This map from Smart Thermometers may have predictive power about Coronavirus COVID – 19

As you know, I do quantitative research of trends, trend changes, and such, which are usually applied to global market trends. I have been studying some quantitative data that appears to front-run COVID – 19 by about a week.

In other words, it appears to have predictive value.

Most of what I’ve seen reported suggests the increase in hospital cases will peak in the next few weeks. Based on what I’m seeing, we may instead observe peak in hospital cases much sooner, as in the next few days.

First, the Observed Illnesses is an index of how severely the population in this area is being affected by influenza-like illness, according to Kinsa Insights.

The next map is The U.S. Health Weather Map, which is a visualization of seasonal illness linked to fever – specifically influenza-like illness, according to Kinsa. What they are calling “atypical illness”, may in some cases be connected to the COVID-19 pandemic. “The aggregate, anonymized data visualized here is a product of Kinsa’s network of Smart Thermometers and the accompanying mobile applications. Kinsa is providing this map and associated charts as a public service.

Kinsa explains on the website:

This chart allows us to compare Kinsa’s observations of the influenza-like illness level in the U.S., in orange and red, against where Kinsa expects them to be, in blue Based on their data, influenza-like illness levels in the U.S. are higher than what we’d expect at this time of year, according to the website.

They go on to explain:

The map shows two key data points:

(1) the illness levels we’re currently observing, and

(2) the degree to which those levels are higher than the typical levels we expect to see at this point in the flu season.

Please note: We are not stating that this data represents COVID-19 activity. However, we would expect to pick up higher-than-anticipated levels of flu-like symptoms in our data in areas where the pandemic is affecting large numbers of people. Taken together with other data points, we believe this data may be a helpful early indicator of where and how quickly the virus is spreading.

Notice in the map above, California is gray now, it was red before. They note: 

Due to widespread social distancing, school closures, stay-at-home orders, etc. influenza-related illness levels are dropping in many regions. In some regions (e.g. CA) they’re dropping below the expected range for this time of year — which reduces the level of atypical illness to zero on our map

I believe this is fascinating and seems to suggest it is likely we’ll see a peak in hospital cases much sooner, as in the next several days. If so, it may also mean Coronavirus passes through faster than many expect. In that case, it would be an unexpected improvement for the economy and stock market, if we aren’t shut down as long.

I like the direction of this trend.

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Check out the incredible US Health Weather Map powered by Kinsa Insights. Also see Can Smart Thermometers Track the Spread of the Coronavirus? from The New York Times, which is where I first learned of it.

Let’s see how it trends from here.

I’m going to be sharing some very interesting observations in the weeks ahead, so I encourage you to follow along by entering your email below for notifications.

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.

Good news for the stock market

Something we have warned about for a while now is the elevated valuation level of stocks in general.

To be sure, I search for “Shiller PE” here on ASYMMETRY® Observations to mention the most recent times.

I promise I’m not just tooting my own horn here. The intent is to make the point that these things were present before this market crash and it’s starting to get cleared up. The same person who wrote about it then is now looking for the trend to change. But, to fully understand, we have to go back and see where we are coming from to know where we are now.

February 6, 2020 19 is the new 20, but is this a new low volatility regime?

I wrote:

  1. The current bull market that started in March 2009 is the longest bull market in history. It exceeded the bull market of the 1990s that lasted 113 months in terms of time, though still not as much gain as the 90s.
  2. The U.S. is in its longest economic expansion in history, breaking the record of 120 months of economic growth from March 1991 to March 2001, according to the National Bureau of Economic Research. However, this record-setting run observed GDP growth far slower than previous expansions.

The aged bull market and economic expansion can naturally lead to some level of complacency and expectation for less downside and tighter price trends. When investors are uncertain, their indecision shows up in a wide range of prices. When investors are smugger and confident, they are less indecisive and it’s usually after a smooth uptrend they expect to continue.

Is it another regime of irrational exuberance?

“Irrational exuberance” was the expression used by the former Federal Reserve Board chairman, Alan Greenspan, in a speech given during the dot-com bubble of the 1990s. The expression was interpreted as a warning that the stock market may have been overvalued. It was.

Irrational exuberance suggests investor enthusiasm drives asset prices up to levels that aren’t supported by fundamental financial conditions. The 90s ended with a Shiller PE Ratio over 40, far more than any other time in more than a century.

Is the stock market at a level of irrational exuberance?

Maybe so, as this is the second-highest valuation in the past 150 years according to the Shiller PE.

shiller pe ratio are stocks overvalued

Before that, on January 17, 2020 in

The aged bull market and economic expansion can naturally lead to some level of complacency and expectation for less downside and tighter price trends. When investors are uncertain, their indecision shows up in a wide range of prices. When investors are smugger and confident, they are less indecisive and it’s usually after a smooth uptrend they expect to continue.

Is it another regime of irrational exuberance?

“Irrational exuberance” was the expression used by the former Federal Reserve Board chairman, Alan Greenspan, in a speech given during the dot-com bubble of the 1990s. The expression was interpreted as a warning that the stock market may have been overvalued. It was.

Irrational exuberance suggests investor enthusiasm drives asset prices up to levels that aren’t supported by fundamental financial conditions. The 90s ended with a Shiller PE Ratio over 40, far more than any other time in more than a century.

Is the stock market at a level of irrational exuberance?

Maybe so, as this is the second-highest valuation in the past 150 years according to the Shiller PE.

shiller pe ratio are stocks overvalued

Before that, on January 17, 2020 in What’s the stock market going to do next? I included:

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.

As a matter of fact, I was quoted three times in Barron’s and MarketWatch in November 2019 and January 2020 warning of the elevated risk level in stocks because of their valuation, the length of the bull market that is 11 years old, and what was a very low level of volatility.

I’m a true independent thinker, and have evidence of that as well. I’m sure my friends at Barron’s may not have liked it when I poke a little fun at the cover on January 18th and made it as clear as it could be! Here is what I wrote in Now, THIS is what a stock market top looks like!

To be fair, I also included how Barron’s had been right before on their cover, but I was just using this as a confirming sign along with many other things I was already seeing.

I followed with;

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. 

Here is the good news. After more than a -30% decline, the S&P 500 Shiller PE is down to 21, which is now within a more normal range, especially if we can assume low inflation. It’s still highly valued, but not the extremely overvalued 32 I warned about several times this year.

At 32 times earnings, it was the second most expensive time for stocks in American history. Second only to the late 1990’s and above Black Tuesday, just before the Great Depression.

The S&P 500 Shiller CAPE Ratio, also known as the Cyclically Adjusted Price-Earnings ratio, is defined as the ratio the the S&P 500’s current price divided by the 10-year moving average of inflation-adjusted earnings. Shiller PE was invented by Yale economist Robert Shiller and has become a popular way to understand long-term stock market valuations. It is used as a valuation metric to forecast future returns, where a higher CAPE ratio could reflect lower returns over the next couple of decades, whereas a lower CAPE ratio could reflect higher returns over the next couple of decades, as the ratio reverts back to the mean.

The mean is 16.70, so it still has a way to go for mean reversion.

The only good thing about falling stock prices is, if you have a lot of cash, as we’ve had, you get to buy stocks and equity ETFs at lower risk entry points. I’m not often a value investor, but I am when prices actually become fairly valued to undervalued.

Another way to observe valuations of the big picture is the S&P 500 PE Ratio. The S&P 500 PE Ratio is the price to earnings ratio of the constituents of the S&P 500. The S&P 500 includes the 500 largest companies in the United States and can be viewed as a gauge for how the US stock market is performing. The price to earnings ratio is a valuation metric that gives a general idea of how a company’s stock is priced in comparison to their earnings per share. Historically, the S&P 500 PE Ratio peaked above 120 during the financial crisis in 2009 and was at its lowest in 1988. I marketed the high, low, and average in the chart.

The trouble is, this PE metric did skyrocket in the last bear market. It’s because in recessions and bear markets, earnings decline. A picture is worth a thousand words, so here is the S&P earnings over the last twenty years with the recessionals in gray.

It all makes more sense when we see all three of the stock market return drivers in one chart. Earnings fall, price falls, dividend increases as the price decrease, and PE spikes up.

Next I show all four; price trend, PE trend, earnings cycle, and dividend yield.

So, the good news is, the US stock market is becoming less overvalued. The downside is, a recession seems imminent as earnings was already expected to slow. This is at least one less risk in the big picture, but we’ll see how it all unfolds from here.

Bear markets are difficult and with all the negative headlines right now, I know it’s hard for people to see light at the end of the tunnel. I don’t see it, either, but as a tactical investment manager, I increase and decrease exposure to the risk/reward and in a volatility expansion, I expect wider swings.

These are fascinating times and past bear markets have been the highlight of my professional investment management career, so sign up if you want to follow along with email notifications of new observations.

Let us know if we can help.

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

Bolted to the chair

Mark Twain’s mother said:

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

I am no Mark Twain.

I’m a tactical trader, so that’s my first purpose.

I’m not always going to take the time to write it out in a format I can share here.

I’ve been bolted to the chair this week but didn’t spend any time sharing my observations.

Instead, I encourage you to do what I did. I went back and reread some observations from January to see what I was seeing and thinking then.

I think about:

What has changed?

How has sentiment changed?

How has the trend direction changed?

Has volatility changed?

Has momentum changed?

Has the narrative changed?

What didn’t we know then we do today?

Is what we believe today congruent with what we believed then?

Here’s what I read:

 

If you do this, you’ll see why.

Historic day for the stock market

Today was just a reversal of Friday’s late-day surge.

SPX SPY TRADING

The stock market is even more washed out.

With the Federal Reserve lowering interest rates and buying back bonds, the long term US Treasury Index reversed back up.

long term treasuries

The stock indexes are down to their 2018 lows and if the selling doesn’t dry up, we may see a mean reversion of the last 10 years. It wouldn’t be surprising for many reasons, especially when we see it happens to be the area of trouble in 2015-16. Keep in mind, the Fed has been a key return driver for the last several years. It doesn’t seem to be working anymore.

spx mean reversion

I’m a risk manager, risk-taker, so I increase and decrease exposure to asymmetric risk/reward as conditions change over time. When I see signs of the selling pressure drying up or buying enthusiasm overwhelming the selling pressure, I’ll be looking to buy stocks again.

That is all.

Let me know if we can help.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas. Shell Capital is 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. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. 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.

Self-discipline, Panic Selling, and the Cycle of Emotions

At the moment, the popular US stock market indexes are down over 25% from their years year-to-date.

STOCK MARKET CRASH 2020

Looking at the Cycle of Market Emotions, where do you think we are at this moment?

THE CYCLE OF MARKET EMOTIONS

The magnitude and speed of the decline are impressive by any measure. For example, below I charted two different historical (realized) volatility measures around the stock index.  The green area is a channel of average true range, which I used to define the normal noise of the market. The waterfall decline has been anything but normal, as it has exceeded two times its average true range several times. We can say the same for the standard deviation, which is the red line.

stock maket crash volatility

This price action is a “black swan” outside anything ‘normal’, so this is an extreme level of panic selling.

Looking at the Cycle of Market Emotions, this is the panic phase

Based on price action across global markets including many alternative assets like Real Estate, Energy MLPs, and investor sentiment measures, this is the panic, capitulation, and despondency phase. The reality of a bear market has to the fore and investors are panicking. Many panic and tap-out from the market from of fear of further losses. Those who stay in and endure the decline may become despondent and wonder whether the markets are ever going to recover. They’ll start to think “this time is different” and we’ve never seen anything like this before.

We haven’t, and this time is necessarily different, as it’s a new moment that never before existed. All market trends are unique because all new momentums are unique – never existed before. But, that doesn’t mean we can use the past to understand future possibilities. History is all we have as a guide and our past experience is essential at times like this.  As my focus is on investor behavior and how it drives market trends, momentum, and volatility, I’ll be sharing my beliefs on this in the days ahead.

Ironically, it’s times like this investors fail to realize markets also reach the point of maximum asymmetric risk/reward after such a radical waterfall decline. We never know in advance if it will keep trending down or reverse. This downtrend has been a fine example as it wasn’t interrupted my much of a countertrend back up. But in the big picture, the more extreme a price move, the higher the likelihood of a swing the other way – at least short term. I said the same about the uptrend. I like uptrends, but sometimes when it comes to momentum; the higher they go, the lower they fall. That’s what we’re seeing now. Investors should also be prepared for the opposite; the speed and magnitude of this decline may result in correspondingly strong countertrend reversals.

THE CYCLE OF MARKET EMOTIONS

This is panic level selling.

This is a volatility expansion, so expect prices to swing up and down.

This price trend will reverse when the selling pressure has exhausted and has driven prices down to a low enough point to attract the enthusiasm to buy.

Surely the trend is nearing that level at least on a short term basis. Market trends are a process, not an event, but this one has been a much faster and deeper process – and it feels like an event.

At times like this, it’s essential to be stoic. For me, as a professional investment manager who has tactically operated through many times like this before, a stoic is being calm,  emotionally intelligent, focus on the things I can control and let go of those I can’t and most of all self-discipline.

Self-discipline is the ability to control one’s feelings and overcome one’s weaknesses; the ability to pursue what one thinks is right despite temptations to abandon it.

I started increasing exposure to stocks after they fell because my managed portfolio was in a position of strength. I was in US Treasuries at the January stock market high, so we missed the first big leg down. We’re participating now as I increased exposure the last two weeks, so my tactical decisions are never perfect and never a sure thing. I don’t have to get it perfectly right every time, which is impossible. I just keep doing what I do, over and over, with great self-discipline and the calm of a stoic.

Hang in there friends, this too shall pass.

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. Shell Capital is 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. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. 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 I’m not surprised to see such a volatility expansion

On November 15, 2019, I published “Periods of low volatility are often followed by volatility expansions” and included the below chart.

The point is just as the title said, when stock prices trend up quietly, they are eventually interrupted by the loud bang of falling prices.

Average True Range ATR use in portfolio management trading volatlity

In this case, it took a few months to see it play out.

Below, I updated the chart so it still has the same starting date, but shows us what happened after I posted it. The 11/15/19 day is labeled on the chart. It had a small decline shortly after, but then resumed the uptrend.

2020 stock market crash volatility expansion

In fact, the stock index went on to gain 9% from that point and was interrupted by only two small countertrend declines of 3-4%.

That is, until February 19th.

Since the peak, the stock index has declined -19% and volatility has exploded.

The volatility measure I used in the chart is an average of the true range, which accounts for a full price range of the period. The average true range is also what I used to draw the channels above and below the price trend to define “normal” price action.

The average true range of the price trend has increased by 420% since December, from 17 to 97. I know it shocked most people in the market and while I didn’t expect a -19% waterfall in just three weeks, I expected a volatility expansion and mean reversion. As I exited stocks a little early, we see now it didn’t matter this time as the stock market has given up far more upside than we missed out on over those few weeks.

Next, let’s look at a chart of implied volatility as indicated by the VIX based on how the market is pricing options. Implied vol spiked over 200%. I also included the 30-Day rolling volatility of the S&P 500 ETF. Implied volatility lead realized, historical, volatility to the upside.

volatilty expansion vix realized

So, the condition of the US stock market is volatile one as prices and swinging up and down, and only December 2008 in the middle of the Financial Crisis was it higher.

vix volatility trading asymmetric risk reward

If the VIX is a fear gauge, it’s signaling a lot of fear.

Again, “Periods of low volatility are often followed by volatility expansions” and that’s what we got. This time it got stretched on the upside so far it has snapped back to very quickly and violently correct it.

The good news is, the opposite is also true; periods of high volaltity are eventually followed by volatility contractions.

But, just as before, as it took time for the volatility contraction to become a volatility expansion, we’ll probably see a continuation of price swings and elevated volatility for a while.

Eventually, this too shall pass.

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. Shell Capital is 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. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. 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.

 

Profiting from the Madness of Crowds

If we want to profit from the madness of crowds, we necessarily need to believe and do different things than the crowd at the extremes.

You may have heard the stock market was down a lot yesterday. I consider yesterday’s price action a black swan event.  The -8% one-day decline was the worst day for S&P500 since 2008 and the 19th worst day since 1928.

The popular S&P 500 stock index dropped -7.6%, which was enough to trigger a circuit breaker to halt trading for the first time in 23 years. Circuit breakers are the thresholds when, if reached during a single-day decline in the S&P 500, trading is halted. Circuit breakers halt trading on US stock markets during dramatic price declines and are set at 7%, 13%, and 20% of the closing price for the previous day.

After yesterday’s waterfall decline, the price trend of the S&P 500 lost the 24% gain it had achieved a month ago.

stock market lost 2020 gain

Interestingly, we’re seeing “mean reversion” as the SPX is now all the way back to the same level it reached in January 2018. In investment management, mean reversion is the theory that a stock’s price will tend to move to the average price over time. This time it did.

mean reversion SPX SPY S&P 500

US equity investors would have been better off believing the market was too overvalued then and shifting to short term Treasuries. But, who would have been able to do that? Who wouldn’t have had the urge to jump back in on some of the enormous up days the past two years? There’s the real challenge: investor behavior. And yes, some may even look back and say they knew then but didn’t do anything. If we believed it then, we can go back and read out notes we made at the time. But, it wouldn’t matter if a belief isn’t acted on. I’m a trigger puller, I pull the trigger and do what I believe I should do in pursuit of asymmetric risk/reward for asymmetry.

Dow Jones is down -16.4% YTD at this point.

dow jones 2020 loss

The Dow Jones has also experienced some “mean reversion” over the 3-year time frame.

dow jones 2020 loss bear stock market

Mid-cap stocks, as measured by the S&P 400, are down, even more, this year, in the bear market territory.

mid cap stock in bear market MDY

Small-cap stocks, considered even riskier, are now down -23% in 2020.

small cap stocks are in a bear market

Clearly, the speed and magnitude of this waterfall decline have been impressive since the February 19th top just three weeks ago. Decreases in these broad stock indexes of -20% are indications of a strong desire to sell and yesterday, panic selling.

So, -20% from peak, the stock market decline has reached bear market territory and is now nearly in-line with the typical market-sell off since 1928 that preceded an upcoming recession.

Global Equity Market Decline

And by the way, it wasn’t just US equities, the selling pressure was global with some markets like Russia, Australia, Germany, Italy, and Brazil down much more.

stock stock market selloff

Extreme Investors Fear is Driving the Stock Market 

Indeed, after Extreme Fear is driving the stock market according to investor sentiment measures. A simple gauge anyone can use is the Fear & Greed Index, which measures seven different indicators.

As of today, it shows the appetite for risk is dialed back about as close to zero it can get.

what is driving the stock market

In the next chart, we can observe the relative level of the gauge to see where it is comparable to the past. While this extreme level of fear can stay elevated for some time, it has now reached the lowest levels of 2018. It’s important to note this isn’t a market timing indicator, and it does not always provide a timely signal. As you can see, at prior extreme lows such as this, the fear remained extreme for some time as the indicator oscillated around for a while. It’s a process, not an event. Investor sentiment measures like this tell us investors are about as scared as they get at their extreme level of fear is an indication those who wanted to sell may have sold.

fear greed investor sentment over time

Monitoring Market Conditions

My objective is asymmetric investment returns, so I look to find an asymmetric risk-reward in a new position. An asymmetric return profile is created by a portfolio of asymmetric risk-reward payoffs. For me, these asymmetric payoffs are about low-risk entries created through predefined exits and how I size the positions at the portfolio level. As such, I’ve been entering what I consider to be lower risk points when I believe there is potentila for an asymmetric payoff. Sometimes these positions are entering a trend that is already underway and showing momentum. The market is right most of the time, but they get it wrong at extremes on both ends. I saw that because of my own personal observations for more than two decades of professional money management, which is confirmed, markets and behavior really haven’t changed.

Humphrey B. Neill, the legendary contrarian whose book “The Art of Contrary Thinking,” published in 1954, including the same observations nearly seventy years ago.

“The public is right more of the time than not ” … but “the crowd is right during the trends but wrong at both ends.”

As market trends reverse and develop, we see a lot of indecision about if it will keep falling or reverse back up, which results in volatility as prices spread out wider driven by this indecisiveness. Eventually, the crowd gets settled on once side and drives the price to trend more in one direction as the majority of capital shifts enough demand to overwhelm the other side.

Risk Manager, Risk Taker

At these extremes, I have the flexibility to shift from a trend following strategy to a  countertrend contrarian investment strategy. My ability to change along with conditions is why I am considered an “unconstrained” investment manager. I have the flexibility to go anywhere, do anything, within exchange-traded securities. By “go anywhere,” I mean cash, bonds, stocks, commodities, and alternatives like volatility, shorting/inverse, real estate, energy MLPs, etc. I give myself as broad of an opportunity set as possible to find potentially profitable price trends. So, as prices have been falling so sharply to extremes, I was entering new positions aiming for asymmetric risk/reward. I was able to buy at lower prices because I had also reduced exposure at prior higher prices. As trends became oversold as measured by my systems, I started increasing exposure for a potential countertrend.

On ASYMMETRY® Observations, I’m writing for a broad audience. Most of our clients read these observations as do many other investment managers. My objective isn’t to express any detail about my specific buying and selling, but instead overall observations of market conditions to help you see the bigger picture as I do. As long time readers know, I mostly use the S&P 500 stock index for illustration, even though I primarily trade sectors, stocks, countries; an unconstrained list of global markets. I also share my observations on volatility, mostly using the VIX index to demonstrate volatility expansions/contractions. At the extremes, I focus a lot of my observations on extremes in investor sentiment and breadth indicators to get an idea of buying and selling pressure that may be drying up.

Market Risk Measurement 

One of my favorite indicators to understand what is going on inside the stock market is breadth. To me, breadth indicators are an overall market risk measurement system. Here on ASYMMETRY® Observations, I try to show these indicators as simple as possible so that anyone can understand.

If we want to profit from the madness of crowds, we necessarily need to believe and do different things than the group at the extremes.

One of my favorite charts to show how the market has de-risked or dialed up risk is the percent of S&P 500 stocks above the moving average. As you see in the chart, I labeled the high range with red to signal a “higher risk” zone and the lower level in green to indicate the “lower risk” zone.

percent of s&P stocks above moving average 2020

I consider these extremes “risk” levels because it suggests to me after most of the stocks are already in long term uptrends, the buying enthusiasm may be nearing its cycle peak. And yes, it does cycle up and down, as evidenced by the chart. As of yesterday’s close, only 17% of the S&P 500 stocks are trending above their 200-day moving average, so most stocks are in a downtrend. That’s not good until it reaches an extreme level, then it suggests we may be able to profit from the madness of crowds as they tend to overreact at extremes.  The percent of S&P 500 stocks above the longer-term moving average has now declined into the green zone seen in late 2018, the 2015-16 period, 2011, but not as radical as 2008 into 2009. If this is the early stage of a big bear market, we can expect to see it look more like the 2008-09 period.

We can’t expect to ever know if equities will enter a bear market in advance. If you base your trading and investment decisions on the need to predict what’s going to happen next, you already have a failed system. You are never going to know. What I do, instead, is focus on the likelihood. More importantly, I predefined the amount of risk I’m willing to take and let it rip when the odds seem in my favor. After that, I let it all unfold. I know I’ll exit if it falls to X, and my dynamic risk management system updates this exit as the price moves up to eventually take profits.

Zooming in to the shorter trend, the percent of stocks above their 50 day moving average has fallen all the way down to only 5% in an uptrend. This means 95% of the S&P 500 stocks are in shorter-term downtrends. We can interpret is as nearly everyone who wants to sell in the short term may have already sold.

stock market breadth risk management market timing

I can always get worse. There is no magical barrier at this extreme level that prevents it from going to zero stocks in an uptrend and staying there a long time as prices fall much more. But, as you see in the charts, market breadth cycles up and down as prices trend up and down.

If we are in the early stage of a big bear market, I expect there will be countertrends along the way if history is a guide. I’ve tactically traded through bear markets before, and the highlight of my career was my performance through the 2007-09 period. I didn’t just exit the stock market and sit there, I traded the short term price trends up and down. If someone just exited the stock market and sit there, that may have been luck. If we entered and exited 8 or 10 different times throughout the period with a positive asymmetry of more significant profits than losses, it may have required more skill. I like my managed portfolio to be in synch with the current risk/reward characteristics of the market. If that is what we are achieving, we may have less (or hedged) exposure at the peak and more exposure after prices fall. I believe we should always be aware of the potential risk/reward the market itself is providing, and our investment strategy should dynamically adapt to meet these conditions.

If we want to profit from the madness of crowds, it means we have some cash or the equivalent near trend highs and reenter after prices fall. It may also be achieved by hedging near highs and using profits from the hedge to increase exposure after prices have dropped. It sounds like a contrarian investor. To be a contrarian investor at extremes to profit from a countertrend, we study crowd behavior in the stock market and aim to benefit from conditions where other investors/traders act on their emotions. These extremes of fear and greed are seen at major market turning points, presenting the disciplined contrarian with opportunities to both enter and exit the market.

This crowd psychology has been observed for many decades, and unfortunately, investors and traders are excellent lab rates to study the behavior.

Believe it or not, 179 years ago, in 1841, Charles Mackay published his book “Extraordinary Popular Delusions and the Madness of Crowds” in which discussing the South Sea Bubble and Dutch Tulip Mania as examples of this mass investment hysteria. People haven’t changed. As a crowd, we the people still underreact to initial information and then overreact at the extremes.

As Mackay observed nearly two centuries ago:

“Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.”

Once people begin to go with the crowd, their thinking can become irrational and driven by the emotional impulses of the crowd rather than on their own individual situation.

According to studies like DALBAR’s Quantitative Analysis of Investor Behavior (QAIB), individual investors have poor results over the long haul. 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 since 1994 and finds people tend to do the wrong things at the wrong time. If we want to create different results from the majority, we must necessarily believe and do things differently.

At this point, we’ve seen fund flows from stocks to bonds reach extreme levels across multiple time frames as panic selling set in. I’m glad to say, while imperfect as to timing, I have done the opposite by shifting to short term US Treasuries at the prior high stock prices and then started rebuying stocks last week. Of course, I have predetermined points I’ll exit them if they fall, so I remain flexible and may change direction quickly, at any time.

I’m seeing a lot of studies showing that history suggests single-day waterfall declines like yesterday were followed by gains over the next few weeks. Rather than hoping past performance like that simply repeats, I prefer to measure the current risk level and factor in existing conditions.

It’s important to understand, as. I have pointed out many times before, that the US stock market has been in a very aged bull market that has been running 11 years now. And the longest on record. The US is also in the longest economic expansion in history, so we should be aware these trends will eventually change. But, when it comes to the stock market, longer trends are a process, not an event. Longer trends unfold as many smaller swings up and down along the way that may offer the potential for flexible tactical traders to find some asymmetry from the asymmetric risk/reward payoffs these conditions may create.

It’s also important to be aware the volatility expansion and waterfall decline the past three weeks seems to indicate a fragile market structure with a higher range of prices, so we’re likely to observe turbulence for some time. These conditions can result in amplified downtrends and uptrends.

Falling prices create forced selling by systematic investment managers similar to what we saw in the December 2018 market crash. As I’ve seen signals from my own systematic trend following and momentum systems shift, it’s no surprise to see some increased selling pressure that may be helped by more money in these programs.

We are in another period of extremes driven by the “madness of crowds,” and my plan is to apply my skills and experience with the discipline to tactically operate through whatever unfolds.

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. Shell Capital is 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. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. 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.

 

 

 

Wrong narrative? Feeling the Bern of socialism may have been even scarier

Yesterday, after the “emergency” interest rate cut by the Federal Reserve, the US stock market trended down to close -2.8%.

Top news headlines looked like this:

fed rate cut march 2020

They were rather alarming, the largest since the financial crisis, and “emergency cut” and “to combat virus fear.”

What if much of the selling pressure in the stock market has been more by “Fear the Bern” more than coronavirus? Stock index futures are up about as much as they fell yesterday after Joe Biden beat Bernie Sanders on Super Tuesday.

stock market feared bernie sanders fear the bern

Prior to last night, Sanders appeared highly likely to secure the nomination; the odds plunged from 65% to 16% now.

You may consider the possibility large stock market investors were more concerned about the recent Bernie Sanders lead over Joe Biden than coronavirus.

Feeling the Bern of socialism may have been even scarier. 

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. Shell Capital is 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. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. 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 Fed did what?

At 10 AM yesterday morning, the Fed cut rates.

The actual statement is worth reading.

March 03, 2020

Federal Reserve issues FOMC statement

For release at 10:00 a.m. EST

The fundamentals of the U.S. economy remain strong. However, the coronavirus poses evolving risks to economic activity. In light of these risks and in support of achieving its maximum employment and price stability goals, the Federal Open Market Committee decided today to lower the target range for the federal funds rate by 1/2 percentage point, to 1 to 1‑1/4 percent. The Committee is closely monitoring developments and their implications for the economic outlook and will use its tools and act as appropriate to support the economy.

Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michelle W. Bowman; Lael Brainard; Richard H. Clarida; Patrick Harker; Robert S. Kaplan; Neel Kashkari; Loretta J. Mester; and Randal K. Quarles.

 

I highlighted in green the 10 AM spike up in the S&P 500 stock index. Then, after the initial reaction, the stock market trended down to close -2.8%.

stock market declined fed rate cut

Normally, an interest rate cut is positive for stocks. But, this time it was considered an “emergency” rate cut (the media term for it today) “In light of these risks and in support of achieving its maximum employment and price stability goals.” 

The headlines were negative.

fed rate cut march 2020

Every new bear markets need a catalyst to get the blame. If this decline were to unfold into a material bear market, down -20% or more, it would be because of its valuation level of this aged bull market in stocks. As stated before, this economic expansion and the bear market is the longest ever in history in terms of time. At elevated valuation levels, we can expect higher volaltity expansion and deeper price swings. Although, these swings can also produce potential tactical trading proprieties.

According to the CME Fed Funds Futures Probability Tree, the futures market seems to expect rates are going much lower, like zero.

Fed Funds Futures Probability Tree Calculator

FOMC meetings probabilities are determined from the corresponding CME Group Fed Fund futures contracts. Probabilities of possible Fed Funds target rates are based on Fed Fund futures contract prices assuming that the rate hike is 0.25% (25 basis points) and assumes the Fed Funds Effective Rate (FFER) will react by a like amount. The probability of a rate hike is calculated by adding the probabilities of all target rate levels above the current target rate.

The Effective Fed Funds Rate long term historical trends are in the next chart.

Effective Fed Funds Rate March 2020

The US 10 Year Treasury Rate has fallen to its lowest level, ever, so it’s not in uncharted territory. With the 10 Year Treasury Rate at about 1%, it was 2.72% a year ago, and the long term average is 4.5%.

uncharted territory 10 year treasury rate

The 10-year treasury is the benchmark used to determine mortgage rates and the most liquid and most traded bond in the world. Financial analyst use the 10-year yield as their “risk-free” rate when valuing a stock, bond, or markets.

Low-interest rates are great for borrowers, but not savers. The continuation of the downtrend in interest rates will continue to punish those who save their money in the bank rather than invest it in stocks, bonds, etc.

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. Shell Capital is 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. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. 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.

 

 

Expect wider price swings in a volatility expansion

I know, it sounds obvious, but yeah, expect wider price swings in a volatility expansion.

The CBOE S&P 500 Volatility Index (VIX) is a popular measure of the stock market’s expectation of volatility based on S&P 500 index options. The VIX Index is a calculation designed to produce a measure of a constant, 30-day expected volatility of the US stock market, derived from real-time, mid-quote prices of the S&P 500® Index (SPXSM) call and put options.

The VIX index shows us the 30-day expected volatility increased 200% during the February 2020 volatility expansion. I may have to define this rate of change as a volatility explosion. Expansion is the act or process of expanding to become or make larger or more extensive. An explosion is a rapid increase in volume and release of energy in an extreme manner. This looks explosive.

February 2020 stock market decline volatility exansion

Viewing it over a wide range of the past 10 years, the 30-day expected volatility is elevated to the second-highest level seen since the 2007-09 stock market crash. In 2011, the VIX spiked to 48.

VIX 1 year volatility expansion trading asymmetric

Putting it into an even broader perspective with the larger sample size of 26 years of historical data, the recent 40 level is about as elevated as 30-day expected volatility gets.

30-day expected volatility

I observe volatility from a perspective of both implied (expected) volatility and historical (realized) volatility. Implied volatility a measured by the VIX Index, is typically priced at a premium since options trading sentiment tends to have more of a hedging tilt. In theory, the VIX at 40 suggested expected 30-day volatility of 40%, which is much higher than the 21.5% realized vol as measured by 30-day Rolling Volatility derived from the actual past 30 days of price action. This is just an idealized, overly simplified example, but the point is both realized and expected vol is elevated.

implied vs realized volatility

Asymmetric volatility is what we see when equities fall sharply. The asymmetric volatility phenomenon is the observed tendency of equity market volatility to be higher in declining markets than in rising markets. Volatility tends to decrease after prices have trended up as investors and traders (the market) become more and more complacent, expecting a smooth uptrend will continue. Then, after prices decline, complacent investors and traders are caught off guard and surprised when prices trend down, and the more prices fall, the more they fear losing more money. The fear of losing money, then, is another driver of asymmetric volatility; Investors experience the pain of loss twice as much as the joy of gains. Nobel Prize-winning behavioral research finds that losses loom larger than gains and that people are loss averse. So, after prices have fallen, investors and traders sell simply because prices are falling, to cut their losses, and avoid larger losses. This selling pressure becomes a serial correlation, contagion, and prices keep falling until the desire to sell has dried up. It’s what I believe, at least, after studying and observing price trends in real-time professionally over two decades.

We saw asymmetric volatility expansion after the astonishingly smooth uptrend in 2017. In the chart, I overlay the 30 Day Rolling Volatility to visualize how the realized vol declined as the S&P 500 trended up quietly. But lower and falling volatility periods tend to be followed by periods of rising volatility.

asymmetric volatility trading exansion hedge hedging

US equities went on to recover two major price shocks and asymmetric volatility expansions in 2018, but here we are in 2020 seeing another smooth uptrend with great momentum interrupted by volatility expansion driven by a waterfall decline in stocks. 

Februrary stock market volatilty what caused crash

Asymmetric volatility is when prices drift (trend) up and then crash down.

When realized and implied volatility is elevated, we should expect to see price swings both up and down. Recovery from a downtrend like this is a process, not an event. We’ll probably see many swings up and down along the way, which is especially true if this unfolds into a bigger bear market level downtrend. Although anything can happen, bear markets don’t just happen all at once. The worst bear markets like 2007 to 2009 unfolded with price swings over many years, not just in 2008.

Only time will tell if this is the early stage of a bigger move, but in the meantime, expect larger price swings as prices spread out and the weight of investors decide which direction to lean.

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. Shell Capital is 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. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. 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: Risk and reward isn’t a knob we turn to get what we want. 

I don’t believe I know anyone who invests all of their money in the stock market, all the time.

In order to invest all of your money in the stock market all the time, you’d have to be willing and able to accept a downside loss (drawdown) of -50% or worse. I say that because it’s the historical drawdown.

S&P 500 Stock Index Historical Drawdowns

In the S&P 500 Stock Index Historical Drawdowns chart below, we see -20% several times, -30% a few times, and -45% or more three times. It happens, it can happen, and it will happen again. It’s why I prefer to instead actively manage my risk for drawdown control.

Losses are exponential the deeper they get and too hard to overcome.

To truly understand the risk, I think we have to know if a market has fallen -50% in the past, it could certainly do it again in the future, or even worse. So, the risk isn’t some multiple times a volatility measure like Value at Risk, but instead, the possible loss is at least the worst historical drawdown. Past performance doesn’t guarantee future returns, so it could be worse next time, for all we know.

Since most people probably don’t have the risk tolerance, risk capacity, or financial ability to take that much risk, most investors invest in some fixed allocation of cash, bonds, and stocks. If they use an advisor, they most likely are further diversified into International markets to make it a diversified portfolio of Global Asset Allocation (GAA). To track Global Asset Allocation, I use the S&P Target Risk Indexes for Global Asset Allocation.

The short story is, S&P allocates between equities and fixed income.

TARGET RISK ALLOCATION

How has a Global Asset Allocation performed so far in 2020 through February?

To answer, I look at these S&P Target Risk Index. But, keep in mind, these indexes do not include fees such as advisory fees or trading costs. Clearly, more risk is not always compensated with more return. All of them are down, but the more aggressive allocation to stocks hasn’t resulted in more return, but less, so far.

Global Asset Allocation GAA performance 2020

In fact, the % off high shows the drawdown for each of the Target Risk Indexes. You can probably see why “growth” and “aggressive” isn’t always as it sounds.

Global Asset Allocation GAA Target Risk Drawdown

Risk and reward isn’t a knob we get to turn to get what we want.

I prefer to rotate, rather than allocation, and actively increase and decrease my exposure to the possibility of risk and reward. It’s the only way I know that has the potential for my objective of asymmetric risk-reward.

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. Shell Capital is 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. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. 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.

I’ve been here before; stocks are entering the zone

Based on breadth and short term momentum indicators, the U.S. stock market is entering what I consider to be the green zone. The green zone is the lower risk area, which is the opposite of the higher risk red zone. As I pursue asymmetric risk-reward by structuring trades with asymmetric payoffs, I’d rather lower my risk in the red zone and increase it in the green zone. Said another way, to structure trades with an asymmetric payoff, I believe the positive asymmetry comes from increasing exposure in the green zone and reducing exposure in the red zone. However, it isn’t a buy or sell signal for me, but instead a risk indicator. My buying and selling is an individual position decision, but my stock portfolio is probably going to be in synch with these overall market risk analysis at extremes.

S&P 500 Percent of Stocks Above 50 Day Moving Average is an indicator showing the percentage of stocks in the S&P 500 that closed at a higher price than the 50-day simple moving average. The chart below was updated after Friday’s close. Only 3% of the stocks in the S&P 500 Index are trading above their 50-day moving average, a short term trend line.

BREADTH PERCENT ABOVE 50 DAY MOVING AVERAGE SPX 500

If you want to see how I applied it in the last big stock market decline, read “An exhaustive analysis of the U.S. stock market” late December 2018 when I suggested the probability was in favor of reversal back up was high. 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’m seeing similar signals now, as you can see in the above chart, the participation in the downtrend has now reached the same level as the price lows of 2018.

Now, make no mistake, trends downtrends can continue. Price trends can unfold unlike anything ever seen in the past as every new moment is unique, having never existed before – so past performance is no guarantee of future results. I have never actually been here before, no one has, but I’ve experienced this kind of condition many times before.

I’ve shared many times, my indicators measure buying and selling demand, so when most stocks are already participating in uptrends, it signals those who wanted to buy have already. I believe the same is true for downtrends; aftermost stocks are already in downtrends, those who wanted to sell may have already sold, their selling becomes exhausted, and when prices are pushed down low enough, it attracts buyers to buy. It’s all probabilistic, never a sure thing. It seems many investors were shocked by the speed and magnitude of his waterfall decline – I was not. If you’ve followed my observations, you’ve read enough to know anything is possible.

The S&P 500 Percent of Stocks Above 500 Day Moving Average is also entering what I considered the green zone.

spx trading advisor

As such, the stock market looks deeply oversold to me. Since I already reducted exposure before this decline, we view this period from a position of strength. It doesn’t always work out so well, it’s always imperfect, but I’m not sitting here down -13% from two weeks ago taking a beating hoping the losses stop.

stock loss 2020 drawdown

Managing risk when it’s at a high level for drawdown control offers the potential to be in a position of strength at times like this, and it’s my preference. Portfolio managers with cash or profits from hedging now can enter stocks and markets at lower-risk entry points with a more favorable asymmetric risk-reward profile than before.

Although, as John Galt shared with me this next chart this morning on Twitter and said, “These are the pros & they were blindsided,” not all professionals are in a position of strength. The chart shows the net exposure to stock index futures at a high level.

spx futures exposure

Everyone gets what we want from the market; as we decide what we get.

If we want to avoid drawdowns, we reduce the risk of drawdown.

If we want to avoid missing out on gains, we stay invested to avoid missing out on gains.

Regardless of choice, it’s never going to be perfect. Those who expect it to be are always disappointed and unable to execute as a tactical operator. This is a human performance that prefers the “C” students. If we weren’t included to get perfect “A,” we have an edge for this skill. I focus my perfection on execution, but not on the individual outcomes.

I accept losses, so I’m able to cut them short. I’ve never taken a loss that was a mistake.

For me, not taking the loss as I had predetermined would be the mistake.

I love taking losses.

It’s why I have smaller ones. I prefer to cut my losses short, rather than let them become big losses.

If I didn’t love taking losses, I would have large losses like others do. Most investors hold on to their losses, hoping to recover from them. Sometimes it works, but when the big one comes, it doesn’t. I prefer more control, so I make active decisions and manage accordingly. Never expecting it to be perfect, accepting the imperfections.

My energy goes into my focus and discipline. For me, it’s all about mindset. I’m a perfectionist on how I execute my tactical trading decisions, which is the activity within my control.

When I enter a position, I can’t control what it will do afterward, but my exit will determine the result every time.

When I exit a position, I can’t control what the security does afterward, but I can re-enter it again if I want, or be glad I got out. Or, I may imperfectly not re-enter and later notice it trended up more. I still didn’t miss out, I made my choice.

So, yeah, I’ve been here before, in this kind of situation. All new moments are always unique. This time has never existed yet, so it’s necessarily unknowable and uncertain. When we accept it and embrace it, we can make decisions and go with the flow. The good news is, this seems like a lower risk level, and though it may make an even lower low at some point and yet unfold into a major bear market, it’s an asymmetric trading opportunity for me.

I enter my positions with predetermined exits in case I’m wrong, and let it rip.

Oh, and I glance at headlines and make note of them at extremes.

bearish bloomberg news coronavirus

I’ll just leave this right here for later reference.

WSJ bearish coronavirus news

I hope this helps.

Have questions? Need help? Get in touch 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. Shell Capital is 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. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. 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.

 

Permabear delight

I love music, so it plays in the background in my office, instead of financial news. Sure, I have Bloomberg playing on a TV, but with the volume down. I rarely turn it up, unless someone I know is speaking of something I’m interested in. My day is filled with music, a wide range of music, so when I thought “delight” and typed out “permabear delight,” I heard three different songs.

A permabear is an investment manager or investor who is always negative about the future direction of the markets and the economy in general, no matter what. The parts of the word help us understand its meaning: “Perma,” which means permanent and “bear,” which is someone who believes the market will fall (a “bear” market.) 

I’ve never been called a permabear in my 20+ year investment management career. But recently, a new follower asked if I am a permabear. It’s understandable because all he’d read was the past few months of my observations, and I have indeed been increasingly bearish. I got utterly bearish late January as my tactical trading signals, risk management, and drawdown control systems guided me to remove our stock market exposure to zero. The signals from my signals drive any “feeling” of bearishness I may have. Additional factors are extreme investor bullishness, implied volatility at extremes, and people wanting to get more aggressive. This is the part I often share here, hoping to help people observe how they feel the wrong feeling at the wrong time, and by doing so, they may eventually learn to feel the right feeling at the right time.

I tend to feel the right feeling at the right time. It’s something I’ve intentionally worked on, daily, for over two decades now, and with repetition comes increased skill and experience. For long term readers of my observations, I hope you’ve observed that. For our investment management clients, they’ve seen it in action in real-time. So, I become increasingly bearish as my quantitative systems signal risk levels are elevated. But, I also become bullish when the algorithms signal a price trend and volatility may have moved too far, too fast. When price trends move too far, too fast, I consider it an overreaction to information. I’ve discussed it a few times lately, especially regarding the coronavirus outbreak. I believe we witnessed an initial underreaction to how investors may eventually react, and then what appears to be an overreaction. At least in the short term.

So, now, I’m far from a permabear myself. I have investment manager friends who are permabears, and their performance reflects it. I also have friends who are permabears and have been unable to invest their money outside an FDIC insured bank account. That has been a big risk to them over the decades, but they may not know it, but to each their own. Banks need CD savers so they can lend the money out to borrowers at higher rates. It all seems to work out as everyone gets what they want.

At this point, the widely followed stock indexes have declined sharply with speed. The S&P 500 is down -14% from its recent all-time high, and the Dow is down over -15%.  The chart below is the % off high to put these drawdowns into context. It still isn’t as deep as late 2018, but it is now very close and happened much faster.

stock market drawdown 2020

While this may be a buying opportunity for those of us who had cash to increase exposure at these lower prices, it’s always possible it could trend lower. What seems more likely at this point is prices get low enough to attract buying enthusiasm, and if it’s enough, it reverses this waterfall decline, at least temporarily. After that, this may well be the bigging of the next big bear market. It’s a process, not an event, although this decline does look much more like an event than usual since it was so far, so fast.

I’ve now become short term bullish on the stock market. My systems which have been quantified and scientifically tested for robustness are now signaling prices are now at a level we consider oversold and a countertrend back up, at least retracing some of the recent waterfall declines that appear to be an overreaction. For example, below is the current chart of the S&P 500, which is down another -3% today. Below the price trend is a  simple 14-day measure of relative strength, a momentum indicator measuring the magnitude of recent price changes to evaluate overbought or oversold conditions. Today it has reached 20, which is the point I consider oversold. In fact, it’s now as low as it was during the late 2018 -19% waterfall decline.

stock market crash februrary 2020

Of course, after prices fall, so does investor enthusiasm to invest in stocks. It is no surprise to see the Fear & Greed Index made up of seven different sentiment measures reach the “Extreme Fear” level.

cnn fear greed Warren Buffett said when it comes to investing in stocks, it is smart to be “Fearful when others are greedy and greedy when others are fearful.” Although I do a lot more tactical strategies that he does, at these extremes we have something in common.

We don’t invest our grocery money in stocks, but this may eventually prove to be a positive asymmetric risk-reward opportunity when risk is defined with a predetermined exit (stop loss) or positions structured in a way that define or limit downside risk.

A permabear, on the other hand, are maybe singing “Don’t go chasing waterfalls” by TLC, I’m hearing a diversified genre of some Rapper’s Delight by The Sugar Hill Gang, Afternoon Delight by Starland Vocal Band, and Dixieland Delight by Alabama if you want to follow along.

I’m about to take the longest trip to Florida to Tennessee of my life. I hope you have a great weekend. As always, next week will be fascinating. Investors will either fear losing more money or fear missing out if they tapped out at low prices. I have bypassed both in our managed portfolios as we avoided the waterfall decline, so we’re in a position of strength to increase exposure to risk and reward. If you sell higher, you can buy lower. At this point, we can tolerate some downside from any new exposure from here as we know its mathematically becoming less likely, and we are now positioned to not have any fear of missing out if the trend reverses up.

I hope this helps!

Have questions? Need help? Contact us 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. Shell Capital is 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. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. 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 panic selling drying up?

After yesterday’s continued selling pressure, only 7% of the S&P 500 stocks remain in uptrends as measured by the 50-day moving average.

percent of stocks above moving average

As most stocks are participating in the downtrend, this breadth measure is about as low as it was in December 2018.

In case you are wondering, here are some of the few stocks in the index that are still above their trend line. I don’t consider this a buy list and we don’t own any of them directly.

stocks above moving average

Another sign of a strong desire to sell is the new highs-new lows as a percentage. It’s as low as it’s been the past year, as new lows are dominating.

new highs new lows percent

As expected, a chart of advance – declining stocks as a percentage is at the low end of its range and about as low as it can get as declining stocks are dominant.

advance decline percent

When investors are panic selling, prices can always trend lower, but this data shows mathematically prices have reached an extreme level on the downside that now appears to be an overreaction. We should be close to seeing this panic selling dry up as selling becomes exhausted and these lower prices attract buyers. After that, we’ll see if any countertrend back up continues, or eventually reverses back down. As I’ve said recently, given this bull market is very aged and we’ve seen the longest economic expansion in history, I believe the years ahead will require tactical trading and risk management.

I hope this helps!

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. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. 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 stock index falls below its long-term trend, but stocks are now getting oversold

The stock index falls below its long-term trend, but just as stocks are getting oversold. The 200-day moving average was about 11% below the high February 19th, just eight days ago.

spx spy 200 day moving average trend 11 percent Feb 2020

As you can see in the chart, this has been a sharp waterfall decline and one I’m glad we avoided so far. For those of us in a position of strength, we stalk the market actively looking for a lower-risk entry point that offers the potential for asymmetric risk-reward payoff. An asymmetric payoff is when we structure our positions so our potential for downside loss is limited to much less than the potential for capital gains.

The stock market is now getting more oversold on a short term basis.

Only 21% of S&P 500 stocks are above their 50 day moving average. That’s a lot of broken uptrend lines shifting into downtrends.

stock market oversold

In the chart, I colored the “buy zone” in green. As you can see, it’s now down to a level I consider an indication that selling pressure may become exhausted as long as prices have been sold down to a low enough level to attract buying demand.

The stock market, and stock prices, are driven by supply and demand. It’s that simple. Measuring supply and demand isn’t so simple for most investors.

In the bigger picture, the longer-term trend lines are still at the 50-yard line, which is where all but one of the past five declines stopped. Of course, the one time stocks really got sold down was late 2018. Only time will tell if this becomes another period like that, but right now, those of us who had reduced or removed exposure to the market losses are probably looking to buy.

stock market breadth

The longer-term trend lines are holding better, which is no surprise because stocks had trended up well above their longer trend lines. For example, the S&P 500 index was trading about 11% above its own 200 day moving average and it just now crossed below it. When many stocks are trending that far above their trend line, it takes more of a price decline to trigger the percent of stocks to fall.

february 2020 stock market loss decline

Stocks market declines to tend to be asymmetric. Prices trend down faster than they trend up. After prices trend down, contagion sets in the lower prices fall. Prices then get driven down even more simply because investors are selling to avoid further loss. But, someone has to be on the other side of their panic selling. It’s those who had the cash to buy.

If you sell higher, you can buy lower.

Need help? Contact us 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. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. 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.

Dow Jones is down -10% off its high

Dow Jones is down -10% off its high. I don’t pay much attention to the Dow Jones Industrial Average as it’s a price-weighted index of 30 stocks. But, the S&P 500 capitalization-weighted index of approximately 500 stocks seems a better proxy for “the market,” and it’s not far behind.

Here is the percent off high (drawdown) chart year to date.

dow jones down over 10 %

We don’t own either of these ETFs, they are for illustration only. In fact, our portfolio is was 85% U.S. Treasuries, and 15% invested in high dividend-yielding positions. One of them has a dividend yield of 9.8% and the other 11.9%, so while their prices may be falling with the stock market, we have some margin of safety from the high yield. In fact, as the prices fall, the yield rises from that starting point.

Speaking of dividend yield below is a visual of the dividend yield of the S&P 500 (1.84’%) and the Dow (2.27%), which are relatively low historically. But, as prices fall, the yields will rise, assuming the stocks in the index keep paying dividends.

stock dividend yield

In the above chart, I’m using the ETF dividend yields as they are real-time. Since the ETFs have only been trading for two or three decades, to see what I mean by “long term” I look at the S&P 500 Stock Index dividend yield (calculated as 12-month dividend per share)/price) to see how low the yield has been the past twenty years.

long term stock dividend yield

So, the future expected return from dividend yields on these stocks indexes is relatively low, looking back 150 years. The spikes you see are after stock market crashes as the price falls, the yield rises, as with bonds. Low dividend yield also suggests the stock market is overvalued. A higher dividend yield indicates the stock market is undervalued, and if nothing else, investors earn a higher income from the dividends from a lower starting price.

Back to the year to date, the short term, the S&P 500 is now down -5% in 2020, and the Dow Jones is down -7%.

stock market drop 2020

I believe this may be the fastest -10% decline in the history of the Dow Jones Industrial average.

I’m just glad we aren’t in it.

This is when drawdown controls and risk management pays. More importantly, it’s when discipline pays as some investment managers intend to manage risk to limit their drawdowns; they don’t excel in doing it. Discipline is a personal edge. It doesn’t matter how good our scientifically tested quantitative models and systems with a mathematical basis for believing in them if we lack the discipline to execute them with precision. But, I can go on to say that it isn’t enough for me to have all the discipline either, as we much necessarily help our investment management clients stick with it, too. So, investor behavior modification is part of our wealth management services. It’s why Christi Shell is not only a Certified Wealth Strategist® with over twenty-six years of experience helping high net worth families with the overall management of assets but also a certified Behavioral Financial Advisor® (BFA®) to help them manage themselves.

It’s what we do.

Need help? Contact us 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. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. 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 recoveries are a process, not an event

After yesterday’s close, the popular stock market indexes, including the S&P 500, Dow Jones Industrial Average, and NASDAQ were down around -3% for the day.

stock market

Adding volatility bands around the price trend and its 20 day moving average illustrates a volatility expansion as prices have spread out to a wider trading range. The S&P 500 stock index traded below its lower volatility band, which expands as the price action becomes volatile. Volatility bands and channels help to answer: Are prices high or low on a short term relative basis? The recent price action is relatively high at the upper band and low at the lower band. By the way, I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. 

volatility expansion bollinger band

At this point, the stock index has traded below its band, demonstrating panic level selling pressure outside what I consider a normal range of price action. 

Volatility channels are even more useful when combined with other indicators for confirmation. Next, I add a momentum measure for confirmation the index is oversold on a short-term basis. It can get more oversold, but a short term reversal now becomes likely if the desire to sell has become exhausted. 

spx spy countertrend trend following asymmetric risk reward

The potential good news for those with exposure to loss, in the short term, we may see a countertrend move back up to retrace some of the stock market losses. However, this will be the test to see if selling pressure has been exhausted or if prices have been driven down low enough to attract sufficient buying interest to push the price trends back up.

Another observation I’ll share is after the close, we recalculated the percent of S&P 500 stocks above their 200 day moving average using the end of day prices. The percent of stocks above their 200 day moving average is now at the 50-yard line, whit bout half of the SPX stocks in a longer-term uptrend and a half in a downtrend. Obviously, that’s more stocks now below the trend line than when I shared it yesterday.

percent of spx stocks above below 200 day moving average

A more significant decline is seen in the percent of stocks above their 50-day moving averages, which fell 38% to only 23% of S&P 500 stocks trading above their shorter-term moving average trend line.

percent of stocks above below 50 day moving average breadth

So, at least on a short term basis, selling pressure has pushed stocks down to the point more are in downtrends than uptrends.

Next, we’ll see if sellers have pushed prices low enough to attract significant buying demand. I expect to see at least a short term countertrend back up, as investors overreacted to the downside, but only time will tell if any countertrend up is sustainable long term. My longer-term indicators are neutral at this point, so there could be more selling if investors and traders anchor to prior highs wishing they’d sold previously and sell into an uptrend.

My objective is asymmetric returns, so I focus on asymmetric risk-reward. After prices seem to trend up too far, too fast, by my quantitative mathematical calculations, the asymmetric returns from future prices are limited, and the asymmetric risk is increased. After prices seem to fall too far, too fast, by my quantitative mathematical calculations, the asymmetric risk-reward profile becomes more positive. And, all of it is probabilistic, none of it is ever a sure thing.

It’s a process, not an event.

As I shared yesterday; Stock prices may not be finished falling, but some opportunities for asymmetric risk-reward may be present for those willing to take risks.  

Need help? Contact us 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. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. 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 prices may not be finished falling, but some opportunities for asymmetric risk-reward may be present for those willing to take risks

Based on my velocity measuring algorithms, the stock indexes are now starting to get oversold. That is, the stock indexes are reaching a point we could see at least a short term countertrend back up, on a short term basis. These measures are based on short term market overreactions, such as when price decline sharply beyond a point we expect mathematically over a period. It certainly doesn’t mean the price trend can’t fall farther as they often do but instead signals a potential countertrend that could drive prices to retrace some of their loss. However, if the downtrend price trend becomes a prolonged and deeper downtrend, these countertrend measures fail to perfectly time the low. Investment management is probabilistic, never a sure thing, so I never expect anything more.

What matters most is if I wanted to take some risk right now on a short term oversold market, I would predefine my exit to cut my loss short if it doesn’t work out and let it rip. We never know for sure in advance when prices will reverse, I can only determine when it is more likely.

The challenge right now, in addition to some other observations I’ve shared recently about valuation, etc. is stock market breadth is far from oversold. So, my breadth measures do not yet suggest any significant selling pressure has been exhausted. I believe when investors sell stocks with great enthusiasm, it shows up in the percent of stocks above and below the trend lines. After prices have plummeted and most of the stocks have fallen into downtrends I start to wonder if the desire to sell is losing steam. At this point, these indicators don’t yet signal a significant panic level selling, so that’s the risk from this point.

I’ll share some of the price trends and indicators I look at when stock prices are falling.

First up is the percent of S&P 500 stocks above their 50-day moving averages. As the chart shows, last month about 82% of the stocks were above their shorter-term trend line. I consider levels above 80% to be a higher risk zone. As we see below, the percent of S&P 500 stocks above their 50-day moving averages made a lower high since January and now is falling at 38%.

breadth percent of stocks below 50 day

While we don’t use it as a market timing indicator, it instead provides some situational awareness of the risk of decline. After most stock prices have already risen, where does more demand come from? At higher levels, I consider the enthusiasm to buy may be becoming exhausted. It once again seems to be what has happened here as investors were enthusiastic about stocks until recently.

Another warning shot across the bow was when this breadth measure failed to confirm an all-time new high in the stock market. Below is the same indicator as above, but I overlayed it with the price trend of the S&P 500. As the SPX trended up to an all-time new high, the percent of S&P 500 stocks above their 50-day moving averages showed a material divergence, indicating fewer stocks were participating in the uptrend. I’ve been monitoring these indicators for two decades now and from my experience, a divergence like this that indicates less participation and “breadth” of the trend is a warning sign. In a healthy uptrend, most stocks are trending higher, so the percent of S&P 500 stocks above their 50-day moving averages is increasing, not decreasing.

breadth failed to confirm new stock market high february 2020

For a longer-term context, below is the percent of S&P 500 stocks above their 200 day moving averages. I consider below 20 or 30% to be an overreaction to the downside, but currently, 66% of stocks are above this longer-term trend line. On the one hand, higher participation is positive, but it’s declining from a relatively high level, which makes it more negative. It also provides us with the awareness that stocks could certainly fall a lot more. The times when less than 20% of these stocks were above their 200-day moving average was periods of notable stock market drawdowns.

percent of stocks above 200 day moving average long term breadth

So, these are some examples of why I started reducing our exposure to zero a month ago and only recently have been increasing exposure by rotating back out of US Treasuries into high dividend yield positions. The nice thing about high dividend yield positions is as the price falls, the dividend yield increases. It’s one time when I buy after prices fall, so we earn the dividend yield from that point forward. My timing is rarely perfect and it doesn’t have to be.

By way of example only, below is a chart of the Alerian MLP Index price and dividend yield. MLP’s are Master Limited Partnerships and in this case, they are publically traded. The Alerian MLP Index is the leading gauge of energy infrastructure Master Limited Partnerships (MLPs). The capped, float-adjusted, capitalization-weighted index, whose constituents earn the majority of their cash flow from midstream activities involving energy commodities, is disseminated in real-time. I’m using this index for illustration to show how (1) the price trend of the MLP index has fallen with energy prices and (2) since its holdings pay high dividend yield, as the price falls, the yield trends up as seen in the chart.

MLP high dividend yield strategy

The purple line shows the dividend yield is 9.41% based on the current price and the price is making a new low. This is one of the most extreme examples right now to make the point. It not only makes the point that buying lower prices in high yield securities can potentially capture asymmetric risk-reward, but also these high yielding securities are not without risks that need to be managed. The risk is made obvious by the price trend chart, which is down -27% over the past year.

As with most things in life, timing is everything. If we had entered a position with the risk/reward profile that existed a year ago, it was more risk than reward, as the high yield income from dividends wouldn’t have been enough to offset the loss from the price decline. But, in the case of exposures that provide higher potential income streams from dividend yield at lower prices, you can probably see how to offset the potential from asymmetric returns from an asymmetric risk-reward payoff. But again, it isn’t so simple and requires risk management, because there is no guarantee stocks, bonds, or MLPs will always keep paying their yields.

In summary, my short term velocity algorithms suggest the popular stock indexes are nearing a short term level we could see a countertrend, but the bigger picture isn’t so positive as there remains plenty enthusiasm to be exhausted. In other words, in late December 2018, my indicators suggested an extreme level of panic selling has happened and it was likely becoming exhausting. It turned out to be exactly what happened. The current measures are nowhere near that level of oversold, but if sellers aren’t panicking to sell it will not get there, either.

At this point, the stock index is only -6% off its high, which is just short of the decline last summer and well within a normal decline. We typically see 2-3 price declines of -5% annually.

february 2020 stock market decline drawdown amount

To put it into context, the current stock market decline is less than 1/3rd of the waterfall decline over a year ago.

stock market historical drawdowns

Only time will tell if the desire to sell is being exhausted. Fortunately, we had already de-risked our portfolio before this started and are now looking to take on new asymmetric risk-reward positions as they present themselves. My risk management and drawdown control systems handle the rest.

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.

Investor sentiment and feelings can be data-driven, quantitative, applying the scientific method, supported by a mathematical basis for feeling and believing

Investor sentiment and feelings can be data-driven, quantitative, applying the scientific method, supported by a mathematical basis for feeling and believing

Individual investors are notably less bearish now, according to the AAII Sentiment Survey.

US Investor Sentiment, % Bearish is an indicator that is a part of the AAII Sentiment Survey. It indicates the percentage of investors surveyed that had a bearish outlook on the market. An investor that is bearish, will primarily believe the US stock market will trend lower in the next six months.

Bearish US Investor Sentiment dropped 25%, so only 26.4% of the investors surveyed expect the stock market to fall in the next 6 months. Bearish sentiment is now below its average over the past year, but far from an extreme reading. I marked the high, low, and average on the chart.

Investor Sentiment less bearish

The most extreme level of bearish sentiment historically going back to 1989 is all the way down to only 6% Bearish, which we haven’t seen since 2003.

bearish extreme sentiment

If you notice, the Bearish level has held a higher low the past decade. That is, recent stock market peaks haven’t resulted in those extreme lows since the investor survey started 22 years ago. So, behavior and sentiment surveys aren’t an exact science, nor are they intended to be. Below we see a Bearish level of 20% has been the common low in Bearish sentiment.

bearish investor sentiment signal

I could put the data into a table format and show a mode analysis, which is a study that shows when Bearish sentiment spikes or falls, what happens to the stock market. Since I apply the scientific approach to trends and cycles, I have certainly tested the indicators I observe scientific for quantitative analysis. I require a mathematical basis behind believing what I believe. If it doesn’t test out mathematically using the scientific approach, it would be of little use. To know what is of use, or not, requires quantitative testing. I don’t share my quant work, but instead, prefer to show observations of the trends in the data. When presenting my research, I do so visually.

In the chart below I overlay the % Bearish sentiment in orange over the S&P 500 % off high (the drawdown) in purple. We can visually see how they interact with each other. As the stock market falls, Bearish investor sentiment % spikes up. I highlighted these times.

stock market drawdowns bearish sentiment

Investors become more afraid of falling prices after they fall. Investors also extrapolate the recent past into the future, so they expect falling prices to beget further falling prices. We can hypothesize this because investors are more Bearish at lower prices, less so at higher prices.

Okay, so far I’ve only shown the Bearish sentiment.

What about Bullish investor sentiment? 

US Investor Sentiment, % Bullish is a gauge of the AAII Sentiment Survey. It registers the percentage of investors surveyed that had a bullish outlook on the market the past week. An investor that is bullish, will primarily believe the market will trend higher in the next six months.

US Investor Sentiment, % Bullish increased 41.33% the week of February 13, 2020. The % Bullish investor sentiment was the most notable change over the last week. Individual investors are notably more Bullish. However, although the Bullish sentiment is well above the average of the past year, individual investor enthusiasm isn’t yet at the highest level reached over the past year, which I marked in the chart.

bullish investor sentiment 2020

Meanwhile, the Fear & Greed Index, driven by 7 market sentiment indicators, is Neutral.

cnn fear greed index predictive

So, while individual investors are becoming more bullish about the stock market trend for the next 6 months, they haven’t quite yet reached an extreme level that often signals buying enthusiasm is becoming exhausted. But, the rate of change in Bullish investor sentiment is worth making note of for situational awareness as investors usually believe and do the wrong things and the wrong time at extremes.

coronavirus headlines

So far, the US stock market has been resilient, especially considering the headlines have been dominated by the virus updates and images of people around the globe bearing masks.

“When the facts change, I change my mind. What do you do, sir?”

John Maynard Keynes

I’ve kept more of my market risk hedged-off than I’d like (in hindsight) if market prices don’t fall to a lower-risk point, but we’ll see how it unfolds from here.

My edge is discipline and my tactical decisions are completely intentional and come from a fully committed state, so I don’t fear losing money or missing out. I tend to feel the right feeling at the right time, as my feelings are data-driven, quantitative, applying the scientific method, supported by maths for a mathematical basis for feeling and believing. Oh, and a heavy dose of stoicism.

I also change as the facts do, and the only facts that ultimately matter are price trends.

Have a Happy Valentines Day and weekend, friends!

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.

 

Global Macro: My favorite economic chart, consumer sentiment, and debt

People typically share their opinions based on their own personal observations of what they see and hear going on around them.

What we believe is always true, for us.

An advantage of a quant, or quantitative analyst, is the ability to study the data and trends to observe what is really doing on.  Data science is an interdisciplinary field that uses scientific methods, processes, algorithms, and systems to extract knowledge and insights from structured and unstructured data. Then, we get to see how it compares to our own unique observations.

A friend of mine who happens to be a business broker helping people buy and sell businesses commented he thinks the next big recession will be caused by consumer debt. As we discussed it a few minutes, his opinion was based on his own observation that it seems the people around him are living “high on the hog” as we say it down South. In other words, people are taking on heavy debt and spending what they earn rather than saving and investing.

I can see why he may perceive it that way if your neighbors have a fleet of newly leased luxury cars in the driveway and seem to be taking vacations beyond what you believe they can afford. In some cases, if not many, it may be true their personal debt to income ratio may be maxed out. They may be buying cars, boats, and trips instead of saving and investing their excess earnings.

But, everything is relative.

Sometimes when things are good people want to take some extra chips and reward themselves. In fact, some of the greatest rainmakers I have known do this very thing. Many hard-charging producers of wealth also enjoy the rewards from their work.

Some of us get as much satisfaction from seeing our investment accounts grow from investing our excess earnings. Maybe we are more Introverts, so motivation comes from within, rather than impressing others. But that doesn’t mean we don’t enjoy the fruits of our labor. As everything is relative, we may be only eating a slice of an apple from a cart of dozens. But, for those who don’t have dozens of apples, it may seem more.

It’s an illusion of asymmetric insight, which is a cognitive bias whereby people perceive their knowledge of others to surpass other people’s knowledge of them.

Others are more extroverted and willing to spend all of their money in the present moment, rather than plan for the future. In this case, they may spend their earnings as fast as they get it, so there is no “excess” earnings to worry about. I suppose if you spend it all, you’ll have less stress about investing it, but you’ll be on the treadmill forever. While those who spend all of their earnings don’t have to concern themselves with the capital markets and investment management, they may not sleep well at night with all the uncertainty the lack of a secure future can bring. But, some of them may not think that far and not worry about it at all.

Consumer sentiment also has a role in how we all spend our money. When people are optimistic about the future, we are more willing to spend. There are infinite factors that drive sentiment, rational or not. For example, with a great credit score, you could get a car loan at 2% for years and such a low rate of cost to borrow may be more enticing to buy new cars. Even wealthy investors will take advantage of low rates since it doesn’t require withdrawing from investment funds and the borrowing cost is minimal. We can say the same for mortgage rates. The wealthiest of investors probably achieved it with some level of leverage. For example, business owners may use debt early on to grow their company and then when they sell it, it may either be debt-free or the net capital gain is much higher than it would have been without using the leverage to grow. Some use of debt or leverage can be good and it’s even essential in some areas such as real estate to maximum return on equity.

So, on the topic of debt, rates, savings, and such, here are some charts of the data.

First, let’s look at consumer sentiment. The US Index of Consumer Sentiment from the 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.

Take out the 1999 euphoric period and consumer sentiment by this measure is about as high as it gets.

consumer sentiment michigan

Historically, the index displays pessimism in consumers’ confidence during recessionary periods, and increased consumer confidence in expansionary periods. So, in the next chart, we highlight recessions in gray.

consumer sentiment recessions

Does consumer spending match consumer sentiment?

As consumer sentiment is relatively high, spending as measured by US retail sales is at an all-time high. I note some divergence since around 2017 as sentiment has remained elevated but cycling up and down mostly above its average as retail sales trends up.

consumer spending sentiment retail sales global macro trend

Employment and interest rates are a drive of these global macro trends. I observed in Employment, Coronavirus, it’s just the market, doing what it does… that unemployment is at historic lows. When most people who want to work are working that’s probably helping consumer sentiment. Gotta love such low unemployment! But, as a risk manager, we also use it as a reminder of situational awareness since nothing lasts forever.

US UNEMPLOYMENT RATE

What about the savings rate?

This is one of my favorite non-market global macro trend charts. Total savings is trending up.

savings rate consumer sentiment

Aside from employment, some other drivers of consumer sentiment are probably the trend and level of retail gas prices, auto loan rates, credit cards, home equity lines of credit, and mortgage rates. While we much prefer to see our fellow American’s use less debt, relatively low rates make borrowing more attractive. Again, some of the wealthiest families may even borrow at low rates and keep their capital invested. So, debt isn’t just borrowing because they can’t afford it otherwise.

The US Retail Gas Price is the average price that retail consumers pay per gallon, for all grades and formulations. Retail gas prices are important to view in regards to how the energy industry is performing. Additionally, retail gas prices can give a good overview of how much discretionary income consumers might have to spend.

We’ve enjoyed some relatively low gas prices for the past five out of ten years. You may have noticed it at the pump or observed the lack of gas price headlines.

gas price past 10 years

I first showed the more recent period to point out we tend to have recency bias, as we weight the most recent experience the most. It’s a “what have you done for me lately” kind of mindset.

Next up is the longer-term trend in retail gas prices. I marked the high and low along with the average gas price going back to 1990.

gas price trend long term trend following

While the retail gas price has been elevated above average, it’s far from the highest levels of the past.

Is there really causation here between the price of gas and consumer sentiment?

There has been a negative correlation between the price of gas and consumer sentiment, so yes. I’ll say they are related the past decade in that a down-trending gas price helped drive up consumer sentiment.

gas price consumer sentiment negative correlation

I’m going to save some interest rates for another observation, so next up is my favorite chart.

The Federal Reserve Board’s Household Debt Service and Financial Obligations Ratios convey how much of US household income is being spent on repaying debts and mortgages. It includes data specific to renters and homeowners. The homeowner data includes income spent on automobile lease payments, property taxes, and homeowner’s insurance.

US Household Debt Service as Percent of Disposable Income and US Household Consumer Debt Service as a Percent of Disposable Income are both at relatively low levels. Debt service is about as low as it’s been. Consumer debt service is below average. 

consumer debt as percent of disposable income

So, in the big picture, my friend is wrong. The consumer debt situation is better than it may seem.  By and large, this trend tells us our fellow American’s aren’t nearly as in debt as they were 10 to 15 years ago and overall, have less debt to disposable income than they’ve had in decades.

So, hopefully, in the next recession, American’s won’t have such a difficult time from being upside down drowning in their debt.

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.

Employment, Coronavirus, it’s just the market, doing what it does…

It seems most people probably believe the news drives the stock market.

I can see why, since the news headlines want to tell a story.

We like a great story. We want to hear the narrative. We definitely want to believe we know the causation of things going on around us.

Do you believe the news drives stock price trends?

Coronavirus Live Updates: Trump Praises China’s Response to Outbreak as Death Toll Passes 600 – New York Times 

The Coronavirus outbreak in Wuhan China has grown exponentially as asymmetric uncertainties usually do. According to Worldometer, there are now 31,535 of which 4,826 (15%) in critical condition 638 deaths and 1,778 have recovered. 
number of Coronavirus Cases
The Coronavirus outbreak only started less than a month ago, but its rate is exponential.
coronavirus total cases deaths
This is not the kind of asymmetry we want to observe. I hope a cure is found soon to save these human lives.
How has the stock market reacted?

The S&P 500 gained over 3% the past 5 days anyway… 

spy spx trend following etf

It’s just the market… doing what it does…

This morning, in the U.S. we get great news on employment data.

The US Unemployment Rate measures the percentage of total employees in the United States that are a part of the labor force but are without a job. It’s one of the most widely followed indicators of the health of the US labor market and the US economy as a whole. Historically, the US Unemployment Rate reached as high as 10.80% in 1982 during a notable recessionary period.

The low Unemployment Rate has been a bright spot for the U.S. economy since unemployment trended up sharply in 2008 and peaked at 10.10% in November 2009, the highest level since ’82. A picture is worth a thousand words, so here the trend. from January 2007 to November 2009 as Unemployment Rate increased sharply from 4.4% to 10.10% in about two years.

us unemployment peak 2008 2009

Looking at the US Unemployment Rate in the bigger picture, below are the trends and cycles going back over sixty years. US Unemployment Rate is at 3.60%, compared to 3.50% last month and 4.00% last year. This is lower than the long term average of 5.73%. The last recession was the second-highest unemployment and it has recovered even smoother than before.

US UNEMPLOYMENT RATE

The headlines today:

January adds a much stronger-than-expected 225,000 jobs, with a boost from warm weather” – CNBC

The stock indexes are down over -0.50% anyway…

I say: It’s just the market, doing what it does… 

I believe investors underreact and overreact to new information “news.”

An overreaction is when price trends become overbought or oversold driven by psychological and investor sentiment reasons rather than fundamentals. It’s why we see crashes and bubbles, over short term and long term periods.

An underreaction is when investors initially underreact to new information such as earnings announcements, which leads to a predictable price drift. In other words, underreaction drives price trends!

Prices drift up or down over time when investors underreact to information.

Prices overshoot, trade up or down too far, too fast, when investors overreact to information.

This why my focus is on the direction of price trends, along with volatility, investor sentiment, and multiple time frame momentum.

My directional trend following systems are designed to catch the trends that drift from underreaction.

My countertrend systems signaled by momentum, extreme investor sentiment, and volatility analysis, are engineered to capitalize on overreactions.

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.

 

 

19 is the new 20, but is this a new low volatility regime?

We used to say the long term average for the Cboe Volatility Index VIX is 20.

Some would mistakenly say that VIX “reverts to the mean”, suggesting it is drawn to the average level of 20, which isn’t exactly the condition. It doesn’t cycle up and down to trend around 20 most of the time, but instead, it spends much of the time between 10 and 30.

Prior to 2015, the long term average of VIX since its inception was 20 and we heard the number 20 referenced with VIX often. ^VIX Chart

Since January 2015, we’ve seen the long term average decline to the 19 levels.  ^VIX Chart

So, 19 is the new 20.

What caused the downtrend in the long term average?

Obviously, it would take a very low level of readings to drive down the long term average of a volatility index introduced in 1993.

What happened in the past 5 years that impacted the prior 21 years of data so much to bring the 26-year average down?

A 5 year period of low implied volatility happened with an average of 15% and a low of 9.14%. Said another way; the past 5 years expected volatility priced into S&P 500 stock options has been about 25% lower than the prior two decades, or 75% of what we previously observed. Here is the trend for VIX from 2015 to today. A VIX level of 15 translates to implied volatility of 15% on the S&P 500. 
^VIX Chart

Is this a new low volatility regime?

Anything is possible, but I’m guessing the lower level of implied (expected) volatility may be driven by two facts that can both result in less concern for volatility.

  1. The current bull market that started in March 2009 is the longest bull market in history. It exceeded the bull market of the 1990s that lasted 113 months in terms of time, though still not as much gain as the 90s.
  2. The U.S. is in its longest economic expansion in history, breaking the record of 120 months of economic growth from March 1991 to March 2001, according to the National Bureau of Economic Research. However, this record-setting run observed GDP growth far slower than previous expansions.

The aged bull market and economic expansion can naturally lead to some level of complacency and expectation for less downside and tighter price trends. When investors are uncertain, their indecision shows up in a wide range of prices. When investors are smugger and confident, they are less indecisive and it’s usually after a smooth uptrend they expect to continue.

Is it another regime of irrational exuberance?

“Irrational exuberance” was the expression used by the former Federal Reserve Board chairman, Alan Greenspan, in a speech given during the dot-com bubble of the 1990s. The expression was interpreted as a warning that the stock market may have been overvalued. It was.

Irrational exuberance suggests investor enthusiasm drives asset prices up to levels that aren’t supported by fundamental financial conditions. The 90s ended with a Shiller PE Ratio over 40, far more than any other time in more than a century.

Is the stock market at a level of irrational exuberance?

Maybe so, as this is the second-highest valuation in the past 150 years according to the Shiller PE.

shiller pe ratio are stocks overvalued

But, the driver here is inflation. When inflation rates are really low, we can justify a higher price to earnings ratio for stocks, so they say.

A new VIX average level of 19 translates to the implied volatility of 19% on the S&P 500 instead of the former after of 20%. It isn’t a huge range difference.

Looking over the full 26 years of implied volaltity, the more elevated levels in the past included the late 90s into around 2003, which elevated the average. Since then, we’ve seen more spikes up but not as many volatility expansions that stay high for longer periods. ^VIX Chart

A behavior of implied volatility I’ve observed over time is it spikes up very fast when the stock market drops and then trends back down more gradually as stocks trend back up.  For this reason, derivatives of volatility provide us an opportunity for asymmetric hedging.

I doubt this is a new lower long term volatility regime. My guess is we’ll see a very significant volatility expansion again at some point during the next bear market and economic recession. Historically we’ve observed trends that stretch far and wide swing back the other way, far and wide.

At a minimum, it’s no time for complacency.

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.

 

 

Energy and MLP’s are the most oversold sector

The energy sector is the most oversold so far.

By oversold, I mean a condition where there has been enough selling pressure to drive prices down to low enough levels which overextended or excessive on a short-term basis, suggesting the downtrend could be an overreaction. When price trends overreact in the short-term by moving potentially too far, too fast, the trend becomes likely to reverse back up, at least temporarily. Afterward a countertrend back up, however, a short-term oversold trend may later reverse down again in continuation of a downtrend. So, observing a short-term oversold condition may not result in a long-term trend reversal up, but instead, my increase the odds of a short-term retracement. In the chart below of the energy sector index, we see an overall downtrend since the price on the left side is higher than the right a year later, however, we also observe the price swings along the way, which are shorter-term overbought/oversold countertrends.

Image

Energy sector is -43% from its early 2014 high.

Image

Energy sector is almost near its 2016 low.

Image

Energy implied volatility is relatively low and below average.

Image

Alerian MLP energy index is at a new low

Image

With the energy sector momentum signaling its price trend may have dropped too far, too fast,  the dividend yield on the MLP index is at its high post-2016 at over 9%.

ENERGY MLP ETF

As the price falls, the dividend rises from that starting point, so it’s the one time we apply countertrend systems to capture future income from dividends. I wouldn’t be surprised to see the energy sector catch some buying enthusiasm soon if the overall stock market can hold up. Sometimes the weakest sectors show strength even as other sectors fall.  Of course, the risk of a falling trend is it may keep falling and they can trend down far more than expected. The trouble is, when a trend does fall more than expected, it results in serial correlation; prices keep falling because, well, prices are falling! Waterfall declines are contagious, so you can probably see the ‘risk premium’ involved in this high dividend yield. There is no free lunch and nothing is without risks.  I deal with risks by managing them through predefined exits, drawdown controls, and hedging.

So, I probably enter and exit a more global opportunity set of markets than most do since the risk for me is how I define it and how the position is structured, not the security itself.

I’m off to the Super Bowl in the morning! Unfortunately, my Tennessee Titans didn’t make it and my Tampa Bay Bucs didn’t come close, but I’ll be there anyway.

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.

Global Macro: is the coronavirus outbreak crushing the China ETF and causing the volatility expansion?

The past five days have been a little choppy in price action.

SPX january 2020

If you’ve been following my observations, it should be a surprise as a volatility expansion was expected.

The VIX CBOE S&P 500 Volatility Index has gained 34% the past five days, so it’s a volatility expansion indeed. At the 17 level, the VIX now implies a 17% volatility in prices over the next 30 days. So, the options market traders expect more vol.

VIX asymmetric risk reward return

I’m no day trader, but I monitor global macro trends daily both systematically through my programs as well as manually and visually. For me, the global macro trend includes other countries and over 100 markets including volatility.

Speaking of other countries…

Below is the US equity index drawdown so far relative to the Emerging Markets Index and EAFE which is developed international countries. Emerging Markets EM is the laggard.

SPY EFA EEM

Looking deeper, here are the country holdings for EEM. China, Taiwan, South Korea, and India are the main exposures in the EM index.

emering markets countires eem holdings

Here are the price trends of China, Taiwan, South Korea, and India that are the principal exposures in the EM index.

global macro trends coronavirus

The drawdowns of these emerging markets countries have been notably greater than the US so far. China and Brazil have fallen the most. As we have been positioned in short tern U.S. Treasuries recently, We have no exposure to these markets.

global macro trend following

I’m sure many investors believe it’s caused by the Coronavirus spreading across China and now the world. At this point, it may be driving some selling for some, but it’s really the market, doing what it does. To be clear, I’m saying the market would respond similarly regardless of the news headlines, because of the math. For some, that may sound provocative and I hope it is at least thought-provoking because I mean it.

To be sure… my assumption is testable.

The coronavirus was first detected in Wuhan city, Central China, in December 2019. It is believed to have originated from wild animals, passing to humans due to the wildlife trade and wet markets. However, Google Trends doesn’t show any activity until January 17th and then it jumped on January 24th.

when did coronavirus outbreak first make headlines

Next, I chart the price trend of the MSCI China stock index ETF along with the CBOE China ETF Volatility Index. Cboe Options Exchange (Cboe) now applies its proprietary Cboe Volatility Index® (VIX®methodology to create indexes that reflect expected volatility for options on select exchange-traded funds (ETFs). Cboe calculates and disseminates the Cboe China ETF Volatility Index (ticker VXFXI), which reflects the implied volatility of the FXI ETF.

Here we see the price trend up to January 17th was up over the past year and the implied volatility was near its low.

china stock trend coronavirus impact on market volatility

And to be sure, here is the chart going back a decade and I marked the lowest point of the China ETF VIX index to show implied volatility had reached an extreme low this month prior to the coronavirus outbreak.

china stock etf vix coronavirus

So, here is the price trend of the China ETF and its volatility index over the past 30 days. The low implied volatility was January 17th, so I was expecting a volatility expansion regardless of any news headlines that would suggest the blame for it. Indeed that’s what we’ve seen.

china etf stocks market vix volatility coronavirus

I believe the markets do what they do and some news gets the headline and the blame. Trends trend and then reverse because mathematically, they reach extreme lows and highs in their momentum making them more likely to reverse direction.

We have no way of knowing exactly why there has been enough selling pressure from investors and traders drive down China stocks, but I expected a volaltity expansion anyway, so if I had exposure to the China ETF  I would have responded accordingly. I didn’t and still don’t, so this is simply for informational purposes, as always.

I believe my systems and methods are robust because I focus on the actual direction of the price trend and its volatility, and the price trend is the final arbiter.  I’ve been doing what I do, over and over, for over two decades now. I’ve just gotten better at it with experience.

I don’t care so much about what news may be driving the trend, I focus on the market overreaction and underreaction and that’s observed in the price and volatility.

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 new virus.

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.

 

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.

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.

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.

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.

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.

 

 

 

 

 

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.

 

 

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.

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.

 

 

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.

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.

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.

 

 

 

 

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.

 

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