Volatility, Put/Call Volume, and such

I see some hedging demand in the options market.

The ratio between Index puts and calls doesn’t get much higher than this. The CBOE Index Put/Call Ratio is elevated at 1.86, indicating probable hedging in the options market.

To be sure, here is the index put volume compared to index call volume.

Total options volume is relatively low for 2020, however.

But, right at its long term average.

The CBOE Equity Put/Call Ratio shows us the relative volume of individual stock puts and calls. Equity call volume was extremely high on June 8th, and has since mean reverted. I considered it to be very speculative, since call options are mostly traded for upside speculation in the underlying stock.

I pointed out before that speculative call volume reached an extreme high level, which was a contrary indicator.

Indeed, the S&P 500 index peaked with the peak in speculative call buying.

The decline in the S&P 500 so far has only been -7%, and it started June 8th. It remains about -6% from its high.

The options market doesn’t see a lot of hedging near the stock market peaks, but it sure does after the market trends down.

The S&P 500 tapped the 200 day moving average last week, but is trying to trend above it. Today was a good start, if it can hold the line.

For those who like the concept of mean reversion, here’s your sign.

This market has impressive resilience, but we never know the next -5% or larger down day is coming.

Well, I may not know for sure, but I know when the odds are stack in our favor as I showed in “If we’re going to see a second leg down, this is where I think it will start.”

For now, expected volatility contracted nearly -9% today, so the options market believes we’ll see less range over the next 30 days.

We’ll see…

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

Global Macro: Signs of bullish sentiment across the globe

In some cases, the recovery of economic and market trends are as impressive as the rate in which they fell.

The so-called “panic button” indicator, TED Spread, is back down to low levels. The chart tracks the daily TED Spread (3 Month LIBOR relative to the 3 Month Treasury Bill) as a measure of the perceived credit risk in the U.S. economy. It tends to widen during times of economic uncertainty. The TED Spread spiked up briefly in March, but has since settled back down.

The TED Spread spiked up briefly in March, but has since settled back down.

German economic sentiment snapped back fast.

The ZEW Indicator of Economic Sentiment is a leading indicator for the German economy. It reflects the expectations in six months of 300 financial experts on inflation rates, interest rates, stock markets, exchange rates, and oil prices for leading global economies. A value greater than 0 reflects more optimism than pessimism and a value less than 0 reflects more pessimism than optimism with respect to economic sentiment.

ZEW Indicator of Economic Sentiment for Germany is at a current level of 63.40, which is right at the high it reached in 2014.

ZEW Indicator of Economic Sentiment for Germany and the Eurozone updates will be released tomorrow, so we’ll see how they have trended through June.

US Consumer Sentiment has trended up off its low. We’ll see if it can continue this uptrend with the COVID cases trending up again.

The Sabrient Insider Sentiment Index is designed to identify companies with potentially superior risk-return profiles that also are;

(1) reflecting favorable corporate insider buying trends (determined via the public filings of such corporate insiders) and/or

(2) have recent earnings estimate increases published by Wall Street analysts.

The Sabrient Insider Sentiment Index declined with the stock indexes in March and has recovered in similar fashion. As with investor sentiment measures, it seems to follow price. Nothing drives sentiment like the price trend.

Speaking of sentiment, the Citigroup Panic/Euphoria model is a gauge of investor sentiment. It identifies “Panic” and “Euphoria” levels which are statistically driven buy and sell signals for the broader market.  Historically, a reading below panic supports a better than 95% likelihood that stock prices will be higher one year later, while euphoria levels generate a better than 80% probability of stock prices being lower one year later.

The current reading of the Citigroup Panic/Euphoria model at 0.41 indicates euphoria and anything at or below -0.17 indicates panic.

The S&P 500 EQUAL WEIGHT is probably the best measure of the U.S. stock market. Here, I charted both the standard capitalization weighted index along with its Equal Weight counterpart. The cap-weighted S&P 500 is heavily driven by its top holdings, whereas the equal-weighted index holds about .20% in the 500 or so stocks in the index.

The S&P 500 Equal Weight Index declined -40% in March, which is more than the -34% of the S&P 500 weighted based on company size. The equal-weighted index also remains in a -17% drawdown off its highs, which is more than the standard SPX index, which is more weighted to the largest stocks.

For example, below are the top 25 stocks in the cap weighted S&P 500 everyone follows. As these top stocks have as much weighting in the index as 5%, the equal weight only holds about 0.20% in these same stocks.

SymbolName% Weight
MSFTMicrosoft Corp5.94%
AAPLApple Inc5.81%
AMZNAmazon.com Inc4.51%
FBFacebook Inc A2.22%
GOOGLAlphabet Inc A1.69%
GOOGAlphabet Inc Class C1.65%
JNJJohnson & Johnson1.44%
BRK.BBerkshire Hathaway Inc Class B1.36%
VVisa Inc Class A1.28%
JPMJPMorgan Chase & Co1.17%
PGProcter & Gamble Co1.14%
UNHUnitedHealth Group Inc1.10%
HDThe Home Depot Inc1.03%
MAMastercard Inc A1.03%
INTCIntel Corp0.97%
NVDANVIDIA Corp0.91%
VZVerizon Communications Inc0.88%
TAT&T Inc0.83%
ADBEAdobe Inc0.82%
NFLXNetflix Inc0.80%
PYPLPayPal Holdings Inc0.79%
DISThe Walt Disney Co0.79%
MRKMerck & Co Inc0.76%
BACBank of America Corp0.75%
CSCOCisco Systems Inc0.75%
S&P 500 Holdings as of June 26, 2020

The price trend for Emerging Markets stocks has been dismal since the 2007 peak, which has had some negative impact on global macro. That is, considering the killer trend from 2003 to 2007 has a strong return driver for us, it hasn’t been the case since then. So, we’ve not had much exposure to EM, even though it’s now considered undervalued relative to the rest of the world, for me, it has to be trending up with some momentum. This tend is non-trending and volatile.

Zooming in to the year to date, at least the MSCI Emerging Markets Index only declined about the same as US stocks.

Looking inside the EM Index we see the top country exposures are China, Taiwan, South Korea, India, and Brazil, all of which we can gain portfolio exposure via ETFs.

Looking at these individual emerging countries, Brazil has been hammered the most, Taiwan, Korea, and China have been relatively resilient.

In fact, the trend in China is probably surprising to investors, especially considering it’s where the COVID-19 Coronavirus started. China only had a -18.4% drawdown priced in US Dollars.

Brazil has some of the worse COVID trends in the world right now, which isn’t helping their stock market trend either.

Here’s a view of the global stock market trends. Though they are down from their February 2020 highs, they are well above their March 2020 lows.

Gold has had one of the most asymmetric risk/reward profiles YTD. In 2020, Gold has only only down about -3% and a drawdown from its peak of -11%, but it has gained 16%. That’s relatively strong asymmetry.

Gold is no contest against the long term US Treasury Index in 2020. Long Term US Treasuries have the strongest momentum and asymmetric risk/reward year to date, which is why I have exposure. Gold has still been a good asymmetric risk/reward, though.

We remain on defense and invested in bonds for now as they seem to exhibit the most asymmetric risk reward.

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

Global Macro Trends: Extreme asymmetric observations and changes

Macroeconomics is a branch of economics dealing with the performance, structure, behavior, and decision-making of an economy as a whole.

Macroeconomics is the part of economics focused on the big picture: analyzing economic phenomena such as interest rates, growth, unemployment, and inflation. Macro is in contrast with microeconomics, the study of the behavior of individual markets, workers, households, and firms. Macroeconomic phenomena are the product of all the microeconomic activity in an economy.

Global is related to, or involving, the whole world, not just one country or state.

Global Macroeconomics, or Global Macro, then, is looking at the whole world for trends and behavior of big picture trends.

US Total Vehicle Sales measures the total number of auto, light truck, and heavy truck sales in the US and helps gauge how consumers are spending their discretionary income. In the chart, we can visually see the trends in car and truck sales going back 43 years.

US Total Vehicle Sales bottomed at prior lows, and is now trending back up.

US Light Truck Sales is part of total sales and at a current level of 9.6 million, it’s up from 6.7 million last month and down from 12.57 million one year ago.

US Light Truck Sales has been in an overall uptrend the past four decades, and it reverted to the long term average, but is recovering. US Light Truck Sales is up 41.68% from last month, and -23.96% from one year ago.

Personal Consumption Expenditures Price Index (PCE) is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The PCE price index is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behavior. The PCE price index, released each month in the Personal Income and Outlays report, reflects changes in the prices of goods and services purchased by consumers in the United States. Quarterly and annual data are included in the GDP release.

Personal Consumption Expenditures Price Index (PCE) Year over Year is is at 0.55%, compared to and 1.38% last year (a decline of 60%) and is materially lower than the long term average of 3.25%.

US Personal Spending Month over Month is at 8.17%, compared to -12.62% last month and 0.44% last year. US Personal Spending is now higher than the long term average of 0.52%. The chart shows this data was historically more stable, but we’ve observe some extreme outlier trends this year never seen in the last 60 years.

The US Inflation Rate is the percentage in which a chosen basket of goods and services purchased in the US increases in price over a year. Inflation is one of the metrics used by the US Federal Reserve to gauge the health of the economy. Since 2012, the Federal Reserve has targeted a 2% inflation rate for the US economy and may make changes to monetary policy if inflation is not within that range. A notable time for inflation was the early 1980’s during the recession. Inflation rates went as high as 14.93%, causing the Federal Reserve led by Paul Volcker to take dramatic actions.

US Inflation Rate is at 0.12%, compared to 0.33% last month and 1.79% last year. This is disinflation, which is a decrease in the rate of inflation. Disinflation is a slowdown in the rate of increase of the general price level of goods and services in a nation’s gross domestic product over time. Inflation has mostly trended below the long term average of 3.23% for years, but is extremely low at 0.12%. We could be a risk of deflation, which occurs when the inflation rate falls below 0%.

Inflation reduces the value of a currency over time, but sudden deflation increases it. As inflation is declining, the US Dollar is trending up.

When we think of macroeconomics trends like inflation and the US Dollar, we also think of gold. Here is Gold, priced in US Dollars. The Gold Price in US Dollars measures the cost in US Dollars for a Troy Ounce of gold. Gold can be seen as a “safe haven” investment since it is a tangible investment. Gold is also believed to be a hedge against inflation, which is why it reached as high as $1,895 per troy ounce in 2011 when inflation trended higher.

Gold is in an uptrend.

Inflation and interest rates are the primary return driver of stocks and bonds as well as some commodities and currencies.

The 10 Year Treasury Rate is the yield earned by investing in a US government issued treasury security that has a maturity of 10 years. The 10 year treasury yield is the longer end of the yield curve. Many analysts use the 10 year yield as the “risk free” rate when valuing the markets or an individual security. Historically, the 10 Year treasury rate reached as high as 15.84% in 1981 as the Fed raised benchmark rates in an effort to contain inflation.

10 Year Treasury Rate is the lowest it has been the past 30 years, currently at 0.64%, compared to 2.01% last year, and is significantly lower than the long term average of 4.45%.

We all know that past performance is no guarantee of future results, and the bond market expected return is a fine example. One thing that is essential for investors to understand is the long term bond returns will not repeat their past performance over the long term.

The directional trend of interest rates like the 10 Year Treasury Rate are a driver of other rates, such as mortgage rates.

The 30 Year Mortgage Rate is the fixed interest rate that US home-buyers would pay for a 30 year mortgage. Historically, the 30-year mortgage rate has trended as high as 18.6% in 1981, and up until now has trended down as low as 3.3% in 2012.

The 30 Year Mortgage Rate is at 3.13%, the lowest in 48 years, compared to 3.82% last year, and less than half of its 7.97% long term average.

The 15 Year Mortgage Rate is trending down low enough to double tap its all time low at 2.59% reached in May 2013, which is significantly lower than the long term average of 5.36%.

That’s all for now.

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

Global Macro trends are all over the place

Macroeconomics is a branch of economics dealing with the performance, structure, behavior, and decision-making of an economy as a whole. Macroeconomics is the part of economics focused on the big picture: analyzing economic phenomena such as interest rates, growth, unemployment, and inflation. Macro is in contrast with microeconomics, the study of the behavior of individual markets, workers, households, and firms. Macroeconomic phenomena are the product of all the microeconomic activity in an economy.

Global is relating to, or involving, the whole world, not just one country or state.

Global Macroeconomics, or Global Macro, then, is looking at the whole world for trends and behavior of big picture trends.

US Existing Home Sales reflects the total unit sales of US homes that are already built. It is a lagging indicator tracking the US housing market, which is impacted by changes in mortgage rates. Historically, US Existing Home Sales declined to a trough of 3.77 million units sold in November 2008 as foreclosures increased and home values fell during the US Housing Crisis.

US Existing Home Sales is at a current level of 3.91M, down from 4.33M last month and down from 5.33M one year ago. This is a change of -9.70% from last month and -26.64% from one year ago.

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

US Retail Gas Price is at a current level of 2.185, up from 2.123 last week and down from 2.821 one year ago. This is a change of 2.92% from last week and -22.55% from one year ago. US Retail Gas Price is trending up from its recent low, which was around the same level of support gas had at prior lows of the past decade.

China Imports YoY is down -16.69%, compared to -14.19% last month and -8.22% last year. This is lower than the long term average of -3.83%.

China Trade Balance is at a high of 62.93B, up from 45.33B last month and up from 41.20B one year ago. This is a change of 38.82% from last month and 52.73% from one year ago.

US Continuing Claims for Unemployment Insurance is at a current level of 20.54M, down from 20.61M last week and up from 1.70M one year ago. This is a change of -0.30% from last week and 1.11K% from one year ago.

US Initial Jobless Claims, provided by the US Department of Labor, provides underlying data on how many new people have filed for unemployment benefits in the previous week. We can gauge market conditions in the US economy with respect to employment; as more new individuals file for unemployment benefits, fewer individuals in the economy have jobs. Historically, initial jobless claims tended to reach peaks towards the end of recessionary periods such as on March 21, 2009 with a value of 661,000 new filings.

US Initial Claims for Unemployment Insurance is at a current level of 1.508M, down from 1.566M last week and up from 222,000 one year ago. This is a change of -3.70% from last week and still up 579.3% from one year ago.

Equity option demand continues to be focused on call buying relative to put options.

The CBOE Equity Put/Call Ratio had reached a very low level, indicating options traders were mostly operating in speculative call options over put options for hedging.

I pointed out in “Volatility contractions are eventually followed by volatility expansions” on May 27th:

“CBOE Equity Put/Call Ratio is trending toward the low level was saw before the waterfall decline in March. A falling put-call ratio, or a ratio less than 1, means that traders are buying fewer puts than calls. It suggests that bullish sentiment is building in the market.”

Shortly after, we saw a -7% decline in the stock indexes.

However, I’m seeing evidence of hedging now. The CBOE Index Put/Call Ratio shows a relatively high degree of hedging with put options.

Implied volatility as measured by the CBOE Volatility Index (VIX) remains very elevated, even though it declined nearly 10% today. In fact, it has mean reversed, as it does. The VIX is at its one year average.

Global Macro trends are all over the place.

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

This is what the stock market will focus on next

As much as I wish it wasn’t so, some important trends are in the wrong direction.

New COVID – 19 cases here in Florida are trending to a material new high.

Contrary to what some seem to blindly say; it isn’t because of more testing.

In Florida, testing slowed down 3% while new cases grew 88% over the last week.

Image

Yesterday, Governor Ron DeSantis acknowledged that the rising number of new Covid-19 cases in Florida cannot be explained away by an increase in testing, and announced plans to step up enforcement of social distancing practices in bars and nightclubs in “DeSantis pivots on Covid-19 surge, says testing doesn’t account for spike.

“Even with the testing increasing or being flat, the number of people testing positive is accelerating faster than that,” DeSantis told reporters during a briefing at the state Capitol. “You know that’s evidence that there’s transmission within those communities.”

Of course, it isn’t just Florida.

As of today, US Coronavirus Tests Administered is at a current level of 26.57 million, up from 25.98 million yesterday. It’s a change of 2.25% from yesterday.

US Coronavirus Cases is at a current level of 2.255 million, up from 2.223 million yesterday, which is a change of 1.46% from yesterday.

Here are the absolute trends in comparison.

The good news is the spread between US Coronavirus Tests and Cases is in an uptrend, so negative tests overwhelm positive test results.

We can use a ratio chart to see the relative trend in cases and tests. I do the same with global market trends. For example, we can compare the US Energy sector to the S&P 500 to see the relative strength or weakness. When the trend is down as it is here, the sector is lagging.

Here is a simple analog chart comparison.

In contrast, the Technology sector has been relatively stronger than the S&P 500 stock index.

And the relative strength ratio between Technology and the broader stock market index shows the opposite trend than what we saw from Energy.

So, back to the COVID trend, taking this same ratio methodology applied to tests and cases, the relative trend is down, so cases are lagging tests by a material amount. We want to see this trend continue.

So far, states have reported 630 deaths and the trend is down, so we are seeing a national decline. Death reporting lags approximately 28 days from symptom onset, according to CDC models that consider lags in symptoms, time in hospital, and the death reporting process.

Image

So, that’s the good news.

What I believe people will increasingly focus on is the breakout in new cases per day. Many trackers are normalizing the trend with a 7 day moving average, but the data already has a natural lag between contraction, testing, a positive case, so I’m not adding one myself.

Instead, I want to see a new breakout as soon as it develops. If we wait for a 7 day moving average new high, the lag will delay noticing the breakout.

I pointed out over a week ago I’m seeing new breakouts to the upside.

I’m still seeing new breakouts in cases per day.

I pointed out Florida, Arizona, and Texas. Now add Georgia.

And it isn’t just more testing in Georgia.

California is still trending up, and although their testing is rising, it isn’t just an increase in tests.

Oklahoma cases have now broken out into an uptrend. Again, the new high in cases per day doesn’t correspond to a new high in testing.

We’re seeing breakouts in other countries, too, such as Brazil.

Others like Russia have peaked and are drifting down.

So, there’s the trends.

What about the momentum of the trend?

Just as I have proprietary momentum and relative strength algorithms to define the speed of a price trend in global markets, they also have a measure of the speed of the COVID – 19 trend.

The values for Rt is a key measure of how fast the virus is growing. It’s the average number of people who become infected by an infectious person. If Rt is above 1.0, the virus will spread quickly. When Rt is below 1.0, the virus will stop spreading. Projecting the reproduction number is essential to understand how explosive an uptrend in new cases may be.

The Rt for Florida is 1.39, so it’s likely to spread relatively fast and we’ll see cases trend up as the new cases are spreading it to others. Florida has been in the top five of all states since I’ve been monitoring it.

Hawaii has the highest reproduction number in the United States.

Tennessee hasn’t been spreading it as fast.

The Rt for New York was as high as 2 early on, so a person who contracted the virus spread it to about two more, but it has slowed.

The states with the lowest Rt levels are in the north right now and the highest are in the south, or the warmest climates.

So much for the theory that heat will smoother the Coronavirus. It doesn’t seem to be the case.

Here are all of the states ranked from lowest to highest R.

Here are the Southern states. Most are in the red zone.

Next is the Northeast, who has maintained the most aggressive shelter in place and such.

Does this mean it’s working? Well, yes, if you aren’t around people, the spread will slow. However, only time will tell if these more city like areas come back sharply once they are back to full production.

By the way, here are the states that never sheltered.

So, we should prepare for the media to increasingly make this a big story again. As I see it, the odds of catching it is relatively low if less than 1% of the population has it. The trouble is, without testing everyone, we don’t know the positive rate. Right now the positive rate in Florida is increasing at 12%.

We should also prepare for the likelihood the stock market will eventually respond to these rising trends in new cases and the possibility of fear driving the stock market down again.

Although, it isn’t just a reaction to the continuation of COVID, but also the high risk level of the stock market.

The stock market is at an elevated risk level based on both fundamental valuation and quantitative momentum measures.

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

S&P 500 Shiller CAPE Ratio is at a current level of 27.64, up from 26.03 last month and down from 29.24 one year ago. This is a change of 6.18% from last month and -5.48% from one year ago. It remains well above average and it’s at the third highest level it has ever been. These trends in valuation get resolved eventually, even if the Fed is trying to support stable prices.

The short term relative strength reading the speed and magnitude of the moves isn’t as overbought as it was when I pointed it out two weeks ago, but it’s also far from oversold.

Let’s see how it all unfolds from here.

Let us know if we can help here.

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

If we’re going to see a second leg down, this is where I think it will start.

“I still had much to learn, but I knew what to do. No more floundering, no more half-right methods. Tape reading was an important part of the game; so was beginning at the right time; so was sticking to your position. But my greatest discovery was that a man must study general conditions, to size them so as to be able to anticipate probabilities.” – Jesse Livermore, Reminiscences of a Stock Operator, by Edwin Lefèvre, first published in 1923.

The US stock market is now at risk of another decline

First, the relative strength of the S&P 500 has reached a level I consider overbought for the first time since the crash.

It’s a measure of too far, too fast.

The Relative Strength Index (RSI), developed by J. Welles Wilder. Born in Noris, Tennessee, Wilder was a mechanical engineer, turned real estate developer, turned technical analyst, and best known for his work in technical analysis. Wilder created the Average True Range, the Relative Strength Index (RSI), Average Directional Index, and the Parabolic SAR, which he published in 1978 in New Concepts in Technical Trading Systems

is a momentum oscillator that measures the speed and magnitude of directional price trends. The RSI oscillates between zero and 100, so it is range bound.I The RSI is defined as overbought when it reaches 70 or higher and oversold below 30.

Another useful measure of market trend conditions is breath. The percent of S&P 500 stocks above their 50 day moving average shows us how many stocks are participating in the uptrend. Since June 1st, 97% of the stock are trending above their 50 day moving average, so they are in short term uptrends.

Strong breadth of participation is a good thing, until it reaches an extreme. A breath thrust as we saw begin the start in April was a good sign as the stock market was trending up, more and more stocks were entering uptrends. However, once all of the stocks are already in uptrends, we eventually have to wonder what is going to keep driving them higher.

Much of investment management is an understanding of what other market participants are likely to do next. When I see the percent of SPX stocks above their 50 day moving average at the highest level in twenty years, it simply tells us most of the stocks are in short term uptrends, but, the next direction for buying enthusiasm is going to be down.

On a longer term time frame, which is the 200 day moving average, only about 60% of the S&P 500 stocks are in longer term uptrends, so there is plenty of room for continuation.

Next up is the good ole NYSE Bullish Percent.

The NYSE Bullish Percent was the first breadth indicator. The NYSE Bullish Percent was developed by Abe Cohen, the founder of Investors Intelligence in 1955. Abe Cohen was an early pioneer of point & figure charting , which he believed provided the ideal building blocks for a market barometer. By recording stock prices, P&F charts effectively map out the relationship between demand (buyers) and supply (sellers). The advantage of P&F charts is the supply/demand asymmetries are clear cut and easy to identify:

If demand outstrips supply, a P&F buy signal is generated

If supply outstrips demand a P&F sell signal is generated.

The Bullish Percent, then, is a breadth indicator that shows the percentage of stocks on Point & Figure Buy Signals. As with other oscillators, the Bullish Percent Index is range bound and fluctuates between 0% and 100%. In its most basic form, the Bullish Percent Index favors the bulls when above 50% and the bears when below 50%. Bullish Percent is considered overbought and a higher risk zone when above 70% and oversold and a lower risk level when below 30%.

At the current reading of 83, it’s clearly in the “high risk” zone.

So, I wouldn’t be surprised to see this uptrend at least stall here, temporarily.

If we’re going to see a second leg down, this is where I believe it will start.

The Federal Reserve is fully committed to keeping this trend going, so we’ll see…

Risk management is essential for all investments because all investments have a risk of loss.

As a tactical decision to reduce our exposure to loss in response to the elevated risk levels I’m seeing, I sold to take profits on our remaining stock positions on Tuesday and invested in US Treasuries.

“But my greatest discovery was that a man must study general conditions, to size them so as to be able to anticipate probabilities. ”

– Jesse Livermore, Reminiscences of a Stock Operator, by Edwin Lefèvre, first published in 1923.

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

The big picture of the stock market in context

It’s essential to make observations about the big picture to see what is going on, since the longer trends eventually have an impact on shorter trends.

Before March, the US economy was in the longest economic expansion on record. It was aged, to say the least. I pointed out several times the past year unemployment was at an all time historic low at 3% or so.

Now it’s 14.7%.

The stock market was in the longest bull market, ever. An uptrend in stocks is usually around 4-5 years before being interrupted by a -20% bear market decline.

This time it was 11 years.

Before March, I had been pointing out the S&P 500 was the second highest valuation going back over 140 years, according to Shiller.

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

Even after the S&P 500 stock index declined -34%, the S&P 500 Shiller CAPE Ratio is at a current level of 25.88, down from its 33.31 high in January 2018, but far from an undervalued level. In fact, it has so far just reverted to its 10 year average.

Long term bull markets have historically started at low levels, like 10. Bull markets historically end at high valuation levels, such as around 20. It’s far from a science and not a good market timing indicator. But, it helps us to understand the big picture risks/rewards. From a high starting point, we shouldn’t expect to see high capital gains from passive indexing.

Here is S&P 500 Shiller CAPE Ratio going back before 1900 to put it into context.

Even though the price to earnings ratio has fallen as the price fell, it isn’t anywhere near what we consider undervalued.

So, it is what it is.

If this is the early stage of a bigger bear market, it has plenty of room to fall before become “undervalued” and this may explain why

On Twitter today was some concern about the famous value investor Warren Buffett isn’t buying stocks. Instead, he’s selling stocks.

“Is it meaningful that Buffett has $137 billion in cash and $40 billion yearly in cash flows to deploy in Berkshire $BRK.B and he’s worried it might not be enough?”

Buffett is famous for buying stocks when others are panicking. But, he isn’t, et. The simple answer is the stock market in general remains at 25 times earnings by the Shiller measure, and it reached the lower teens in March 2009 and single digits before that before another secular bull market occurred.

Prices have to reach a low enough level to attract buying demand. As of now, we’re seeing it happened in March, considering the gains since the March 23rd low.

But, it looks like prices may have to fall a lot more before big value investors like Buffett get more invested.

An investment manager like me has much more flexibility. I’m far more quick and nimble, so I can make tactical decisions and then change my mind with liquidity.

If no buyers are willing and able to enthusiastically buy the stocks and bonds we’re selling, especially because we have to much of it, then;

oops.

Semper Gumby.

Always Flexible.

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

A new volatility expansion

And just like that, we have another volatility expansion.

Yesterday, in Global Macro: Volatility expands and divergence between sectors I suggested “It is likely we’ll see a volatility expansion from here.” Indeed, with the VIX and VVIX (volatility of volatility) both up 10% today, we are entering a volatility expansion.

Implied volatility had settled down gradually since it peaked in March, but it now looks like we may see prices spread out into a wider range.

As of this moment, the S&P 500 is down -2.34% and it is reversing down from the average of its price trend year to date, so I’ll call it “mean reversion.”

In fact, it’s mean reversion from the 1 year price trend, too.

It’s a negative sign that small and mid size stocks are trending down even more, down nearly -4%. They’ve been laggards in this rally from the March low. In the early stage of a new bullish trend, smaller companies should trend up faster. Smaller companies are more nimble than large companies, so we expect to see them recover quicker from declines. When they don’t, we consider it a bearish divergence.

I can’t say I’m surprised. This is likely the early stage of a deeper bear market as I’ve operated through 2000-03 and 2007-09.

But, nothing is ever a sure thing. It’s probabilistic and probably necessarily implies uncertainty.

Managing money though a big bear market isn’t as simple as an ON/OFF switch, whereby we get out near the peak and then reenter near the low. I’ve traded through a lot of nasty market conditions, the nastiest aside from the Great Depression, and that isn’t how it has worked for me. I didn’t just get out and then back in a year or two later. There are opportunities in between for skilled tactical traders who are able to direct and control risk and manage drawdowns.

There’s a good chance this becomes a prolonged bear market similar to what we’ve seen twice over the past two decades I’ve been a professional money manager.

I wrote yesterday;

“It’s probably a good time for individual investors who don’t have tight risk management systems to shift to defense to preserve capital, but it’s not a guarantee, and yes, we’ll see.”

I’ll just leave it at that, today.

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

Global Macro: Volatility expands and divergence between sectors

Implied volatility is mean revering in some ways. Volatility expands and contracts, so it oscillates between a higher level an a lower range.

I was monitoring various measures of volatility, such as the CBOE Implied Volatility Index as my systems were indicating a potential short term trend change.

Sure enough, at the end of the trading day, VIX expanded 20%.

Over the year to date time frame, VIX has reverted to its mean.

It is likely we’ll see a volatility expansion from here.

The VIX is implied volatility, which is its the expected vol over the next 30 days for the S&P 500 stocks. More specifically, a VIX of 33 implies a 2% range over the next 30 days. That’s less than half what it was in March with the VIX at 80, it implied a 5% range in prices. Still, investors have gotten used to a VIX around 12 or lower in recent years, except for the occasional volatility expansions. Over the past decade, the bull market presented an average VIX of 17.45, which is materially lower than the long term average of 19.36. At a 17 vol, the implied vol is around 1% a month.

The VIX isn’t always right. Implied vol is calculated based on the options prices of the S&P 500 stocks. It’s a forward looking expectation, as opposed to a rear view looking historical actual volatility, such as standard deviation.

The VIX of VIX (VVIX) is a measure of the volatility of the VIX. The CBOE’s VIX measures the short-term volatility of the S&P 500, and the VVIX measures the volatility of the price of the VIX. So, we call it the VIX of VIX, or the vol of vol.

VVIX gained 10% today, too, signaling a vol expansion.

All of this is coming at at time when my systems are showing a declining rate of change over the past month. The initial thrust off the March 23rd low had momentum, but since then the rate of change has been slowing. It’s running out of steam, or velocity.

Don’t fight the Fed

My systems monitor thousands of macroeconomic data and programmed to let me know what has changed.  Macroeconomics is an observation of the entire economy, including the growth rate, money and credit, exchange rates, the total amount of goods and services produced, total income earned, the level of employment of productive resources, and the general behavior of prices.

I know, sounds exhausting. It is, unless you have a computerized quantitate systems to do it with perfection.

Looking at global macroeconomics, the Fed balance sheet is a key right now.

The H.4.1 from the Federal Reserve is a weekly report which presents a balance sheet for each Federal Reserve Bank, a consolidated balance sheet for all 12 Reserve Banks, an associated statement that lists the factors affecting reserve balances of depository institutions, and several other tables presenting information on the assets, liabilities, and commitments of the Federal Reserve Banks.

US Total Assets Held by All Federal Reserve Banks is the total value of assets held by all the the Federal Reserve banks. This can include treasuries, mortgage-backed securities, federal agency debt and and so forth. During the Great Recession, having already lowered the target interest rate to 0%, the Federal Reserve further attempted to stimulate the US economy by buying and holding trillions of dollars worth of US treasuries and mortgage-backed securities, a process known as Quantitative Easing or QE.

US Total Assets Held by All Federal Reserve Banks is at a current level of 6.721 TRILLION, up from 6.656 TRILLION last week and up from 3.890 TRILLION one year ago. This is a change of 72.80% a year ago.

The chart shows the last 15 years. I marked the last recession in grey.

It’s really high.

The Fed seems much more concerned this time as they have rolled out a much larger helicopter to drop over the cash.

I’m seeing a lot of divergence between sectors as a smaller number of stocks The chart is year to date. Only Technology is positive, by 1.86%. Otherwise, it’s a relative notable range of divergence.

The sector divergence is more obvious over the past month. Barely half of the sectors are positive, the rest and down.

This is just a simple illustration of what appears to be some weakness. The rate of change is slowing and I’m guessing it’s been driven by the massive Fed action.

Now, America is opening for business, but some research I’ve been doing shows it may be a bigger problem that I thought.

I’ll share that shortly.

I’ve also got an important piece I’m going to share about my experience trading the last two big bear markets.

It seems inevitable we’ll get to flow through another one and this one may be bigger and badder, we’ll see.

I think skill and experience is going to be an edge and make all the difference as it did in the past, we’ll see.

But, nothing is ever a sure thing. It’s probabilistic, but probably necessarily implies uncertainty.

It’s probably a good time for individual investors who don’t have tight risk management systems to shift to defense to preserve capital, but it’s not a guarantee, and yes, we’ll see.

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

Individual investors are screaming bearish

The US Investor Sentiment survey shows individual investors are the most negative about the direction of the stock market they’ve been the past five years.

In fact, the last time investors were this bearish was over seven years ago, in January 2013.

I remember 2013 started off with great pessimism, but end up a stunner.

There was a lot going on in the news in 2012 going in to 2013, so investor sentiment reflected it. Then, there was the stock indexes finally reaching their late 2007 highs after a crushing -56% bear market. It took over five years to recover, but it finally did by the end of 2013.

This time may be different.

The individual investors survey for the sentiment gauge may be right.

But more often than not, when their sentiment reaches an extreme, the market proves them wrong.

Anything is possible. Every new trend is unique. The Fed and US Treasury have made it clear they’ll do anything necessary, so those of us moving around big money probably do so knowing the Fed Put is there.

The Fear & Greed Index is diverging from the sentiment poll. The Fear & Greed Index looks at seven different indicators to gauge investor sentiment. Only one of them is positive right now and the level is at mid field.

US Bullish investor sentiment is at an extreme level, too.

The Bull Bear Spread is about as low as it has ever been.

The market climbs a wall of worry, and that’s exactly what it’s been doing.

So far.

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

The 2 Year U.S. Treasury trends to uncharted territory and you better git your mind right

The 2 Year U.S. Treasury has never been this low before.

2 Year Treasury Rate is at 0.13%, compared to 0.17% the previous market day and 2.30% last year. This is lower than the long term average of 3.32%.

2 Year Treasury Rate is the yield received for investing in a US government issued treasury security that has a maturity of 2 years. The 2 year treasury yield is included on the shorter end of the yield curve and is important when looking at the overall US economy. Historically, the 2 year treasury yield trended as low as 0.16% in the low rate environment after the Great Recession post 2008. Here is the chart.

This is uncharted territory.

Here is the trend in the interest rate since 1990.

The 10 year treasury remains at an all time low.

On December 29, 2019, I shared my observations of the yield spread in “Asymmetry in yield spreads, inverted yield curve warning shot, and unemployment” when I said:

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

With the 2 year reaching an all time low, it’s a good time to revisit the yield curve.

10-2 Year Treasury Yield Spread is at 0.50%, compared to 0.55% the previous market day and 0.19% last year. This is lower than the long term average of 0.93%. But, it isn’t zero. Instead, the yield spread is trending up some. I labeled recessions in grey. The current recession hasn’t been called one yet by the historian economist, but it will be.

The 10-2 Treasury Yield Spread is the difference between the 10 year treasury rate and the 2 year treasury rate. A 10-2 treasury spread that approaches zero signifies a “flattening” yield curve. A negative 10-2 yield spread has historically been viewed as a precursor to a recessionary period. A negative 10-2 spread has predicted every recession from 1955 to 2018, but has occurred 6-24 months before the recession occurring, and is thus seen as a far-leading indicator. The 10-2 spread reached a high of 2.91% in 2011, and went as low as -2.41% in 1980.

Interest rates in the U.S. are trending toward zero.

Effective Federal Funds Rate is at 0.05%, compared to 2.40% last year. This is lower than the long term average of 4.75%. The Effective Federal Funds Rate is as low as its ever been.

The Effective Federal Funds Rate is the rate set by the FOMC (Federal Open Market Committee) for banks to borrow funds from each other. The Federal Funds Rate is important because it can act as the benchmark to set other rates. Historically, the Federal Funds Rate reached as high as 22.36% in 1981 during the recession. Additionally, after the financial crisis in 2008-2009, the Federal Funds rate nearly reached zero when quantitative easing was put into effect.

Here is the Effective Federal Funds Rate going back to 1976.

Interest rates can’t be lowered in depressions.

They are already at or near zero.

Operating through the years ahead is going to require rowing, not sailing. It’s going to require rotating, rather than allocating. It’s going to require actively directing and controlling risk, rather than a passive buy and hope approach. We are entering a cycle that is long overdue, but it’s here, now, and I’m looking forward to operating through it tactically.

This is going to be big boy stuff here.*

You better git your mind right.

*Sorry ladies, saying big girl stuff wouldn’t be right.

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

A tale of two risk managers; trend following vs. hedging with put options

Let’s get right to it.

Which do you prefer?

What you see in the chart is The S&P 500 stock index, which is an unmanaged index of 500 or so stocks, weighted by their capitalization (size of company) and it’s long-only, fully invested, and therefore fully exposed to the risk/reward of the stocks. The S&P 500 is often considered a proxy for “the stock market”, like the Dow Jones. The risk of the S&P 500 is unlimited, although all 500 stocks would have to fall to zero to lose all your money. It hasn’t done that before, but it has declined -56% just a decade ago. See the red arrow.

Before that period 2008-09, the S&P 500 declined -50% from 2000 to 2003. If something has declined this much before, it should be assumed it can and will again.

So, it’s risky.

And that’s the true risk. The worst historical drawdown is the real measure of risk. If some advisor is telling you risk is two or three standard deviations, run, don’t walk, out that door.

Since being fully invested in the stock market all the time is so risky, real investors with real money tend to want real risk management.

That is, not just “diversification”, which is often touted as “risk management.” Buying 500 stocks isn’t true diversification. Niether is buying 1,000 or 3,000 stocks.

To be sure, the Vanguard Total Stock Market ETF holds 3,542 stocks. The next chart is the Vanguard Total Stock Market fund vs. the S&P 500 ETF. We don’t own either of them, so this doesn’t represent anything we’re doing at my investment company. It’s just an example, that yeah, the stock market is risky, not matter who you are, or how many you hold. Even with over 3,000 more stocks than the S&P 500, it falls the same.

But, to their credit, Vanguard does a good job saying their funds are risky. When I visited their website to see the number of holdings, it says:

Plain talk about risk

An investment in the fund could lose money over short or even long periods. You should expect the fund’s share price and total return to fluctuate within a wide range, like the fluctuations of the overall stock market. The fund’s performance could be hurt by:

  • Stock market risk: The chance that stock prices overall will decline. Stock markets tend to move in cycles, with periods of rising stock prices and periods of falling stock prices. The fund’s target index may, at times, become focused in stocks of a particular sector, category, or group of companies.
  • Index sampling risk: The chance that the securities selected for the fund, in the aggregate, will not provide investment performance matching that of the index. Index sampling risk for the fund should be low.

Risks associated with moderate to aggressive funds

Vanguard funds classified as moderate to aggressive are broadly diversified but are subject to wide fluctuations in share price because they hold virtually all of their assets in common stocks. In general, such funds are appropriate for investors who have a long-term investment horizon (ten years or longer), who are seeking growth in capital as a primary objective, and who are prepared to endure the sharp and sometimes prolonged declines in share prices that occur from time to time in the stock market. This price volatility is the trade-off for the potentially high returns that common stocks can provide. The level of current income produced by funds in this category ranges from moderate to very low.

Ok, so we’ve established that the stock market is risky and even a fund invested in thousands of stocks can decline over -50% and take years to recover.

So, we just answered: Why risk management?

It doesn’t matter how much the return is if downside drawdowns are so high you tap out before the gains are acheived.

It also doesn’t’ matter how big the gains are if you give it all up before selling and realizing a profit.

I digress.

I specialize in active dynamic management strategies. I’ve been developing and operating investment risk management systems for the past two decades. Since my focus is on managing the downside, within our risk tolerance, I’m left to let the horses run. If we can direct and control our drawdowns, within reason, it’s never a sure thing, then we are left to focus on the upside of profits.

To illustrate two different methods of risk management, I’m going to use the most simple examples possible. I’m also going to use indexes managed by others, instead of my own. It’s all about keeping it simple to make a point.

So, here we go. I explained the orange line is the S&P 500, fully invested in stocks, all the time, no risk management beyond the diversification of investing in 500 stocks across 10 sectors like financial, healthcare, and tech.

The blue line in the chart is the S&P Trend Allocator Index. The S&P 500® Trend Allocator index is designed to track the performance of a systematic trend-following strategy allocating between the S&P 500 and cash, based on price trends. If the S&P 500 is observed to be in a positive trend, then the index is allocated to the S&P 500, otherwise, it is allocated to cash. It’s a very simple form of trend following applied to stocks. When the S&P 500 is above its 200 day simple moving average, it invests in stocks. When it trends below the 200 day for more than 5 days, it shifts to cash.

The purple trend line, which has achieved the highest return, is the CBOE S&P 500 5% Put Protection Index. The CBOE S&P 500 5% Put Protection Index is designed to track the performance of a hypothetical strategy that holds a long position indexed to the S&P 500® Index and buys a monthly 5% out-of-the-money S&P 500 Index (SPX) put option as a hedge. It’s a defined risk strategy, using put options for dynamic hedging.

Trend Following vs. Hedging with Options

Which worked better?

For a closer look, here is the year to date return streams.

Clearly, hedging with 5% out of the money put options has achieved the better asymmetric risk/reward this time. Applying the simple trend following strategy of selling after the stock index declines below its 200 day moving average exited before the low of the S&P 500, but it remains uninvested, missing out on the upside. The trend following streastgy is down -23% year to date, which is worse than the S&P 500. The hedged index is actually positive for 2020. The hedge paid off, according to this index.

Let’s take a closer look at the downside via a drawdown chart, the % off highs. As expected, the S&P 500 stock index had the worst drawdown, so far. It declined -34%.

The strategy of buying 5% out of the money put options had a drawdown of -20%, which is about half of the S&P 500. The systematic trend following strategy was able to cut the drawdown a little short at -27%. The trend following strategy is currently still in its drawdown.

It’s out of the stock market, so it has also missed out on the recent uptrend. Although, it the stock market enters another waterfall decline, that may turn out better. But, to catch up with the fully invested stock index, that’s what would have to occur. The stock market would have to fall a lot, then the strategy reenter at a better point. However, trend following never enters the lows, and never sells the highs, either. Instead, it enters and exits on a lag and the 200 day moving average is a significant lag. For example, I new this trend following strategy would have at least a -11% drawdown, because when the stock market was at its high in February, the 200 day moving average sell signal was -11% lower.

However, this simple system also requires the index to remain below the 200 day average for 5 days, which is intended to reduce whipsaws. That’s why it didn’t initially sell on the first leg down. Instead, it sold after the second leg down. Since the S&P 500 is still below its 200 day moving average, this trend following system hasn’t invested in the stock market yet. In fact, it would have to stay above the 200 day for 5 days. It’s a symmetric trading system. It applies the same signal for the entry and the exit. I know that price trends drift up and crash down, so my version of this is an asymmetric trading system. I apply a different exit than the entry to account for the unique behavior of price trends since they drift up, but crash down.

How has systematic trend following worked on stocks over a longer period?

It’s had some challenges. Volatile periods, when a market swings up and down over shorter time frames, are hostile conditions for trend following methods. This index has only gained 7% the past 5 years after this recent drawdown. While it does cut the losses short, which is what trend following is known for, it has struggled due to market conditions.

I marked up the next chart, where I include its trend relative to the S&P 500 index. I labeled when it sold, which was three times. The first two times, selling with the trend following sell signal of a 200 day SMA avoided a little of the downside. This time it hasn’t helped so much. Overall, the trend following applied to stocks had lower relative strength than the fully invested stock index with no risk management. But, it avoided some downside. Over this short time frame, the downside loss mitigation probably isn’t deemed enough to account for the difference in the outcomes.

With risk management systems, we never expect them to achieve the same or better return than a fully invested stock index that is always exposed to the risk/reward of stocks. The stock index also doesn’t include expenses and it may not be invested in directly. Investors demand risk management because they don’t want the -50% declines they would endure being invested in the stock market with no exit and no hedge.

Speaking of hedge.

Neither of these risk management indexes I’m using for this example have been around long. The CBOE CBOE S&P 500 5% Put Protection Index started in 2015.

The CBOE S&P 500 5% Put Protection Index is designed to track the performance of a hypothetical risk-management strategy that consists of a long position indexed to the S&P 500 Index (SPX Index) and a rolling long position in monthly 5% Out-of-the-Money (OTM) SPX Put options. This is a relatively simple example, though executing it well isn’t so simple. The protective put strategy has achieved better asymmetry, this time. I say this time, because it doesn’t always work as well as it did this time. But, here it is.

As you can see, it lagged the stock index in the uptrend, until now. Lagging in the uptrend is expected. Buying a put option gives us the right to sell our stock below a certain price. It’s similar to buying home or car insurance. When we buy a protective put option, we literally pay a “premium” for a time period to expiration, like insurance. Some call it portfolio insurance. If we pay an insurance premium for years, it reduces our personal profit and loss statement. The protection is an expense. We’re willing to pay it to avoid large drawdowns. A skilled options trader can potentially execute it better, if an edge can be gained with timing the relative value of the options.

Asymmetric hedging beat the simple following strategy this time. I call it asymmetric hedging, because when we buy a put option, we have limited downside risk (the premium paid) but we have a maximum gain of the Strike price – premium paid. To learn more about a Long Put option, here is a video from the OIC.

The protective put strategy has achieved better risk/reward. I say this time, because it doesn’t always work as well as it did this time. Also, I said the Long Put protection strategy is an “asymmetric hedge” because it has a larger potential profit than the cost for the exposure. There are much better examples of what I call an asymmetric hedge, for example, going long volatility can have a substantial asymmetric payoff. Just look at the VIX. It spiked up more than ever in history, so even a small option position to be long volatility would have a tremendous payoff. Imagine if we spent just 1% of a portfolio but the payoff was 10% at the portfolio level. Yeah, that’s asymmetry.

Back to the comparison of trend following to hedging with options, here is the return streams over the past five years. I consider both of these risk management methods to be basic asymmetric risk/reward payoffs. The trend following system didn’t do so well this time, at least so far, but it still has limited downside risk and unlimited upside gain potential. If the stock market keeps going up and never trends down below its 200 day average, it would keep gaining.

But, if we believed that was what it will do, we wouldn’t care about risk management. Some people actually do put their money in stocks and stock funds and don’t consider limiting their downside. To each their own. Before this bear market is over, they may be crying about their large losses, as they did last time. But I’m guessing this time, if they do it again, they may learn the lesson. The stock market is risky, all investing involves risks as do all strategies. No strategy is perfect. We have to be willing to accept the imperfections and settle with a C sometimes, if we want to A over the long run. This isn’t college. Money compounds.

This leads me to one more thought to share. I was watching this video from Ray Dalio, the founder of the largest hedge fund in the world. Dalio was speaking of this chart in his presentation. He calls it “The Holy Grail.”

In an ideal world, we could invest in 15-20 different assets that are uncorrelated and because one trends up with others are trending down, similar to the hedging strategy, we would achieve an edge from pure diversification. He says The Holy Grail is combining these unique returns streams, which has gains and losses at different times, but overall, the portfolio trends up to the upper right corner.

That’s in an idealized world.

You may know better. Shit happens in the real world. A joke going around is:

Started the year off January 1st: THIS IS MY YEAR!

By April, wiping my …. with coffee filters.

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

Yeah, I said it. It’s a sign of the times. We need to lighten up and laugh as much as we can, especially about the simple things in life, like running out of tp.

In bear markets, correlations go to one. That is, most everything falls. Why? Even if you have gains in some uncorrelated markets, if you have big losses in others, as a fund manger, you take the profits to help deal with the losses. It eventually pushes down the leaders, too. That’s just one of many examples. Here’s an old chart I’ve used for years to illustrate how diversification along can fail.

There is no free lunch, but Dalio is right, if we could combined 15 or so unique return streams, it could be an edge. The trouble is, what markets can you simply invest in that are truly disconnected from the others?

No many. Maybe long term US Treasuries along with stocks, but going forward, it’s not going to look like the past. US Treasuries will be tradable, but with the interest rate down to 1%, the upside in price is very limited, so is the interest income.

Uncorrelated Return Streams

I did both of this type of strategy, and more, in Asymmetry Global Tactical Fund, LP which was a private managed by another company I founded in 2012, Asymmetry Fund Management, LLC. What I believe is more of “The Holy Grail” isn’t making simple investment allocations into different funds or markets hoping for diversification from non-correlation, but instead, combining asymmetric trading systems that have unique return drivers and asymmetric risk/reward profiles. My different trading systems have different return drivers. Instead of market factors and conditions driving the return stream, the buy, sell, and risk management system extracts from the market a unique return stream. It’s a return stream we can’t get from just investing in some funds with different managers. They are mostly correlated, multiple asymmetric trading systems may be very uncorrelated from each other. For example, one system may trend follow longer term trends. Another may trend follow short term trends. Then, they are applied to difference markets, say stocks, bonds, currency, and commodities. Another complete different system may be volatility trading, aiming to gain from a volatility expansion. Add in some countertrend systems, that buys short term oversold and sell short term overbought, and it’s going to produce a unique return stream from everything else. What if the countertrend system is applied to different markets, then, each extracting a unique return stream.

That’s real diversification.

It can’t be achieved by just investing in different markets, or investing in a bunch of funds. But, someone like Dalio, or me, who has multiple trading systems and strategies, we may benefit from the edge of combining them, o even shifting between them.

But I have an edge, and a very big one, over Dalio. He’s got to move around billions. He can’t trade nimble as I can. My flexibility and nimbleness is an edge. I’m not ever going to manage 50 billion or 100 billion and would never want to. I already have what I want. I have enough. It allows me to focus, and be dynamic. I’m happier with little to no distraction.

Now, this is an overly simplified idealized example I’ve used here with the trend following and put buying hedging strategy, but just thing about how this would look if we combine them along with 15-20 others. The larger the money we manage, the more we need to just allocate capital into something rather than trading.

You can probably how these three trends are correlated in uptrends, then disconnect in downtrends. Some combination of them can smooth the ride. In this overly simple example, it would mean some exposer to long-only fully invested in stocks, all the time, no matter how far they fall. Another is always hedged, so it will lag on the upside, but limit the risk on the downside. Then, the trend following system absolutely exits in downtrends and waits for an uptrend. When the market is crashing, nothing looks better in our account that FDIC insured cash deposits.

But, I rotate, instead of allocate.

I would rather shift between markets to be exposed when I believe the risk/reward is asymmetric and avoid it when it isn’t.

Then, imagine if each of these have its own risk management to predefine risk in advance and a portfolio level drawdown control to limit overall drawdowns to less than the -30% of more than is common with the stock market.

So, there you go, a trend following system relative to a options hedging system, and a hint at how we see it. I’m an unconstrained tactical money manager. I don’t constrain myself to a box. I never liked being put in a box and I don’t fit well in any box. I’ll go were the money is treated best. Flexible, adaptable, nimble, unconstrained, and unbiased.

That’s just how I roll.

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

The market climbs a wall of worry

Last week, the US investor sentiment, an indicator that is a part of the AAII Sentiment Survey, indicated the percentage of investors surveyed that had a bearish outlook for the stock market. An investor that is bearish believes the stock market will head lower in the next six months.

US Investor Sentiment, % Bearish was at 50.00% for the week ending April 23rd, compared to 42.75% the prior week.

Considering the number of global macroeconomic indicators in uncharted territory, it’s expected to see many investors bearish. But, the stock market is climbing the wall of worry.

When an uptrend in the stock market includes a lot of uncertainty about its sustainability, we say the market is climbing a wall of worry.

That’s exactly what we’re seeing now.

I’m guessing investors who sold their stocks at lower prices are feeling the fear of missing out about now.

I’ve always said that everyone has an exit point, it can be predefined like mine is, or it can be your uncle point. If you reach the point you tap-out to avoid more loss, it’s probably at much lower prices. I prefer to exit before losses get too large, but also exit based on logical price levels that suggest a change of trend. Or, portfolio level exits designed for drawdown control to limit loss.

If you tapped out at lower prices last month because you felt afraid, I don’t know when you would feel better about buying again?

Suppose the chart below represents what you invest in. At what point do you get bullish again and invest?

If you say at the lower level, you may be fooling yourself.

You don’t know it doesn’t go down another -20% from there. But, I know if you tapped out before it was down so much, it is highly unlikely you’ll feel more positive at lower prices. Instead, you’ll extrapolate the recent past into the future.

Just like you are, now.

Except now, prices are trending up, and if you tapped out at the low, you’re feeling the fear of missing out.

So, do you feel better now that prices have risen?

Using the same price series, let’s pretend you sold at the first low.

Then, a few weeks later, the price is trending up and you get excited and buy.

Oops. What you didn’t know, and never will know, is the trend reversed down to an even lower low. What do you do then?

Maybe you sell at the same price level you did before. The market is falling and you just want out, again.

Once if falls a lot more, do you ever get to feeling like buying again? You’ve already created two losses of around -20%, each trip. You first lost -20%, then bought the high, then lost about -20% again in the same price range. Now, here you are, the market is down over -60% and you’re supposed to feel good?

I doubt it.

The headlines are blood red.

It seems everyone is taking on heavy losses and the waterfall has been so deep and long it doesn’t seem it will ever end.

Then, there it goes.


You want to buy every time it moves up 10% and you feel like you’re really missing out on the opportunity of a lifetime when it trends up 20%, without you.

But you’re stuck. So afraid of “another leg down” as everyone is worried about.

Every decline seems to be the beginning of a new leg down, but it isn’t, until it is, but even then, it’s “only” -30%.

I used the trend as an example, but it’s a real trend. I successfully made tactical trading decisions through it, so I know the mindset and behavioral challenges. It wasn’t an ON/OFF switch, either. I entered and exited many times, trading the swings along the way, never sure if it would trend higher, or reverse back down, but applying systems that account for the unknowable outcome.

The market climbs a wall of worry. Fortunately, we’re participating in this uptrend.

It doesn’t do what we expect it to sometimes.

Some investors seem to oscillate between the fear of missing out and the fear of losing money.

Some of them tend to be more afraid, so they are oriented toward the fear of losing money.

Others are optimists, so while they may panic out, they quickly get optimistic after prices trend back up.

Regardless of the behavioral tendency, if you tap out at the lows, I don’t know when you’ll ever get back in. I have no answer for it.

If you buy now, you may exposure yourself to the possibility of loss just as it reverses back down again.

If you wait for the next leg down, what if it never comes?

To me, the solution is to avoid investment programs that may result in your tapping out to start with. That is, know your true risk tolerance. Know at what % loss you are prone to tap out, and invest with a manager who has drawdown controls to help manage the risk.

If you are sitting there in cash, waiting to reinvest, there will never be a perfect time to do it.

Invest with someone who can hedge and manage risk, then let it rip.

The next AAII investor sentiment survey is out tomorrow. It will show fewer bearish investors, now that price has trended up.

Nothing changes investor sentiment the a price trend.

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

The longest economic expansion in U.S. history is over, but…

As the US and and global economies are entering a recession, this is when I start actively monitoring global macro-economic trends.

My investment and tactical trading decisions are informed by directional price trends, momentum, volatility, and investor sentiment. So, this quantitative data is my primary focus as a global macro/tactical investment manager.

That is, until economic trends shift outside their range and reach extremes.

Then I start observing these global macro trends to observe what has changed. We monitor thousands and data streams and time series, daily, with quantitative alerts that signal when these trends change, or when their rate of change shifts. For example, we monitor 4,136 global Gross Domestic Product (GDP) indicators alone.

US GDP Growth released today indicates the longest U.S. economic expansion in history is over.

The Bureau of Economic Analysis releases quarterly figures for US Gross Domestic Product. In addition to the Real GDP, the report also includes data for income, sales, inventories, and corporate profits. It is one of the most important parts of the National Income and Product Accounts.

US Real GDP Growth is measured as the year over year change in the Gross Domestic Product in the US as adjusted for inflation. Gross Domestic Product is the total value of goods produced and services provided in a the US. Real GDP Growth is a vital indicator to analyze the health of the economy. Two quarters of consecutive negative real GDP growth officially signifies a recession. Additionally, GDP is used by the Fed (FOMC) as a gauge to make their interest rate decisions. In the post World War II boom years, US Real GDP grew as high as 12.8% in a year, but in the late 20th century 0-5% growth was more the norm.

US Real GDP Growth is now at -4.80%, compared to 2.10% last quarter and 3.10% last year, which is materially below the long term average of 3.18%. This GDP is sharpest drop since 2008 as governments and consumers responded to the new coronavirus.

I expect the second quarter will be worse.

I’ve been pointing out a few years now that this is the longest economic expansion in U.S. history as well as the longest bull market for stocks that was very aged.

But, after a -37% decline in the popular market proxy, the Dow Jones Industrial Average, the stock market is climbing a wall of worry.

Despite the negative GDP, the Dow Jones is up 2.7% today.

And the Dow Jones is now just -13.28% year to date, after starting 2020 up 3.55% and then crashing down -35% just a few weeks ago.

I have tactically operated through bear markets, so investors should be prepared for many significant swings along the way, but for now, it seems on March 24th stock prices reached a low enough point to attract buying enthusiasm that exceeds the desire to sell.

Of course, the buying enthusiasm may be mostly the Federal Reserve, but notwithstanding who is driving up prices, the trend is up for now.

The stock market is forward-looking, so what is, is.

For investors who have been afraid to invest with their long-only advisors strategy, I manage a hedged portfolio using options and volatility trading for asymmetric hedging. Our minimum is $1 million, but we may make an exception depending on the circumstances.

Giddy up.

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

Global Macro Trends in Uncharted Territory

I primarily focus on directional price trends, momentum, volatility, and investor sentiment. That is, until economic trends trend to extremes. Then I start observing these global macro trends.

We monitor thousands and data streams and time series with quantitative alerts that signal when these trends change. We are seeing many economic trends in uncharted territory.

US Retail Gas

The US Retail Gas Price is the average price that retail consumers pay per gallon, for all grades and formulations. Retail gas prices are important to view in regards to how the energy industry is performing. Additionally, retail gas prices can give a good overview of how much discretionary income consumers might have to spend. The current price is $1.87 which is below the average of $2.21 and near the prior lows in 2016 and 2009. In the late 1990s gas was around $1 and traded as high as $4 in 2007-08.

Texas Manufacturing Outlook Survey

The Dallas Fed conducts the Texas Manufacturing Outlook Survey monthly to obtain a timely assessment of the state’s factory activity. Companies are asked whether output, employment, orders, prices and other indicators increased, decreased or remained unchanged over the previous month. Responses are aggregated into balance indexes where positive values generally indicate growth while negative values generally indicate contraction. It’s at a new low, so the Texas Manufacturing Outlook Survey is in uncharted territory.

Richmond Fed Survey of Manufacturing Activity

The Survey of Manufacturing Activity is sent electronically to manufacturing firms that are selected for participation according to their type of business, location, and firm size. About 200 contacts receive questionnaires and approximately 90 to 95 of those surveyed respond in a typical month. Respondents report on various aspects of their business, such as shipments, new orders, order backlogs, inventories, and expectations for business activity during the next six months. It fell to a new low, so another has reached uncharted territory.

US Index of Consumer Sentiment

US Index of Consumer Sentiment is at a current level of 71.80, a decrease of 17.30 or 19.42% from last month. This is a decrease of 25.40 or 26.13% from last year and is lower than the long term average of 86.69. The US Index of Consumer Sentiment (ICS), as provided by University of Michigan, tracks consumer sentiment in the US, based on surveys on random samples of US households. The index aids in measuring consumer sentiments in personal finances, business conditions, among other topics. Historically, the index displays pessimism in consumers’ confidence during recessionary periods, and increased consumer confidence in expansionary periods. Consumer sentiment is materially below its long term average.

Since the index shows pessimism in consumers’ confidence during recessionary periods, in the next chart I highlight historical recessions in gray to illustrate.

Hey Crude… WTI Crude Oil Spot Price trended negative. WTI Crude Oil Spot Price is at a current level of -36.98, down from 18.31 the previous market day and down from 64.02 one year ago. Clearly, WTI Crude has reached uncharted territory.

WTI Crude Oil Spot Price is the price for immediate delivery of West Texas Intermediate grade oil, also known as Texas light sweet. It, along with Brent Spot Price, is one of the major benchmarks used in pricing oil. WTI in particular is useful for pricing any oil produce in the Americas. One of the most notable times for the WTI Crude Oil Spot Price was in 2008 when prices for WTI Crude reached as high as $145.31/barrel because of large cuts in production. However, because of the financial crisis and an abrupt loss of demand for oil globally, the price of WTI Crude fell as much at 70% off highs in January of 2009.

US Inflation Rate

The US Inflation Rate is the percentage in which a chosen basket of goods and services purchased in the US increases in price over a year. Inflation is one of the metrics used by the US Federal Reserve to gauge the health of the economy. Since 2012, the Federal Reserve has targeted a 2% inflation rate for the US economy and may make changes to monetary policy if inflation is not within that range. A notable time for inflation was the early 1980’s during the recession. Inflation rates went as high as 14.93%, causing the Federal Reserve led by Paul Volcker to take dramatic actions.

With commodities like gasoline and crude falling, it should be no surprise to see inflation trend down. US Inflation Rate is at 1.54%, compared to 2.33% last month and 1.86% last year. This is lower than the long term average of 3.23%.

10 Year Treasury Rate

10 Year Treasury Rate is at 0.67%, compared to 2.51% last year. The 10 Year Treasury Rate is the yield received for investing in a US government issued treasury security that has a maturity of 10 year. The 10 year treasury yield is included on the longer end of the yield curve. Many analysts will use the 10 year yield as the “risk free” rate when valuing the markets or an individual security. Historically, the 10 Year treasury rate reached 15.84% in 1981 as the Fed raised benchmark rates in an effort to contain inflation. The 10 Year Treasury Rate is in uncharted territory.

US Initial Jobless Claims has trended up with such magnitude I almost hate to show it.

US Initial Jobless Claims is at a current level of 4.427 million last week, a decrease of 810,000 or 15.47% from last week. US Initial Jobless Claims, provided by the US Department of Labor, provides underlying data on how many new people have filed for unemployment benefits in the previous week. Given this, one can gauge market conditions in the US economy with respect to employment; as more new individuals file for unemployment benefits, fewer individuals in the economy have jobs. Historically, initial jobless claims tended to reach peaks towards the end of recessionary periods such as on March 21, 2009 with a value of 661,000 new filings.

US Continuing Jobless Claims

US Continuing Jobless Claims is at a current level of 15.98M, up from 11.91M last week and up from 1.654 million one year ago. This is a change of 34.12% from last week and 865.9% from one year ago. I marked historical recessions in gray to show continuing jobless claims trend up in recession.

US Federal Reserve is in uncharted territory

The US Federal Reserve is taking massive action in attempt to fend off a crisis. We had seen unprecedented quantitative easing the past decade, but it was wimpy compared to what we are seeing now.

US Total Assets Held by All Federal Reserve Banks is the total value of assets held by all the the Federal Reserve banks. This can include treasuries, mortgage-backed securities, federal agency debt and and so forth. During the Great Recession, having already lowered the target interest rate to 0%, the Federal Reserve further attempted to stimulate the US economy by buying and holding trillions of dollars worth of US treasuries and mortgage-backed securities, a process known as Quantitative Easing or QE. This time, they are doing anything necessary.

US Total Assets Held by All Federal Reserve Banks is at a current level of 6.573 TRILLION, up from 6.368 TRILLION last week and up from 3.932 TRILLION one year ago. This is a change of 3.22% from last week and 67.18% from one year ago.

Federal Reserve Easing: Traditional Security Holdings is at a current level of 1.118T, up from 1.074T last week and up from 724.75B one year ago. This is a change of 4.07% from last week and 54.25% from one year ago.

So, you want to know if things are going back to normal anytime soon?

Maybe not.

But, the Dow Jones Industrial average declined -37% in a month and has retraced about half of the loss this past month.

The market climbs a wall of worry and during extreme times like this, markets do what you least expect.

We’ve been invested in stocks again the past few weeks, but only time will tell if we see the stock market trend back down, or reaches a new high.

Big bear markets swing up and down along the way to lower lows, so that’s what I expect is likely here. I operated successfully through both of the last two bear markets and trade the swings. It’s not as simple as an ON/OFF switch of existing at the peak, as we did in February, and then reentering at “the” low. Instead, for me, it’s a lots of entries and exits as it all unfolds.

We’ll probably see a reversal back down at some point, but we may not. If there’s anything I’ve learned the hard way, it’s don’t fight the Fed. But, Fed interference isn’t a sure thing, either. It doesn’t matter, for me, my process doesn’t require me to figure out what’s going to happen next. Instead, I know how I’ll take risks and when the risk/reward is more likely asymmetric. If the risks don’t pan out, I’ll cut my loss short and try again.

I’ve done it over and over and over again, which discipline.

I’ve been here before, many times. This is when I do things very different from the crowd and it has historically made all the difference. There is never any guarantee of the future, but I’m as ready as I’ve ever been. With the past experiences, I’m more prepared than ever.

I’m looking forward to it.

Let’s roll.

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

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

I respect history. The past is no guarantee of future results, but it’s all we have to draw statistical inference from, so we need to understand its risks and rewards. We use past data to determine future possibilities. If we don’t know where we’ve been, we unlikely know where we’re going. It’s essential to have a deep understanding of time, the past, the present, and the future that doesn’t exist. I have great respect for the past, but I’m always here, now, at this moment. As a professional decision-maker, I can only do something now or not now. I can’t do anything in the past. I can’t do anything in the future. It’s now, or not. This alone has removed a lot of behavioral issues for decision making. I review historical trends and my decisions, but I don’t get stuck there at a time I can’t actually do anything. It is what it is, so I accept it and learn from it. If we want to learn from the past, we necessarily must know what it was. That’s why I observe charts of price trends, investor sentiment, global macroeconomic trends, volaltity, and momentum.

A global macro strategy is a hedge fund style investment and trading strategy typically focused on the overall economic and political views of various countries or their macroeconomic principles. Positions in a global macro portfolio may include long and short positions in various equity, fixed income, currency, commodities, and other alternatives like volatility. Although most global macro hedge fund strategies may be focused on views of macroeconomic trends, my focus is on directional price trends.

The price trend is the final arbiter, if you keep disagreeing with the trend, you’ll lose.

The longer you disagree with the trend, the more you lose.

Other indicators like sentiment, rate of change (momentum/relative strength), and volatility are confirming indicators for the price trend. For me, they signal when a trend may be reaching an extreme, becoming more likely to reverse. I like to be positioned in the direction of the price trend, but I’m situational aware of when the trends may be reaching an extreme and likely to result in a countertrend.

So, let’s see what in the world is going on. I concentrate on what has changed. If a trend or level hasn’t changed, it doesn’t warrant the attention, so my systems signal when something has changed. I then examine the rate of change, which is why I speak of momentum, velocity, and relative strength. The trend tells us the direction of change, but the rate of change indicates how fast it’s changing.

Investor Sentiment: are investors bullish, feeling positive about the future direction of stock price trends? or bearish, feeling stock prices will fall?

US Investor Sentiment, % Bullish is an indicator that is a part of the AAII Sentiment Survey. It indicates the percentage of investors surveyed that had a bullish outlook on the market. An investor that is bullish believes the stock market will trend higher. The AAII Sentiment Survey is a weekly survey of its members which asks if they are “Bullish,” “Bearish,” or “Neutral” on the stock market over the next six months. The percent of bullish investors is slightly below average, so the bullish individual investors haven’t really changed much.

US Investor Sentiment, % Bearish is at 49.73%, compared to 52.07% last week and 27.20% last year. Pessimistic investor sentiment materially higher than the long term average of 30.4%, so this is a change. Individual investors are generally more bearish than they were. When their bearishness reaches a historical extreme, they’ll likely be wrong. As you see in the chart, investors are abnormally negative on the future of stock price trends right now.

The stock market will reverse its current trend when prices are pushed down to a low enough point to attract new buying demand.

Stock prices will also reach their bottom when investors who want to sell have sold, so there is no overhead resistance.

Nothing tells us more about market dynamics better than the price trend itself, but investor sentiment measures like AAII Investor Sentiment Survey indicates if do-it-yourself individual investors are capitulating. When their bearishness is at a historical high it may confirm with the price trend those who want to sell have probably already sold. So, their desire to sell has less impact on an uptrend.

If most of the investors with a desire to sell have already sold they won’t be selling as prices trend up, so the market will have less resistance as it trends up. For example, the S&P 500 stock index had gained nearly 5% in the first two months this year. It peaked on February 19th. then all hell broke loose. The S&P 500 dropped -34% in just three weeks, so the S&P 500 was down -31% for the year at that point.

Some of the selling pressure was driven by systematic trading, such as trend following and momentum. As rules-based systematic trading pushed prices lower and lower, other investors were panic selling to avoid more losses. The trouble is, individual investors tend to sell into the bloodbath when prices reach their lowest points. Emotional reactions are driven by falling prices. People sell because prices are falling and they are losing money. Systmatic rules-based systems also sell to avoid more loss, but do so based on predefined exits to manage risk and drawdown controls.

What I observed in the early stage of this waterfall decline is what seemed to be an overreaction from an initial under-reaction.

At the peak on February 19th, here is what the stock index looked like as it trended to an all-time high. This is three months of history. What I noticed, then, was the relative strength indicator didn’t follow it up. This was a very negative divergence.

At the same time, I was seeing other bearish signs of a major market top. To be sure, here are the observations I shared in January and February.

I was a little early with my boldest statement on January 18th: Now, THIS is what a stock market top looks like! Stock Market Risk is Elevated.

But, fortunately, I acted on it. Seeing a very bullish cover of one of my favorite investment publications was the final straw, along with all the other things I observed that seemed to signal a major top in stock prices.

I don’t always sell my stocks because the market risk seems elevated, but when I do it’s because the weight of the evidence is overwhelming.

But, it didn’t work out perfectly and it never does, so I don’t have an expectation of perfection. If I did, I could have never created the asymmetric risk/reward return profile I have, especially the downside risk management and drawdown control. It’s an imperfect science with a dash of art.

I’m okay with that.

Asymmetric investment returns are created from a positive mathematical expectation, not being right more often than wrong, but instead losing less when I’m wrong and earning more when I’m right. The rest of you are simply focused on the wrong thing. You want to be right, and it ain’t happin’. I’m not right all the time, either. But when I’m wrong, I cut it short. I don’t let the wrong become really wrong. I take the loss. I love taking losses. I do it all the time. It’s how and why I have smaller losses, rather than large ones. It’s the only Holy Grail that exists. The Holy Grail is asymmetry: larger average gains than losses. This positive mathematical expectation doesn’t require me to know the future and be right all the time. Instead, I focus on what I can actually control, and that’s mainly the size of my losses. If I limit the size of my losses, I’m left to focus on the upside of profits. That’s my edge, and it isn’t just a mathematical edge, it’s a psychological edge, a behavioral edge. It’s not easy to execute for most people because you want to be right, so you’ll hold those losses hoping they’ll recover. If they do and the price trends back up, then you may sell, if you remember you wish you had before at those higher prices, before you saw a -30% loss.

That’s resistance.

If you wait to sell when the price trends back up some, you’re selling creates resistance if there are enough of you driving the volume of selling pressure. If you instead feel more bullish now that prices trended up some, you may hold on, hoping it continues up. In that case, you’re not the overhead resistance at higher prices causing the halt that prevents the price from trending higher. If enough volume is like you, prices will keep trending up because the rising prices aren’t met with a stronger desire to sell than the enthusiasm to buy.

Here is the full -34% downtrend. It was the fastest downtrend of this magnitude in history.

What in the world was going on? The first leg down, which we only know in hindsight it was the “first”, was a sharp downtrend of -13%. The stock market falls so far, so fast, it becomes deeply oversold with the relative strength index at only 19. The relative strength of 30 is low. Below 30 is oversold and below 20 is extremely oversold. Under normal circumstances, this results in a short term bounce at a minimum, and when I say normal, I’m talking about looking at over a century of history.

To make the point clear, using a simple measure of relative strength as an indicator in the lower section of the chart below, the last times it reached such an oversold level were the lows in late 2018.

But, if you notice, the second time the SPX got so oversold in 2018, the price trend was significantly lower. So, the risk of a countertrend signal like this is even after the price trend reverses back up, it may later reverse back down to an even lower low. It did then, and it did it again this time.

To illustrate what happened from there, I’ve marked up the next chart pretty well. Keep in mind, I don’t necessarily trade the S&P 500 index. I’m simply using it as a proxy for the overall market. I focus more on more granular ETFs like sectors and individual equities. To see the trends play out, walking through time, the first part is the red vertical arrow to point out the first level of extreme oversold conditions as the stock market dropped -13%. My managed portfolio was in short term US Treasuries during this because I hold sold weeks ago.

So, because of my risk management from elevated risk levels, we were in a position of strength, as I call it. I mean we were not participating in the -13% waterfall decline, so as others (who are losing money quickly) are getting more and more bearish, I’m getting bullish. Once stocks got oversold, however, I invested in stocks again. Of course, you can see what happened afterward. The next leg down was even worse and we got caught in it. Like I said, my tactical trading decisions are never perfect timing, nor does it have to be. I just need my average profits to be larger than my average losses to create positive asymmetry. I eventually reduce risk exposure again to zero and then I’m back to looking to buy again, which I have. This is for educational purposes, so I’m leaving out all the other things going on, too, such as buying US Treasuries, etc. The point is, this is what in the world was going on.

Looking at the chart again, a few more points to make. Notice the two red horizontal lines I drew are showing a price range that could be resistance. I say that because of 1. it’s the first area of a prior high, so those who wish they’d sold there may sell now. 2. the relative strength is now at its halfway point and specifically, its average level, so we may see some mean reversion. We’ll see.

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On the bullish side, however, just as individual investors are really bearish, I’m seeing some divergence again in the price momentum. The green arrow shows it. As the stock market reached a low, down -34% off its high, the momentum didn’t make a new low. It didn’t even reach the prior low or even close to it. Instead, it’s making a higher low and higher high.

If I claim the February divergence was bearish because the relative strength didn’t confirm the all-time new high, then I’ll also claim the opposite is true: this is a bullish divergence.

What’s going to happen next with the US stock market?

We’re about to find out!

Only time will tell, but from what I’m seeing, the crowd is expecting a retest of the lows or even lower lows, and that seems reasonable. A global recessional is imminent at this point. But, the stock market has already fallen -34% from its high, so anything is possible. This could be it, for all we know. If most people believe it will get worse, the capital markets have a funny way of proving the crowd wrong. At least temporarily, as it’s doing right now. But, the big picture isn’t real positive.

We now have unprecedented jobless claims and unemployment. American’s are going to be hurting without jobs. That chart is so ugly I don’t want to show it.

We also have unprecedented intervention from the federal government and the Federal Reserve. So have central banks around the world responded.

I believe the last five years of this bull market and economic expansion were driven by the Federal Reserve Zero Interest Rates Policy and other forms of quantitative easing. What was then unprecedented Fed action drove the longest bull market and economic expansion in US history. It also drove the stock index to its second-highest price to earnings valuation in 140 years. I’ve pointed out many times before the Shiller PE Ratio for the S&P 500 was over 30 and the only time it was “more expensive” was the late 1990s. That didn’t end well. It was higher than 1929 just before the Great Depression.

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

The S&P 500 Shiller CAPE Ratio was at a high level of 33, which was higher than the long term average of about 17. Today is has declined to 25.42, while still well above an “overvalued” level, it could be justified by the low inflation we are seeing. Right now, we are looking at deflation as prices of stuff are falling.

I don’t have to correctly predict with the direction the stock market will trend next. I instead increase and decrease exposure to the possibility of risk/reward aiming for asymmetric risk-reward. I tactically trade the cycles and swings as I’ve done many times before. We achieve an asymmetric risk-reward when the downside potential is less than the upside. We achieve asymmetric investment returns when our average profits exceed our average losses. I call it ASYMMETRY® and everything I do centers around it.

Do you really want to know the harsh reality of what the stock market is going to do next?

Most likely the opposite of what you think.

Contact us here if we can help.

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


Periods of high volatility are followed by volatility contractions

Prior to the volatility expansion that started a month ago, my mantra was:

Periods of low volatility are followed by volatility expansions.

The other side to it is:

Periods of high volatility are followed by volatility contractions.

Yes, indeed, after the CBOE S&P 500 Volatility Index (VIX) shattered it’s former all-time high when implied volatility spiked to 83, it is now settling down retracing about half of what it gained. For now, it’s a volatility contraction.

For a closer look, here is the trend zoomed in to the one year chart.

The stock market as measured by the S&P 500 made a solid advance today by any measure. According to Walter Deemer, today was a 90.3% upside day with 2732 advances and 276 declines. So far, March 23rd was the lowest point and the stock market is trying to recover some of the losses. The day after the low was March 24 was a 93.9% upside day with 2791 up and 244 down, which was even stronger. So, the advance off the low is showing some thrust, but only time will tell if it can continue, or if this is just an oversold bounce.

Getting more technical with the charting, the candlesticks show some bullish patterns. However, the S&P 500 has already reached the mid way point in my momentum measures were I expect if it’s going to stall, this is where it happens.

Many people believe the news headlines drive stocks prices, but today is yet another example that it isn’t necessarily that case. The news was bad today, with headlines like “U.S. Death Toll From Coronavirus Tops 10,000” and “U.K. Prime Minister Boris Johnson Moved to Intensive Care” and then “Virus Puts a Prison Under Siege.”

US Initial Jobless Claims last week was off the charts. Provided by the US Department of Labor, US Initial Jobless Claim provides underlying data on how many new people have filed for unemployment benefits in the previous week. Given this, one can gauge market conditions in the US economy with respect to employment; as more new individuals file for unemployment benefits, fewer individuals in the economy have jobs. Historically, initial jobless claims tended to reach peaks towards the end of recessionary periods such as on March 21, 2009, with a value of 661,000 new filings.

US Initial Jobless Claims is at a current level of 6.648M, an increase of 3.341M or 101.0% from last week. This is an increase of 6.436M or 3,004% from last year and is higher than the long term average of 353698.

If there was anything we learned from the last 11 years is the truth behind the axiom “don’t fight the Fed.” Fed intervention and the passage of a record-breaking $2.3 trillion US fiscal stimulus has supported fragile consolidation across many markets, including Treasuries, agency mortgage-backed securities and money markets.

A global recession is now imminent.

They won’t call it for another year or two, but I will now. We’ll see negative GDP growth across the world, although it may well recover as sharply as it fell. Once restaurants, etc. finally open back up, they will be in high demand. So, if restaurants can hang in there, there will be brighter days ahead. Right now, we just don’t know how long it may take.

As for the Coronavirus and data, we’ve discovered many issues with the data being reported by states. I’ve been monitoring it waiting for some improvements before sharing any more quantitative analysis.

This ain’t my first rodeo riding a bucking bear. I operated successfully through the 2008-09 bear market as well as the 2000-03 bear market. Both of them included ugly recessions with people losing their jobs, etc.

This one will be worse. But, again, there’s also a good chance the recovery is just as stunning as the waterfall decline.

So, stay tuned.

Periods of high volatility are often followed by volatility contractions and that’s what we’re seeing now. However, it is highly likely we won’t be seeing a VIX at 12 anytime soon as I expect elevated implied volatility for a long time, driven by demand for hedging with options. It’s likely to be similar to post 1987 when the risk of a price shock remains price into options.

I’ve got a lot more to share, but timing is everything.

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

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Quantitative Technical Analysis of the Coronavirus COVID – 19 Trend

My expertise is the quantitative and technical analysis of trends, momentum, countertrends, and volatility as well as tactical risk management and hedging. As the investment manager of ASYMMETRY® Global Tactical and ASYMMETRY® Managed Portfolios, professionally, I apply it to global market price trends for portfolio management. The methods and systems are robust, so the skills can be applied to understand trends of a pandemic, too.

Since I expect to see the speed of new Coronavirus COVID – 19 cases to increase exponentially, I’m going to start sharing my observations on it from the lens of a “quant” and a technical chartist.

I’m concerned many American’s will become overwhelmed at the sheer speed of growth.

It’s going to happen, but we have to put it into perspective. I’m going to help.

It’s essential to look for the logical fallacy of the herd and consider how they may be wrong. A logical fallacy is a flaw in reasoning. Logical fallacies are like tricks or illusions.

The herd gets trends wrong at extremes, then become shocked by the staggering swing the other way. The trend and momentum of this virus isn’t a lot different than capital markets as it contains a fundamental, in this case, physical science element, and a whole lot of human emotion and behavior.

Just like capital markets. 

People initially underreact, then they panic because they underreacted, then they overreact.

We’re seeing it now. I know people who initially laughed it off, now those same people have swung to the extreme on the other side. If you underreact, you’re likely to overreact and panic.

This pandemic is spreading at an exponential rate with no significant risk management or drawdown control tools to apply except for social distancing. For example, in investment management, we can hedge our positions or exit early to avoid more losses. Here, the risk management is to avoid contact with other people. Why? because this is an ASYMMETRIC UNCERTAINTY, as there are many parts of it we are unsure about such as whether contagious asymptomatic carriers exist. Asymptomatic carries are those not yet showing symptoms who are infected and don’t know it yet. In “Authorities should use data science tools to be precise in QUARANTINE mandates” I discuss how we can use asymptomatic data from digital thermometers as an early warning sign.

If someone has it and doesn’t show symptoms, they spread it unknowingly. So, we don’t know if taking temperatures at airports and such has any impact at this time.

It seems the most critical issue right now is N95 masks and protective supplies for our Physicians and medical professionals. This is their time and we need to support them. The next issue seems to be a ventilator shortage, and that’s a big one. If hospitals reach their capacity, especially with a limited number of ventilators, the death rate will increase, with nothing else to slow or stop it but social distancing. 

The key, right now, is to slow down the spread of Coronavirus affording more time for more testing, spread out the hospital/ventilator use, and find a vaccine. Read: Social distancing. Stay home, hunker down, it’s simple.

With that said, the next trend, then, will be the overall impact on the country and the world from shutting down for so long. All of which are asymmetric uncertainty and unknowable, just like the future of global capital markets I deal with every day.

So, here we are, at the longest economic expansion in American history and the longest bull market in stocks and bonds, and we now have a catalyst for the cycles and trends to swing the other way.

INTRODUCING: A Quantitative Technical Analysis of the Coronavirus COVID – 19 Trend

First, all of the information provided is deemed reliable but is not guaranteed. So, we immediately realize there are limits to the data, since we can’t independently verify if a country, state, or county is reporting accurately.

Now that we have enough data from which to begin to draw inference, or charting trends, we us the data from Johns Hopkins Center for Systems Science and Engineering. The Center for Systems Science and Engineering takes a multidisciplinary approach to modeling, understanding, and optimizing systems of local, national, and global importance.

First shared on January 22, 2020, the Coronavirus Tracker tracks the progression of Coronavirus (also known as 2019-nCoV or COVID 19) across the world. COVID 19 was first detected in Wuhan, China in December 2019. On January 13, 2020 Thailand reported the first international case outside China, while the first cases within China, but outside of Wuhan were reported on January 19, in Guangdong and Beijing. Since then, the virus spread across the world.

As any good chartist, we’ll start at the top and work our way down into more granular observations. This is just my first observation, so later I’ll add more detail and analysis of the trends and momentum over time.

Coronavirus (COVID-19) is a global pandemic that originated in Wuhan, China in 2019. The virus has sparked a global economic slowdown because countries including China, Italy, and Iran having more than 1000 deaths within the first few months of the virus emerging. The virus also caused many countries to provide fiscal and monetary stimulus. For example, in the United States, the Federal Reserve conducted two surprise rates cuts to lower the Federal Funds rate to nearly 0%. Additionally, parts of the world implemented a complete lockdown of cities to prevent the spread of the virus. The Coronavirus pandemic eclipsed 10,000 cases on February 1, 2020, and 100,000 cases on March 6, 2020.

World Coronavirus Cases is at a current level of 691,867, up from 660,706.0 yesterday, which is a change of 4.72% from yesterday. This first chart can be somewhat misleading, so here is lesson one. This is a linear chart, so each level on the y-axis (horizontal axis) is the spacing is equal between the number of cases.

In comparison, below is the logarithmic chart. Logarithmic scales use percentage moves for spacing, rather than number of cases, so a log scale emphasizes the rate of change in a way that linear scales do not.

Notice how different looking the trend is for the same data. The top chart, linear,  is an equally spaced grid of the number of cases. The linear chart plots the number of cases exactly as they are in person terms. For example, in the beginning there wasn’t nearly as many cases as now, so it’s at a lower level. So, when there was only 1,000 cases and now there are nearly 700,000 cases, the grid spacing on the chart doesn’t change. So, the earlier cases seem small on the chart because as a fixed number it is much smaller than more recent larger numbers.

The logarithmic chart corrects this issue and instead shows us the trend of the rate of change based on percentage moves. So, when the number of cases changes from 100 to 200, it’s a 100% change and it gets the same spacing as a change from 30,000 to 60,000, which is also a 100% change. A log chart helps us to normalize the data and see the trend in rate of change terms. The log chart is unique in that it shows a very fast uptrend early on that has sense slowed its rate of change.

Which scale is right? They both are. They just show the data in different ways. We primarily us logarithmic scales for price trends, especially longer time frames. We use linear charts with short term trends, when the data doesn’t spread out that much, or when we view an oscillator like breath indicators showing the percent of stocks in uptrends vs. downtrends.

One more example of the difference between the two, but this time with less words, more the picture. This is the World Coronavirus Cases Per Day on a linear chart, which makes me wonder if all the data is in, or it is really dropped that much. It’s possible it did, as the number of cases per day should decline at some point, so we’ll see tomorrow.

Here is the same date in the logarithmic chart. Applying the rate of change, it doesn’t look so strange because the percentage change isn’t as much as it appears in number form.

Next we look at the worst part: World Coronavirus Deaths, Death Rate, and Deaths per day. For now, I’ve put them on one chart for quick observation of the trend. The death rate at the world level is high at 4.77%, which may not be a predictor of the US death rate.

US CORONAVIRUS COVID – 19 CASES

In later observations, I’ll start analyzing the trends including ratios between them, correlations, spreads, and such, to see if we can find any signals in the noise. Next is a overall summary of US Coronavirus Cases, Deaths, Death Rate, and Cases Per Day, and Deaths Per Day. These trends are up, except the death rate, which was initially greater and has since declined. The general older age of some of the early infected on a cruise ship may have driven the higher rate initially.

The US Death Rate is an important number as it normalizes the number of deaths as a rate of change we can use to compare to other areas.

Speaking of comparison to other areas, I have other countries data, too, and also the US States. Since our clients are in the US, I’ll focus mainly here and within our states. We may eventually get more granular into county level data.

US States: Florida, Tennessee, Texas, North Carolina, California, New York

Since most of our clients are in these states, here is the percentage change to normalize the growth to compare.

New York has by far the highest number and rate of cases. California has the least! I pointed out in Increasing evidence social distancing policies at the state level are causing decreases in the viral transmission of Coronavirus COVID 19 that the quick response of California seems to have slowed their growth.

I’m in Tampa Bay, so here’s a look at Florida. As the number of tests administered is increasing, so is are the number of cases.

As we get more data over time, the number of hospitalizations will be more and more telling. At this point, it’s 526 out of 3,763 cases, or about 14%. This percentage will become much more accurate as the sample size increases.

The death rate for Coronavirus in Florida is declining, but it’s too early and we don’t have a large enough sample size to draw a statistical inference from it just yet. We hope to see the death rate stay this low.

I’m going to monitor this data once a day, just as I monitor global market trends around the world. When I observe something asymmetric or useful, I’ll share it. In addition to viewing the trends and rate of change (momentum), I’ll also do some studies of ratios, correlations, and spreads to see if we can spot any patterns. If you have any questions for charting requests, contact me at the top of the page.

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

Authorities should use data science tools to be precise in QUARANTINE mandates

As I was writing this follow up to the Kinsa data US Health Weather Map, my conclusion is it seems Authorities should use all the data science they can to be as precise as possible for any government-mandated quarantines. I thought so because I believe, although social distancing is essential to slow the spread of COVID – 19,  a government-mandated quarantine is a very big step. A government-mandated quarantine, especially one mandated at the federal level, has its risks. I’m thinking in terms of the impact on the individual mental and physical health of Americans, our communities, and the economy. At the federal level, their duty is to make decisions in the best interest of the overall situation.

Data Science

Data science is an interdisciplinary field that uses scientific methods, processes, algorithms, and systems to extract knowledge and insights from many structural and unstructured data. Data science is related to data mining and big data.

I’m doing a Twitter poll that asks: Do you believe a broad quarantine worth the cost to the individual mental/physical health, community, and the economy? As of this writing, here are the results so far.

Twitter Poll Q

Polls such as Twitter polling is crowdsourcing. Crowdsourcing is a form of data science in that it gives us an idea of the opinions and observations of a large group of people. It also starts a conversation around the topic if it’s thought-provoking.

As I said in Increasing evidence social distancing policies at the state level are causing decreases in the viral transmission of Coronavirus COVID 19 the exponential trend in new cases in the US is already underway, so I’m now focusing on the inflection point. I’m concerned many Americans will be more panicked when they see how fast the spread compounds in the weeks ahead, so you should be prepared for it. However, as the trend is adrift, I’m thinking of inertia such as social distancing and how we can potentially find any signals in the noise.

I shared in Increasing evidence social distancing policies at the state level are causing decreases in the viral transmission of Coronavirus COVID 19 the best tool I’ve seen so far that may have some useful predictive ability is the Health Weather Map by Kinsa.

The U.S. Health Weather Map is a visualization of seasonal illness linked to fever – specifically influenza-like illness. The aggregate, anonymized data visualized on the map is a product of Kinsa’s network of Smart Thermometers and accompanying mobile applications, and Kinsa is providing this map and associated charts as a public service.

Kinsa has updated its atypical Illness map to reflect the cumulative amount of atypical illnesses we’ve observed since March 1.  Previously the Health Weather Map reflected only new atypical illness, updated daily. Kinsa says:

As widespread social distancing measures take effect, feverish illness levels are dropping, and we feel this way of looking at the data gives a more accurate and comprehensive view of what’s happening. Change is effective as of March 27.

Here is the chart today. Since we are in Tampa Bay in Florida, I especially notice the red here in south Florida. The Miami-Dade area has especially active atypical data from their thermometers. The map above shows us how much influenza-like illness above the normal expected levels Kinsa has detected since March 1.

HEALTH WEATHER MAP KINSA

The time series chart allows us to compare Kinsa’s observations of the influenza-like illness level in the U.S., in orange and red, against where we’d expect them to be, in blue, and see how that relationship has changed over the past few weeks,

time series chart allows you to compare Kinsa observations

I made a gif video of the map taking a closer look around south Florida including Tampa Bay and Miami-Dade to show the level of detail.

kinsa health weather map

I’m thinking this data is likely to have predictive power and may help authorities to monitor, track, and make decisions about quarantines and such.

Just imagine the ability to electronically monitor certain health measures of thousands or millions of people around the country. That’s essentially what we have here, and it’s a  visualization of seasonal illness linked to fever, specifically influenza-like illness, which is a common characteristic of Coronavirus COVID – 19.

The CDC says:

“People may be sick with the virus for 1 to 14 days before developing symptoms. The most common symptoms of coronavirus disease (COVID-19) are fever, tiredness, and dry cough.”

So, it seems identifying and tracking the trend as soon as possible is essential.

Aside from a concern, Americans will start to panic more when they see a very fast accelerating growth of new cases, I’m now concerned about how they may react to a government-mandated lockdown. We are seeing evidence the social distancing is working and needs to continue, but a government-mandated quarantine may have more mental trama to it.

As I was writing this, I saw the President tweeted he is considering a more targeted quarantine:

It seems the more precise they can be in deciding areas to lock down the better. I believe it because when we look at the map of confirmed cases, the red areas are distinct. Much of the US doesn’t have any cases at all. So, I can see why the federal authorities hesitate to quarantine the entire country.

COVID 19 CASES US

But, if they can more precisely define the risk areas using the tools available, the data from the map from Kinsa’s network of Smart Thermometers and accompanying mobile applications may help them to see early warning signs in new areas. 

As a libertarian myself, I’m not an enthusiast of the federal government mandating a shutdown, and I prefer to at least let the state, county, and city make their own decisions. I’m also one to try to be a part of the solution rather than part of the problem, so we are self-quarantined to the extent we can and I support a more precise government-mandated quarantine.

The reality is, we don’t know if the cost of a broad quarantine is worth the cost to the individual mental/physical health, community, and the economy, so the best thing is to be as precise as possible about managing the risks.

I believe tools like the US Health Weather Map can be part of the solution.

We are working on a report of the COVID – 19 trends I’ll be sharing shortly. I’m going to start analyzing the trends quantitatively. Don’t miss out, sign up to get the email:

Join 40,596 other followers

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

Good news for the stock market

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

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

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

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

I wrote:

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

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

Is it another regime of irrational exuberance?

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

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

Is the stock market at a level of irrational exuberance?

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

shiller pe ratio are stocks overvalued

Before that, on January 17, 2020 in

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

Is it another regime of irrational exuberance?

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

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

Is the stock market at a level of irrational exuberance?

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

shiller pe ratio are stocks overvalued

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

THE BIG PICTURE 

First, I start with the big picture.

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

Shiller PE ratio for the S&P 500

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

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

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

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

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

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

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

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

I followed with;

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Let us know if we can help.

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

You probably want to sell stocks, now

On January 11, I shared an observation “You probably want to invest in stocks

The great thing about sharing written observations is the ability to go back and read what was going on in the past to learn from it.

On January 11, I wrote:

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

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

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

Then, included the Fear & Greed Index dialed all the way up to 97, Extreme Greed.

fear greed index

I went on to write; (I’m bolding the key points this time)

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

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

I included this chart of the stock index at all time highs.

stocks stock market at all time high

I then wrote: (I added the bold this time)

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

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

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

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

What has changed?

A lot has changed since then.

First, the S&P 500 stock index which most investors use as a proxy for “the stock market” is down -34% from it’s high reached on February 19th. To put the fall into context, I included the history going all the way back to the 50s. This is now the 4th deepest decline since then.

The speed of the decline was most impressive.

The next chart is the price trend of the S&P and Dow Jones year-to-date. The decline happened very fast, in just a few weeks.

By March 12, the Fear & Greed Index was pegged back to 1 indicating “Extreme Fear.”

 “Be fearful when others are greedy and greedy when others are fearful.”

 ― Warren Buffett

I know. It’s much harder than it sounds!

But at the extremes, which is what I mostly point out here on ASYMMETRY® Observations, is when we want to step away from the crowd and shift from trend following to countertrend tactics.

That’s what I’ve been doing.

I know you think “it’s different this time” because of the Coronavirus COVID – 19 and such. Now, the Federal Reserve has committed to taking unprecedented actions even more than after 2008. The US government is printing even more money than before.

It all seems so uncertain, but it always is.

“Don’t fight the Fed.”

“Don’t fight the Fed” suggests investors can do well by getting in synch with monetary policies of the Federal Reserve Board, rather than against them. The Fed has lowered rates to zero and announced it will be buying traditional securities including bonds and ETFs as “The Fed Goes All In With Unlimited Bond-Buying Plan.” I’ll share my detailed observations of it later.

Yesterday, I had a significant cash position, so was looking for the most likely asymmetric risk/reward positions to take. Tactical trading isn’t easy. It requires tremendous discipline, stoicism, patience, skill, ability to be wrong, and acceptance of the uncertainty.

RISK MANAGER / RISK TAKER

I’m a tactical risk manager and also a risk-taker. I increase and decrease exposure to the possibility of profit or loss based on my estimates of asymmetric risk-reward. After prices have already fallen over -30%, we have to realize the risk level decreases. It doesn’t seem that way, because of the volatility expansion. Prices swing wider up and down at the lowest lows, so there is nothing easy about taking a risk when its the lowest.

If you are like the majority of investors, you are feeling “Extreme Fear” right now as you fear taking on more loss. Below is the Fear & Greed index over time. Notice it oscillates between fear and greed. After prices trend up, it enters the red zone I colored. After prices fall, it enters the green zone.

Clearly, this has been one of the most staggering waterfall declines in American history. As such, investor sentiment has followed the price trends down.

So, you probably want to sell your stocks right now.

I’ve been hearing from other financial advisors who aren’t tactical like me and don’t increase and decrease exposure to asymmetric risk/reward as I do, saying their clients were tapping out on these big down days the past week.

That’s what I hope to avoid with our clients.

If you tap out, I would NEVER know when you could get back in.

Would you feel better of prices fall another -30%?

Or, would you buy back if prices trend back up to all time new highs?

What would it take?

I have no idea.

I want to avoid that situation because I have no idea how to resolve it. So, I prefer to try to apply my drawdown controls to manage the downside the best we can to keep it within our clients tolerance and capacity for risk.

This is why I actively manage risk by increasing exposure to risk and reward over time. It ain’t perfect, but it doesn’t have to be, as evidenced by my 16-year track record. I just need the average gains to be larger than the average loss over time.

It’s what I call ASYMMETRY®.

That’s all for now. I’ve got some good stuff in the queue, so if you haven’t already, I encourage you to sign up for automatic email alerts of new observations.

I also encourage you to go back and read You probably want to invest in stocks from January 11th and think about what has changed since then. This has been one of the most fascinating swings in US history, so let’s learn all we can from it!

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas. Shell Capital is focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

Bolted to the chair

Mark Twain’s mother said:

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

I am no Mark Twain.

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

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

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

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

I think about:

What has changed?

How has sentiment changed?

How has the trend direction changed?

Has volatility changed?

Has momentum changed?

Has the narrative changed?

What didn’t we know then we do today?

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

Here’s what I read:

 

If you do this, you’ll see why.

Historic day for the stock market

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

SPX SPY TRADING

The stock market is even more washed out.

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

long term treasuries

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

spx mean reversion

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

That is all.

Let me know if we can help.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas. Shell Capital is focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

Panic selling drove a waterfall decline and washout for the stock market

Growing up in East Tennessee and the Great Smoky Mountains, I observed a lot of waterfalls.

Wiki says a fall of water is an area where water flows over a vertical drop or a series of steep declines in the course of a stream or river.

According to National Geographic, a waterfall is a river or other body of water’s steep fall over a rocky ledge into a plunge pool below. Waterfalls are also called cascades. The process of erosion, the wearing away of earth, plays an essential part in the formation of waterfalls.

waterfall decline in stocks stock market

What we have witnessed in the global equity markets is a waterfall decline, the question now is if the plunge pool has developed.

water fallAn overhang in a waterfall can sometimes protrude out enough to form a base, or even drive the water to flow upward for a while, but the waterfall isn’t over until the plunge pool develops.

waterfall overhang spring hill

Using the S&P 500 stock index as a proxy, it’s pretty clear there wasn’t much of an overhang along the way. For example, in the middle of this 3-year chart, we see how the decline in late 2018 played out. It had a lot of overhangs as the stock market was swinging up and down for several weeks.  Now, compare that to this time…

SPY SPX

What we have here is panic selling.

Investors tend to underreact and overreact to new information.

Underreaction: Trends begin to drift in a direction as people initially underreact to change, so the price trend unfolds gradually.

Overreaction: Sometimes, investors overreact to new information, so the price is driven too far, too fast. When the market overreacts, prices overshoot too high, or too low.

At the bottom of a waterfall is a plunge pool, where the water settles. What does the plunge pool look like as it develops? It’s a floor that has enough support the water stays were it is.

The trouble is, in the market, we don’t physically see the rock bottom. Unlike in physical science, an exchange market is a social science because it’s human behavior. Don’t think this is humans? Maybe it’s the computer algorithms? They are created and operated by humans.

I apply quantitative tools to get a read on how extreme investor sentiment is.

In analyzing market trends and price action, we can see what is going on with market internals, such as breadth. The NYSE Bullish Percent was developed by Abe Cohen was the first breadth indicator. Abe Cohen was an early pioneer of Point & Figure charting and created the NYSE BP in the mid-1950s. The NYSE Bullish Percent is a market risk barometer that measures the percent of stocks listed on the New York Stock Exchange that have a Point & Figure buy signal, so they making higher highs, so they are in uptrends. The NYSE Bullish Percent is washed out. It hasn’t been this low since the waterfall decline in October 2008.

NYSE BULLISH PERCENT

The challenge with countertrends is they can also trend farther than you would ever believe is possible. It’s because markets don’t follow a normal distribution. Instead, market trends have fat tails, meaning some gains and losses exceed an otherwise normal distribution, as we see in physical science. As such, the overreactions can overshoot and just keep overshooting. We never know for sure when a trend has stopped. What we can do, however, is apply quantitative tools to gauge and guide. I use these as a guide and barometer for overall market risk.

The percent of the S&P 500 stocks above the 50-day moving average is washed out to 1%. In fact, only 7 of the 505 stocks in the S&P 500 are in a short term uptrend. While in a big bear market such as 2008-09, these conditions can continue for a long time, historically, this lower level of risk eventually offers the potential for asymmetric risk/reward. That is, the possibility for reward is greater than the risk it takes the achieve it. Or, the magnitude for a reward is greater than the downside risk, which can be predetermined with options or an exit (i.e., stop-loss.)

$SPXA50R breadth is washed out crash 2020

A material change that has occurred the past week is the percent of S&P 500 stocks above their 200 day moving average, or longer-term uptrends have washed out. Only 5% of the stocks are in uptrends now, so 95% of them are in long term downtrends. That doesn’t sound good, but when it reaches an extreme, it suggests to me the selling pressure is intense and could eventually dry up.

percent of stocks above 200 day

This is about as oversold the stock market gets, both internally looking at the individual stocks and the indexes. Sure, it can get more oversold and stay there for as long as sellers have the desire to sell, but it has reached the point the odds of a short term reversal is increasing the lower it goes.

Yesterday I asked: where do you think we are in the cycle of market emotions?

THE CYCLE OF MARKET EMOTIONS

Clearly, when stock indexes drop 8-10% in a single day after already well off their highs, it is driven by emotional panic.

The US Investor Sentiment poll from AAII is released on a few day’s time lag, but Bearish % of those polled is another measure up to 2008-09 levels.

AAII INVESTOR SENTIMENT MARKET CRASH 2020

 

To no surprise, the Fear & Greed Index was penned all the way back to 1 after yesterday’s close.

fear greed panic market crash 2020

What we have here is a washout. A washout is an event or period that is spoiled by constant or heavy rain. We may see more rain, but it’s a washout nonetheless. A washout in the stock market is when prices have been flooding down so hard, so broad, it seems like a washout of rain.

As you can imagine, with a waterfall, heavy rains increase the volume and speed of water flow. A washout pushes the river to its limits.

The desire to sell has been overwhelming any buying interest that remains for a few weeks now. This has been the fastest decline in US stock market history. I guess we shouldn’t be so surprised if we believe a trend stretched far in one direction is more prone to snap back harder and faster. That’s what we’ve seen here.

This is the end of the longest bear market in US history, and it has indeed ended with a bang. That also means this is the beginning of a bear market. What we don’t know in advance is how long it will last or how low it will go. If we knew it would be -50%, we could simply sell short and profit from the fall. If we knew this was “the bottom,” we could use leverage to maximize gains on the upside. But, none of us know the outcome in advance, not the biggest banks, not the largest asset managers, and neither you nor I. The edge I do have is accepting this reality and embracing it to the point I drove me to create risk management systems to limit the downside when I’m wrong and focus on the things I can control. I’ve operated tactically through periods like this many times before in the last two decades, so I’ll just do what I do, which means I’ll execute many entries and exits until we find the trend. In conditions like we’ve seen this year, they’ll be countertrends. Once trends do develop, they’ll be trend following.

What I’ve typically seen in past bear markets is many cycles up and down along the way. That isn’t what we’ve seen this time, so far. This reminds me more of September 11, 2001, after the World Trade Center was attacked. The difference is, the S&P 500 was already down about -17%, and since the planes hit the World Trade Center in New York, the NYSE was closed. The New York Stock Exchange remained closed until the following Monday. This was the third time in history that the NYSE experienced prolonged closure, the first time being in the early months of World War I[2][3] and the second being March 1933 during the Great Depression.

It may not play out this way this time, but countertrends should be expected. Here is what the stock market did after the exchange opened after September 11. The SPX dropped -12% quickly, but then investors become patriotic, and it recovered a few weeks later. Of course, this happened inside a bear market that started in 2000 and didn’t end until 2003.

stock market v recovery september 11 9:11

Is this so different than 9/11? Of course, it is. Every new moment is always different. But, we’ve experienced these things before. I was much more of a rookie 20 years ago when I walked into my investment firm office to see the planes hit. It was an incredibly emotional and panicked time in American history. At the time, it wasn’t just the one attack, we wondered what would be next. It was the Pentagon, and another plane was hijacked. We didn’t know what to expect, it was uncertain. When would we be attacked again? Where? Would it wipe us out?

We didn’t know.

Portfolio managers and tactical traders must be here, now, in the present moment, not dwelling on the recent past, there will be time for that later when things are calm and quiet. But even then, we can’t do anything in the past, we can only do it now.

I hope this helps.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas. Shell Capital is focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

 

 

 

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

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

STOCK MARKET CRASH 2020

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

THE CYCLE OF MARKET EMOTIONS

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

stock maket crash volatility

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

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

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

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

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

THE CYCLE OF MARKET EMOTIONS

This is panic level selling.

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

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

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

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

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

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

Hang in there friends, this too shall pass.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas. Shell Capital is focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

 

 

 

Why I’m not surprised to see such a volatility expansion

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

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

Average True Range ATR use in portfolio management trading volatlity

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

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

2020 stock market crash volatility expansion

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

That is, until February 19th.

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

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

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

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

volatilty expansion vix realized

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

vix volatility trading asymmetric risk reward

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

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

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

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

Eventually, this too shall pass.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas. Shell Capital is focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

 

Profiting from the Madness of Crowds

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

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

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

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

stock market lost 2020 gain

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

mean reversion SPX SPY S&P 500

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

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

dow jones 2020 loss

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

dow jones 2020 loss bear stock market

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

mid cap stock in bear market MDY

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

small cap stocks are in a bear market

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

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

Global Equity Market Decline

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

stock stock market selloff

Extreme Investors Fear is Driving the Stock Market 

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

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

what is driving the stock market

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

fear greed investor sentment over time

Monitoring Market Conditions

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

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

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

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

Risk Manager, Risk Taker

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

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

Market Risk Measurement 

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

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

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

percent of s&P stocks above moving average 2020

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

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

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

stock market breadth risk management market timing

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

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

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

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

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

As Mackay observed nearly two centuries ago:

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

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

According to studies like DALBAR’s Quantitative Analysis of Investor Behavior (QAIB), individual investors have poor results over the long haul. QAIB has measured the effects of investor decisions to buy, sell and switch into and out of mutual funds over short and long-term timeframes since 1994 and finds people tend to do the wrong things at the wrong time. If we want to create different results from the majority, we must necessarily believe and do things differently.

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

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

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

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

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

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

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas. Shell Capital is focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

 

 

 

Coronavirus quick take and useful resources to track COVID-19

The Coronavirus outbreak is the current headline scare. I focus on data, data mining, analyzing trends, momentum (rate of change), and volatility. I like my information succinct and factual, so when I look at Coronavirus COVID-19, I’m not reading opinions and other nonsense, I’ve focused on the facts in the data, its trend, and rate of change. I took some time today to get my head around what is going on. Here, I share the best resources we found.

As of this writing, here are the Total Confirmed Coronavirus cases, Total Deaths, and Total Recovered. I’m using an outstanding website from Coronavirus COVID-19 Global Cases by Johns Hopkins CSSE.

CORONAVIRUS TOTAL CONFIRMED CASES

Is Coronavirus COVID-19 being overhyped?

Only time will tell. But, there are things we can do in advance to be pro-active and situationally aware.

The single best resource I’ve found is the map from Johns Hopkins University’s Center for Systems Science and Engineering. It draws data from global disease control agencies on Coronavirus cases for a worldwide view of coronavirus cases in real-time. You can zoom in on the map and get detail to monitor an area.

Here is what the Coronavirus around the world looks like.

coronavirus worldwide

Here is the Coronavirus map of the US.

coronavirus us cases

I’m in the Tampa, Florida area, so here is how we can zoom in to see the details.

coronavirus tampa florida

In the bottom right, we can observe a chart of the mainland China cases, other locations, and total recovered.

coronavirus chart of dealth cases recovery

At this time, the orange line represents China, and the rate of change has shifted from exponential growth to leveling off. However, there is a risk of a pandemic, according to the CDC. In the CDC Risk Assessment, they say two of the factors have been met for a pandemic, and; “As community spread is detected in more and more countries, the world moves closer toward meeting the third criteria, worldwide spread of the new virus.”

I’m watching for a new virus since it will trigger the label “pandemic.” 

Specifically, here is a useful passage from the CDC to know: (the bold is mine)

Risk Assessment

Outbreaks of novel virus infections among people are always of public health concern. The risk to the general public from these outbreaks depends on characteristics of the virus, including how well it spreads between people; the severity of resulting illness; and the medical or other measures available to control the impact of the virus (for example, vaccines or medications that can treat the illness). That this disease has caused severe illness, including illness resulting in death is concerning, especially since it has also shown sustained person-to-person spread in several places. These factors meet two of the criteria of a pandemic. As community spread is detected in more and more countries, the world moves closer toward meeting the third criteria, worldwide spread of the new virus.

It is important to note that current circumstances suggest it is likely that this virus will cause a pandemic. This is a rapidly evolving situation and CDC’s risk assessment will be updated as needed.

Current risk assessment:

  • For most people, the immediate risk of being exposed to the virus that causes COVID-19 is thought to be low. This virus is not currently widespread in the United States.
  • People in places where ongoing community spread of the virus that causes COVID-19 has been reported are at elevated risk of exposure, with increase in risk dependent on the location.
  • Healthcare workers caring for patients with COVID-19 are at elevated risk of exposure.
  • Close contacts of persons with COVID-19 also are at elevated risk of exposure.
  • Travelers returning from affected international locations where community spread is occurring also are at elevated risk of exposure, with increase in risk dependent on the location.

CDC has developed guidance to help in the risk assessment and management of people with potential exposures to COVID-19.

What May Happen

More cases of COVID-19 are likely to be identified in the coming days, including more cases in the United States. It’s also likely that sustained person-to-person spread will continue to occur, including throughout communities in the United States. It’s likely that at some point, widespread transmission of COVID-19 in the United States will occur.

Widespread transmission of COVID-19 would translate into large numbers of people needing medical care at the same time. Schools, childcare centers, and workplaces, may experience more absenteeism. Mass gatherings may be sparsely attended or postponed. Public health and healthcare systems may become overloaded, with elevated rates of hospitalizations and deaths. Other critical infrastructure, such as law enforcement, emergency medical services, and sectors of the transportation industry may also be affected. Healthcare providers and hospitals may be overwhelmed. At this time, there is no vaccine to protect against COVID-19 and no medications approved to treat it. Nonpharmaceutical interventions would be the most important response strategy.

According to the data from Johns Hopkins CSSE, a peak was reached on February 13, 2020, when the number of cases spiked. February 14 was also a big day of new cased reporting. However, just looking at the downtrend in the data before the spike, it seems like China may have underreported leading up to the 13th.

CORONAVIRUS DAILY

Coronavirus is getting the blame for the stock market decline. If you’ve been reading my observations here the past few months, you know I don’t believe news drives the stock market as much as people think. To be sure, we can simply look back over past observations, and it may surprise you.

So, February 19 was the peak price for the stock market index, which I labeled on the chart as well as the February 13 spike. If the news of Coronavirus is causing the stock market to fall, it underreacted.

IS CORONAVIRUS CAUSING STOCK MARKET STOCKS TO FALL

I’m not downplaying Cornonviris COVID-19 as the risks are real and it’s an asymmetric uncertainty. If we get it wrong, the risk of loss is substantial, and we just don’t know how it will unfold. What I do know is what I can control. Be prepared with situational awareness. What if it does become a pandemic? Prepare for the possibility as best you can, then let it all unfold.

I glance over headlines to see what the herd is thinking and doing, but I prefer analyzing the data myself, directly. So, I’ll continue monitoring the interactive web-based dashboard to track COVID-19 in real-time with the exceptional resource Coronavirus COVID-19 Global Cases by Johns Hopkins CSSE.

I’m also monitoring the narrative from the CDC updates at Coronavirus Disease 2019 (COVID-19). 

And then there is the Florida Health Department, which has a dynamic page that may be useful for confirmation: Florida 2019 Novel Coronavirus (COVID-19)

florida 2019 Novel Coronavirus COVID-19

 

So, those are the resources. It seems the essential thing to do is be prepared with supplies and monitor the number of outbreaks, its trend, and momentum. But, maybe more important is the possibility of it becoming a pandemic, which will be called if a new virus. It’s worth reading again from the CDC:

That this disease has caused severe illness, including illness resulting in death is concerning, especially since it has also shown sustained person-to-person spread in several places. These factors meet two of the criteria of a pandemic. As community spread is detected in more and more countries, the world moves closer toward meeting the third criteria, worldwide spread of the new virus.

It is important to note that current circumstances suggest it is likely that this virus will cause a pandemic. This is a rapidly evolving situation and CDC’s risk assessment will be updated as needed.

Is this really driving the stock market?

Go back and read my observations for the past few months and decide for yourself. I believe it was initially just the market, doing what it does. However, if this does spread rapidly in the US and cannot be contained as well in the US as they supposedly have in China, and is a pandemic, it could be just enough catalyst to tip over what is already a slowing economy.

Beyond that, I encourage you to learn from the past, as I do, by reading what was just a few weeks ago.

November 16, 2019: Periods of low volatility are often followed by volatility expansions

November 21, 2019: I was quoted in Barron’s: Investors are ignoring two major risks to stocks, warns fund manager

January 6, 2020: I was quoted in MarketWatch: U.S.-Iran tensions will spark increased volatility — here’s how to play stocks, fund manager says

January 21, 2020: What could go wrong

At the time, you have thought I was early, but… it wasn’t raining when Noah build the ark. 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas. Shell Capital is focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

 

 

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

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

Top news headlines looked like this:

fed rate cut march 2020

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

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

stock market feared bernie sanders fear the bern

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

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

Feeling the Bern of socialism may have been even scarier. 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas. Shell Capital is focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

 

The Fed did what?

At 10 AM yesterday morning, the Fed cut rates.

The actual statement is worth reading.

March 03, 2020

Federal Reserve issues FOMC statement

For release at 10:00 a.m. EST

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

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

 

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

stock market declined fed rate cut

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

The headlines were negative.

fed rate cut march 2020

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

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

Fed Funds Futures Probability Tree Calculator

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

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

Effective Fed Funds Rate March 2020

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

uncharted territory 10 year treasury rate

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

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

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas. Shell Capital is focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

 

 

Global Asset Allocation: Risk and reward isn’t a knob we turn to get what we want. 

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

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

S&P 500 Stock Index Historical Drawdowns

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

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

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

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

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

TARGET RISK ALLOCATION

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

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

Global Asset Allocation GAA performance 2020

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

Global Asset Allocation GAA Target Risk Drawdown

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

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

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas. Shell Capital is focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

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

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

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

BREADTH PERCENT ABOVE 50 DAY MOVING AVERAGE SPX 500

If you want to see how I applied it in the last big stock market decline, read “An exhaustive analysis of the U.S. stock market” late December 2018 when I suggested the probability was in favor of reversal back up was high. The next day, on December 24, 2018, in “An exhaustive stock market analysis… continued,” I shared:

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

I’ve been here before.

I’m seeing similar signals now, as you can see in the above chart, the participation in the downtrend has now reached the same level as the price lows of 2018.

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

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

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

spx trading advisor

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

stock loss 2020 drawdown

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

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

spx futures exposure

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

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

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

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

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

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

I love taking losses.

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

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

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

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

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

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

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

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

bearish bloomberg news coronavirus

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

WSJ bearish coronavirus news

I hope this helps.

Have questions? Need help? Get in touch here.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas. Shell Capital is focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

 

Permabear delight

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

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

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

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

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

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

stock market drawdown 2020

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

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

stock market crash februrary 2020

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

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

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

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

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

I hope this helps!

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Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas. Shell Capital is focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.