Divergence between Value, Growth, and Momentum.

There is an interesting divergence today between Momentum, Growth, and Value.

Up until now, Value has lagged Growth and Momentum, as seen in this 5-year chart.

The underperformance of Value has been a topic of conversation of hedge fund managers I know who are Value investors.

Three-month momentum shows Value is trending up.

I believe styles like Growth vs. Value are largely driven by sectors, which is why I tend to focus more on the more granular sectors rather than broader styles.  Today we see the relative strength is in Energy and Financials, which have been the lagging sectors lately.

value underperforming growh momentum

So, this may not be enough to say the trend is changing to a period where Value outperformance growth for years, but it’s at least enough to be aware.

At some point, Value will take over leadership and when it does, it may continue for years.

For now, exposure to Value, including high dividend-paying stocks like we have, is having a good day while other factors are not.

 

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

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

Sector SPDRs are subject to risk similar to those of stocks including those regarding short selling and margin account maintenance. All ETFs are subject to risk, including possible loss of principal. Sector ETF products are also subject to sector risk and non-diversified risk, which will result in greater price fluctuations than the overall market.

 

 

Global Macro observations and the period of indecision ends with an upside breakout in stocks

In the last observation, The stock market is in a period of indecision that it will break out of I shared:

Looking at the price trend of the S&P 500 index over the past six months, today’s 1.4% move so far has the trend tapping the upper end of the range. I encluded this chart last Thursday:

asymmetric risk reward return stocks

Here we are a week later, and sure enough, this stock index broke out of the range.

stock market spx spy trend

Of course, past performance doesn’t assure future results, so while this upside breakout is positive, it isn’t without some risks and potential headwinds.

I hedged off some of my market risks, based on pattern recognition hedging the price trend could once again fall back to the lower red line. Of course, my exits on these hedges are predefined, as always, so none of the following global macro observations have any real tactical decision-making authority.

When I enter a position, I predetermine at what price I’ll exit if it becomes a loser or overtime, a laggard.

I’m no economist, so I rarely mention any economic data trends as they don’t lead to actionable tactical signals to buy or sell. However, one of the economy’s strongest segments may be showing signs of weakening: job growth, and it seems important enough to mention. On the global macro front, it seems like the market wasn’t concerned about employment data, and for now, it was right. 

In the big picture from a global macro perspective, the probabilities of a recession are trending higher, earnings growth is lagging, and business and manufacturing sentiment are trending lower. These may be necessary issues the U.S. has to deal with to get through the trade war with China.

On the other hand consumer confidence, spending, and employment have been able to withstand difficult conditions and recover. Up until now, the consumer and employment has been the bright spot. From this point forward, any weaknesss in consumer spending, confidence, and employment is a risk. Momentum in job growth has turned down from a cyclical peak this year, so I’m guessing it’s something that may become an issue eventually. When it comes to global macro data, there’s always something to worry about, so I don’t make my decisions with it.

Today’s employment data was a little better than expected, so it’s a driver of today’s stock market upside breakout. As past performance never guarantees the future, it may be different next time.

Until then, the stock market has indeed broken out of its coil and is sprung up.

 

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

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

 

 

 

 

 

 

 

The stock market is in a period of indecision that it will break out of

As I’ve been pointing out all month in August, the stock market is in a period of indecision, that it will eventually break out of.

Looking at the price trend of the S&P 500 index over the past six months, todays 1.4% move so far has the trend tapping the upper end of the range.

asymmetric risk reward return stocks

Zooming in to the beginning of the month of August, it’s been a month of indecision. Those who want to buy are battling with those who want to sell.

The range of the price trend has spread out, as was implied by the CBOE S&P 500 Volatility Index VIX. It’s been a relatively volatile month with this big-cap stock index swinging up and down in a range of 4%.  As we can see in the chart below, the VIX trended up sharply as stocks declined in price.

What we also see, however, is implied is settling back down as the price trend is swinging up and down in this 4% range of indecision.

What’s going to happen next? 

I don’t need to know what’s going to happen next. I know exactly what I’ll do next with my positions if they continue trending up, or reverse back down.

Using this stock index as an example, if it breaks below this range it’s bearish, but if it has the buying demand to break above it, the uptrend resumes.

That’s why we call price action as we’ve seen this month a base patter and we’ll eventually see a big move out of it one direction or the other.

The S&P 500 index is an unmanaged index and cannot be invested into directly, but if we could and I wanted to be long stocks, I would exit if it fell below the three recent lows.

If I wanted to be short, I would exit if it broke out above the prior high.

This is just an oversimplified example of how I tactically manage risk.

Hurricane Dorian looks to add to the August volaltity.  Hurricane Dorian is now expected to intensify into a Category 4 hurricane as it moves toward Florida and the U.S. Let’s hope it loses its momentum. I’m in Tampa Bay on the other side. It should slow down by the time it reaches us. Our home is made of concrete, tile roof, and 150 MPH hurricane windows, so we’ll be fine.

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

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

The value of technical analysis of stock market trends

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

I’ll share a simple and succinct example.

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

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

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

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

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

spy spx ytd trend following

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

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

setting stop loss for stocks

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

If it doesn’t, I’d say:

Look out below!

Do I trade-off this? Nope.

Am I telling you to? Nope.

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

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

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

I hope you find it useful.

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

Let me know if we can help!

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

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

The stock market is holding its breadth… for now

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

spx percent of stock above 50 day moving average

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

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

spx stocks above 200 day moving average asymmetric risk reward

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

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

spx spy trend following

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

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

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

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

We’ll see how it all unfolds from here.

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

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

 

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

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

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

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

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

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

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

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

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

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

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

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

Bloomberg goes on to say:

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

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

Global X MSCI Argentina ETF AGT ARGT

 

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

 

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

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

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

All investors are market timers

All investors are market timers.

It isn’t just tactical traders.

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

But they are.

We all are.

And timing is everything. Like it or not.

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

According to Wikipedia:

Market timing is the strategy of making buying or selling decisions of financial assets (often stocks) by attempting to predict future market price movements. The prediction may be based on an outlook of market or economic conditions resulting from technical or fundamental analysis.”

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

Next is Investopedia:

“What Is Market Timing?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Past performance is no guarantee of future results.

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

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

Global Asset Allocation hasn’t done any better

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

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

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

Each ETF has a fixed allocation to stocks and bonds.

ishares global allocation ETF

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

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

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

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

I don’t believe I know anyone who does.

Why?

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

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

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

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

Shiller PE Ratio

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

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

May as well be honest and realistic about it.

Not convinced?

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

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

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

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

It isn’t going to last forever.

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

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

Charting and technical analysis of the stock market trend

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

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

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

stock market momentum and support resistence

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

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

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

“May you live in interesting times” 

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

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

We’ll see how it all unfolds.

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


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

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

“THEY KNOW NOTHING!”

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

So, I have shared it below.

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

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

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

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

 

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

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

Is volatility setting up for an expansion?

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

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

According to Bloomberg:

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

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

VIX $VIX #VIX VOLATILITY EXPANSION JULY 2019

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

vix-futures-term-structu

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

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

bollinger bands realized volatility

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

Let’s see how it goes…

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

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

 

A few observations on Global Macro and Trend Following

A few observations on #GlobalMacro and #TrendFollowing

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

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

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

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

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

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

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

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

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

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

Logical Inconsistency?

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

 

“Rule No. 1: Never lose money.

Rule No. 2: Don’t forget rule No.1.”

 

But.. is it a logical inconsistency?

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

Logical Insonconsinecy:

When multiple statements are given which contradict one another.

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

 

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

 

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

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

 

The normal noise of the market?

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

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

TECH SECTOR MOMENTUM XLK $XLK $IYW

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

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

stock market SPY $SPY

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

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

 

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

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

Giddy up…

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

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

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

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

global macro asymmetric risk reward .jpg

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

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

Giddy up…

 

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

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

Going with the flow

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

global macro tactical momentum trend following asymmetric risk reward

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

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

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

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

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

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

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

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

The empirical evidence is observed visually in this chart.

SPY SPX VOLATILITY MOMENTUM TREND

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

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

small cap momentum RUT IWM trend following system

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

gold gld $GLD

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

EMERGING MARKETS TREND MOMENTUM

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

TLT LONG TERM TREASURY HEDGE ASYMMETRIC RISK REWARD

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

SHV SHORT TREASURIES TREND VOLATITLIY MOMENTUM YIELD

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

shv

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

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

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

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

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

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

global asset allocation ETF ETFs asymmetric risk reward .jpg

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

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

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

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

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

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

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

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

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

Global Allocation Index Construction

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

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

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

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

global tactical asset allocation asymmetric risk reward

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

GLOBAL TACTICAL ASSET ALLOCATION ASYMMETRIC RISK REWARD DRAWDOWN

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

iShares Core Moderate Allocation ETF

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

iShares Core Total USD Bond Market ETF (IUSB)

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

GLOBAL ASSEST ALLOCATION ADVISORS TACTICAL

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

global tactical asset allocation drawdown risk management

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

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

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

Strong stock market momentum was accompanied by broad participation

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

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

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

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

percent of stocks above 200 day moving average trend following

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

We’ll see…

 

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

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

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

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

tactician technical analysis analyst tactical manager trader

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

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

SPY VWAP MOMENTUM RELATIVE STRENGTH TREND FOLLOWING

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

SPY

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

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

 

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

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

U.S. Stock Market Update

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

stock market momentum

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

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

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

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

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

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

We’ll see.

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

Mike Shell and Shell Capital Management, LLC provides investment advice and portfolio management solely to clients with a signed and executed agreement. The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Asymmetry in the CBOE Index Put/Call Ratio suggests hedging

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

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

cboe index put:call ratio asymmetric hedging

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

cboe index put call long term history asymmetric hedge

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

equity put call ratio asymmetric risk reward hedging

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

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

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Stock market internals are signaling an inflection point

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

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

That’s exactly what we’ve seen since.

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

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

percent of stocks above 200 day moving average asymmetric

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

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

percent of stocks above 50 day moving average asymmetric

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

nyse bullish percent asymmetric risk reward 2019

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

s&p 500 bullish percent asymmetric risk reward

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

record high percent

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

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

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

asymmetric risk reward trend following

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

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

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Feeling and Doing the Right Thing at the Right Time

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

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

vix volatility expansion regime change

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

I believe the timing is everything.

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

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

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

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

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

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

equity put call ratio asymmetric risk reward

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

cboe index put:call ratio aymmetric risk reward

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

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

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

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

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

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

Is sound only sound if someone hears it?

Can something exist without being perceived?

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

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

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

high yield fund flow hyg jnk

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

price trend shows fund flow of etf

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

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

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

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

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

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

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

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

high yield income investment strategy

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

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

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

high yield trading momentum system trend following

It’s all a matter of perception and observation.

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

 

 

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Uncharted Territory

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

Everything about the future is always uncharted territory.

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

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

uncharted territory

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

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

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

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

We are always in uncharted territory.

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

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

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

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

FAANG Stocks and Momentum Trends

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

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

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

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

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

nifty 50 ko ibm ge

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

fifty 50 stock asymmetry ratio

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

tech stocks

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

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

1990s momentum tech stocks

Those are the momentum trends of the past.

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

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

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

faang stocks fb aapl amzn nflx goog momentum asymmetric risk reward

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

fang faang stock momentum fb aapl amzn nflx goog

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

 

faang stock asymetric risk reward momentum drawdown

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

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

A Tale of Three Vols

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

Nope.

Different vol.

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

Someone asked:

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

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

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

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

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

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

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

A few observations:

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

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

You may be wondering why?

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

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

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

What does it matter, anyway?

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

spx spy $spx $spy atr sd vix volatility asymmetric

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

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

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

A countertrend system does just the opposite.

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

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

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

trend following stocks stock market asymmetric risk reward

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

Appalachian Magazine shares the story:

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

So, there you have it.

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

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Investor Sentiment into the New Year 2019

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

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

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

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

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

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

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

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

Bearish Investor Sentiment is Negatively Correlated with Stock Index Returns

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

Bullish Investor Sentiment is Positively Correlated with Stock Index Returns

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

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

VIX VXX VXXB 2018 VOLATILITY EXPANSION TRADING INVESTMENT ADVISOR.jpg

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

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

equity put call ratio 2018 spx spy

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

INDEX PUT CALL RATIO CBOE 2018

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

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

total put call ratio spx comparison

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

spy spx stock index 2018 bear market

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

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

 

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

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

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

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

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

Mark Twain’s mother once said:

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

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

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

JANUARY 2018

All Eyes are Now on the Potential Government Shutdown

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

FEBRUARY 2018

In the final stages of a bull market

Asset Class Returns are Driven by Sector Exposure

Stock Market Analysis of the S&P 500

Stock market indexes lost some buying enthusiasm for the day

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

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

February Global Market Trends

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

Buying demand dominated selling pressure in the stock market

Asymmetric Volatility

MARCH 2018

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

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

Asymmetric force direction and size determines trend

Asymmetric force was with the buyers

My Introduction to Trend Following

When I apply different trend systems to ETFs

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

Apparently there was more enthusiasm to sell

What’s going to happen next?

What’s going to happen next? continued

APRIL 2018

Is this correction and volatility normal?

Global Market Trends

MAY 2018

Is the economy, stupid?

JUNE 2018

Growth Stocks have Stronger Momentum than Value in 2018

Sector Trends are Driving Equity Returns

Trend Analysis of the Stock Market

Trend of the International Stock Market

Interest Rate Trend and Rate Sensitive Sector Stocks

Expected Volatility Stays Elevated in 2018

Sector ETF Changes: Indexes aren’t so passive

Commodities are trending with better momentum than stocks

Investor sentiment gets more bearish

Is it a stock pickers market?

JULY 2018

2nd Quarter 2018 Global Investment Markets Review

Global Stock and Bond Market Trends 2Q 2018

Stock market investor optimism rises above historical average

Trend following applied to stocks

Asymmetry of Loss: Why Manage Risk?

Earnings season is tricky for momentum growth stocks

Front-running S&P 500 Resistance

The week in review shows some shifts

AUGUST 2018

Global Market ETF Trends

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

The Big Picture Stock and Bond Market Valuation and Outlook

SEPTEMBER 2018

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

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

What trends are driving emerging markets into a bear market?

VIX level shows market’s expectation of future volatility

Rising Interest Rate Impact on Real Estate and Home Construction

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

OCTOBER 2018

Stanley Druckenmiller on his use of Technical Analysis and Instinct

Here comes the volatility expansion

Intermarket trends change over the past two weeks

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

Divergence in Global Asset Allocation

The Stock Market Trend

U. S. Sector Trends

Observations of the stock market decline and volatility expansion

The stock market trends up with momentum

Observations of the stock market downtrend

NOVEMBER 2018

The stock market is swinging its way to an inflection point

Divergence in the Advance-Decline Line May be Bullish

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

Momentum stocks need to find some buying interest

Will the stock market hold the line?

The Death Cross on the S&P 500

DECEMBER 2018

Stock Market Observations

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

Global asset allocation takes a beating in 2018

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

An exhaustive analysis of the U.S. stock market

An exhaustive stock market analysis… continued

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

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

HAPPY NEW YEAR! 

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

 

An exhaustive stock market analysis… continued

I guess An exhaustive analysis of the U.S. stock market wasn’t exhaustive enough, because I now have a few things to add.

First, since the financial news media, as well as social media like Twitter, is so bearish with all kinds of narratives about why the stock market is falling, I’ll go ahead and discuss it here. This observation will not be complete without first reading An exhaustive analysis of the U.S. stock market so you know where I am coming from. If you haven’t read it already, I would before continuing so you understand the full context.

It is the financial news media’s business to report new information. We all know that if they want to get people to tune in, the fastest way is to provide provocative and alarming headlines and commentary. So, we shouldn’t be surprised to see distressing news.

There are always many reasons for the stock market to trend up or down. It isn’t hard to write some narrative attempting to explain it. The reality is, there are all kinds of causes that create an effect. None of them alone drive price trends. Ultimately, what drives price trends is behavior and sentiment which drives supply and demand. Behavior and investor sentiment may be impacted by the news and what people decide to believe.

I often say “what you believe is true, for you” even if it isn’t actually true. A person’s beliefs could be completely wrong and could be scientifically disproven, but if they still believe it, it’s their truth, so it’s true – for them. So, whatever you choose to believe is going to be your truth, so I suggest weighing the evidence to determine the truth if you want it to be more accurate. In science, we can’t prove the truth to be true, we can only disprove it as untrue.

Let’s look at some truths that I believe to be true based on empirical observation of facts.

The biggest news headline is probably the government shutdown. There have been twenty U.S. government shutdowns over the budget since 1976 by both political parties. Half of the time it was followed by stock gains and half the time declines. The average result is -0.40% and the median is 0%. So, historically a government shutdown hasn’t seemed to drive prices. Below is the table. It is what it is.

What does the stock market do after government shut down

Yesterday evening Steven Mnuchin, the 77th Secretary of the Treasury, tweeted a note that he had called the nations six largest banks to confirm they have ample liquidy for consumer and business lending and other market operations. The words “Plunge Protection Team” started trending in social media. Much of the response has been negative, which seems odd to me.

Since when was doing “channel checks” not a good idea?

It seems not doing it would be imprudent…

There are many things going on all over the world all the time, so we can always find narratives to fit the price trend and believe it’s the driver. Narratives and news also seem to drive more emotional responses since people like to hear a story. I focus on the data, which is the price action. Whatever is driving the markets is reflected in the price trend. The price trend is the final arbiter. Nothing else matters.

The Morningstar table of index performance shows the 2018 total return of large, mid, small cap stocks along with growth, value, and blend.

STOCK MARKET INDEX RETURNS 2018

The most popular broad-based indexes like the S&P 500 and Dow Jones Industrial Average show 2018 is ending just the opposite of the way it started.

stock index performance return 2018

Let’s look at some price trends.

Yesterday I shared the Bullish Percent measures on the broad stock market indexes and each individual sector. We observed the percent of stocks in all sectors except for the Utility sector was already at historical lows after previous market declines. After today’s price action, we have some updated observations to explore.

The S&P 500 is in a bear market, commonly defined as a -20% decline from a prior price peak. What is most interesting is how fast it reached -20%.  In the chart below, I included the S&P 500 Total Return Index (including dividends), the S&P 500 Index price only, and the S&P 500 ETF (SPY). On a total return basis, the S&P 500 Total Return Index that includes no costs or fees didn’t quite close down -20% from its high, but the rest did. It’s close enough.

bear market 2018 October November December Crash

Though the stock indexes had declined -10% earlier this year, they had recovered to new highs by September and it appeared the primary uptrend would resume. Starting in October, the stock market declined again and attempted to recover twice in November. What came next was probably most shocking to those who follow market seasonality; the stock indexes are down over -15% in the month of December, which is historically one of the strongest months of the year. It seems this decline happening so fast and at the end of a calendar year is going to make it seem more significant.  Because it’s at year end it results in a “down year” instead of having time to recover during the normally seasonally strong period after October. The period from November to April historically has stronger stock market gains on average than the other months. Not this year.

The Utility sector reverses down to participation in the market decline. 

Yesterday I had highlighted the top range of the Bullish Percent chart in yellow to mark the high-risk zone above 70%. After today, the Utilities sector has declined below that range. Individual Utility stocks are now participating in the stock market decline.

Utilities Sector ETF XLU BULLISH PERCENT RELATIVE STRENGTH MOMENTUM

The Utilities sector ETF declined over -4% today and is now slightly down for the year.

Utilities Select Sector SPDR® ETF $XLU

During significant market declines, diversification sometimes isn’t the crutch it is promoted to be by most of the investment industry. Broad asset allocation and diversification do not assure a profit or protect against a loss in a declining market. In declining markets, we often see price trends cluster more as serial correlation. That is, prices begin to fall more just because they are falling. Investors sell because prices are falling. So, stocks, sectors, and markets can all become highly correlated to the downside. By the end of a market decline, all stocks, sectors, and markets are often participating.

The upside is, this panic selling is capitulation as the final weak holders stop resisting and begin to “sell everything!” We eventually see the selling dry up and buyers step in with enthusiasm at lower prices.

In the big picture, as I said in An exhaustive analysis of the U.S. stock market I guess we shouldn’t be surprised to see prices falling with greater velocity since this is an aged bull market at high valuations and the same Fed actions that probably drove it up are probably going to reverse it in a similar fashion. I started this year warning of complacency from the 2017 low volatility uptrend and the potential for a volatility expansion. I also pointed out during the stock market peak in September that volatility had contracted to a historically very low level in VIX shows the market’s expectation of future volatility. Specifically, on September 25th I wrote,

“Looking at the current level of 12 compared to history going back to its inception in 1993, we observe its level is indeed near its lowest historical low.”

I ended it with;

“When the market expects volatility to be low in the next 30 days, I know it could be right for some time. But, when it gets to its historically lowest levels, it raises situational awareness that a countertrend could be near. It’s just a warning shot across the bow suggesting we hedge what we want to hedge and be sure our risk levels are appropriate.”

Well, that has turned out to be an understatement I guess.

What’s more important is what I actually did. On August 23th as the stock market began to appear overbought on a short-term basis, I took partial profits on our leading momentum stock positions. In hindsight, it would have been better to sell them all. By September 26th (when I wrote the above) I had reduced our exposure to only around 30% stocks and the rest in Treasury bonds. It still didn’t turn out perfectly as the stocks we did hold declined, too, and in many cases even more than the stock indexes. As we entered October, I shared a new observation “Here comes the volatility expansion” as stock prices fell and volatility increased. As prices fell to lower and lower levels, I started adding more exposure. At this point, prices have broadly become more and more extremely “oversold” and sentiment has become more negative. This has been a hostile period for every strategy, but I’ve been here before.

By the way, I have been a tactical portfolio manager for over twenty years now. The highlight of my performance history has been the bear markets. I executed especially well in the October 2007 to March 2009 period when the S&P fell -56%. My worst peak to trough drawdown during that period was only -14.3% and I recovered from it about six months or so later. That was compared to a -56% drop in the stock index that took several years to recover. In fact, I did so well at a time when very few did that it was almost unbelievable, so I had my performance verified by a third party accountant. I have considered writing about it and sharing the commentaries I wrote during the period and the tactical decisions I made. Make no mistake, it wasn’t easy nor was it pleasant. I didn’t lose the money others did, so I was in a position of strength, but it was still a challenging time. What I will tell you is I entered and exited various positions about seven or eight times over that two year period. We never know in advance when the low is in, or when a trend will reverse back down. Buy and hold investors just take the beating, I entered and exited hoping the average gain exceeds the average losses. The swings are the challenge. It takes great discipline to do what needs to be done. Most people had very poor results, for me to create good results, I necessarily had to feel and do the opposite of most people. The market analysis I’m sharing here as observations aren’t necessarily the exact signals I used to enter and exit, but they are part of the indicators I monitored during the crash. Every trend is unique. We have no assurance my methods will do as well as in the past. But, the one thing I feel confident in is I’ve been here before. This ain’t my first rodeo. I know what I’m doing and I’m disciplined in my execution. That’s all I can do. I’m dealing with the certainty of uncertainty, so I can’t guarantee I’ll do as well the next time around, but I am better prepared now than I was then.

So bring it. Get some. I’m ready. 

Yesterday I shared the extreme levels of Bullish Percent indicators for the broad market and sectors as well as other indicators like the Put/Call Ratios. I want to add to these observations with more indicators reaching an extreme. I’ve not seen these extremes since 2008 and 2009.

The Nasdaq has declined the most which is no surprise since it’s mostly emerging companies and heavily weighted in Technology. Market conditions have pushed the number of Nasdaq stocks hitting new lows to over 1,100 as of last week. Since the total number of Nasdaq issues is about 3,200 that has caused the value, in percentage terms, to jump to over 30% of the total. As you can see, the last time this many Nasdaq stocks hit new lows was the October 2008 low and the March 2009 low. The current level has exceeded other corrections since then and even the “Tech Wreck” after 2000. At this point, it becomes a contrarian indicator.

NASDAQ NEW LOWS PERCENT OF INDEX

To no surprise, the same trend is true for NYSE stocks. As of last week, the percent of stocks listed on the New York Stock Exchange at new lows has reached the levels of past correction lows, but not as high as the 2008 period.

NYSE NEW LOWS PERCENT NYA INDEX

From here, I’ll share my observations of the relative strength and momentum of the sectors and stocks within them so we can see how oversold they have become. We already looked at the Bullish Percent of each sector yesterday, this is just more weight of the evidence.

First, I applied the Relative Strength Index to the S&P 500 daily chart. This RSI is only 14 days, so it’s a short-term momentum indicator that measures the magnitude of recent price changes to estimate overbought or oversold conditions. RSI oscillates between zero and 100, so it’s range bound and I consider it overbought above 70 and oversold below 30. Below we see the current level of 19 is very low over the past twenty years and is at or below the low level reached during past shorter-term market bottoms. However, we also see during prolonged bear markets like 2000 to 2003 and 2007 to 2009 it reached oversold conditions two to three times as the market cycles up and down to a lower low.

RSI SPX RELATIVE STRENGTH S&P 500 INDEX

Zooming out from the daily chart to the weekly chart, we see the extremes more clearly and this is one of them. On a weekly basis, this oversold indicator is as low as it’s been only at the low points of the last two major bear markets.

sS&P 500 RSI WEEKLY RELATIVE STRENGTH SPX

Zooming out one more time from the weekly to the monthly chart, we observe a monthly data point only highlights the most extreme lows. It’s the same data but ignores the intra-month data. On a monthly basis, the current measure isn’t as low as it reached at the bear market lows in March 2009 or October 2002. For it to reach that level, I expect the green area I highlighted in the price chart to be filled. In other words, this suggests to me if this is a big bear market, we could ultimately see the price trend decline to at least the 2015 high. It only takes about -10% to reach that level. However, as we saw in the shorter term readings, if history is a guide, it would most likely cycle back up before it would trend back down.

RSI S&P 500 MONTHLY RELATIVE STRENGTH INDEX SPX

You can probably see why I stress that longer-term price trends swing up and down as they unfold. Within a big move of 50%, we see swings around 10 – 20% along the way.

Let’s continue with this same concept to see how each sector looks. The broader indexes are made of the sectors, so if we want an idea of the internal condition of the broader market it is useful to look at each sector as I did yesterday with the Bullish Percent indexes.

Since we just had a -15% correction in August 2015 and January 2016, we’ll just focus on the daily RSI looking back four years to cover that period. Keep in mind, none of this is advice to buy or sell any of these sectors or markets. We only provide advice and investment management to clients with an executed investment management agreement. This observation is for informational and educational purposes only.

The Consumer Discretionary sector is as oversold as it’s been at historically low price points. A trend can always continue down more and stay down longer than expected, but by this measure, it has reached a point I expect to see a reversal up.

CONSUMER CYCLICAL SECTOR RELATIVE STRENGTH MOMENTUM RSI TREND

The price trend of Consumer Staples that is considered to be a defensive sector initially held up, but then the selling pressure got to it. It’s oversold as it’s been at historical lows.

consumer staples etf relative strength trend RSI XLP

The Energy sector has declined the most in 2018 and is oversold similar to prior price trend lows. We can see the indicator isn’t perfect as a falling trend sometimes reverses up temporarily, then trends back down to a lower low only to get oversold again. We’ll observe this same behavior at different times in each sector or market.

energy sector etf xle relative strength rsi momentum trend following buy signal.jpg

The Financial sector is deeply oversold to the point it has reached at prior lows. Any market could always crash down more, but Financials have reached a point we should expect to see at least a temporary reversal up.

FINANCIAL SECTOR ETF XLE IYF RELATIVE STREGTH MOMENTUM RSI

Healthcare is a sector that isn’t expected to be impacted by the economy, but it has participated in the downtrend. It’s also reached the oversold point today. You can see what happened historically after it reached this level. If history is a guide, we should watch for a reversal.

XLV HEALTH CARE ETF RSI MOMENTUM RELATIVE STRENGTH

The Industrial sector is trending down but has now reached a point we could see a reversal back up.

XLI INDUSTRIAL SECTOR ETF MOMENTUM RSI

Clearly, the market decline has been broad as every sector has participated. The Materials sector reached the oversold level today.

XLB BASIC MATERIALS SECTOR ETF RSI MOMENTUM RELATIVE STRENGTH

Real Estate has not been spared during the selloff. It has now reached an oversold level normally seen at lows, but historically it’s cycled up and down a few times before reversing up meaningfully. That can be the case for any of them.

XLRE REAL ESTATE ETF IYR MOMENTUM TREND FOLLOWING RSI

The Technology sector had been one of the best-looking uptrends the past few years. It’s now oversold after today’s action.

TECHNOLOGY ETF XLK IYR MOMENTUM RSI RELATIVE STRENGTH ASYMMETRIC RISK REWARD

Up until today, the Utility sector was the lone survivor, but it was one of todays biggest losers. It’s falling so sharply so fast it’s now oversold with the other sectors.

XLU IDU UTILITIES UTILITY SECTOR ETF ETFS MOMENTUM RSI

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.

I’m just going to do what I do.

Have a Merry Christmas!

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

 

An exhaustive analysis of the U.S. stock market

It’s a big task for me to use the word exhaustive when it comes to stock market analysis. Exhaustive is examining, including, or considering all elements or aspects; fully comprehensive. There is no way to consider all elements, but we can focus on how the price trends are actually trending and the behavior and sentiment that is driving the trend.

Many years ago a friend of mine once tried to debate me about what trend following is or is not. He argued that trend following is all lagging moving averages or breakouts. The more we discussed it, the more we both realized that isn’t true. What made us realize it was when I said:

A skillful trend follower wants to catch a trend early in its stage and capitalize on it until it ends.

That’s hard to argue against. Who would rather enter a trend later in its stage? Who wants to catch less of the trend? My point is: we should want to capture as much of a trend as possible and for me, that necessarily means I want to not only determine the direction of a trend but also observe when trends are likely to change direction.

I want to share this with you so you know where I’m coming from. My objective is all about ASYMMETRY®. For me, it’s all about asymmetric risk/reward. Asymmetric risk/reward is an expectation of average gains larger than average losses. It could be as simple as risking a loss of 10% for the potential to earn a gain of 20%. That’s an asymmetric payoff. If I did that with just a 50% probability, I would earn 5% on average. How much total return we would achieve over time would be controlled by how much capital I risk in each position. How much I risk in each position across the portfolio dictates my portfolio drawdown. The portfolio drawdowns relative to total return since inception creates an asymmetric risk/reward profile. So, everything I do involves ASYMMETRY® and that’s why it’s my trademark. As you read my observations you can probably see how I’m looking for exposure at lower risk levels and less exposure at higher risk levels and that can be counterintuitive. It can certainly go against investor sentiment and emotions at times.

Every decision we make is in the present moment. We can do nothing in the past. We can do nothing in the future. The only time we can do something is now, or not.

To get an understanding of an asymmetric risk/reward let’s look at an idealized situation. The chart below, unnamed because it doesn’t matter, is a price trend that gained over 100%. If your objective is an asymmetric payoff and you have perfect hindsight, what would be your best entry point?

asymmetric risk reward investment

Clearly, the price is trending from the lower left to the upper right, so the answer is the lowest price possible. As I said, in the real world we don’t know in advance the trend will continue, so we have to be willing to place our bet and let it unfold. When I enter a trend, I determine how much capital I’ll risk to see if it becomes an asymmetric payoff. If we were looking at the trend in 2016 with perfect hindsight, where would be the very best entry? Of course if would be the -15% dips in 2015 and 2016. The trouble is, as the price is falling sharply, it never seems there will be a catalyst to make the market trend back up. The news is always bad. Investor sentiment is very bearish. The sky is falling and all people want to do is duck for cover.

After trends have moved, I find it more productive to look for a change of trend.

After price trends up, I start looking for signs of a potential countertrend back down.

After prices have fallen, I start looking for signs of a potential countertrend back up.

What I do as a tactical portfolio manager is systematic rules-based. Although, it isn’t so mechanical that my computers are doing it all and executing trades. I am Man + Machine, not Machine – Man. I make no bones about it. I ultimately make tactical decisions that are informed by all of the proprietary systems I’ve developed over the past two decades. Some of my systems are more automated than others, but ultimately I am the portfolio manager.

So, when I share market analysis observations, this is something different than specific trading signals to enter and exit. Market analysis is something I do to gain insights from my observations.

Observations are the action or process of observing something carefully in order to gain information.

Insights are the capacity to gain an accurate and deep intuitive understanding of something.

Observations are “what is going on” and insights are “understanding what is going on.”

I can share my observations of what is going on, but I can’t necessarily give you the insight to understand it. Understanding is up to you. To gain an accurate and deep intuitive understanding of something you have to study it closely.

So, you can probably see why I believe it’s useful to do market analysis to get an understanding of the probabilities and possibilities. I do it by looking at the current price trend and where it’s been and more likely to go next.

Here we go.

I said this is going to be exhaustive, so I’m going to share my top down macro view of the U.S. stock market. I also do this for International stock markets, bonds, commodities, etc. but this is going to be focused on the U.S. stock market. However, I may throw in some relative comparisons of other markets to make a point. The top-down macro view is going to be in this order;

  1. Broad stock market index price trends and breadth
  2. Sectors within the stock market price trends and breadth
  3. Stocks within those sectors price trends and momentum

THE BIG PICTURE

The big picture is the overall long-term secular situation. In April I presented my big picture observations to a group of advisors. The two things I shared are:

  1. This is the longest bull market in history. At 9 years old, it’s very aged. The average length of a bull market is 4 to 5 years. Twice the average is aged by any measure.
  2. The Shiller PE Ratio was the second highest, ever. Only the 1999 bubble was higher. When the stock market is trading so expensive, we have to be prepared for the trend to reverse the other direction.

Below is a 20-year monthly chart of the S&P 500. I added the green highlight to show the current price is only -35% from the October 2007 high eleven years ago. Losses are asymmetric as they compound exponentially. Losses erode gains asymmetrically. For example, the price gain from the 2007 high to the current price is 56%, but it only takes -35% to decline back to that point. You may also consider the stock index is only 56% higher than its 2000 peak eighteen years ago.

stock market secular trend

In The REAL Length of the Average Bull Market I wrote: “Whether you believe the average bull market lasts 39 months, 50 months, or 68 months, it seems the current one is likely late in its stage at 54 months as of September 2013.” Yes, I was saying 5 years ago the trend seemed late stage – and it was. It just continued anyway, though was interrupted by two declines in the range of -15% in 2015 and 2016.

At the same time in late 2013, the Shiller PE Ratio was increasing to a very overvalued level. It only kept going higher. By January of this year, it reached 33x earnings, the second highest ever. In fact, the only two times it reached this extreme the stock market followed with the Great Depression crash and the -46% decline after 2000. After the current -18% decline in the S&P it is now down to 26.74. The median is around 15, secular bear markets often begin at 20 or higher, secular bull markets begin below 10.

The bottom line is:

Shiller PE Ratio

I’m guessing the unprecedented Quantitative Easing of the Federal Reserve helped to push the valuations to an extreme. The Fed is now unwinding the QE and raising interest rates, which may be partly why we are seeing prices fall. So, we certainly can’t overlook the situational awareness that this could eventually become a much worse bear market to the -50% level. However, if it does, it will usually unfold with many swings up and down along the way. Falling prices are eventually followed by sharp countertrend moves up. It’s when we see lower highs and lower lows over time that it becomes more evident it’s a big bear market.

One thing that’s been talked about a lot lately is the risk of an inverted yield curve. An inverted yield curve is when the short-term 3-month interest rate is higher than the long-term 30-year interest rate. The yield curve hasn’t inverted like it did in December 2006 and August 2000. The yield curve doesn’t suggest a recession anytime soon.

Here’s what an inverted yield curve looks like… when it inverted December 2006. A year later, the stock market started its decline of over -56%.
Here is the inverted yield curve in August 2000. In 2000, the yield curve was more accurate as to timing. The broad stock market declined -50%.
The normal yield curve, 3 month vs 30 year, has not inverted. The long-term interest rate is higher than the short-term rate. For the yield curve to invert, the short-term interest rate will have to increase higher than the longer-term interest rate. Or, the long-term interest rate decrease below the short term. Either way, that hasn’t happened yet.

How big are the stock market losses in 2018? 

Starting with a top-down view. First, the broad asset classes and styles like large, mid, small and value, growth, and blend using Morningstar Small Value is down the most at -19% YTD. Small Cap stocks are down the most. Large Growth and Large Cap generally have declined the least. The average U.S. Market index is down -8.58%. Keep in mind that index performance does not include any costs or fees and may not be invested in directly.

stock market sector asset class performance 2018

The table above also includes sectors. Energy and Basic Materials are down over -20%, so any tactical system that avoided them had an advantage.

Most investors don’t necessarily invest all of their money in the stock market all the time. Many instead do global asset allocation like I wrote about in Global asset allocation takes a beating in 2018. Fewer have an objective like mine; a global tactical strategy that shifts between markets by increasing and decreasing exposure aiming for asymmetric risk/reward. Here are iShares asset allocation ETFs YTD as a proxy for low-cost exposure to a global asset allocation of stocks and bonds all the time with no active risk management or tactical decisions. Each “risk level” has a different exposure to stocks/bonds. Even the most conservative allocation which is mostly invested in bonds is down -4% in 2018.

global asset allocation etf

I shared more detailed observations of global asset allocation Global asset allocation takes a beating in 2018.

For a more exhaustive observation of GAA trends, here I included some of the more popular active global allocation funds along with the iShares ETFs that track allocation indexes. Clearly, 2018 has been a hostile year for most every strategy; static, balanced, or tactical.

global asset allocation funds 2018 ETF ETFs

So, that’s the big picture. From there, let’s zoom in for a closer look for a shorter term observation.

The downside very quickly erodes the progress. However, the asymmetric nature of losses starts to really compound against capital after -20%. At this point, the S&P 500 is down -18%. It’s a little lower than 2016 and about the same as the decline in 2011.

2018 stock market loss

Though this has been a very long bull market, it has been interrupted by deeper “corrections” of more than -10%.

stock market drawdown bear markets asymmetric risk

In comparison, the 2003 to 2007 bull market corrections were less than -10%.

stock market corrections bear market average

When does the bleeding stop? 

After prices have already fallen, I start looking for signs of a potential countertrend and divergence.

The price trend itself is the final arbiter. It is what it is. A price that is trending down is going to continue to trend down until the desire to sell has been exhausted and drives prices low enough until the enthusiasm to buy takes over. After sharp selling pressure like we’ve seen since September, we’ll likely see some similarly sharp countertrend reversals up. Market trends don’t usually drift in a direction until it’s over, instead, we observe swings up and down as the price trend cycles. Short term cycles develop the longer term cycles.

Though the price trend itself is the final arbiter, the best way I have identified when trends are most likely to change direction at extremes is to observe extremes in investor sentiment and breadth. Ultimately, investor sentiment and the breadth is evident in the price, but at extremes, these measures can be a warning shot across the bow at high levels and indicate panic selling exhaustion at lows. From here, we’ll look at investor sentiment measures. We’ll also look at breadth indicators that quantitatively tell us the breadth of participation in the decline. The thinking is at some point these measures reach an extreme, suggesting the selling may be becoming exhausted and to prepare for a potential reversal. Since asymmetric risk/reward is my objective, I’m looking for lower-risk entries that have the potential for greater payoff than the amount I risk.

Investor Sentiment: Fear is Driving the Stock Market

A simple way to quickly observe overall investor sentiment is the Fear & Greed index, which tracks seven different indicators.

Fear Greed Index Low 2018 lowest levelIt’s the lowest level I’ve seen it, suggesting we’ve observed panic level selling. If you read my observations from the beginning of this year, you’ll see the opposite was true at the start of 2018.

FEAR GREED INDEX 2018 LOW

We’ve observed a round trip this year from Extreme Greed to Extreme Fear. Investor sentiment obviously swings up and down over time. As sentiment oscillates, it drives price tends to cycle, too. Even in bull markets, there are declines and in bear markets, we’ll see sharp upswings.

When investor sentiment is so bearish we see a spike in the words “bear market.” Google Trends shows the bear market talk on the Internet has spiked to the highest level in five years, even higher than 2015-16 and February this year.

GOOGLE TRENDS BEAR MARKET STOCK

I’m also hearing the typical talk about a 1987 type crash. The October 1987 -20% single day crash was 32 years ago but it’s still talked about today when prices fall. Markets are risky, so a crash is something we risk when we invest our money. The risk is partially why markets generate a return. We have to be willing to have exposure to risks that can come when no one expects it. Has modern market regulation and technology created any prevention of an ’87 type crash? Around 2012 circuit breakers were created to theoretically prevent a single day crash.

Circuit breaker thresholds: trading is halted market-wide for single-day declines in the S&P 500. Circuit breakers halt trading on the stock market during dramatic drops and are set at 7%, 13%, and 20% of the closing price for the previous day. There are also single stock limits and halts by the exchanges

Buy and hold, long-only asset allocation investors may take comfort in knowing there is some limit, but for those of us who actively manage our risk we prefer to deal with risk sooner if we can, but there is no assurance any strategy will always do as intended.  You can read more about circuit breakers in Measures to Address Market Volatility. The bottom line is these circuit breakers are intended to limit a single day waterfall decline, they do not control overall drawdowns.

How many stocks are participating in the decline? 

Another way to say it; How “washed out” is the stock market? To understand the internal condition, I look inside the indexes at the sectors and stocks. We’ll start with Breadth indicators, which quantitatively measure the percent of stocks in uptrends vs. downtrends.

  • When 70% of stocks are already in uptrends it signals a strong market trend but also suggests as most stocks have caught up and participated, buying enthusiasm may be getting exhausted.
  • When less than 30% of stocks are in uptrends, 70% of them are in downtrends, so the market trend is bearish. However, after most of the stocks have already fallen, at some point, it suggests we look for the exhaustion of selling pressure that could reverse the downtrend.

The percent of the S&P 500 stocks above their moving averages tells us how many of the 500 stocks are in an uptrend vs. a downtrend. When it’s declining, the market is bearish so we can see how many stocks are participating in the decline. When it reaches an extreme low, it may be an indication selling could be becoming exhausted. As we see, it has reached the low levels of past stock market lows with the exception of the low in March 2009.

PERCENT OF STOCKS ABOVE 200 DAY MOVING AVERAGE

Notice the low was reached October 2008 and stayed down until late March 2009. In the massive crash when stocks fell over -50%, it stayed “oversold” for over 6 months. It’s an example of the limitations of countertrend signals in outlier events.

For a view of the short-term trends, I do the same for the 50 day moving average. Only 6% of the S&P 500 stocks are in uptrends, so 94% are in short-term downtrends. That’s the bad news for stock investors. The good news is, it’s reached the low range where we have historically seen a reversal up. A reversal up from here would be bullish, at least temporarily.

PERCENT OF STOCKS ABOVE 50 DAY MOVING AVERAGE

The S&P 500 Bullish Percent Index is the number of stocks in the S&P that are trading on a Point & Figure buy signal. By this measure, only 17% of the 500 stocks are in uptrends. I highlighted the top are in red to note the contrary indicator of breadth and green on the bottom to mark the contrarian bullish zone where downtrends may reverse to uptrends when selling gets exhausted. The S&P 500 Bullish Percent Index is below 2011, 2015 and 2016 stock market correction lows. BPI is considered overbought when above 70% and oversold when below 30%. Once it reaches the green zone, I start looking for a reversal up from a low level, which is a bullish signal. 

S&P 500 BULLISH PERCENT $BPSPX

Notice the current level is below the 2011 and 2015-16 decline, but not as low as the 2008-09 bear market when the stock index fell -56%.

We see the same scenario in the NYSE Bullish Percent, which applies the same method to the stocks trading on the NYSE.

NYSE BULLISH PERCENT

We’re not seeing any divergence in the breadth indicators, they are all down as most stocks have fallen. These are now at the level to look for countertrend signals.

The High-Low Index is a 10-day moving average of new highs vs. new lows. This breadth indicator shows when new highs outnumber new lows and when new highs are expanding. In general, new highs outnumber new lows when the indicator is above 50. New highs are expanding when the indicator is above 50 and rising. As with most range bound oscillator indicators, high is over 70 and low is below 30. Here we see it’s about as low as it has been. We also see how it can swing around for a year or two in a bear market. Since it can take time for prices to reach all-time highs and lows, the High-Low Index is more lagging than similar indicators.

High Low HILO SPX

Before we look inside the sectors, we’ll look at some other indicators of sentiment. This week, the CBOE Total Put/Call Ratio spiked to 1.82, which is its highest put volume over call volume ratio ever. We have data going back to 1995. As you can see in the chart, we normally see this ratio less than one as more calls trade than puts. A reading over 1 is usually a signal of pessimism as options traders appear to buy buying put options for protection or to speculate the stock market will fall. We’ve never seen put volume so high. Options traders appear to be very bearish, which has historically been a contrarian indicator at some point.

PUT CALL RATIO HIGHEST EVER 2018

By the way, big bear markets unfold in cycles as the trend swings up and down. In the last bear market, the stock indexes fell -15%, then gained 10%, then fell 20%, then gained 15%, along the way you never know in advance which direction it is going to trend next. Many tactical traders had trouble with the 2007 to 2009 period because of whipsaws. By the time they exited, the market trended up without them, then they reentered just in time for the next fall. This is the risk of tactical trading, whether the method is breakouts, momentum, relative strength, or any other rotation style. I know this because I’ve known over 100 other tactical traders for over two decades. The price swings are the challenge. For example, below is the 2008 – 2009 -56% decline. As you can see, the Equity Put/Call Ratio is on top. I drew green lines at its peaks to show they typically indicate a short-term price low, but probably not as well as it would in a correction within a primary bull market. The point is, sometimes signals work out well, other times they don’t. They don’t have to be perfect and none are. The key is asymmetry: higher average profits than losses over full market cycles.

2008 spx put call ratio study

One indicator showing some divergence is the VIX CBOE Volatility Index. Although the S&P 500 is about -5% lower than its February low when the VIX spiked up to nearly 40, the VIX is only at 30 this time. However, I point out it did the same thing in the lower low in January 2016. The VIX initially spiked more in the first decline in August 2015 but remained less evaluated at the lower low in January 2016. It appears the options market  expects elevated volatility, but not as much as an expansion as before. We’ll see.

VIX DIVERGENCE VOLATILITY EXPANSION

Drilling down, what about sectors? Below are the individual sectors YTD. Energy and Materials are down the most. Ironically, they are tied to inflation. Where is the rising prices (inflation) the Fed is supposed to be fighting?

SECTOR SPDRS MOMENTUM RELATIVE STRENGTH

Sector Trends and Breadth 

To get an underatnding of the individual stock trends within a sector, I look at the bullish percent of the sectors.

First, we’ll observe the bullish percent of the Energy sector. Energy is down the most and only 3% of stocks in the index is an uptrend as measured by a point & figure buy signal. It’s as low as its been in 20 years. Though it could stay at this low level in a bear market as it did around 2008, it still swings up and down for those willing to trade it.

BULLISH PERCENT ENERGY SECTOR

The next biggest loser sector is Basic Materials, another commodity-related sector. I highlighted the current low level in green, which is nearly as low as it’s ever been in 20 years. These indicators are range bound, so they can only fall to 0% and as high as 100%.

BASIC MATERIALS SECTOR BULLISH PERCENT

The Financial sector is the third largest weight in the S&P 500 stock index at 13%. It’s down -18%, making it one of the biggest laggards. Banks, brokers, etc. are leading the market down and that isn’t a good sign for the economy of the market. Financials often lead in bear markets. However, as we see below, their participation in the fall is about as high as it’s ever been. On the other hand, we see how volatile and weak Financials were in 2007 to 2009. During that “Financial Crisis”, they were among the worst.

financial sector bullish percent momentum relative strength

The industrials sector, down about -18%, continues the trend of broad participation in the sell-off. It’s also reached the lowest it did in 2008 and 2011.

industrial sector bullish percent momentum

Consumer Staples is a sector that is supposed to hold up in market declines, but the index is down -12% year to date, which is more than the S&P. Staples stocks have participated as much as they did in prior corrections in 2011 and 2016, but not as much as around 2008.

consumer staples sector bullish percent index

The Technology sector is a big one because at 20% it has the largest weighting in the S&P 500. The Technology sector is down about -7% YTD. The Technolgy sector bullish percent is down below its lows in prior corrections and nearing the 2008 and 2009 lows. Keep in mind, once prices have moved to a low point, they eventually attract buying demand and reverse the other direction. These indicators help us see the levels it is more likely to happen and a reversal in these indicators increases the potential even more.

BULLISH PERCENT TECHNOLOGY

Consumer Discretionary is 10% of the S&P and down -5% YTD. Its bullish percent is as about as low as it’s been.

BULLISH PERCENT CONSUMER DISRCRETIONARY SECTOR

Another major sector is Healthcare, it’s the second largest weighting at 16% of the S&P 500. It’s flat for the year, but its bullish percent is very washed out.

HEALTHCARE SECTOR BULLISH PERCENT MOMENTUM RELATIVE STRETGH

The Utility sector is the lone survivor so far in 2018. Like Consumer Staples, Utilities are considered “defensive.” That expectation hasn’t held true for Consumer Staples down -12% this year, but the Utility sector is up 2% YTD. The first half of the year, Utilities were laggard as they are sensitive to rising interest rates, but the last half they’ve found some buying interest. As we see, the Utility sector momentum has been strong enough to keep its stocks in uptrends and into the higher risk zone. However, notice they tend to stay at higher bullish percent levels over time. Utilities don’t usually have strong momentum against other sectors, but they do tend to have less volatility. Of course, in the last big bear market that wasn’t the case as everything fell.

UTILITY SECTOR MOMENTUM TREND BULLISH PERCENT RELATIVE STRENGTH

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.

I hope you find this market analysis helpful. If you don’t believe it is exhaustive enough, I encourage you to read some of the other recent observations since they cover more detail on some of the topics above.

Have a Merry Christmas!

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

 

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

The popular stock indexes are now down about -5% year to date.

dow jones stock market

The popular stock indexes are now about -13% off their highs.

stock market dow jones spx spy dia

I don’t normally include the NASDAQ since it’s so overweight the Technology sector, but it’s down -17% off its high and the Russell 2000 small-cap index is down -19%. The year started off very strong and is ending with weakness so far.

nasdaq russell 2000 dow jones

I pointed out earlier this year that Emerging Markets and Developed countries stock markets were already in a bear market if we define it as -20% off highs. Here we see they are down even more than the U.S. stocks year to date.

emering markets stocks

I warned before that with interest rates rising, bonds may not provide the crutch they have in past stock market declines. That has been the case in 2018. Even with the long-term Treasury gaining recently from being down -12%, it’s still down -6% year to date.

BOND ETF TLT LQD AGG ETFS

Many investors are probably wondering what’s going to happen next. I said a week ago in Stock Market Observations that stocks have fallen far enough that “We would expect to see some potential buying support at these levels again.” For these popular stock indexes, they are now at the point of the February and April lows and reaching an oversold level by my momentum measures.

We are looking for signs that selling pressure is drying up as those who want to sell have been exhausted and new buying demand increases to take over. Some signs of stock prices reaching a low enough point to attract more buying than selling are observed in investor sentiment measures and breadth indicators.

A simple easy to follow gauge of investor sentiment is the Fear & Greed Index, which is a composite of seven Investor sentiment measures. The investor sentiment reached an “Extreme Fear” zone again.

investor sentiment fear greed index

Investor fear by this measure has been high for the past few months. At some point, we would expect to see those who want to sell have sold. However, if this stock trend becomes a bear market we would expect to see this gauge remain low for a long time. Although, the stock indexes will swing up and down along the way.

fear and greed over time investor sentiment stock market

Another observation of investor sentiment reaching an extreme was last week’s AAII Investor Sentiment Survey. Last week pessimism spiked to its highest level since April 2013, while optimism fell to an unusually low level.

bearish investor sentiment

For some historical context, the % of bearish investors has reached the high level it did at the 2016 stock market low. When investor fear reaches such extremes, it’s a contrary indicator.

bearish sentiment

A bear market is a process, not an event. At -13% it’s hard to say if this will become a bear market, though there are some potential drivers that could cause stocks to fall more over time.

The first warning sign for the big picture is earlier this year the Shiller PE ratio for the S&P 500 reached the second highest level ever, with data going back before 1880.

Shiller PE ratio for the S&P 500

The only two times the Shiller PE ratio for the S&P 500 had reached this “overvalued” level was 1929 and 1999. Of course, 1929 was followed by The Great Depression and 1999 was followed by the Tech Bubble Burst. The only time I pay attention to the PE ratio is for a big picture assessment of valuation when it reaches extreme highs or lows. At such a high level of valuation, we shouldn’t be surprised to see volatility and stocks decline. The unknown is if it keeps declining much more to reach an “undervalued” level at some point. So far, with -13% decline, the Shiller PE ratio for the S&P 500 has declined from 33 at the beginning of the year to 28 now. Twenty or higher is considered high, 10 or less is considered low. It is what it is.

A bear market is a process, not an event, which means the stock market will swing up and down along the way. For example, historical bear markets are made up of swings of -10%, +8%, -14%, +10%, each swing doesn’t make a higher high, but instead prints a lower high and lower lows. The good news is, the swings are potentially tradable. However, for those tactical traders who attempt to trade them, it isn’t easy and it doesn’t always feel good. These kind of periods are volatile, so a skilled tactical trader has to increase and decrease exposure to the possibility of gain and loss. For me, predefining risk is essential, but so is holding the predetermined exposure to give a trend room to play out.

Some potentially positive news is the breadth indicators suggest most stocks are participating in the downtrend. That doesn’t sound positive unless you realize as stocks get washed out on the downside the selling pressure is eventually exhausted, at least temporarily. Below is one indicator we observe to see what is going on inside S&P 500 stock index. It’s the percent of the 500 stocks in the index that are trending above their 50-day moving average. When this indicator is low, it signals stocks may be nearing a level of selling exhaustion as most of them are already in downtrends. However, if this does become an actual bear market of -20% or more, we’ll see this indicator swing up and down along with the price trend. At this point, it’s in the green zone, suggesting the stocks may be near the “washed out” area so we could see some demand take over supply in the days or weeks ahead.

As you can see below, the percent of stocks above their 50 day moving average has now reached the low level it did in February and back in August 2015 and January 2016 that preceded a reversal back up.

percent of stocks above 50 day moving average

I shared my observations of this breadth indicator back in February when I explained it in more detail if you want to read it Stock Market Analysis of the S&P 500. I also shared it in October when the current downtrend started. In October, the percent of stocks above their 200 day moving average was still high and hadn’t declined much. That isn’t the case now. As you can see, even this longer term breadth indicator is now entering the green zone. As more stocks have already declined, it becomes more and more likely we’ll see selling exhausted and shift to buying demand as prices reach lower more attractive levels for institutional investors.

As you can see below, the percent of stocks above their 200 day moving average has now reached the low level much below February and now down to the levels reached in August 2015 and January 2016 that preceded a reversal back up in stocks.

stock market breadth percent of stocks 200 day

Another indicator that measures the participation in the trend is the S&P 500 Bullish Percent index that I have been observing for over two decades. This is the percent of stocks on a Point & Figure buy signal, which often traces a pattern something similar to the 50 day and 200-day moving averages as it has the past four years. As we see below, this indicator is reaching the low level not seen since August 2015 and January 2016 that preceded a reversal back up.

buliish percent index

At this point, we haven’t yet seen enough buying enthusiasm to overwhelm the desire to sell. But, many of these indicators I’ve been monitoring for nearly two decades are reaching a level we should see some shift at some point. If we don’t, the stock market may enter into a more prolonged and deeper bear market. However, historically lower lows are made up of cycle swings along the way, so we should still see at least some shorter-term uptrends.

I’m starting to hear a lot of “bear market” talk in the news and on social media, so I thought I would put the current decline into context. My mission isn’t to take up for the stock market, but instead to present the facts of the trends as they are. I was defensive at the beginning of the year and then added more exposure after prices fell. I predefine my risk by predefining my exits in all of my positions, so any exposure I have has a relatively short leash on how low I’ll allow it to go before I cut my loss short, rather than let the loss get large. I am never a market cheerleader, but because I was already defensive near the peaks, I may have the potential to take advantage of the lower prices. I’m almost always going to be a little too early or a little too late and that is fine. It’s never been perfect but has still achieved the results I want the past two decades.

To put the current decline into historical contacts, we can simply compare it to the last decline of -10% or more, which was around August 2015 and January 2016. For nearly two years, the stock index was range bound with no upside breakout.

stock market 2015 2015 decline bear market

Looking closer at the % off highs, we see the late 2015 decline was -12% and the first few months of 2016 was about -15%.

stock market decline 2015 2016 asymmetric risk reward

Here is 2018. So far, it isn’t actually as much of a decline.

bear market stocks stock market

Another interesting observation I’ll share is the trend in the CBOE S&P 500 Volatility Index (VIX). Below is the 2015 to 2016 period again with the S&P 500 in the top panel and VIX volatility index in the bottom panel. We see the VIX spiked up sharply around August 2015 when the stock market decline. However, when the stock market recovered the loss and then declined again to a lower low, the VIX index didn’t reach the same high level the second time. The volatility expansion wasn’t nearly as high even though the stock index reached an even lower low.

VIX VOLATILITY expansion 2016

We are observing that same divergence in volatility this year. The VIX spiked over 100% when stocks fell -12% around February this year. The stock market recovered and printed a new high in September, then has since fallen -13% from that high. This time, however, the implied volatility VIX index hasn’t spiked up nearly as high.

divergence volatility expansion vix

What could it mean? When the VIX increases it is an indication of expected future 30-day volatility implied by the options on the stocks in the S&P 500. When the VIX increases, it means options traders are probably using options to hedge against market declines. I’m guessing it could signal that hedging and possible selling enthusiasm could be drying up. That seems to be what it suggested in 2015 to 2016 when it did the same, then the stock market trended up into 2017.

We’ll see how it all unfolds from here, but the stock market has clearly reached an inflection point. Stocks have trended down to a low enough level we should see some buying demand if it’s there. You can probably see why I believe markets require me to actively manage my risk through predefined exits and hedging to extract from it the asymmetric risk-reward I want.

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

The Death Cross on the S&P 500

I wonder when we’ll start hearing about the death cross again like we did in 2016.

The S&P 500 Equal Weight signaled a death cross today. As with any trend following signal or any signal at all, it doesn’t come with a 100% probability. No signal is always accurate. Nor do they need to be for an edge.

The cap-weighted S&P 500 that everyone follows has more large-cap stock exposure than the equal weight. The cap weight hasn’t yet reached the “death cross” level yet.  But it is going to cross soon even if the stock index trends up sharply. We know this because of the length of the lag time in the 50-day moving average. Even big daily gains won’t be enough to stop the downtrend in the 50-day moving average before it crosses below the 200 day moving average.  Each days weight is only 1/50, so it is up against the trend of the other 49 days.

The equal weight S&P 500 has much more exposure to small company stocks. The S&P 600 small-cap index had already achieved a “death cross” when its 50-day moving average crossed below the 200 day recently.

The death cross is considered a bearish indicator that generates a trend following signal to exit or go short when the 50-day moving average drops below 200-day moving average. We last saw it in 2015 and 2016 when it got a lot of media attention. The death cross signals also resulted mostly in whipsaws.

One difference in 2015 and 2016 was the Equal Weight S&P 500 only gave one signal as the cap-weighted whipsawed with two.

Here we can see why… the Equal Weight has more exposure to small-cap stocks and small-cap stock index only generated one signal.

What the death cross 50/200 moving average “death cross” indicator signals is, with a necessary lag, prices have been declining. That part is a fact.

Only time will tell if it accurately signals more price decline, or if prices have reached a low enough level for buying demand. Indicators that generate trend following signals like the 50/200 moving average crossover are often discussed incompletely regarding only their accuracy (probability), but its the mathematical expectation that matters: are the average profits > average losses?

And indicators that generate systematic trend following signals like the 50/200 moving average crossover are often discussed incompletely regarding a single market like stocks instead of applied across broad markets like currency, bonds, and commodities.

If we remove the moving averages from the chart and focus on the upward momentum the last few days, even the equal-weighted index with its “death cross” signal appears to be attempting to trend back up. So, chances are this will be one of the 60% of the time the signal isn’t accurate.

So far, the index is holding the line. Only time will tell, so let’s see how it all unfolds.

 

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

 

 

 

Will the stock market hold the line?

The popular U.S. stock market indexes almost formed a potential inverse head and shoulders reversal pattern, however, the right side was met with selling pressure that exceeded enthusiasm to buy. For those who care to observe the price action as it unfolds, I’ll share my observations of what I’m watching for to identify a reversal or continuation of the trend. I don’t necessarily make my tactical trading decisions based on these things, it’s instead market analysis I do for observation of the shifts in supply and demand that ultimately drive trends.

At this point, these stock indexes we use as a proxy for the stock market have reached the October lows as we knew they could.

stock market trend following momentum

The bad news is we’ve continued to see the desire to sell exceed the enthusiasm to buy. When selling pressure is dominant, prices fall.

The good news is the price level has now reached a point were another potential reversal pattern could form; a double bottom reversal. A double bottom reversal is commonly seen when prices reach a prior low and then find enough buying interest to shift the trend from down to up. Such a shift necessarily requires prices to fall to a low enough point that buyers become willing to buy.  For the trend to change; buying demand overwhelms selling pressure. So, the shift involves some combination of the desire to sell becoming exhausted and the desire to buy becoming dominant. Prices trend in the direction of the most asymmetry.

I don’t get caught up in the semantics of the names of patterns, but instead what the formation is showing about the shift in supply and demand. When a potential inverse head and shoulders pattern fails on the right shoulder, the possibility of a double bottom reversal exists, but still needs to be confirmed. For me, the whole point is; in a downtrend (uptrend), no matter what the time frame, I look for signs of a reversal of the trend through a shift in the supply/demand seen in price action. None of them are ever 100% predictive or accurate, it’s always about possible outcomes and observing the trend. It’s always probabilistic, never a sure thing. But, that’s all we need.

We’ll see if the stock indexes can hold the line, or not.

It’s a process, not an event, so we just watch it all unfold.

Let’s see what it does from here.

Have a Happy Thanksgiving!

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

 

 

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

I don’t always share when I observe stock market patterns unfold, but when I do, it’s usually to inform (or aggravate) my friends who don’t understand (or want to understand) technical analysis.

Long before I started developing computerized trading systems based on quantitative signals I learned and applied chart patterns and trend lines to determine if a trend was up, down, or sideways. Said another way, up until 15 years ago I identified the direction of price trends visually looking at a price trend on a chart. I later defined up, down, and sideways with mathematical equations that help to systematize the process of trend identification. I believe my starting out learning trends by hand and visual representation helped me to develop better quantitative trend systems. The two go hand in hand.

We can define the direction of a trend with an equation as simple as momentum. For example, I have 14 different definitions of momentum and equations that define it. A simple one is X period rate of change. If it’s positive, the trend is up. If it’s negative, the trend is down. The factor that determines the trend direction is the time frame. Many academic types like using simple time series momentum methods like this because it’s easy to backtest. Pattern recognition is more difficult, so fewer have developed systems to automate pattern recognition and make it testable.

Chart patterns have historically been more visual. Chartists or technical analysts look at the chart of a price trend to determine if there is a pattern. The pattern we are looking for tells the story of supply and demand. The chart of a price trend shows us what has been going on with the battle between supply and demand from buyers and sellers. We may get an idea of who may be winning the battle and position our capital in that direction. For example, when prices are rising the buyers are in control and when prices all falling selling pressure is dominant. So, pattern recognition is just another form of trend following. Instead of using X-day breakouts, moving average, or channel breakouts, it’s using a pattern that is believed to tell the story of price action. We don’t make decisions based on a pattern, but the underlying asymmetry between buyers and sellers that caused the pattern and the direction of the price trend.

Simple > Complex

To me, it’s a much more simple way to determine if buyers or sellers are in control of the price trend than trying to find a fundamental narrative. There are so many different reasons for buying demand and selling pressure we could never really know why one is dominating the other. The news attempts to explain it, but the truth is, investors could be buying or selling based on perceived fundamentals, trend lines, moving averages, stop losses, buy stops, fear of missing out, fear of losing money, or tax reasons. Rather than trying to figure out what the majority is thinking, the pattern of the price trend tells the net result of all the buying and selling. It fits the idea of simple beats complex and if we simply stay with the direction of the trend we can’t be too wrong for too long. Someone making decisions based on things other than the price trend itself has the potential to stray far away from the reality of the price.

To me, chart patterns are really just a little more elaborate versions of trend lines. A trend line is just a line marking a chart such as how I marked the higher highs and higher lows yesterday in Divergence in the Advance-Decline Line May be Bullish. 

I observed today the S&P 500 seems to be forming a head and shoulders bottom pattern. The head and shoulders pattern happens when a market trend is in the process of reversal either from a bullish or bearish trend.  There are two kinds of head and shoulders.

  • A head and shoulders top is a pattern that forms after an uptrend. After it is completed, it signals a reversal of the trend from up to down.
  • A head and shoulders bottom is an inverse of the head and shoulders top. The head and shoulders bottom forms after a downtrend and signals a change of trend from down to up.

Below is the chart of a theoretical index used to represent an idealized head and shoulders. It includes both head and shoulders tops and head and shoulders bottoms. Stockcharts offers this index for educational purposes to see what idealized head and shoulders look like. You may notice each top and bottom are a little different – they aren’t perfect.

head and shoulders pattern recognition

I put the green box around a head and shoulders bottom. You can see why when you look at the S&P 500 stock index chart below.

head and shoulders bottom patterns recognition

An inverse head and shoulders pattern is simply a downtrend caused by selling pressure, interrupted by a brief reversal (left shoulder), a selling climax (head), an interruption again (right shoulder), then it would move on to new highs. Moving on to new highs will determine if it is completed as a reversal bottom, or not. To reverse the downtrend, selling pressure must be exhausted as buying demand becomes dominant.

Many patterns like the head and shoulders rely on volume as confirmation, so chartists can make it as complicated as they want, or keep it simple by looking at the pattern. For my purpose, I’m going to keep it simple and say we’ll know if this is indeed a head and shoulders bottom reversal pattern if it follows through on the upside. If it does, we would expect the price trend of this index to at least reach its old highs. If the price doesn’t hold and it doesn’t follow through to the upside, it’s probably going to at least test the prior low again.

Either way, patterns are never completely accurate. It’s probabilistic, never a sure thing. The head and shoulders is simply a pattern formation commonly seen after a downtrend that, if completed, may signal the end of the downtrend and reversal into a new uptrend. It’s based on the visual representation of the battle between supply (selling pressure) and demand (buying interest). For example, when the head and shoulders bottom completes the low point in the (inverse) head, it marks the point when those who wanted to sell have sold. So, the right (inverse) shoulder signals selling has dried up and buyers are taking over. It is completely normal to observe profit-taking after an advance, so the last few days is normal even if this is a reversal up. You can probably see how volume gets involved to confirm the pattern. In the case recently, the volume was high at the lows signaling selling pressure. The volume is declining on the right shoulder. The good news is, the volume didn’t expand on these recent down days.

Let’s see how it all unfolds.

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

 

Observations of the stock market downtrend

Observations of the stock market downtrend

In the last observation I shared about the stock market, “The stock market trends up with momentum,” we saw the stock market reverse back up with strong momentum. The S&P 500 stock index had declined about -7% from its high, then reversed back up 3%. I discussed how investor behavior and sentiment drives market prices. Many investor sentiment measures signaled investor fear seemed to be in control, driving down prices. Volatility had spiked and then started to settle back down. Many individual stocks in the S&P 500 had declined enough to signal shorter-term downtrends, but then they reversed up. I closed by saying:

In summary, today was a strong upward momentum day for the stock market and most stocks participated in the uptrend. After sharp declines like we’ve seen this month, the stock market sometimes reverses up like this into an uptrend only to reverse back down to test the low. After the test, we then find out if it breaks down or breaks out.

One day doesn’t make a trend, but for those who are in risk taker mode with stocks, so far, so good.

The part I bolded with italics has turned out to be the situation this time.

Below is a year to date price trend of the S&P 500 stock index. As of today, my observation “the stock market sometimes reverses up like this into an uptrend only to reverse back down to test the low” is what we are seeing now.

stock market trend

I’ve always believed investment management is about probability and possibilities, it’s never a sure thing. The only certainty is uncertainty, so all we can do is stack the odds in our favor. As I said before, “After the test, we then find out if it breaks down or breaks out.” 

The positive news is, investor sentiment measures are reaching levels that often precede short-term trend reversals back up.

The bad news is if the current trend becomes a bigger downtrend these indicators will just stay at extremes as long as they want. We have to actively manage our exposure to loss if we want to avoid large losses, like those -20% or more that are harder to overcome.

Down -10% is one thing, down -20% is another. Any investor should be willing to bear -10% because they will see them many times over the years. Only the most passive buy and hold investors are willing to bear the big losses, which I define as -20% or more.

Nevertheless, I see some good news and bad, so here it is. I’ll share my observations of the weight of the evidence by looking at relatively simple market indicators. I don’t necessarily make my tactical decisions based on this, but it is instead “market analysis” to get an idea of what is going on. Observations like this are intended to view the conditions of the markets.

Fear is the dominant driver. 

The Fear & Greed Index tracks seven indicators of investor sentiment. When I included it a week ago, it was at 15, which is still in the “Extreme Fear” zone. The theory is, the weighting of these seven indicators of investor sentiment signals when fear or greed is driving the market. Clearly, fear is the dominant driver right now.

fear greed index investor sentiment behavioral finance

At this point, we can see investor sentiment by this measure has now reached the low level of its historical range. In this chart, we can see how investor sentiment oscillates between fear and greed over time in cycles much like the stock market cycles up and down.

fear and greed back test over time investor sentiment indicator

I believe investor behavior is both a driver of price trends, but investors also respond to price trends.

  • After prices rise, investors get more optimistic as they extrapolate the recent gains into the future expecting the gains to continue.
  • After prices fall, investors fear losing more money as they extrapolate the recent losses into the future expecting them to get worse.

Investor sentiment and price trends can overreact to the upside and downside and the herd of investors seems to get it wrong when they reach an extreme. We observe when these kinds of indicators reach extremes, these cycles are more likely to reverse. It is never a sure thing, but the probabilities increase the possibility of a reversal. But, since there is always a chance of a trend continuing longer in time and more in magnitude, it is certainly uncertain. Since there is always a chance of a bad outcome, I  have my limits on our exposure to risk with predetermined exits or a hedge.

Speaking of a hedge. 

I started pointing out my observation several weeks ago of a potential volatility expansion. If you want to read about it, most of the past few weeks observations have included comments about the VIX volatility index. Over the past few days, we’ve observed a continuation in the volatility expansion.

vix hedge volatility expansion asymmetric hedge asymmetry

Implied volatility has expanded nearly 100% over in the past 30 days.

vix volatility expansion trading

As a tactical portfolio manager, my first focus is risk management. When I believe I have defined my risk of loss, I become willing to shift from risk manager to risk taker. I share that because I want to point out the potential for hedging with volatility. Rather than a detailed exhaustive rigorous 50-page paper, I’m going to keep it succinct.

My day job isn’t to write or talk about the markets. I’m a professional portfolio manager, so my priority is to make trading and investment decisions as a tactical investment manager. I’m a risk manager and risk taker. If I never take any risk, I wouldn’t have any to manage. The observations I share here are just educational, for those who want to follow along and get an idea of how I see things. I hope you find it helpful or at least interesting. It’s always fun when it starts new conversations.

To keep the concept of hedging short and to the point for my purpose today, I’ll just share a simple chart of the price trend of the stock index and the volatility index over the past 30 days. The stock index has declined -8.3% as the implied volatility index expanded over 95%. You can probably see the potential for a hedge. However, it isn’t so simple, because these are just indexes and we can’t buy or sell the VIX index.

vix volatility as a hedge stock market risk management

The purpose of a hedge is to shift the risk of loss from one thing to another. The surest way to reduce the possibility of loss is to simply sell to reduce exposure in the thing that is the risk. That’s what I do most of the time. For example, when I observed a potential volatility expansion, I reduced my exposure to positions that had the possibility of loss due to increased volatility. Once prices fall and volatility contracts, maybe we increase exposure again to shift back to risk-taking. If we take no risk at all, we would have no potential for a capital gain. So, tactical portfolio management is about increasing and decreasing exposure to the possibility of gain and loss. If we do it well, we create the kind of asymmetric risk/reward I aim for.

So, any hedging we may do is really just shifting from one risk to another, hoping to offset the original risk. Keep in mind, as I see it, a risk is the possibility of loss. I’ll share more on hedging soon. I have some observations about hedging and hedge systems you may find interesting.

Most stocks are participating in the downtrend. Below is an updated chart of the percent of the stocks in the S&P 500 that are above their 50-day moving average. If you want to know more about what it is, read the last observations. The simple observation here is that most stocks are declining.

stock market breadth risk indicator

Much like how we saw investor sentiment cycle and swing up and down, we also see this breadth indicator oscillate from higher risk levels to lower risk levels.

  • After most stocks are already in uptrends, I believe the risk is higher that we’ll see it reverse.
  • After most stocks have already declined into downtrends, it increases the possibility that selling pressure may be getting closer to exhaustion.

The good news is, at some point selling pressure does get exhausted as those who want to sell have sold and prices reach a low enough level to bring in new buying demand.

That’s what stock investors are waiting for now.

These are my observations. I don’t have a crystal ball, nor does anyone. I just predetermine my risk levels in advance and monitor, direct, and control risk through my exits/hedging how much I’m willing to risk, or not. We’ll just have to see how it all unfolds in the days and weeks ahead.

Only time will tell if this is the early stage of a bigger deeper downtrend or just another correction within the primary trend.

I hope you find my observations interesting and informative.

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Observations of the stock market decline and volatility expansion

Observations of the stock market decline and volatility expansion

On September 25th I shared in VIX level shows market’s expectation of future volatility when I pointed out a low level of expected volatility as implied by the VIX index.

I said:

The current level of the VIX index has settled down to a lower historical level suggesting the market expects the future range of the price of the S&P 500 to be lower. Below is the current level relative to the past year.

I went on to explain my historical observations of volatility cycles driven by investor behavior:

The VIX Index is intended to provide a real-time measure of how much the market expects the S&P 500 Index to fluctuate over the next 30 days. The VIX Index reflects the actual order flow of traders

Since investors tend to extrapolate the recent past into the future, they usually expect recent calm markets to continue and violent swings to persist.

After the stock market declines and volatility expands, investors extrapolate that recent experience into the future and expect volatility to continue. Sometimes it does continue, but this time it gradually declined as the price trend became calmer.

When markets have been calm, traders and investors expect volatility to remain low. Before February, the VIX implied volatility had correctly predicted low realized volatility for months. But, both realized and expected volatility was so low that many investors were shocked when stock prices fell sharply, and volatility expanded.

When the market expects volatility to be low in the next 30 days, I know it could be right for some time. But, when it gets to its historically lowest levels, it raises situational awareness that a countertrend could be near. It’s just a warning shot across the bow suggesting we hedge what we want to hedge and be sure our risk levels are appropriate.

I shared the chart below, showing implied volatility at the low end of the cycle over the past year:

Since that date, we’ve indeed witnessed a volatility expansion of more than 90% in the VIX index and a decline in the S&P 500 stock index over -6%.  Implied volatility has expanded and stocks declined. As implied volatility is now starting to contract, below we can see the recent expansion as it trended from 12 to 24. Today its back to its long-term average of 20.

Stock market indexes, both U. S. and international, have declined 6 – 7% from their highs.

At this point, this has been a normal short-term cycle swing in an ongoing uptrend that is frequently referred to as a “correction.”

To be sure, we can see by looking at the % drawdowns in the primary uptrend that started in March 2009.

Markets cycle up and down, even within overall primary uptrends. As we see over a nine-year period, the current decline is about average and half as deep as the largest declines since 2009.

You can probably see what I meant by situational awareness of the markets cycles, trends, and volatility levels.

It isn’t enough to just say it or write about it. My being aware of the situation helps me to do what I said, which is worth repeating:

But, when it gets to its historically lowest levels, it raises situational awareness that a countertrend could be near. It’s just a warning shot across the bow suggesting we hedge what we want to hedge and be sure our risk levels are appropriate.

As far as the stock market condition, I like to see what is going on inside. Just as volatility swings up and down in cycles, so do price trends. As I’ve pointed out before, I observe prices swinging up and down often driven by investor behavior. For example, many investors seem to oscillate between the fear of missing out and the fear of losing money.

“The less the prudence with which others conduct their affairs, the greater the prudence with which we must conduct our own.” – Warren Buffett

One visual way to observe the current stage is the breadth of the stock market as I shared last week in The Stock Market Trend. Below is the percent of stocks in the S&P 500 index trending above their 50 day moving averages often used as a short-term trend indicator. This is a monthly chart since 2009 so we can see how it oscillates up and down since the bull market started. At this point, the number of stocks falling into short-term downtrends is about what we’ve seen before.

stock market breadth asymmetric risk

The risk is: this continues to be an aged old bull market, so anything is possible. That is why my focus every day is situational awareness. But, there is always a risk of a -10% or more decline in the stock market, regardless of its age or stage.

The good news is, we’ve now experienced some volatility expansion, stocks have now pivoted down to the lower end of their cycles, so maybe volatility will contract and stock prices resume their uptrend.

We’ll see.

All that is left to do is observe, be prepared, and respond tactically as it all unfolds.

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

The Stock Market Trend

The stock market declined with heavy selling pressure on a major stock market anniversary that I haven’t heard anyone mention.

October 10, 2018, is the 10-year anniversary of the waterfall decline of 2008.

Below is the S&P 500 stock index from October 9, 2007 to October 10, 2008. I remember it very well. It was the first part of the waterfall decline up to this day 10 years ago.

stock market decline 2008

But, as a reminder, while this bear market is often called the “2008 Financial Crisis” and misquoted as being only about the year 2008, it actually continued through March 9, 2009.

average length of bear market crash 2008.jpg

With stock indexes only about -5% or so off their all-time highs, we are far from that today.  But, the stock market decline today was impressive in magnitude and broad across all sectors.

stock market sector ETF October 10 2018

The breadth of the decline was unmistakable by the 50% decline in the % of stocks in the S&P 500 trading above their 50 day moving average. The percentage of stocks trading above the moving average is a breadth indicator that measures internal strength or weakness in the stocks in the index and the index itself. We say that breadth is strong when the majority of stocks in an index are trading above their moving average. Since the 50-day moving average is used to measure the short-medium term trend, it reveals that only 24% of the 500 stocks in the S&P 500 index are above their short-term trend.

percent of stocks above 50 day moving average SPX SPY.jpg

I colored the top red and the bottom green because the extreme highs and extreme lows can signal overbought and oversold levels.

The indicator is an oscillator that cycles between 0% and 100%.

After most stocks have trended up, we say an uptrend has broad participation, which is positive. However, markets cycle and oscillate up and down, so once most stocks have already been in uptrends at some point they reverse back down.

After most stocks have trended down, we say a downtrend becomes washed out. As selling eventually gets exhausted because those who want to sell have already sold.

Next, we observe the % of stocks in the S&P 500 index that are trending above their 200 day, which a longer term trend signal. 19% of the stocks declined below their 200 day moving average today leaving about half of the stocks still in a longer-term uptrend.

SPX BREADTH PERCENT OF STOCKS ABOVE 200 DAY MOVING AVERAGE

Since we are talking about moving averages and the S&P 500, below is the index itself with the 50 and 200 day moving average. Notice the 50 day moving average has been too tight to contain the uptrend. In other words, entering and exiting it would lead to many buys and sells and whipsaws like in June. The 200 day has better contained the trend since April, but notice if it were used as an exit it would have resulted in selling at the low. This observation is just using these moving averages as a very simple way to define uptrend vs. downtrend, it is not a complete trading system. Such measures are never perfect, and they don’t have to be.

stock market SPX 200 day moving average trend following

Today’s decline was impressive because the stock indexes declined over -3% in a single day. One day doesn’t make a trend, but it was enough to erase most of the year to date gains for the stock index.

stock market year to date 2018 trend following momentum

 

The Dow Jones Industrial Average of 30 of America’s largest companies declined even more than the S&P 500. There was even more weakness in small companies, momentum stocks, and an ETF tracking the top-ranked growth and momentum stocks by Investor’s Business Daily declined nearly -6%. As a proxy for leading growth and momentum stocks, this is an indication the leaders declined the most today.

stock market momentum ETF trend following asymmetric

You can probably see why I believe it’s essential to actively manage risk by knowing in advance when to exit a loser to cut losses short as well as understanding the market risk level. For those of us who weren’t fully exposed to the decline who have the capital to eventually buy at lower prices, we get to take advantage of a falling trend.

Over the past week, I shared observations of volatility expansion as the implied volatility index has been trending up. Below is its year to date trend.

VIX VOLATILITY EXPANSION

Here it is over the past week since I mentioned it. I included the S&P 500 stock index to illustrate as the stock market declined about -5% the past week, implied volatility expanded 98%.

SPY SPX VIX ASYMMETRIC RISK REWARD

We’ll see in the days and weeks ahead if this is the beginning of a more significant downtrend that becomes a waterfall decline or if it was enough to exhaust the selling pressure of those who wanted to sell.

 

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

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

 

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

The volatility expansion observation I shared last week has continued.

If you haven’t followed along, I suggest reading VIX level shows the market’s expectation of future volatility and Here comes the volatility expansion to see where I am coming from.

Implied volatility as measured by the CBOE Volatility Index $VIX has gained about 45% in the past three trading sessions, so volatility is expanding.

VIX $VIX VOLATILITY EXPANSION VOL TRADING ASYMMETRIC.jpg

I discussed what a rising VIX and volatility expansion means in the prior observations.

Rising implied volatility means rising expectations for future volatility as implied by options prices. Ultimately, Implied volatility is determined by the price of options contracts.

In other words, implied volatility is driven by supply and demand and order flow.

An increase in options buying increases the price of options which results in higher implied volatility.

The net selling of options decreases the price of options which results in lower implied volatility.

Volatility isn’t directional.

Volatility is a measure of movement and how wide prices spread out, which says nothing about the direction of the price trend. Prices can be trending up sharply and volatility measures could expand.

Here are some examples:

Trending up with volatility expansion: a price trend that gains 10% a day for several days is a directional uptrend, but it’s also volatile. We would say the trend is up, but it’s also a volatility expansion as the price range is expanding.

Non-trending with volatility expansion: a price trend that cycles up and down around 5% a day for a long time with no clear direction up or down is a non-trending condition, but it’s also volatile. We would say it is non-trending, but it’s also a volatility expansion.

Trending down with volatility expansion: a price trend that declines 10% a day for several days is clearly a downtrend, with volatility. We could say the trend is down with expanding volatility.

Most of the time, the risk is asymmetric since we tend to see increased volatility when we see falling prices. As prices fall, more investors and traders respond to the simple fact the prices are falling and they are losing money. This serial correlation with falling prices can lead more prices falling even more as investors sell because prices are falling.

However, occasionally we may observe prices trending down with volatility contraction. A falling price trend with contracting volatility is necessarily going to be a slower downtrend with less directional movement. Instead of 5% or 10% declines, it may be 1 or 2% declines. A downtrend without volatility expansion would be observed as a slower decline that would necessarily take longer for a large loss to develop. For example, a -30% loss would happen much faster with -10% down periods than it would at a rate of -1%. You can probably see how volatility expansions in downtrends get the attention of someone who wants to manage their drawdown.

I’ll share some more detailed ways to observe volatility to decide if volatility is expanding or contracting.

At the top of the chart is the S&P 500 stock index. The bands around the stock index are 2 times the stock index average true range over the past 20 days. The dotted line in the center of the bands is the 10-day moving average. Price trends move in cycles, so they oscillate up and down over time. When we apply bands around the price trend is gives us a visual representation of a “normal” range of prices around the trend. We observe the price trend tends to oscillate or cycle up and down within certain parameters – the range. When this range spreads out, I call it volatility expansion. When the range contracts, it’s volatility contraction. Volatility itself also tends to cycle between expansion and contraction. We can see that here.

volatility expansion stock market VIX ATR

Below the price trend chart with bands of the average true range (ATR) I included a chart of ATR, standard deviation, and the VIX. Both standard deviation and average true range are actual, historical, and realized volatility. These indicators are measuring how the price of the index has actually expanded or contracted. As I pointed out before, the VIX is a measure of options prices on the stocks in this index, so it’s driven by expectations of future volatility over the next 30 days determined by the price of options. ATR and standard deviation are the actual range of movement of the index.

I started with the year-to-date time frame to show how the price trend spread out as it started swinging up and down at the beginning of the year and has since trended up with lower volatility; smaller cycles, smaller swings.

Just as we observe market price trends tend to cycle and swing up and down over time, so does volatility. p

  • Price trends may reach an extremely high or low point, then reverse in the other direction.
  • Volatility may reach an extremely high or low point, then reverse in the other direction.

When we see volatility reach an extreme low/high point, we can expect to see it drift the other way eventually. Investors and traders who only believe trends in price and volatility only go one way are those who get surprised and caught in a loss trap.

Now, let’s zoom in for a closer look with just a three-month time frame to observe what has been going on more recently.

I highlighted in green the recent volatility expansion I pointed out last week. Notice the forward-looking VIX index at the bottom turned up sharper and has trended up higher than its last cycle high last month. However, realized historical volatility as measured by standard deviation and the average true range of index prices has also trended up, but on a lag relative to the forward-looking VIX.

Volatility expansion stock market risk management vix asymmetric risk reward

So, you can probably see why I’m calling it a volatility expansion. It is drifting up, though it could certainly trend up a lot more, or it could reverse back down. For now, the rising prices in options suggest there is demand for protection and it is probably in response to something the market believes may lead to increase risk or volatility. It could be something seasonal like earnings season or it could be as simple as the month of October is historically one of the most volatile months.

Speaking of October…

October is a typical month to see hurricanes in the Gulf and Atlantic, too. Right now, we have Michael (no relation) coming up through the Gulf of Mexico. As of this morning, Michael was just a named storm, but its expected to expand into a Category 2 or 3 hurricane by the time it reaches the Florida panhandle to our favorite places like Sandestin, Miramar Beach, Destin, and the 30A area like Rosemary Beach and Alys Beach. The intensity, speed, and how wide the storm spreads out to reach higher categories is a lot like volatility expansion in market price trends. Most people prefer to experience calm and quiet. We would prefer to see the storm contract and slow down its speed.

Although the tropical storm monitors have ways of measuring the probability of speed, expansion, etc. we are always dealing with the certainty of uncertainty. Hurricanes can shift and drift in different directions, speed up or slow down, and expand or contract. How we respond is a matter of situational awareness of measuring the cone of uncertainty as best we can. Some of us do it better than others. Some of us prepare more timely and respond better than others.

Right now we have some volatility expansion and we are positioned as such. The implied volatility index suggests the market believes we’ll see some price swings (up and down) this month.

We’ll see how it all plays out.

Semper Gumby (Always Flexible).

Let’s hope Michael doesn’t give me a bad name.

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

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.

 

 

 

 

 

 

Here comes the volatility expansion

Nine days ago in VIX level shows market’s expectation of future volatility I shared an observation that the implied volatility VIX, a measure of expected future volatility that is implied by option prices, had reached an extremely low point. I explained what that means and how I use it:

When the market expects volatility to be low in the next 30 days, I know it could be right for some time.

But, when it gets to its historically lowest levels, it raises situational awareness that a countertrend could be near.

Today we have some volatility expansion.

The VIX Volatility Index has gained 35%. It implies the market now expects higher volatility. Specifically, the market expects the range of prices to spread out over 15% instead of 12%.

VIX $VIX Volatility Expansion asymmetry asymmetric convexity divergence

The popular stock indexes are down over -1% for the first time in a while.

stock market asymmetry asymmetric risk

As I said nine days ago, it should be no surprise to see some volatility expansion. Volatility is mean reverting, which means it tends to oscillate in a high and low range and reverse back to an average after its reaches those cycle highs and lows.

Implied volatility had reached its historical low end, so it’s expanding back out. Stock prices are also spreading out and declining so we shouldn’t be surprised to see more movement in prices in the coming weeks.

At around the same time volatility was contracting and calm, my momentum indicators were signaling stock indexes and many individual stocks were reaching short-term extreme levels that often preceded a short-term decline. These systems prompt me tactically reduce exposure to stocks to dynamically manage our risk.

Only time will tell how it all plays out. We’ll see how it unfolds from here.

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

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The 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. 

Stanley Druckenmiller on his use of Technical Analysis and Instinct

Stanley Druckenmiller has a 30-year track record that is considered “unrivaled” by many. From 1988 to 2000, Druckenmiller was a portfolio manager for George Soros as the lead portfolio manager for Quantum Fund. He founded Duquesne Capital to manage a hedge fund in 1981 and closed the fund in August 2010.

Kiril Sokoloff of Real Vision interviewed him recently and shared parts of the interview on YouTube.

I watched the full 90-minute interview and noted some observations I’ll share.

Speaking of dealing with “algo trading” and “the machines,” Kiril Sokoloff asks Stan Druckenmiller:

“Let’s talk about the algos. We haven’t seen the algos sell, we’ve only seen them buy. We saw a little bit of it in February when there was some concentrated selling. We saw it in China in 2015, which was scary. Most people weren’t focused on that but I was and I think you were, too.

They (algos/machines) are programmed to sell when the market is down -2%. The machines are running and can’t be stopped and a huge amount of trading and money is managed that way. We’ve been operating in a bull market and a strong economy.

What happens when it’s a bear market and a bad economy, will things get out of hand?”

So, knowing that and knowing we’re at risk of that any moment… what are you watching for? …. how are you protecting yourself? What are you watching for? 

Stanley Druckenmiller answers:

“I’m going to trust my instincts and technical analysis to pick up this stuff up. 

But what I will say… the minute the risk reward gets a little dodgy I get more cautious than I probably would have been without this in the background.”

What was most fascinating about the rare interview of Stanley Druckenmiller is that some of us have figured out a successful tactical trading global macro strategy using the common elements of price trends, relative strength, risk management, and momentum combined with a dose of instinct all applied to global markets.

You can see for yourself at:

This wasn’t the first time Stan Druckenmiller spoke of his use of technical analysis and charts. In Part IV “Fund Managers and Timers” of The New Market Wizards in 1992, Jack Schwager included an interview with Stanley Druckenmiller titled “THE ART OF TOP-DOWN INVESTING.”

When asked what methods he used, he spoke of earnings, and then:

“Another discipline I learned that helped me determine whether a stock would go up or down is technical analysis. Drelles was very technically oriented, and I was probably more receptive to technical analysis than anyone else in the department. Even though Drelles was the boss, a lot of people thought he was a kook because of all the chart books he kept. However, I found that technical analysis could be very effective.”

Then, he was asked about his experiences during the 1987 stock market crash:

Jack Schwager: What determined the timing of your shift from bullish to bearish?

Stanley Druckenmiller: It was a combination of a number of factors. Valuations had gotten extremely overdone: The dividend yield was down to 2.6 percent and the price/book value ratio was at an all-time high. Also, the Fed had been tightening for a period of time. Finally, my technical analysis showed that the breadth wasn’t there—that is, the market’s strength was primarily concentrated in the high capitalization stocks, with the broad spectrum of issues lagging well behind. This factor made the rally look like a blow-off.

Jack Schwager: How can you use valuation for timing? Hadn’t the market been overdone in terms of valuation for some time before you reversed from short to long?

Stanley Druckenmiller: I never use valuation to time the market. I use liquidity considerations and technical analysis for timing. Valuation only tells me how far the market can go once a catalyst enters the picture to change the market direction.

Jack Schwager: The catalyst being what?

Stanley Druckenmiller: The catalyst is liquidity, and hopefully my technical analysis will pick it up.

Well, that sounds familiar.

What is most fascinating to me is that I’ve come to the same conclusions through my own experience over more than two decades without knowing Stanley Druckenmiller or others similar to him beforehand. I have to admit that I didn’t remember having so much in common with his strategy because I read The New Markets Wizards so long ago.

Some of us have discovered very similar beliefs and strategies through independent thinking and our own experiences. When I discover that others have found success I see the common characteristics and that confirms what drives an edge.

 

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

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

 

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.

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

The Federal Reserve raised interest rates and raised expectations for a fourth rate hike in December. The Fed unanimously agreed to raise the federal funds rate a quarter percentage point, to a range of 2% to 2.25%.

But, what does that mean?

The Federal Funds Rate is the interest rate at which depository institutions like banks and credit unions lend their reserve balances to other banks and credit unions overnight, on an uncollateralized basis. The U.S. Target Federal Funds Rate is at 2.00%, compared to the previous market day and 1.00% last year. This is lower than the long-term average of 2.61%.

The interest rate the borrowing bank pays to the lending bank to borrow the funds is negotiated between the two banks. The weighted average of this rate across all such transactions is the Effective Federal Funds Rate. The Effective Federal Funds Rate is at 1.91%, compared to 1.91% last month and 1.16% last year. This is lower than the long-term average of 4.83%.

Below we chart the trend of the Federal Funds Rate and the Effective Federal Funds Rate over the past 5 years. The trend in interest rates is clear.

Federal Funds Rate Interest Rates Effective Target

Why do we care about rising interest rates?

The Federal Funds Rate drives in