining an exit if they continue to fall, but it’s more probable they may reverse back up and continue their uptrends. If they do, it becomes a trend-following trade. Of course, the indexes cannot be invested in directly, and this isn’t advice, but an example of how a countertrend system may look.

So, the bottom line is this has been a non-trending, very volatile two years for U.S. stocks and it’s a state that is hostile for simple directional trend following methods. If the recent breakout to the upside continues, the market state shifts to trending and maybe less volatile, but as I pointed out in Quantitative trend and technical analysis indicators signal strong U.S. equity participation in the uptrend but it may be nearing exhaustion it seems more likely we’ll see some countertrend or at least a stall even though this is a historically seasonably strong period.

The trick is to be prepared for whatever may happen next, and I am.

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The use of this website is subject to its terms and conditions.

 

 

 

 

Happy Veterans Day: The land of the free, because of the brave. 

“A veteran is someone who, at one point in their life wrote a blank check made payable to ‘The United States of America,’ for an amount up to and including their life.”

We are the land of the free, because of the brave.

Veterans Day Marines #Veterans #VeteransDay #SemperFi

“Honor never grows old, and honor rejoices the heart of age. It does so because honor is, finally, about defending those noble and worthy things that deserve defending, even if it comes at a high cost. In our time, that may mean social disapproval, public scorn, hardship, persecution, or as always, even death itself. The question remains: What is worth defending? What is worth dying for? What is worth living for?” – William J. Bennett

Happy Veterans Day to my fellow Veterans.

Semper Fi

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The use of this website is subject to its terms and conditions.

Quantitative trend and technical analysis indicators signal strong U.S. equity participation in the uptrend but it may be nearing exhaustion

I focus on the directional price trend of my individual positions for my entry and exit signals. However, I also systematically monitor a range of indicators like investor sentiment and breadth that measures the participation of individual stocks in uptrends and downtrends. These quantitative indicators look at the directional movement of the stocks inside an index. The price trend is the final arbiter, but we can get a better observation of what is really going on by looking at the rate of change in the participation of stocks.

Another advantage of these indicators is they are not capitalization-weighted like the stock index. For example, the S&P 500 stock index weighs the larger company stocks more than smaller company stocks. The index includes 500 leading companies and covers approximately 80% of available market capitalization. The cap weighting methodology results in asymmetry between the sector and stock weighting. Out of 500 stocks, the top 10 are 22% of the S&P 500. So, exposure from only 0.01% of the stocks in the index drives 22% of the index trend. They are the largest companies in America.

Apple Inc. 4.30 %
Microsoft Corporation 4.30 %
Amazon.com Inc. 2.90 %
Facebook Inc. Class A 1.79 %
Berkshire Hathaway Inc. Class B 1.70 %
JPMorgan Chase & Co. 1.62 %
Alphabet Inc. Class C 1.54 %
Alphabet Inc. Class A 1.53 %
Johnson & Johnson 1.35 %
Exxon Mobil Corporation 1.21 %

Why does it matter?

See for yourself. The equally weighted S&P 500 index has gained significantly more since inception, although there have been long periods when it lags. Of course, the performance divergence is driven by the smaller company stocks that get more weighting in the S&P 500 Equal Weight Index. When small stocks are trending strong, the equal weight wins.

As always, looking at a historical price isn’t complete without observation of the ASYMMETRY® Ratio. The drawdowns between both indexes are similar, except for a notable divergence from 2000 to 2005. The large cap-weighted index actually declined more. The divergence was driven by heavier weighting in the large-cap growth stocks which were mostly technology.

So, you can probably see how an equal weighting of stocks may be a better guide for the quality and participation of a market trend.

That leads us to the indicators, which are also size agnostic. One stock is one vote.

The High-Low Index is a 10-day moving average of Record High Percent, which equals new 52-week highs divided by the sum of new 52-week highs plus new 52-week lows. This breadth indicator shows when new highs outnumber new lows and when new highs are expanding. So, new highs outnumber new lows when the indicator is above 50. We can also say new highs are expanding when the indicator is above 50 and rising, or contracting when it’s falling. Many stocks in the S&P 500 have been reaching new highs and it’s reached the high level that, in my opinion, suggests the market could become exhausted. I say that because after most stocks have already reached a new high, the enthusiasm to buy may have run its course. At this point, we start to monitor for a trend reversal. When individual stocks start to break down, we’ll see them in their individual price trend charts, but also in indicators like the High-Low Index. In the chart below I marked the extreme level in red and the peaks are also colored. Below the indicator, I include the stock index. The signal is not perfect, none are, but we can observe how it tends to interact with the price trend. This is admittedly a small sample size, but you probably see the point.

Hi Lo Index S&P 500 SPX SPY

Next is the S&P 500 number of stocks above their 200-day moving average. It is of no use to apply too many indicators if they reach the same conclusion or drive the same signal. The percent of stocks indexes are based on the status of price trends in the stocks, not the number making all-time new highs or lows. My observation here is once again, the number of stocks trending above their 200-day moving average is on the high end right now. This indicator cycles up and down as the stocks trend up and down. It’s at a peak, so we shouldn’t be surprised to see some exhaustion in buying pressure and the price trends stall or turn down at least briefly. Of course, it’s an imperfect indicator, so the stocks can remain in uptrends for months after this high level of participation has been reached. We see an example in the middle of the chart.

Percent of S&P 500 stocks above 200 day moving average $SPXA200

Next, we zoom in to the shorter-term trend, using the 50-day moving average. For no reason whatsoever, I’m also showing his chart as the percent of stocks above their 50-day moving average, rather than the number. Here we see something interesting. As 74% of stocks are in a longer-term uptrend as measured by the 200-day moving average, the percent of stocks in shorter trend uptrends is only 66%.  The trend is also down, showing less participation in the shorter-term trend.

percent of stocks below 50 day moving average S&P 500 index SPX SPY

My interpretation is the stocks inside the index seem to be getting weaker looking at 50-day trends. It signals about 35% of stocks are presently in 50-day downtrends and we may see that number expand.

It’s also concerning to observe fewer and fewer stocks have participated in uptrends since July.

I could go deeper and look at the breadth of the individual sectors. The short version is, the Financial, Industrial, and Utilities are participating most in uptrends and Energy, Consumer Staples, and Telecom are not.

bullish percent sector

I enjoy looking at charts for visual observation of what is going on but don’t have to sit around watching these indicators as I have developed systems that alert me when they reached extreme points of interest.

At this level, we may see some enthusiasm exhaustion because once stocks have already trended up, it takes a boost in optimism to continue to drive the momentum.

Looking at the already high levels of sentiment I shared last week in Investor sentiment signals greed is driving stocks as the U.S. stock market reaches short term risk of a pullback, it seems less likely we will see prices move a lot higher from here without a pause or dip. I consider this a higher risk level for stocks.

We’ll see…

Why does any of this matter? read Why we row, not sail.

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The use of this website is subject to its terms and conditions.

 

 

Why we row, not sail

When a market is rising, we can let out the sail and enjoy the ride, but when the wind stops, we row, not sail.

I started using this analogy in 2005 after reading my friend Ed Easterling’s book Unexpected Returns, which is a fine example of the distinction in mindset between tactical and dynamic risk management decisions vs. traditional (passive) asset allocation.

About sailing, he said:

Most investors, especially those with traditional stock and bond portfolios, profit when the market rises, and lose money when the market declines. They are at the mercy of the market, and their portfolios prosper or shrink as the market’s winds blow favorably or unfavorably. They are, in effect, simple sailors in market waters, getting blown wherever the wind takes them…

In sailing with a fixed sail, the boat moves because it grabs the wind; it grabs the environment and advances or retreats because of the environment. Relative return investing corresponds to this fixed-sail approach to sailing. When market winds are favorable, portfolios can increase in value rapidly. When the winds turn unfavorable, losses can accumulate quickly. Bull markets are the friends of relative return sailors, and catching the favorable bull market winds and continuing to ride them are the secrets to making money in a bull market.

About rowing, he said:

Rowing, as an action-based approach to boating, is analogous to the absolute return approach to investing. The progress of the boat occurs because of the action of the person doing the rowing. Similarly, in absolute return investing, the progress and profits of the portfolio derive from the activities of the investment manager, rather than from broad market movements.

Around 2005 I taught a course to portfolio managers via DWA Global Online University on presenting global tactical investment management and dynamic risk management to investors because it was challenging to get clients to understand why we row, not sail.

For example, we use a chart like this one to illustrate the secular bull and bear market periods are made up of several years of uptrends followed by several years of crushing downtrends.

Secular bull bear market trend chart

It doesn’t matter if you gain 100% or 200% in an uptrend if you lose your gains in a -50% downtrend.

The foundation of my ASYMMETRY® Investment Program that focuses on asymmetric risk/reward is a deep understanding of the mathematics of loss. Most of the investment industry tells investors they should hold on through losses. However, I believe investors’ natural instinct to limit loss is mathematically correct.

asymmetry of loss losses are asymmetric risk management

As we show in more detail on ASYMMETRY®  Managed Portfolios: As investors are loss averse, losses are also asymmetric. So, the natural instinct to avoid large losses is mathematically correct.

A -50% decline requires a gain of 100% just to get back to where it started.

For example, the more than -50% loss in U.S. stock indices from October 9, 2007, to March 9, 2009, wasn’t recovered until late 2013, nearly six years after it started.

The -50% loss took a 100% gain and six years to recover.

As losses increase, more gain is necessary to recover from a loss. The larger the loss, the harder it becomes to get back to the starting point before the loss. This asymmetry of loss is in direct conflict with investors’ objectives and provides us with a mathematical basis for active risk management and drawdown control.

This is why I row, not sail.

When a market is rising, we can let out the sail and enjoy the ride, but when the wind stops, I get out the oars and start rowing.

I prefer not to sink to the bottom.

The last bear market may be becoming a distant memory of investors, but those who forget the past are doomed to repeat it.

Don’t.

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

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The use of this website is subject to its terms and conditions.

 

Investor sentiment signals greed is driving stocks as the U.S. stock market reaches short term risk of a pullback

The Fear & Greed Index reaches the Extreme Greed level as I got a short term countertrend sell or hedge signal for U.S. stocks.

Investors are driven by two emotions: fear and greed.

Too much fear can drive stocks well below where they should be, an overreaction to the downside.

When investors get greedy, their enthusiasm to buy may drive stock prices up too far, an overreaction to the upside.

The Fear & Greed Index is a simple gauge that attempts to signal which emotion is driving the stock market. It’s made up of seven indicators, and though it doesn’t generate a perfect timing signal, it’s useful for investors to compare to their own sentiment.

fear greed index investor sentiment

As I pointed out last week, expected volatility has also declined to a low level. The VIX is now in the 12 range.

Here is a chart of the Fear & Greed index over time. As we highlighted, it’s at its historical peak.

fear greed index over time

Investors tend to want to do the wrong thing at the wrong time, so measuring extremes in overall investor sentiment is a useful way to modify investor behavior.

I operate with a massive intention of feeling the right feelings at the right time. Some claim to use systems to overcome their feelings or remove feelings altogether, but as a tactical decision-maker, I know it isn’t actually possible. I prefer to experence my emotions and let them be but have shifted my mindset to feel the right feeling at the right time.

Based on my systems and indicators, suggesting sentiment and price trends have reached a point of extreme, I feel more defense right now. My quantitative methods drive my feelings. I see the signal, get a good sense about it, then pull the trigger.

As sentiment is reaching the extreme greed level, as see the S&P 500 index below is at all-time new highs.

When I see such enthusiasm, it’s initially good for momentum, but it eventually fades and so does the price trend.

But, it doesn’t matter if we monitor quantitative measures without them driving our decisions. When I see points like this, it’s just a reminder to review my portfolio to see if I’m comfortable with the risk/reward exposures. If I see asymmetric risk/reward, I do nothing. If I have too much risk exposure, I reduce it or hedge it off.

We shouldn’t be surprised to see a decline of 2-5% from here or at least a pause, but anything is possible.

Being prepared in advance is a useful way to avoid bad investor behavior, which is why I predefined my exposure to the possibility of loss by knowing in advance when I’ll exit or reduce the exposure.

 

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 are 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. The use of this website is subject to its terms and conditions.

Global Macro Observations of Stock and Bond Market Trends and Volatility

The U.S. stock market indices are finally reaching new highs, but momentum indicators show them getting overbought at the same time. Nevertheless, the trend is up and volatility is declining as the trend of the S&P 500, for example, has tightened up with the range of prices not as spread out as it was.

Speaking of volatility, the next chart is an observation of the stock index price trend with the 30 Day Rolling Volatility to see how it interacts. The formula for the 30 Day Rolling Volatility is Standard Deviation of the last 30 percentage changes in Total Return Price x Square-root of 252. YCharts multiplies the standard deviation by the square root of 252 to return an annualized measure. 252 is the number of trading days in a year.

I consider it an observation of realized volatility since it’s a measure of the last 30 percentage changes of price. Here we observe the 30 Day Rolling Volatility has declined recently, though it still isn’t as low as it was a few months ago.

Realized historical volatility is in a contraction, so after it declines we shouldn’t be surprised to see volatility expand again since volaltity is mean-reverting.

It’s an observation that volatility was dynamic, not static, so it’s constantly trending and cycling up and down. Volatility contractions are often followed by volaltity expansions as investors oscillate between the fear of missing out and the fear of losing money.

The CBOE S&P 500 Volatility Index (VIX) on the other hand, is a measure of implied volatility based on options prices of the stocks in the S&P 500.  The VIX measures expected volatility. As we see below, the VIX is close to its low around 12 it reached twice this year.

Once again, an indication that we could see a volatility contraction anytime from this starting point. Or, the uptrend in stocks and downtrend in their volatility could continue.

We could look a lot deeper into more measures, such as the VVIX Index, which is an indicator of the expected volatility of the 30-day forward price of the VIX. This volatility drives nearby VIX option prices. CBOE also calculates a term structure of VVIX for different VIX expirations. It’s the vol of implied vol.

At this point, the trend for U.S. stocks is up, and the volaltity is quiet.

At the same time, U.S. stock short term momentum is reaching overbought, long term U.S. treasury bonds are oversold. An example observation is the ICE US Treasury 20+ Year Index. Overall, these bonds are in an uptrend over the past year but have corrected recently. I wouldn’t be surprised to see the long term treasuries find some buying demand here and resume the uptrend. If they don’t, there are prior levels of support for a predefined exit to cut a loss if it doesn’t work out.

Within the U.S. high yielding dividend stocks have shown relative strength and good momentum this year. The trend is seen in the index below.

As seen in the trend of the S&P Global Dividend Opportunities Index, the same is true for global high dividend stocks. 

Looking beyond stocks and bonds, the trend of gold has finally turned up after being flat for over five years.

Gold over the past 10 years shows a strong trend post-2010, a downtrend, then a generally non-trending period for years until recently.

You can probably see why a robust trend following system and risk management is useful for markets including gold. If the 10-year chart didn’t make the point, this chart going back to the 1970s probably will.

There is a time for everything under the sun.

There is a time for offense and time for a defense.

The recent trend in gold is more clear over the one-year time frame.

That’s all for now.

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 flaw of average in stock market returns

We apply a lot of probability and statistical analysis for investment management and also our wealth management and strategy.

However, I do it with a complete system and framework that includes a heavy dose of skepticism and acceptance of reality.

There are many things we just can’t know and many other things people believe they know that just ain’t true.

Then, there are many flaws in the perception and how investors and wealth management clients use data.

Like a financial engineer, I focus on what may be wrong, what may go wrong, and how our thinking could be flawed. To achieve this level of reality, we necessary think deeply about it and share our independent thinking with other believable people who may disagree.

One of the flaws I see most often in investment management, retirement planning, and retirement income management is the flaw of averages.

The flaw of averages is the term used by Sam L. Savage to describe the fallacies that arise when single numbers (like averages and average returns for stock and bond markets) are used to represent uncertain outcomes.

A great example of the flaw of averages is a 6 ft. tall statistician can drown while crossing a river that is 3 ft. deep on average.

the flaw of averages stock return

Too often we see the reliance on historical “average returns”.

Yet, almost 80% of rolling decades since 1900 have delivered returns 20% above or below the historical average

So, there is an 80% chance that the total nominal return for the next decade will be either above 12% or below 8%.

And, then, there could also be underwater periods that are much longer and deeper than the average portrays. These periods may cause investors to tap out when the water gets too deep, or the deep water lasts too long.

 

You can probably see why I think it’s essential to tactically manage risk to actively direct and control the possibility of loss and control drawdowns.

Knowing what I know, I don’t offer investment management any other way.

It’s why we describe it on the front page of our website at Shell Capital.

 

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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.

What I learned about Semper Fi from former Tennessee Coach Phillip Fulmer

It may seem odd to hear a U.S. Marines Veteran who never played football under Phil Fulmer say he learned something about the Marine Corps motto “Semper Fi” from the old Tennessee coach.

Afterall, Semper Fi means “always faithful” but it also means “always loyal“.

I have learned a valuable lesson from this past decade from the firing of Phillip Fulmer as any Tennessee Volunteers fan probably has.

Before I go on, I’ll also be the first to say I am fully aware the following is an example of outcome bias: the tendency to judge a decision based on the outcome, rather than the quality of the decision at the time it was made. Outcome bias is a significant error observed often in investment management, but it applies to all human endeavors.

Back in 2008, Dusty Floyd explained it well:

150 career wins, a winning percentage of almost 75 percent, a national title, and five trips to the SEC championship in 17 years. How would a coach with this kind of résumé get fired?

Tennessee football coach Phillip Fulmer has done a great job at the University of Tennessee but has struggled in the past few years. In the past four seasons, Tennessee’s record has been 27-20. That’s way below par for a school with as much tradition as Tennessee has.

I have to admit,  I too was excited when the University of Tennessee announced the hiring of Lane Kiffin. At the time, it seemed the fresh eyes and energy of a younger coach with a chip on his shoulder and something to prove was an exciting new direction for the Vols. I was especially excited to hear Lane Kiffin’s father, the famous Monte Kiffin of Tampa Bay Bucs, was going to join him along with an excellent recruiter Ed Orgeron. It seemed Tennessee had the potential to become an NFL looking powerhouse. And, it did.

At the same time, we were renovating Neyland Stadium and I was grateful to be able to invest in the prestigious new West Club. The donation was large enough to get a plaque on the front of Neyland Stadium behind the General Neyland statue, who was the only coach to win more games than Fulmer as a UT football coach.

Mike Shell Capital Neyland Stadiium Statue

On the wall behind the statue are the names of the proud donors, myself included.

Mike Shell Capital Neyland Tennessee Volunteers Vols Knoxville

We enjoyed the games at the West Club and most of the time stayed on our boat with the Vol Navy for the long weekend.

After a period of walking the walk of shame, losing to teams Tennessee should beat, we eventually bought a second home in Tampa, Florida and spent the winter and football season there. Now, we spend most of our time there and this summer was our first summer in Florida.

I’m not going to rehash what happened next and the roller coaster of the past decade. It’s a national story at this point. One of the most storied football programs in the county has had some highs, but many lows. Fortunately, with a few well-timed picks, we’ve got to be present for the highs such as the huge win over Virginia Tech at The Battle of Bristol, which holds the record for NCAA football’s largest single-game attendance at an astonishing 156,990. It was held at the Bristol Motor Speedway and we enjoyed it very much.

A football coach is measured by quarters, games, and seasons. If he doesn’t have the assistant coaches and players he wants, he has to make due and wait until next season. So, it could take a few years to get the adjustments right.

Phil Fulmer had lost David Cutcliffe, the outstanding UT offensive coordinator, who became the head coach of Duke, where he still is today. When Cutcliffe left, the offense struggled, and UT had it’s second losing season since 2005. So, one of the winningest coaches in college football history agreed to resign in a very emotional press conference.

I didn’t like the way that press conference felt, seeing the extremely passionate Phil Fulmer emotional on a national podium. It felt like betrayal and disloyalty then. It felt like a very proud football program had cut out one of its own, who played football at UT, in favor of a younger more aggressive coach with something to prove. At the time, Fulmer seemed to be still enjoying the fame of the 1998 National Championship and many SEC East wins.

Then came the young Lane Kiffin. We had hope of his fresh energy, but we know how that turned out. His true dream job opened up the very next season, and he bolted for the University of Southern California. Who could blame him? He had coached at USC and wouldn’t have to compete in the powerhouse Southeastern Conference and the likes of Nick Saban’s Alabama, Auburn, Georgia, Florida, LSU, and the list goes on.

Nevertheless, it was a harsh lesson of loyalty. Kiffin wasn’t loyal, but Fulmer was.

We’ve since had to endure the roller coaster of Dooley, Butch Jones, and now the new Jeremy Pruitt. Pruitt certainly has a better history than the former, so we’ve got to give him a chance to get it right. It isn’t going to happen overnight. He may have a rocky start on Rocky Top, but at this point, we’ve got to apply some semper fi. We now have Fulmer back at UT as the Athletic Director and he picked Pruitt, so let’s give him what he needs to succeed.

I’m going to the Tennessee vs. Georgia game today. We won’t be in our old West Club seats, but we’ll be front and center. Sure, we know the probable outcome in advance, but we’re here in Knoxville to cheer them on, win or lose.

The same applies to investment management.

If I applied the same mindset to any of my most profitable trading systems over the past two decades, we would have missed out and never achieved their long term asymmetric risk/reward profile. I operate about three dozen unique systems and not a single one of them wins all the time or always achieves our desired outcome. I have scientifically backtested thousands of systems of entry, exit, and position sizing, and risk management and even with perfect hindsight, we are unable to create perfect systems that perform well over every single market regime and condition. Even when I add my own skill, intuition, and experience I am unable to make it perfect.

What I’ve learned as an investment manager all these years is we have to make it okay to lose, or we would never cut our losses short and prevent them from growing into large losses. We have to be willing to experience imperfect periods of performance because we simply can’t achieve the asymmetric risk/reward profile we want to create without accepting the periods it doesn’t look as we want.

Today, I”m reminded of what I’ve learned about semper fi from Phillip Fulmer as I’m going to attend my first Tennessee football game since he became the UT AD.

There are many similar parallels between investment management and football coaching. There is a time for offense and a time for defense. Both require tremendous commitment, discipline, and execution to operate successfully long term. Some are much better at it than others and there is a significant divergence between the skill of the best and the mediocre.

What did I learn from Phil Fulmer?

Semper Fidelis: Always be faithful and loyal. 

Stick to the system and stick with good people with passion. 

In hindsight and a large dose of outcome bias, I’m pretty sure Phil Fulmer would have achieved more the past decade.

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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.

I don’t always comment on economic indicators, but when I do, it’s a trend like ISM Manufacturing Index

The ISM Manufacturing Index monitors changes in production levels from month to month and is considered an important economic indicator by many global macro investment managers. Some of them consider a level above 50 as an indicator of a growing manufacturing sector.

However, the current level is now down to 47.30, down from 49.50 last month and down from 63.90 one year ago. This is a change of -4.44% from last month and -25.98% from one year ago.

Global Macro traders and investors who rely on economic indicators monitor the ISM Manufacturing Index to observe US economic trends and conditions. When the index is rising, they expect a bullish stock market in reaction to higher corporate earnings. Looking at the past year, the level is in a downtrend. As such, this downtrend may be bearish for the economy and stock market.

In fact, there seems to be a trend here as I broaded out the time horizon to see the bigger picture. ISM Manufacturing Index is also in a downtrend over the past three years.

We can say the same about the past five years. This economic indicator is trending down and in a downtrend.

Next is the 10-year trend. Over the past 10 years, the recent trend is notable.

Looking back over the full period I have data, which is before 1950, the historical trend suggests it could get worse, but it’s also at the lower range it has reached before it does.

So, this economic indicator suggests as investors, we had better be prepared and aware of the situation as tactical risk management is likely to be more obviously necessary for the near future. This is potentially negative for stocks from this point.

What about bonds?

The opposite is the case for bonds. Bonds may fall as the ISM Manufacturing Index rises and in an uptrend because of the sensitivity of bonds to inflation. However, when the ISM Manufacturing Index is declining like it is now and in a downtrend, it can be positive for bonds.

The funny thing is my directional price trend systems already have us meaningful exposure to long term U.S. Treasury bonds.

You see, I don’t have to know about economic indicators or follow them, my systems and methods identify when the trends are actually starting as well as when they reverse. When they do this well, we naturally get in sync with the price trends and what these economic indicators observe.

It looks like there are real signs of a slowing U.S. economy. As such, investors need to be prepared and not be complacent with non-risk managed holdings in their portfolio. I manage our risk at Shell Capital Management by predefining my exits on all of our holdings, hedging, and tactically investing in the direction of trends and sometimes likely countertrends. It’s what our clients pay us for. As this economic expansion is very aged as is the bull market in stocks, the only certainty is the change we’ll see in the future. What has been trending up so long will eventually trend down.

I’m as prepared as I’ve ever been and probably better now than I was in the past when I operated through such conditions.

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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.

 

 

 

 

 

 

 

 

 

 

 

 

 

Implied volatility as measured by VIX indicates a volatility expansion in the near term

Implied volatility as measured by VIX indicates wider prices in the near term. The CBOE Volatility Index VIX has increased to 20, which is it’s long term average, suggesting prices will spread out to 20%.

Along with a volatility expansion, as typical, we are seeing stock prices trend down.

My leveraged exposure to the long term U.S. Treasuries has offered an asymmetric hedge in recently. The long term U.S. Treasuries don’t always play out this way, but this time we’ve benefited from their uptrend and some negative correlation with stocks.

Gold is another alternative used as a hedge exhibiting relative strength and time-series momentum.

 If this is just a short term correction, we should see some buying interest near this point or a little lower. If last month’s lows are taken out, this may be the early stage of a larger decline.

We were well-positioned in advance this time, so we’ll see how it all plays out.

 

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

Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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.

 

 

 

 

 

 

 

 

 

 

 

What is going on? 3rd Quarter Market Trends and Mean Reversion

The third quarter is now in the past, so I’ll share a few observations of what is going on.

First, below is the S&P 500 stock index over the past quarter. For observation purposes, if we simply define an uptrend as higher highs and higher lows and a downtrend is lower lows and lower highs, what do we have here?

I guess we have to add a non-trend, which is when the price trend made a lower high like it did last month but still bound within the range of the prior low.

No trend analysis is complete without also observing the drawdowns along the way. At this point, the SPX is about -3% off its high and its already getting attention in the headlines.

Stretching the price trend out farther to the past year, we see it is barely positive and I define this trend as non-trending and volatile.

The drawdowns over the past year have ranged from -5%, which we normally see about three times a year, to -20% which is less common.

What about mean reversion?

In investment management, mean reversion is the belief that a stock’s price trend will tend to move toward its average price over time.

So, you can probably see how we can use simple moving averages to illustrate mean reversion and the potential for countertrends.

I don’t trade off of moving average signals since I have my own algorithms that define the trend direction, momentum, and volatility. But, most investors have a basic understanding of moving averages so they are useful for sharing observations.

During the quarter, the S&P 500 dropped below its 50 day moving average, which is a shorter-term trend measure. Yesterday, it trended down below that trend line again. A -5% decline would be normal, as we observe them two or three times a year.

I included the 200-day moving average in the chart as well. The 200 day has been a popular trend following indicator, though it has had many whipsaw signals. A whipsaw is when the price trend trades above or below the moving average and then reverses the other way. Any trend following signal has the potential to result in whipsaws, though some are better than others.

So, what we have here is a sideways quarter with a price trend that has been range-bound.  Year to date, however, the stock market is off to a strong start, but that’s because 2018 ended with a sharp waterfall decline that recovered some of the losses the first two quarters this year.

Fortunately for us, we had exposure to alternative assets, some hedging, and some stronger momentum positions that have resulted in a more smooth quarter than is trending in the right direction.

Investors need to realize this is a very aged old bull market and the economic expansion is one of the longest in American history. If you are investing based on recent past returns of the past five or ten years, I believe you are going to experience some longer-term mean reversion in the coming years. By my measures, investors seem to be complacent again, as they were in 1999 and 2007, so it seems we may be getting closer and closer to a different kind of trend.

Investors didn’t want tactical risk management before the big bear markets, they wanted it after the fact.

The next time will be no different.

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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.

 

 

 

 

Divergence between Value, Growth, and Momentum.

There is an interesting divergence today between Momentum, Growth, and Value.

Up until now, Value has lagged Growth and Momentum, as seen in this 5-year chart.

The underperformance of Value has been a topic of conversation of hedge fund managers I know who are Value investors.

Three-month momentum shows Value is trending up.

I believe styles like Growth vs. Value are largely driven by sectors, which is why I tend to focus more on the more granular sectors rather than broader styles.  Today we see the relative strength is in Energy and Financials, which have been the lagging sectors lately.

value underperforming growh momentum

So, this may not be enough to say the trend is changing to a period where Value outperformance growth for years, but it’s at least enough to be aware.

At some point, Value will take over leadership and when it does, it may continue for years.

For now, exposure to Value, including high dividend-paying stocks like we have, is having a good day while other factors are not.

 

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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.

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

 

 

Global Macro observations and the period of indecision ends with an upside breakout in stocks

In the last observation, The stock market is in a period of indecision that it will break out of I shared:

Looking at the price trend of the S&P 500 index over the past six months, today’s 1.4% move so far has the trend tapping the upper end of the range. I encluded this chart last Thursday:

asymmetric risk reward return stocks

Here we are a week later, and sure enough, this stock index broke out of the range.

stock market spx spy trend

Of course, past performance doesn’t assure future results, so while this upside breakout is positive, it isn’t without some risks and potential headwinds.

I hedged off some of my market risks, based on pattern recognition hedging the price trend could once again fall back to the lower red line. Of course, my exits on these hedges are predefined, as always, so none of the following global macro observations have any real tactical decision-making authority.

When I enter a position, I predetermine at what price I’ll exit if it becomes a loser or overtime, a laggard.

I’m no economist, so I rarely mention any economic data trends as they don’t lead to actionable tactical signals to buy or sell. However, one of the economy’s strongest segments may be showing signs of weakening: job growth, and it seems important enough to mention. On the global macro front, it seems like the market wasn’t concerned about employment data, and for now, it was right. 

In the big picture from a global macro perspective, the probabilities of a recession are trending higher, earnings growth is lagging, and business and manufacturing sentiment are trending lower. These may be necessary issues the U.S. has to deal with to get through the trade war with China.

On the other hand consumer confidence, spending, and employment have been able to withstand difficult conditions and recover. Up until now, the consumer and employment has been the bright spot. From this point forward, any weaknesss in consumer spending, confidence, and employment is a risk. Momentum in job growth has turned down from a cyclical peak this year, so I’m guessing it’s something that may become an issue eventually. When it comes to global macro data, there’s always something to worry about, so I don’t make my decisions with it.

Today’s employment data was a little better than expected, so it’s a driver of today’s stock market upside breakout. As past performance never guarantees the future, it may be different next time.

Until then, the stock market has indeed broken out of its coil and is sprung 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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 in a period of indecision that it will break out of

As I’ve been pointing out all month in August, the stock market is in a period of indecision, that it will eventually break out of.

Looking at the price trend of the S&P 500 index over the past six months, todays 1.4% move so far has the trend tapping the upper end of the range.

asymmetric risk reward return stocks

Zooming in to the beginning of the month of August, it’s been a month of indecision. Those who want to buy are battling with those who want to sell.

The range of the price trend has spread out, as was implied by the CBOE S&P 500 Volatility Index VIX. It’s been a relatively volatile month with this big-cap stock index swinging up and down in a range of 4%.  As we can see in the chart below, the VIX trended up sharply as stocks declined in price.

What we also see, however, is implied is settling back down as the price trend is swinging up and down in this 4% range of indecision.

What’s going to happen next? 

I don’t need to know what’s going to happen next. I know exactly what I’ll do next with my positions if they continue trending up, or reverse back down.

Using this stock index as an example, if it breaks below this range it’s bearish, but if it has the buying demand to break above it, the uptrend resumes.

That’s why we call price action as we’ve seen this month a base patter and we’ll eventually see a big move out of it one direction or the other.

The S&P 500 index is an unmanaged index and cannot be invested into directly, but if we could and I wanted to be long stocks, I would exit if it fell below the three recent lows.

If I wanted to be short, I would exit if it broke out above the prior high.

This is just an oversimplified example of how I tactically manage risk.

Hurricane Dorian looks to add to the August volaltity.  Hurricane Dorian is now expected to intensify into a Category 4 hurricane as it moves toward Florida and the U.S. Let’s hope it loses its momentum. I’m in Tampa Bay on the other side. It should slow down by the time it reaches us. Our home is made of concrete, tile roof, and 150 MPH hurricane windows, so we’ll be fine.

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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 S&P 500 stock market index is holding the line

The stock index is holding the line so far.

spx spy technical analysis trend following asymmetric risk reward retrun

You can see the percent of S&P 500 stocks trading above their 50 day moving average closed at 30% last week. It’s also testing a low trend, not it is a real trend where buying/selling pressure exists, it’s just a line showing the percent of stocks in short term uptrends are where they were at the May low.

spx percent of stocks above 50 day moving average $SPXA50R

Next, we see the percent of stocks above the longer-term trend closed at 55% last week, the same level as the March and May lows.

$SPXA200R spx percent of stocks above 200 day moving average trend following breadth

CBOE S&P 500 Volatility Index $VIX only dropped -2.77%, which is light, considering the S&P 500 closed up 1.1%.

The options market last Friday showed asymmetry between put buying and call buying with the market favoring puts 144%. Index options seem to be mostly used for hedging.

Individual equity options are more traded for speculation. Put buying was high on individual stocks last Friday, too. You can see the typical range is much lower.

This isn’t advice for anyone as this index cannot be traded directly, but I want to make a point that if I wanted to take a position here to increase explore, I would place my exit just below the red line. The red line is the May and March lows, so if the price trend falls below that, the trend changes from up to down. Lower highs and lower lows is a simple example of a downtrend. I just wanted to point that out as a very simple example of a tactical trade based on the price trend.

spx stop loss

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 focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only 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. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. 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.