VIX level shows market’s expectation of future volatility

Volatility is a measure of the frequency and magnitude of price swings up and down in a market or stock over a period of time.

  • Lower volatility is when prices are calmer and don’t swing up and down as much.
  • Higher volatility is when price movement spreads out, and prices swing up and down in a wider range.

We can measure volatility using two general methods:

  • Realized Volatility: based on actual historical price data. For example, we can see realized volatility by looking at historical standard deviation or average true range.
  • Implied Volatility: is a measure of expected future volatility that is implied by option prices. For example, the VIX Index is a measure of expected future volatility.

The VIX Index measures the market’s expected future volatility based on options of the stocks in the S&P 500® Index. The VIX Index estimates expected volatility by aggregating the weighted prices of S&P 500 Index put and call options over a range of strike prices.

The last observation I shared of the trend and level of VIX was VIX Trends Up 9th Biggest 1-day Move. I pointed out the VIX level had been very low, and it was an observation of complacency. The VIX spiked up nearly 300% – a volatility expansion. Actually, we could call it a volatility explosion.

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

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

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

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

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

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

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

 

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

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

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

 

Global Market ETF Trends

Looking at the broad global markets, U.S. stocks are in a positive trend along with the U.S. Dollar. International stocks, commodities, and foreign currency are trending down.

With the directional trends and momentum being in U.S. stocks, though not without volatility, that has been our focus this year.

International stocks including both developed countries $EFA and emerging markets $EEM are trending down so far in 2018 as the U.S. Dollar $UUP is trending up.

The U.S. Dollar $UUP is trending similar to U.S. stocks $SPY in April.

The dollar has an inverse correlation with foreign currency like the Euro.

With the rising dollar $USD, gold $GLD is trending down even more than the Euro currency $FXE.

So, the overall broad observation of global macro picture is clearly a rising U.S. Dollar and U.S. stocks that are diverging from other markets.

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

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

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

Trend following applied to stocks

A stock must be in a positive trend to earn a huge gain…

A stock must be in a downtrend to produce a large loss…

The common factor? the direction of the trend…

That’s what investors like about the concept of trend following.

We want to have capital in trends that are rising and out of trends that are falling.

 

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

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

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

 

 

 

Stock market investor optimism rises above historical average

“Optimism among individual investors about the short-term direction of the stock market rebounded, rising above its historical average.”

AAII Investor Sentiment Survey

The AAII Investor Sentiment Survey is a widely followed measure of the mood of individual investors. The weekly survey results are published in financial publications including Barron’s and Bloomberg and are widely followed by market strategists, investment newsletter writers, and other financial professionals.

It is my observation that investor sentiment is trend following.

Investor sentiment reaches an extreme after a price trend has made a big move.  After the stock market reaches a new high, the media is talking about and writing about the new high, which helps to drive up optimism for higher highs.

When they get high, they believe they are going higher.

At the highest high they are at their high point — euphoria.

No, I’m not talking about cannabis stocks, I’m just talking about the stock market. Cannabis stocks are a whole different kind of high and sentiment.

A few years ago, I would have never dreamed of making a joke of cannabis stocks or writing the word marijuana on a public website. Who had ever thought there would be such a thing? But here I am, laughing out loud (without any help from cannabis).

Back to investor sentiment…

Excessive investor sentiment is trend following – it just follows the price trend.

Investor sentiment can also be a useful contrarian indicator to signal a trend is near its end. As such, it can be helpful to investors who tend to experience emotions after big price moves up or down.

  • Investor sentiment can be a reminder to check yourself before you wreck yourself.
  • Investor sentiment can be a reminder to a portfolio manager like myself to be sure our risk levels are where we want them to be.

Although… rising investor optimism in its early stages can be a driver of future price gains.

Falling optimism and rising pessimism can drive prices down.

So, I believe investor sentiment is both a driver of price trends, but their measures like investor sentiment polls are trend following.

For example, below I charted the S&P 500 stock index along with bullish investor sentiment. We can see the recent spike up to 43% optimistic investors naturally followed the recent rise in the stock price trend. investor sentiment July 2018

However, in January we observed something interesting. Investor sentiment increased sharply above its historical average in December and peaked as the stock market continued to trend up.

Afterward, the stock market dropped sharply and quickly, down around -12% very fast.

Maybe the investor sentiment survey indicated those who wanted to buy stocks had already bought, so there wasn’t a lot of capital left for new buying demand to keep the price momentum going.

The S&P 500 is still about -2.4% from it’s January high, so this has been a non-trending range-bound stock market trend for index investors in 2018. The Dow Jones Industrial Average was last years more gaining index and it is still -6% from its high.

stock market 2018 level and drawdown

The stock index will need some buying enthusiasm to reach its prior high.  We’ll see if the recent increase in optimism above its historical average is enough to drive stocks to new highs, or if it’s a signal of exhaustion.

Only time will tell…

I determine my asymmetric risk/reward by focusing on the individual risk/reward in each of my positions and exposure across the portolio. For me, it’s always been about the individual positions and what they are doing.

 

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

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

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

 

The week in review

The week in review

In case you missed it, below are all of the observations we shared this week. When there are more directional trend changes and volatility, I find more asymmetries to write about. That’s because I look at markets through the lens of “what has changed”?

When I observe more divergence between markets and trends, I see more asymmetries to share.

When global markets are just trending up together and quiet, investor sentiment is usually getting complacent, I typically point it out, since that often precedes a changing trend.

All of it is asymmetric observations; directional trends and changes I see with a tilt.

The opposite is symmetry, which is a balance. Symmetry doesn’t interest me enough to mention it.

When buying interest and selling pressure are the same, the price doesn’t move.

When risk equals the return, there is no gain.

When profit equals loss, there is no progress.

In all I do, I’m looking for Asymmetry®.

I want my return to exceed the risk I take to achieve it.

I want my profits to far surpass my losses.

I want my wins to be much greater than my losses.

I want more profit, less loss.

You probably get my drift.

 

Here are the observations we shared this week: 

Growth has Stronger Momentum than Value

https://asymmetryobservations.com/2018/06/25/growth-has-stronger-momentum-than-value/

 

Sector Trends are Driving Equity Returns

https://asymmetryobservations.com/2018/06/25/sector-trends-are-driving-equity-returns/

 

Trend Analysis of the Stock Market

https://asymmetryobservations.com/2018/06/25/trend-analysis-of-the-stock-market/

 

Trend of the International Stock Market

https://asymmetryobservations.com/2018/06/26/trend-of-the-international-stock-market/

 

Interest Rate Trend and Rate Sensitive Sector Stocks

https://asymmetryobservations.com/2018/06/27/interest-rate-trend-and-rate-sensitive-sector-stocks/

 

Expected Volatility Stays Elevated in 2018

https://asymmetryobservations.com/2018/06/27/expected-volatility-stays-elevated-in-2018/

 

Sector ETF Changes: Indexes aren’t so passive

https://asymmetryobservations.com/2018/06/27/sector-etf-changes-indexes-arent-so-passive/

 

Commodities are trending with better momentum than stocks

https://asymmetryobservations.com/2018/06/28/commodities-are-trending-with-better-momentum-than-stocks/

 

Investor sentiment gets more bearish

https://asymmetryobservations.com/2018/06/28/investor-sentiment-gets-more-bearish/

 

Is it a stock pickers market?

https://asymmetryobservations.com/2018/06/29/is-it-a-stock-pickers-market/

 

Investor sentiment gets more bearish

Investor sentiment gets more bearish

Investor pessimism shifted to an unusually high level for the time this year. It spiked up from 24% bearish to 41%.

investor sentiment investment strategy

Bearish investor sentiment is now as high as it was in April after the stock declined a second time and formed a double bottom. Interestingly, this time the stock market is only down about 6% from its high. The last time investors were so bearish it had reached -10%, for the second time.

bearish investor sentiment

Investors may be turning more bearish more quickly since the stock market remains in a drawdown. Investors tend to feel the wrong thing at the wrong time at extremes so this could be a bullish signal.

Investor optimism declined more moderately and still remains within its normal long-term range. We can see how optimism trend up to an extreme in January as the stock index reached an all-time new high and investors were becoming euphoric.

bullish investor sentiment signal

Investor sentiment measures show that investors do the wrong thing at the wrong time as their beliefs about future stock market returns reach the more extreme levels.

A good investment program isn’t enough to help clients reach their objectives.

We necessarily have to help them avoid the typical misbehavior the majority of investors fall in to.

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

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

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

Growth Stocks have Stronger Momentum than Value in 2018

Growth Stocks have Stronger Momentum than Value in 2018

After a sharp decline in stock prices in February that seemed to shock many investors who had become complacent, the stock market indexes have been trying to recover.

At this point, the popular S&P 500 has gained 1.75% year-to-date and the Dow Jones Industrial Average is down -2.56%. I also included the Total Stock Market ETF, which tracks an index that represents approximately 98% of the investable US equity market. Though it holds over five times more stocks than the 500 in the S&P 500 SPY, it is tracking it closely.

stock market index returns 2018 SPY DIA

The Dow Jones Industrial Average was the momentum leader last year, but the recent price action has driven it to converge with the other stock indexes. Past performance doesn’t always persist into the future.

Dow was momentum leader

What is more interesting, however, is the divergence at the size, style, and sector level.

The research firm Morningstar created the equity “Style Box.” The Morningstar Style Box is a nine-square grid that provides a graphical representation of the “investment style” of stocks and mutual funds. For stocks and stock funds, it classifies securities according to market capitalization (the vertical axis) and growth and value factors (the horizontal axis).

equity style box

  • The vertical axis of the style box graphs market capitalization and is divided into three company-size indicators: large, medium and small.
  • The horizontal axis seeks to represent stock funds/indexes by value, growth, and blend which represents a combination of both value and growth.

Looking at their distinct trends, we observe a material divergence this year. As we see below, the S&P 500 Growth Index ETF has gained 16.45% % over the past 12 months, which is triple the S&P 500 Value ETF. So, Growth is clearly exhibiting stronger momentum than value over the past year. But, notice that wasn’t the case before the February decline when Growth, Value, and Blend were all tracking close to each other.

 

Equity Style and Size Past 12 Months

Year to date, the divergence is more clear. Growth is positive, the blended S&P 500 stock index is flat, and Value is negative.

momentum growth stocks 2018

Showing only the price trend change over the period isn’t complete without observing the path it took to get there, so I’ve included the drawdown chart below. Here, we see these indexes declined about -10% to as much as -12% for the Value index.

The Value index declined the most, which requires more of a gain to make up for the decline. The Value ETF hasn’t recovered as well as the others.

To look even closer, we can get more specific into the style and size categories. Below we show the individual Morningstar ETFs that separate the stock market into the Large, Mid, and Small size stocks and then into Growth vs. Value.

All three at the top are Growth. The three at the bottom are Value. So, the divergence this year isn’t so much Large vs. Small cap, it’s Growth vs. Value.

Clearly, Growth stocks are leading the stock market so far in 2018.

Why do we care about such divergence?

When there exists more difference between price trends, it provides more opportunity to capture the positive direction and avoid the negative trend if it continues.

In part 2, we’ll discuss how sector exposure is the primary driver of style/size returns.

 

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

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

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

Is the economy, stupid?

Many investment professionals admit they are unable to “time the market.”

What is “market timing,” anyway? Wikipedia says:

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

One reason they “can’t time the market” is they are looking at the wrong things. The first step in any endeavor to discover what may be true is to determine what isn’t. The first step in any endeavor to discover what may work is to determine what doesn’t.

For example, someone recently said:

“A bear market is always preceded by an economic recession.”

That is far from the truth…

The gray in the chart is recessions. These recessions were declared long after the fact and the new recovering expansion was declared after the fact.

The most recent recession:

“On December 1, 2008, the National Bureau of Economic Research (NBER) declared that the United States entered a recession in December 2007, citing employment and production figures as well as the third quarter decline in GDP.”

So, the economist didn’t declare the recession until December 1, 2008, though the recession started a year earlier.

In the meantime, the S&P 500 stock market index declined -48% as they waited.

While the recession officially lasted from December 2007 to June 2009, it took several years for the economy to recover to pre-crisis levels of employment and output.

The stock market was below it’s October 2007 high for nearly six years.

Economists declared the recession had ended in June 2009, only in hindsight do we know the stock market had bottomed on March 9, 2009. The chart below shows the 40% gain from the stock market low to the time they declared the recession over. But, they didn’t announce the recession ended in June 2009 until over a year later in September 2010.

Don’t forget for years afterward the fear the economy will enter a double-dip recession.

If you do believe some of us can predict a coming stock market decline or recession, it doesn’t seem it’s going to be based on the economy. Waiting for economics and economic indicators to put a time stamp on it doesn’t seem to have enough predictive ability to “time the market” to avoid a crash.

I suggest the directional price trend of the stock market itself is a better indicator of the economy, not the other way around. Then, some other signals begin to warn in advance like a shot across the bow.

But, for me, it’s my risk management systems and drawdown controls that make all the difference.

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

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

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

Global Market Trends

Looking at broad indexes for global macro trends, global stocks are flat for the year, bonds are down as much as 6%, commodities are recently trending up.

At this point, U.S. stocks continue to look like a normal “correction” within ongoing higher highs and higher lows (a bull market). In this case, a correction is just a countertrend of “mean reversion” that has “corrected” the prior upside overreaction.

What would change the trend? changing from a normal “correction” within ongoing higher highs and higher lows (a bull market) to lower lows and lower highs. In that scenario, it would be a change in the dominant trend.

Only time will tell how it all plays out.

 

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

The is no guarantee that any strategy will meet its objective.  Past performance is no guarantee of future results. The observations shared are for general information only and are not intended to provide specific advice or recommendations for any individual.

When I apply different trend systems to ETFs

In my portfolio management, I primarily want to identify trends and get positioned with that trend. As long as there is uncertainty, we’ll see trends. Investor sentiment and expectations underreact to information causing the price to adjust gradually and that’s what produces a trend. The trend following systems I wrote about in My Introduction to Trend Following are designed to buy an asset when its price trend goes up, and sell when its trend goes down, expecting price movements to continue.

We also see the overreaction of investor sentiment and their expectations. After price keeps rising, investors may become overly enthusiastic, which causes prices to overreact and move up to an extreme that matches their sentiment. We saw that the last part of 2017 and it continued in January. We say these markets have become “overbought” and mathematical indicators can signal a countertrend.

We also sometimes see investor sentiment and their expectations plunge as they panic when prices are falling. We say these markets have become “oversold” and mathematical indicators can signal a countertrend. Looking back over the past two months, we may have seen an overreaction on the upside, then an overreaction on the downside. I say that because the stock market very quickly dropped -10%, then recovered most of it a few weeks later.

Someone asked recently “Do you invest and trade in all ETFs and stocks using the same trend system?” The answer is “not necessarily.” As I described above, trend following and countertrend systems are very different. Trend following systems can be multiple time frames, but usually longer trends of at least several months to years. Countertrend moves are normally shorter term as a market may get overbought or oversold, but it doesn’t usually stay that way a long time. For example, the S&P 500 was overbought the last few months of 2017 and that was an anomaly. It was one of the most overbought periods we’ve seen in the stock indexes. So, it was no surprise to see a fast -10% decline.

My point is, different trend systems can be applied to markets. Both trend following and countertrend are trend systems, they just intend to capitalize on a different trend in behavior – overreaction or underreaction.

When I apply my countertrend systems to markets, a great illustration is the high dividend yield market. A great example is the Global X SuperDividend® ETF $SDIV which invests in 100 of the highest dividend yielding equity securities in the world.

Below is a price chart in blue and it’s dividend yield in orange over the past five years. As you can see, the price trend and dividend yield have an inverse correlation. As the price goes up, the dividend yield from that starting point goes down. That is, if we invest in it at higher prices, the dividend yield would have been lower. But, as the price goes down, the dividend yield from that starting point goes up. If we invest in it at lower prices, our future income from dividend yield is higher.

 

For example, I highlighted in green the price was at its low when the yield was also at its highest at 8%. Investors who bought at the lower price earn the higher yield going forward (assuming the stocks in the index continue paying their dividend yields). If we invested in it in 2014 the yield was 6%. High yielding stocks are not without risks. High yielding stocks are often speculative, high-risk investments. These companies can be paying out more than they can support and may reduce their dividends or stop paying dividends at any time, which could have a material adverse effect on the stock price of these companies and the ETFs performance. You can probably see how an ETF that includes 100 of these stocks may be more attractive to gain exposure rather than risking a few individually.

This is an example of when we may use a countertrend system. As I am more inclined to invest in positive trends, this is an example of a situation I may be more willing to buy low. But, I always focus on Total Return. All of my systems include Total Return data that includes the dividend yield, not just the price trend. So as I explain this, keep in mind we still apply my risk management and trend systems but we consider and account for the high yield that makes up its total return.

Below is a chart of the Global X SuperDividend® ETF $SDIV from the low point in 2016 (I highlighted in green above). I charted both the price trend by itself as well as the Total Return which includes dividends. Had someone invested in it at the low, we saw above their yield would be 8% and the impact is evident in the difference. With the dividend yield included, the return was 36% and 18% without it. In other words, the dividend was half the return over this period. The higher the dividend yield at the point of entry, the more it can have an impact on Total Return.

As a special note for our investment management clients who are invested in ASYMMETRY® Global Tactical. We do not reinvest dividends. Instead, we want the cash dividends to go into the cash portion of our portfolio. Since we usually have some positions that generate a monthly yield, it provides the cash balance we need to cover any slippage between trades, investment management costs, as well as provide cash for other investments. I mention this, because any position we hold like this with a high yield may not appear to have as large of a percentage gain since it only represents the price return, not the total return. That is simply because we are using the cash instead of reinvesting the dividends.

 

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

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

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

 

 

Betting on price momentum

“Don’t fight the tape.”

“Make the trend your friend.”

“Cut your losses and let your winners run.”

“These Wall Street maxims all mean the same thing—bet on price momentum. Of all the beliefs on Wall Street, price momentum makes efficient market theorists howl the loudest. The defining principle of their theory is that you cannot use past prices to predict future prices. A stock may triple in a year, but according to efficient market theory, that will not affect next year. Efficient market theorists also hate price momentum because it is independent of all accounting variables. If buying winning stocks works, then stock prices have “memories” and carry useful information about the future direction of a stock.”

James O’Shaughnessy, What Works on Wall Street: A Guide to the Best-Performing Investment Strategies of All Time 1st Edition (1996) 

 

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

It takes at minimum a full market cycle including both bull/bear markets to declare an edge in an investment management track record.

But we also have different regimes. For example, each bull market can be different as they are driven by unique return drivers. Some are more inflationary from real economic expansion driving up prices. Others are driven by external manipulation, like the Fed intervention.

I’ve been managing ASYMMETRY® Global Tactical for fourteen years. It’s an unconstrained, flexible, adaptable, go-anywhere global tactical program without the limitations of a fixed benchmark. I pursue absolute returns applying dynamic risk management and unconstrained tactical trading decisions across a broad universe of global currency, bonds, stocks, and commodities.

So, I can tell you the bull market 2003-07 was a regime of rising commodities, foreign currency, and international producers of commodities. In this bull market, U.S. equities have dominated. We can see that in the chart below. If your exposure up until 2008 was only U.S. stocks, you would be disappointed as Emerging Markets countries like China and Brazil were much stronger as was commodities. We can also see how those markets have lagged since the low in 2009.

Everything is impermanent, nothing lasts forever, so this too shall change eventually.  Those who believe the next decade will be like the past do not understand the starting point matters, the return drivers, and how markets interact with each other. Past performance is never a guarantee of future results.

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

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

Investment results are probabilistic, never a sure thing. Past performance is no guarantee of future results.

 

Stock market indexes lost some buying enthusiasm for the day

Buying enthusiasm reversed from positive to selling pressure today after the first hour. I observed notable selling volume at the close, which was the opposite of what I pointed out last Thursday.The S&P 500 Stock Index was down -1.27% for the day.

 

I’ll also share that volume increased sharply during the -10% decline in the S&P 500 Stock Index earlier this month. No surprise, it was selling pressure after many months of buying enthusiasm, just an observation…

 

So far, the S&P 500 Stock Index has regained approximately half of its -10% loss earlier this month and is now up 2.64% for the year.

Since I pointed out that the stocks inside the S&P 500 has dropped to a much lower risk zone in Stock Market Analysis of the S&P 500, the % of stocks in the index above their 50 day moving average increased from only 14% in a positive trend to 55%. Today, 18% fewer stocks are above their 50-day moving averages.

S&P 500 percent of stocks above 50 day moving average Feb 2018

None of this is yet suggesting a change of trend, but when stock popular stock indexes gain or lose more than 1% or so my plan is to update it here.

 

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

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

Investment results are probabilistic, never a sure thing. Past performance is no guarantee of future results.

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

I have recently found myself reminiscing about the late 1990’s – specifically the grand euphoric year of 1999. If you aren’t sure why then maybe you aren’t paying attention. Sometimes not paying attention is a good thing if it prevents you from following a herd off a cliff.

The four most expensive words in the English language are “this time it’s different.” – John Templeton

Lately, I’ve been reminiscing about the tech stock bubble, the .com’s, and how the Nasdaq QQQ replaced the Dow Jones Industrial Average as the favorite index by 1999. Then there were all the infamous statements like “you don’t understand the New Economy”. We’ve been talking about the funny commercials from the baby trader to the college-age guy helping the mature executive start trading online, to “Be Bullish”.

Do you remember Stuart and Mr. P? Back in 1999, there were traditional “stockbrokers” who were registered with a brokerage firm, who bought and sold stocks, bonds, and options for individual and institutional clients. If you were a stockbroker back then, like I was, you probably remember it well. Online trading was the beginning of the end for the traditional “stockbroker” firms earning a $200 commission to buy or sell 100 shares. The great thing about the evolution of online trading is it lowered trading costs dramatically. For someone like me who wanted to be a tactical money manager anyway, that was a great thing. I embraced it and went on to start my investment management company. But the point of this observation is the investor sentiment in 1999. The video below is amazing to watch 20 years later. But what fascinates me the most is how it reminds me of today; different subjects, same sentiment.

Watch:

 

That may remind you of some of the things we hear today.

Those type of commercials flooded the financial news and evening news channels in 1999. To be sure, below is a WSJ article printed about the “Let’s Light This Candle” ad on December 7, 1999. I’ll tell ya what… that’s about as close to the top as you can get.

So, I wondered, what happened to Stuart and Mr. P? 

Stuart was helping Mr. P buy Kmart stock online. Kmart was then one of America’s leading discount retailers. The Kmart Corporation was the second largest U.S. discount retailer and major competitor to Walmart. Kmart filed for Chapter 11 bankruptcy protection in January 2002. Just two years after Stuart helped Mr. P buy shares online it filed for the largest ever retail bankruptcyKmart was later bought by Sears, which is now a failing company. At least Mr. P was wise enough to only buy 100 shares, young Stuart wanted him to buy 500 shares! They had no position size method to determine how much to buy based on risk, which would include a predefined exit. It is unlikely Mr. P had a predefined exit in place to exit the stock to cut the loss short. During that time, investors were only thinking about what to buy. They rarely considered how and when to exit a stock with a small loss to avoid a larger loss. After such a strong bull market, who is thinking about the risk of loss?

For those of us who remember, in the late 1990’s most investors weren’t just buying the largest retailers – they were buying technology. In hindsight, that period is now referred to as the “tech boom” or “tech bubble”. That’s because almost everyone wanted to buy tech stocks. Literally, even the most conservative seniors were cashing out bank CD’s to buy tech stock.  And… I’m not even going to get into the .com stocks, most of which no longer exist from that time.

Whether you remember the trend as my friends and I do or not, we can use historical price charts to see what happened. Below is the Technology Select Sector SPDR® ETF  since its inception 12/16/1998 to today. I’m starting with the full history to see the initial gain, before the waterfall decline. The Technology Select Sector SPDR® Fund seeks to:

“Provide precise exposure to companies from technology hardware, storage, and peripherals; software; diversified telecommunication services; communications equipment; semiconductors and semiconductor equipment; internet software and services; IT services; electronic equipment, instruments, and components; and wireless telecommunication services.”

Those were the most popular sectors, aside from the actual Internet stocks.

Below is what happened from December 9, 1999, when WSJ printed the article about the ad because it was so interesting and popular, to now. After nearly 20 years an investor buying the diversified tech sector would have just recently realized a profit, assuming they held on for 19 years.

Here is what that -80% drawdown looked like that lasted 19 years.

“Those who cannot remember the past are condemned to repeat it. “

George Santayana

 

This is a kickoff of a series of articles on this topic I have in queue on current global market conditions. Stay tuned…

Mike Shell is the founder of Shell Capital Management, LLC, a registered investment manager and portfolio manager of ASYMMETRY® Global Tactical.

All Eyes are Now on the Potential Government Shutdown

If the U. S. Government shuts down, it will be the 19th time. Looking at the table below, it doesn’t seem a big deal. The table shows the 18 prior government shutdowns going back to 1976. It lists the start and end date of the shutdown and the gain or loss for the S&P 500 stock index. The average is only a -0.60% loss from beginning to end of the shutdown.

But, here are some considerations: 
1. It is too small of a sample size to draw a statistically significant inference. Basic probability needs 30 data points.
2. It only shows the gain/loss from beginning and end of the shutdown.
3. It doesn’t show what happened before and after those dates. Was there more movement/drawdown before or after?
4. It doesn’t show what happened in between the start and end date so it may have been worse.
5. It doesn’t consider market stage at the time of shutdown. Was it overvalued and overbought? Or was it undervalued and oversold?

The truth is; anything can happen.
We don’t know for sure how it will play out. With such a small sample size of prior events and without factoring in the market conditions at the time, what it did in the past doesn’t provide us with a good expectation.

The current condition: if the government shuts down this time:
1. It will be when the U.S. stock market is at the second most expensive fundamental valuation, ever.
2. When investor and advisor bullish sentiment has reached record highs, at this point a contrary indicator.
3. As recent momentum indicators are at the highest levels ever seen before, at this point a contrary indicator.

My solution? always be prepared that anything can happen.
I know how much risk I’m willing to take given the possible outcomes and define my risk by knowing when I’ll hedge or exit.

 

Mike Shell is the founder of Shell Capital and the Portfolio Manager of ASYMMETRY® Global Tactical.

What do wealthy people do differently?

This morning a financial planner who knows we are the investment manager to wealthy families asked me a great question:

“What do wealthy people do differently?”

I thought I would just sit here and write it out. These are my own observations over a few decades.

First, let’s define “wealthy”.

I’m going to define “wealthy” as someone who has already achieved “freedom”. Notice I said “freedom”, not just “financial freedom”. I’ve asked thousands of people over the past two decades “what is important about money to you?”. Ultimately, the question leads to one single word: “freedom”. So, there doesn’t seem to be a need to add “financial” in front of “freedom”. But, that isn’t to say you can’t have plenty of money without much freedom. You could say “Some people have far more money than they ever need but they still don’t enjoy their freedom because they keep working for more”. You may consider that person is still getting what they want. Some people just want to produce, and they never stop. They are still free. They have the freedom to keep doing what they love doing. In fact, some wealthy people are driven to create more wealth for a charity. No matter what our goals are in life, traveling, relaxing, time with family and friends, helping others, having enough capital to do what we want seems essential.

Having enough money to do what we want, when we want, seems to be the primary goal of most of us.

So, I define “wealthy” as someone who has already achieved “freedom”, regardless how he or she chooses to enjoy his or her freedom.

What do these people do differently than those who haven’t accumulated enough capital to say they are “wealthy”?

1. They save and invest money. The first thing that I have observed is that they simply save part of their income and invest it.

a. Save: They save it because they don’t spend more than they should. They save a large amount of themselves to use later. Even if they earn $X a year, they don’t the most they can for their home or carts. For example, a person earning $1 million a year may live in a $1 million neighborhood and a neighbor who earns $200,000 a year. Who do you think will be “wealthy”? One is stretched, the other is saving.

b. Invest: People who achieve “freedom” and the “wealthy” status don’t stop and just saving money in a bank account, they invest it. Wealthy people take the time to invest their money. Most of them invest with an investment manager who is fully committed to investment management.

2. Wealthy people care about their money. I know a lot of wealthy people, and I know just as many who aren’t. Those who are wealthy save and invest money, those who don’t spend it. As investment management clients, wealthy families are the first to complete forms, etc. as needed because they care about their money. They also appreciate investment managers who are on top of things as they would be.

3. Wealthy people are focused on that ONE thing they do best. Just like the book The ONE Thing: The Surprisingly Simple Truth Behind Extraordinary Results says: they are focused. If they are a Physician, they focus on being a great Physician. If they own a company, they focus on their business. If they are a country music artist, they focus on being the best they can be. If they are an engineer, that’s their focus. They do what they do best and they find other people to do the things they don’t want to do like lawn maintenance or whatever. If you want to earn more money to save and invest, focus on what earns you the most and pay others for the things you aren’t so great at or don’t want to do.

4. They take some risks and manage their risk. To achieve wealth, we have to be both risk-takers and risk managers. If we take no risks in life, we’ll have no chance of reward. Not graduating from college has some risks, but so does attending. Who we marry, how we title our assets, how we insure our assets, and how we manage our assets all have risks and the potential for reward. Wealthy people tend to take risks in that one thing they are best at. They go “all in”. But wealthy people also direct and control their risks. They try to take good risks that are worth taking. It doesn’t matter how much wealth we accumulate if we aren’t able to keep it. For example, many people can remember how much wealth they created on paper up to 2000 only to see it cut in half. They did it again up to 2007 through 2009, and it took years to break even. Wealthy people know to realize a real profit, you have to take a profit. To avoid a large loss, we have to cut losses off at some point. Proper planning and risk management are essential.

5. Everything is relative, but yet it isn’t to them. I know business owners as well as Physicians who I consider wealthy as well as musicians, and athletes. But, you don’t have to earn $500,000 a year all your life to become wealthy. You don’t have to earn it all in a short time, either. I know people who have a total $500,000 invested who are wealthy. They have “enough”, for them. Depending on the lifestyle, others may not become wealthy until they have over $5 million if they spend a few hundred thousand a year traveling, etc. I also know families with several hundred million. Everything is relative, but wealthy people don’t compare their wealth and assets to others. They aren’t “keeping up with the Joneses”. People who do that often have large debts because they buy things they can’t afford with money they don’t have. Or, they save and invest less.  Wealthy people don’t buy a new car or house because their friend does, or compare their investment account to others. Wealthy people may be more introverted when it comes to personal finance – their focus is on their own family needs.

What do the wealthy do differently? They discover how much capital they need to enable the freedom to do what they want when they want, whatever that may be. Income alone, or the neighborhood we live in, or the cars we drive, or memberships don’t signal that we are wealthy. Some wealthy people are still operating their business, practice,  or “working”. A distinction is that they want to and they could choose to do something else with their time if they want. Wealthy families have saved and invested enough money to have achieved freedom. To do that, they focus on the thing they do best. They delegate the other stuff to someone else. They care about accumulating and managing their money and managing their risks. They appreciate investment managers and wealth managers who help them do it.

Resolving Conflicts with Relative Strength

In “Relative Strength can be a source of conflict for Tactical Traders” I explained how two different momentum indicators are in conflict with each other and can lead to conflict in tactical trading decisions. Tactical traders may use many different indicators and methods to determine whether to enter, hold, or exit a position. If we look at two conflicting indicators like this, we have to avoid becoming conflicted ourselves.

To avoid the conflicts, define clearly what they are and how to use them. To do that, I’m going to mix up a bowl of Physics and Psychology.

The indicators essentially represent the same thing. They apply a different algorithm, but both are momentum measures that determine the speed of change in price movements. A key difference is that the basic Relative Strength I used is a simple price change over a period. That simple Relative Strength algorithm simply compares the price change over a period to determine which trends are stronger and which are weaker. Tactical Traders using this method of Relative Strength expect the stronger trends will continue to be stronger and the weaker trends will continue to be weaker. A trend in motion is expected to continue in that direction until some inertia comes along and changes it. You may recognize this from Physics:

Newton’s first law of motion states that “An object at rest stays at rest and an object in motion stays in motion with the same speed and in the same direction unless acted upon by an unbalanced force.” Objects tend to “keep on doing what they’re doing.” In fact, it is the natural tendency of objects to resist changes in their state of motion. This tendency to resist changes in their state of motion is described as inertia.

Inertia: the resistance an object has to a change in its state of motion.

We can say the same about investor behavior and beliefs when we look at confirmation bias.

Confirmation bias is the tendency to search for, interpret, favor, and recall information in a way that confirms one’s preexisting beliefs or hypotheses.

That psychological bias is similar to the physics law of motion;

“Objects tend to keep on doing what they’re doing. In fact, it is the natural tendency of objects to resist changes in their state of motion.”

Investor and trader behavior and Confirmation Bias seems to agree with the first law of motion.

You can probably see how we may develop our beliefs because of our environment. If we observe over time the natural tendency of objects to resist changes in their state of motion then we may expect a trend to continue.

It gets more interesting. According to The Physics Classroom:

Newton’s conception of inertia stood in direct opposition to more popular conceptions about motion. The dominant thought prior to Newton’s day was that it was the natural tendency of objects to come to a rest position. Moving objects, so it was believed, would eventually stop moving; a force was necessary to keep an object moving. But if left to itself, a moving object would eventually come to rest and an object at rest would stay at rest; thus, the idea that dominated people’s thinking for nearly 2000 years prior to Newton was that it was the natural tendency of all objects to assume a rest position.

So, up until Newton’s first law of motion, people believed trends would eventually end instead of continue. In that same way, some people look for and expect recent price trends to change rather than continue.

We have discovered two different beliefs.

  • A trend in motion will stay in motion with the same speed and direction (unless acted upon by an unbalanced force).
  • A trend will eventually stop moving (a force is necessary to keep an object moving).

A Tactical Trader using Relative Strength based on the rate of change assumes that trend speed and direction will continue into the future. This is more in agreement with Newton’s first law.

A Tactical Trader using the Relative Strength Indicator, an oscillator,  assumes that trend speed and direction will oscillate between a range. If it reaches “oversold” it may reverse back up and if it reaches “overbought” it may reverse back down. This is more like the Physics beliefs prior to Newton’s first law when they expected a trend or motion to change.

To avoid conflicts between these two concepts and indicators, I define them separately as Trend Following and Countertrend.

Trend Following systems are methods that aim to buy securities that are rising and sell securities that are declining. Trend following is directional – it focuses on the direction of prices. Not all measures of Relative Strength are directional, but the one I used is. I simply ranked the sectors based on their price change over 3 months. That is an absolute ranking, but also a relative ranking. I may require the price change to be positive to enter a position. Some Relative Strength methods are only relative, so they don’t require a positive trend. They may enter the sectors that have the better price change over the period even if it’s negative.

Countertrend systems aim to bet against the recent price trend for the purpose of pursuing a capital gain or for hedging. In a strongly rising market, a countertrend strategy may believe the price is more likely to reverse. For example, the RSI is “overbought.” In a  declining market, a countertrend strategy may indicate the trend is likely to reverse back up. For example, RSI is “oversold.” The risk is, an oversold market can keep trending lower and an overbought market may keep trending up!

I believe there are directional trends that are more likely to continue than to reverse – so I apply Trend Following to them. That necessarily means I believe investors may underreact to new information causing the price trend to drift gradually over time to match supply and demand.

I also believe that trends can reach an extreme, especially in the short run, by overreacting to information or extremes in sentiments like fear and greed. Because I have observed trends reaching an extreme, I may apply overbought and oversold methods for countertrend trading.

When I see the chart below, I think:

“The trend is up, it has moved up fast enough to be overbought in the short term, so it may pull back some and then the trend may resume to the upside”.

I combine the two, rather than them necessarily being in conflict with each other. I believe the high RSI number is confirming the strong trend, but I also believe it suggests it may not be the best entry point if you care about entering a position that may decline a few percent after you enter it.

So, I believe both of these systems can be applied at different times depending on the market state of the trend type. When a price trend is oscillating up and down over time but not necessarily making a major new high or low, a Countertrend method may capture profits from those swings. When a trend is moving up or down for a prolonged period that same Countertrend system may catch some of the profits and miss some as well. That is because it expects the trend to reverse at certain points and it doesn’t. However, a Trend Following system may better capture the overall trend when it keeps trending. But, none of them are perfect. If a Trend Following system captures the bigger trend it also means it will likely participate in a drawdown when the trend does end. If the Trend Following algorithm is loose enough to ride the trend without whipsaws, it will also be loose enough to lose some gains when the trend does change to the other direction.

If Tactical Traders and investors have useful definitions like these and can apply these different methods to different types of markets, with the right mindset and expectations we can avoid the conflicts.

Relative Strength can be a source of conflict for Tactical Traders

Relative Strength can be a source of conflict for Tactical Traders. I was talking to another tactical trader who manages a hedge fund. He said:

“Industrials are a leading sector, but it’s overbought”.

Relative Strength is a simple measurement to determine which stock, sector, or market has trended up the most over a period of time.  For example, when we rank U.S. sectors over a period of 3 months to see which sectors have been trending the strongest, we see sectors like Financials, Energy, Materials, and Industrials have been the leaders over the past three months. Of course, past performance doesn’t necessarily indicate it will continue into the future. As with any trend indicator, Relative Strength is always looking at the past, never the unknowable future.

To see a different visual, below is how those same sectors appear in a line chart over the past 3 months. We observe that most of the sectors have trended in a wide range over the past few months.

 

When ranked by Relative Strength, the Industrial Sector is a leader compared to other sectors and its directional trend can also be seen in its price chart.

No, wait.

Now that I’ve pulled the chart up: The Industrial sector is overbought right now based on the Relative Strength Index. I highlighted the indicator over 70 with the red line.

So, one “Relative Strength” indicator says it’s in a strong relative trend, the other suggests its “overbought”.

These two indicators sound the same, but they are different, but also the same. It depends on what you think it represents. Both of them actually represent the same thing, but the expectation from them is the opposite.

Relative Strength as I used above, is just a simple comparison of the price trends over the past 3 months, or whatever time frame you want to use.

The Relative Strength Index is a momentum oscillator that measures the speed and change of price movements. That doesn’t sound much different than Relative Strength. The equation is different. The way it is used is different. RSI oscillates between zero and 100. The default time frame is only 14 days. Without writing a book on it, I’ll share that RSI is intended to capture the shorter term swings in a price trend. Since it’s using 14 days, it’s assuming a cycle of 28 days.

When the RSI exceeds 70 it’s considered “overbought” because, mathematically, it has moved a little too far, too fast. When it gets “overbought” it’s expected to either drift sideways for some time or reverse back down. We may indeed observe the price trend stalling at overbought levels. The trouble is, it isn’t perfect. A strong trending price with a lot of inertia can continue trending up and just get more and more overbought. I find that investors who pay a lot of attention to it are concerned their profit will be erased, so they are looking to take profits when it appears overbought.

When the RSI declines below 30 it’s considered “oversold” because, mathematically, it has moved down a little too far, too fast. When it gets “oversold” it’s expected to either drift sideways for some time or reverse back up. We may indeed observe the price trend stalling at oversold levels. The trouble is, a waterfall declining price trend with a lot of inertia like panic can continue trending down and just get more and more oversold. Buying oversold markets, sectors, or stocks can lead to profits, but it’s like catching a falling knife. When I buy oversold markets, I focus on the high dividend yield positions whos yield gets higher as the price falls.

Tactical traders use many different indicators and methods to determine whether to enter, hold, or exit a position. If we look at two conflicting indicators like this, we have to avoid becoming conflicted ourselves. Many tactical traders may experience Confirmation Bias, looking for an indicator that agrees with what they already believe.

So, let’s look at that chart again. On the one hand, it’s trending up! On the other hand, it’s overbought! Will the trend continue or will it reverse down?

We don’t know, but different tactical traders use different methods to enter, hold, and exit positions. I know tactical traders who use only Relative Strength. I know others who mainly use RSI. They are buying and selling each other’s positions and both of them could be profitable overall. If you don’t like to enter a position that may decline in the weeks ahead you may want to avoid high RSI “overbought” markets if you believe they may decline in the short term. If you are a trend following purist who loves to buy new breakouts you’ll ignore the RSI and instead realize a high RSI indicators a strong trend and go for it. Said another way: do you fear missing a trend or fear losing money short term.

It’s easy to say “Don’t get conflicted and biased!” but another to shed more light on the conflict.

Tomorrow I’m going to share with you how I see it.

Stay tuned.

Read Part 2: Resolving Conflicts with Relative Strength

How Future Losses Erase Prior Gains

Someone was talking about how much the stock market is “up”.

However, it’s the exit that determines the outcome.

When someone talks about being “up” that doesn’t mean anything unless they have sold to realize the profit.

If they haven’t sold, it’s the markets money. The market may giveth, but it can also taketh away. Market gains are just market gains. To realize a profit, we have to sell.

Open profits aren’t yet realized.

Open profits may never be realized.

Open profits may be evaporated by later losses.

Closed profits are ours. When we exit and take a profit, we’ve realized the gain and have the cash to show for it.

To be sure, let’s look at the last 20 years. It’s hard to believe that a data point of 1997 is now 20 years ago! It seems like yesterday to me. Talking about 1997 may sound ancient now, but it wasn’t so long ago. The late 1990’s was one of the strongest cyclical bull markets in history. The S&P 5oo stock index gained over 200% in five years! The sharp gains of the late 1990’s inspired even the oldest bank savers to cash in CD’s that were paying 5% to 7% for the chance for high profits.

Only in hindsight do we know what happened next.

The essential concept investors must understand is not only how capital compounds, but also the math of loss.

Losses are asymmetric. In fact, losses are more asymmetric than gains.

That is, losses compound more exponential than gains.

Losses are exponential. As they get larger, it takes more gain to recover the loss to be back to even.

That’s why we don’t have to capture 100% of a gain to result in the same or better return if the downside loss is limited. When we avoid much of the downside, we simply don’t need to risk so much on the upside to compound capital positively. And, if we don’t have large losses on the downside investors are less likely to tap out with losses. Those concepts are essential to understand. It doesn’t matter how much the return is if the downside is so large they tap out before the gain is realized.

In the chart below, we can see how the math works.

A -10% loss takes +11% to recover. A 20% loss takes +25% to recover. Beyond -20%, the losses become more asymmetric and exponential. A -30% loss needs a +43% to get back to even. At -40% you need +67% to regain. That’s why losses in the -50% range as we’ve seen twice over the past 15 years are so devastating to life plans. At -50% you need +100% just to recover the loss and get back to breakeven. If your loss is -60%, it’s +150% to recoup. So when you hear people bragging about the stock market gains since 2009, don’t forget the other side of the story. It’s the other side the makes all the difference. How many years of staying fully invested in risky markets did it take to recover the loss?

Let’s look at how this matches up with real price trends we’ve observed over the past 20 years.

Below we see the late 1990’s gains more than erased by the sharp decline from 2000 to 2002. But keep in mind, while the decline was a sharp one at -50%, the decline was made up of many swings up and down along the way. The swings of lower highs and lower lows swayed many investors back “in” as those swings up along the way made them think the low was in and it was a “buying opportunity”. They did that just in time for the next down move. Avoiding bear markets isn’t as simple as exiting near the peak and reentering near the low. It’s far more complicated. Investors fear missing out during every 10% to 20% upswing, then they fear losing more money after every -10% to -20% downswing. But, the point here is that the large uptrend was erased by the later downtrend. What happens along the way brings additional challenges.

After the low around 2003, a new cyclical bull market began. As we know in hindsight, it lasted until October 2007. In October 2007, investors were pretty optimistic again and maybe a little euphoric. Stocks had gained over 100% from the bear market low and they wanted more stocks. It didn’t take long for a decline large enough that more than erased all the gains they were so excited about.

In fact, not only did that bear market erase the gains of the cyclical bull market that started in 2002, it also erased all of “The Tech Bubble” gains going back to 1995! By 2009 the past fourteen years was at a loss for stock index investors.

Even the largest uptrends have been erased by the later downtrends. This has happened many times in stock market history.

It doesn’t matter how much the stock market had gained. It only mattered if the profits were realized. Otherwise, it was just a rollercoaster.

You can probably see why I say that markets have profit potential, but because they don’t always go up, they require risk management. It’s why I actively manage risk and apply directional trend systems intended to capture profits and avoid significant losses.

March 9th is the Bull Market’s 8-Year Anniversary

I observed many headlines pointing out that March 9th is the 8th anniversary of the current bull market in U.S. stocks.

The rising trend in stocks is becoming one of the longest on record. It is the second longest, ever.

Looking at it another way, March 9, 2009 was the point that stock indexes had fallen over -50% from their prior highs.

Since most of the discussion focuses on the upside over the past 8 years, I’ll instead share the other side so we remember why March 9, 2009 matters.

 ‘Those who cannot remember the past are condemned to repeat it.’

– George Santayana

When investors speak of the last bear market they mostly call it “2008” or “o8”.

However, the end of the last bear market was actually March 9, 2009 and the beginning was October 2007.

Below is a chart of the S&P 500 stock index from October 9, 2007 to March 9, 2009. The price decline was -56%.

No one knew that March 9, 2009 was the lowest it would go. It could have gotten much worse.

Talking only about the gains since the low leaves out the full story.

When we research price trends, we must necessarily consider the full market cycle of both rising and falling trends. For example, below is the price trend since the peak nearly 10 years ago on October 9, 2007.  Even after such a large gain, the Risk-to-Reward Ratio isn’t so good if you had to hold through the big loss to achieve it. That is, investors had to experience -56% on the downside for how much gain?

It isn’t the upside that causes so much trouble, it’s the downside.

That’s why we must manage risk to increase and decrease exposure to the possibility of gain and loss.

Asymmetric Volatility Phenomenon

In Asymmetric Volatility, I used the range of weather temperatures to show that volatility is how far data points are spread out.

While it’s 72 degrees and sunny in Florida it can be below freezing in Boston with snow on the ground.

We observe asymmetric volatility in equity markets, too.

The equity market tends to crash down, but drift up. That is, uptrends tend to drift slower and less steep, and downtrends tend to fall faster and sharper and can become waterfall declines.  We observe fewer geysers than waterfalls.

asymmetric-volatility-phenomenon

The drivers of this market dynamic seem to be mainly based on behavior and a reaction to price trends.

I could add that leverage has an impact, too. As markets have gone up for a while investors are more likely to use leverage to “get more aggressive”. Leverage levels tend to be highest at peaks. But, leverage and volatility feedback tend to be linked to panic selling leading to selling pressure. Prices fall more because they are falling.

I believe that upward price trends are primarily driven by underreaction to information. Even if we all get the same information at the same time, but we respond to it differently and at different times. Some get in the trend sooner, others enter later, some even wait until the end (and use leverage!).

Investors may underreact in downtrends, too. Many investors may not react to a loss of  -5%, but -10% they may start to pay more attention and -20% some may panic. The deeper the fall, the more investors are likely to tap-out. By the time the stock market is down -20%, many may be selling to cut their loss. As selling pressure builds, selling leads to more selling as prices fall. If you are bold and -20% isn’t enough to tap you out, maybe -50% is.

If you are bold and -20% isn’t enough to tap you out, maybe -40% is. Or, -50%. I think everyone has a tap-out point. It could be losing it all.

Here is an example you may remember.

stock-market-crash-2008

As the price trend made lower highs and lower lows, selling pressure continued and it led to a waterfall panic level decline. This kind of decline is what many “risk measurement” systems fail to acknowledge. Actually, they intentionally ignore them.  If you use a risk measurement system that says it has a “95% Confidence Level”, these downtrends are the 5% it ignores.  It acts like they won’t happen. It even does it on purpose.

That’s the very move you want to avoid.

You can probably see why I believe it is necessary to actively manage risk and apply drawdown control.

For the record, the period above wasn’t the full downtrend. I often see that period misquoted as “2008”.

It wasn’t just 2008.

The S&P 500 was just down -37% in the calendar year 2008.

The full decline was actually -55%. It began at the peak in October 2007 and didn’t end until March 2009.

It began at the peak in October 2007 and didn’t end until March 9, 2009.

stock-market-bear

2009 ended positive, so many people don’t include it when they speak of this last bear market. Below is January 1, 2009, to March 9, 2009. It continued to decline nearly -30% in those two months after 2008.

2009-stock-market-decline

Beware of those who understate the historical downside and the potential for downside.

They are the same people who will experience it again.

I always say that you could publish trading rules in the newspaper and no one would follow them. The key is consistency and discipline. Almost anybody can make up a list of rules that are 80 percent as good as what we taught people. What they couldn’t do is give them the confidence to stick to those rules even when things are going bad.”

– Richard Dennis

richard-dennis

Investors feel and do the wrong thing at the wrong time…

Investors feel and do the wrong thing at the wrong time…

Many studies show that investors have poor results over the long haul including both bull and bear markets. For example, DALBAR has been conducting their annual Quantitative Analysis Of Investor Behavior study for 22 years now.

DALBAR’s Quantitative Analysis of Investor Behavior (QAIB) has been measuring the effects of investor decisions to buy, sell and switch into and out of mutual funds over both short and long-term time frames. The results consistently show that the average investor earns less – in many cases, much less – than mutual fund performance reports would suggest.

Their goal of QAIB is to improve investor performance by pointing out the factors that influence behaviors that determine the outcome of investment or savings strategies. They conclude individuals have poor results for two primary reasons:

  1. Lack of capital investment.
  2. Investor Psychology.

If someone doesn’t save and invest some of their money, they’ll never have a chance to have good long-term results. However, they find the biggest reason for poor results by investors who do invest in the markets over time is investor psychology. Investors tend to do the wrong thing at the wrong time, especially at market extremes.

The chart below illustrates how investors tend to let their emotions lead them astray. The typical “bull market” for stocks may last four or five years. After investors keep hearing of rising market prices and headlines of “new highs” they want to invest more and more – they become euphoric. The may get more “aggressive”. However, those gains are in the past. Market trends are a good thing, but they can move to an extreme high (or low) and then reverse. Investors feel euphoria just as the stock market is getting “overvalued” at the end of a market cycle.

Look at that chart: what big trend do you think happens next? 

do-your-emotions-lead-you-astraySource: Investing and Emotions

On the downside, investors panic after large losses. There are many ways that investors get caught in this loss trap. For example, some are told to “stay in the market” so they hold on beyond their uncle point and then tap out. After they sell at much lower prices, they are too afraid to “get back in.”  They are “Panic-Stricken.” They don’t discover the actual risk of their passive asset allocation until it’s too late and their losses are larger than they expected.

Investors need to know their real tolerance for loss before the loss happens. Then, they need to invest in a program that offers a matching level of risk management, so they don’t lose so much they tap out and lock in significant losses. If they reach their uncle point and tap out, they have an even more difficult challenge to get back on track.

You want to be greedy when others are fearful. You want to be fearful when others are greedy. It’s that simple. – Warren Buffett

The chart above shows twenty-one years of the historical return of the S&P 500 stock index. Look at the graph above to see the points this happens. It shows an idealized example of investor emotions as prices trend up and down. As prices trend up, investors initially feel cautious, then hopeful, encouraged, positive, and as prices move higher and higher, they feel confident and thrilled to the point of euphoric. That’s when they want to get “more aggressive” when they should be doing the opposite. The worst investors actually do get more aggressive as they become euphoric at new highs, and then they get caught in those “more aggressive” holdings as the markets decline -20%, -30%, -40%, or more than -50%.

After such investment losses investors first feel surprised, then as their losses mount they feel nervous, then worried, then panic-stricken. But this doesn’t happen so quickly. You see, larger market declines often take a year or two to play out. The most significant declines don’t fall in just a few months then recover. The significant declines we point out above are -50% declines that took 3 – 5 years or more to get back to where they started. So, they are made up of many swings up and down along the way. If you look close at the chart, you’ll see those swings. It’s a long process – not an event. So few investors notice what is happening until it’s well in the past. They are watching the daily moves (the leaf on a tree) rather than the bigger picture (the forest).

So, investors get caught in a loss trap because the swings along the way lead them astray.  Their emotions make them oscillate between the fear missing out and the fear of losing money and that’s why investors have poor results over a full market cycle. A full market cycle includes a major peak like the Euphoric points on the chart and major lows like the Panic-Stricken points. Some investors make their mistakes by getting euphoric at the tops, and others make them by holding on to falling positions too long and then panicking after the losses are too large for them.

At Shell Capital, I manage an investment program that intends to avoid these mistakes. I prefer to avoid the massive losses, so I don’t have panicked investors. And, we don’t have to dig out of large holes. That also necessarily means we don’t want to get euphoric at the tops. I want to do the opposite of what DALBAR finds most people do. To do that, I must necessarily be believing and doing things different than most people – a requirement for good long term results. But, creating exceptional investment performance over an extended period of ten years or more isn’t enough. We also have to help our investor clients avoid the same mistakes most people make. You see, if I am doing things very differently than most people, then I’m also doing it at nearly the opposite of what they feel should be done. Our investors have to be able to deal with that, too.

If you are like-minded, believe what we believe, and want investment managementcontact us. This is not investment advice. If you need individualized advice, please contact us  

 

Source for the chart: BlackRock; Informa Investment Solutions. Emotions are hypothetical and for illustrative purposes only. The S&P 500 Index is an unmanaged index that consists of the common stock of 500 large-capitalization companies, within various industrial sectors, most of which are listed on the New York Stock Exchange. Returns assume reinvestment of dividends. It is not possible to invest directly in an index. Past performance is no guarantee of future results. The information provided is for illustrative purposes only.

Systems trading is ultimately discretionary. The manager still has to decide how much risk to accept, which markets to play, and how aggressively to increase and decrease the trading base as a function of equity change. These decisions are quite important – often more important than trade timing.”

Ed Seykota in Market Wizards: Interviews with Top Traders By Jack D. Schwager

Market Wizards Interviews with Top Traders

Essence of Portfolio Management

Essence of Portfolio Management

“The essence of investment management is the management of risks, not the management of returns. Well-managed portfolios start with this precept.”

– Benjamin Graham

The problem is many portfolio managers believe they manage risk through their investment selection. That is, they believe their rotation from one seemingly risky position to another they believe is less risk is a reduction in risk. But, the risk is the exposure to the chance of a loss. The exposure is still there. Only the perception has changed: they just believe their risk is less. For example, for the last thirty years, the primary price trend for bonds has been up because interest rates have been falling. If a portfolio manager shifts from stocks to bonds when stocks are falling, bonds would often be rising. It appears that trend may be changing at some point. Portfolio managers who have relied on bonds as their safe haven may rotate out of stocks into bonds and then their bonds lose money too. That’s not risk management.

They don’t know in advance if the position they rotate to will result in a lower possibility of loss. Before 2008, American International Group (AIG) carried the highest rating for an insurance company. What if they rotated to AIG? Or to any of the other banks? Many investors believed those banks were great values as their prices were falling. They instead fell even more. It has taken them a long time to recover some of their losses. Just like tech and telecom stocks in 2000.

All risks cannot be hedged away if you pursue a profit. If you leave no chance at all for a potential profit, you earn nothing for that certainty. The risk is exposure to an unknown outcome that could result in a loss. If there is no exposure or uncertainty, there is no risk. The only way to manage risk is to increase and decrease the exposure to the possibility of loss. That means buying and selling (or hedging).  When you hear someone speaking otherwise, they are not talking of active risk management. For example, asset allocation and Modern Portfolio Theory is not active risk management. The exposure to loss remains. They just shift their risk to more things. Those markets can all fall together, as they do in real bear markets.

It’s required to accomplish what the family office Chief Investment Officer said in “What a family office looks for in a hedge fund portfolio manager” when he said:

“I like analogies. And one of the analogies in 2008 brings to me it’s like a sailor setting his course on a sea. He’s got a great sonar system, he’s got great maps and charts and he’s perhaps got a great GPS so he knows exactly where he is. He knows what’s ahead of him in the ocean but his heads down and he’s not seeing these awesomely black storm clouds building up on the horizon are about to come over top of him. Some of those managers we did not stay with. Managers who saw that, who changed course, trimmed their exposure, or sailed to safer territory. One, they survived; they truly preserved capital in difficult times and my benchmark for preserving capital is you had less than a double-digit loss in 08, you get to claim you preserved capital. I’ve heard people who’ve lost as much as 25% of investor capital argue that they preserved capital… but I don’t believe you can claim that.Understanding how a manager managed and was nimble during a period of time it gives me great comfort, a higher level of comfort, on what a manager may do in the next difficult period. So again it’s a it’s a very qualitative sort of trying to come to an understanding of what happened… and then make our best guess what we anticipate may happen next time.”

I made bold the parts I think are essential.

If you are like-minded and believe what we believe, contact us.

Investor Optimism Seems Excessive Again

When someone asks me why I hold so much cash or against a market decline, it always corresponds to extreme optimism readings in the most basic investor sentiment indicators. Investors have poor long-term results because they feel the wrong feeling at the wrong time. They feel optimistic after price gains just before they decline. They fear more losses after they hold on to losing trends, and their losses get large.

After the stock market declined and then reversed back up to make headlines investor sentiment has reached the level of “Extreme Greed” once again. I don’t use the CNN Fear & Greed Index as a trading signal as my systems focus on other things, but I think it’s a publically available source that is useful to help investors avoid feeling the wrong feeling at the wrong time.  For example, the CNN Fear & Greed Index uses eight indicators of investor sentiment to determine Fear or Greed. The reading oscillates between Extreme Fear, Fear, Neutral, Greed, and Extreme Greed. If you feel optimistic about future prices and the reading is at Extreme Greed, you are probably wrong. If you feel fearful about future prices and the reading is at Extreme Fear, you are probably wrong. You see, most investors feel the wrong feeling at the wrong time.

As you see below, it has reached the “Extreme Greed” point, and that often signals high risk and eventually precedes at least a short-term trend reversal.

CNN Fear Greed Index

Source: CNN Fear & Greed Index

 

Below is a chart of the past 3 or so years of the Fear & Greed reading. As you see, the levels of fear and greed do indeed oscillate from one extreme to the other over time. I think we observe these readings indicate the wrong feeling at the wrong time.

Fear and Greed over time investor sentiment

Source: CNN Fear & Greed Index

The most obvious extreme level is the extremely low level of expected future volatility. Maybe they are right, but when the VIX Volatility Index reaches such as extreme low it often signals at least a short-term stock market peak that reverses down.

VIX Volatility Index.jpg

I like directional trends, but I also believe they sometimes reach extremes at a point and then reverse.

We’ll see how this one unfolds in the weeks and months ahead…

You can probably see why it’s prudent to actively manage risk and hedge at certain extremes.

To learn more, contact us.

Each of us tends to think we see things as they are, that we are objective. But this is not the case. We see the world, not as it is, but as we are—or, as we are conditioned to see it. When we open our mouths to describe what we see, we in effect describe ourselves, our perceptions, our paradigms.”

– The Seven Habits of Highly Effective People: Powerful Lessons in Personal Change by Stephen R. Covey, Quote Page 28 (2004)

We see the world not as it is but as we are

The U.S. Stock Market Trend

When we define the direction of a trend, we consider the most basic definitions.

  • Higher highs and higher lows is an uptrend.
  • Lower lows and lower highs is a downtrend.
  • If there is no meaningful price break above or below those prior levels, it’s non-trending.

Below is the past year of the S&P 500® stock index, widely regarded as a representation of large cap stocks. Notice a few key points. The top of the price range is just that: a range, with no meaningful breakout. The bottom is the same. The price trend has dropped to around the same level three times and so far, has trended back up. What’s going to happen next? At this point, this stock market index is swinging up and down. It would take a meaningful break below the prior low that holds to make a new “downtrend”. It could just as well trend up. We could put an exit point below those prior lows and let it all unfold.

Stock market trend

Of course, as I’ve mentioned a lot the past several months, other global markets and small company U.S. stocks and mid-cap stocks have been much weaker than large U.S. stocks and certain sectors within the U.S. You can read the details of this in The Stock Market Trend: What’s in Your Boat? As I pointed out then, in the chart below we can see the mid-size and small cap stocks have actually declined much more. But, the capitalization-weighted indexes are driven by their sector exposure.

small cap mid cap stocks

Some U.S. sectors are still holding up and still in uptrends. Below is the Technology sector index, for example. I consider this an uptrend, though volatile. Less volatile trends are easier to hold, more volatile trends are more difficult unless we focus on the directional trend.

Tech Sector Trend

Below is the U.S. Healthcare sector. It’s down, but not out. It’s still so far holding a higher low.

healthcare sector

The really weak markets that have been in more clear downtrends are the commodity related sectors like Energy and Basic Materials.  This could signal the beginning of a larger move down in other sectors if they follow, or not. But if we focus on “what’s in our boat” we are focused only on our own positions.

Energy Sector basic materials

The key to tactical decision-making is sometimes holding exposure to potentially positive trends and giving them room to see how they unfold: up or down. The other key is avoiding the clearest downtrends. Then, there comes a point when those trends change and reverse. Even the downtrends eventually become uptrends. We can be assured after that happens everyone will wish they had some exposure to it!

Never knowing for sure what will happen next it always involves uncertainty and the potential for a loss we must be willing to bear. I think the edge is predefining risk by knowing at what point to exit if the trend has really changed, accepting that, then letting it all unfold.

 

Extreme Fear is Now Driving Markets

On October 27th I wrote in Fear and Greed is Shifting and Models Don’t Avoid the Feelings that:

The CNN Fear & Greed Index shows investor fear and greed shifted to Extreme Fear a month ago as the popular U.S. stock indexes dropped about -12% or more. Many sectors and other markets were worse. Since then, as prices have been trending back up, Greed is now the driver again. I believe fear and greed both drives market prices but also follows price trends. As prices move lower and lower, investors who are losing money get more and more afraid of losing more. As prices move higher and higher, investors get more and more greedy. If they have reduced exposure to avoid loss, they may fear missing out.

Since global markets declined around August and some markets recovered much of their losses by November, global markets have declined again. Below are charts of U.S. stocks, International stocks, U.S. bonds, and commodities. Even the iShares iBoxx $ Investment Grade Corporate Bond ETF that seeks to track the investment results of an index composed of U.S. investment grade corporate bonds is near -8% from its peak. Small and mid companies U.S. stocks are down more than -20% from their peak. Commodities and emerging countries are down the most.

global markets 2016-01-15_13-59-45.jpg

This all started with investors being optimistic in late October as I mentioned in Fear and Greed is Shifting and Models Don’t Avoid the Feelings. So, it is no surprise that today is just the opposite. As markets have declined investors become more and more fearful. As of now, Extreme Fear is the driver of the market.  Below is the current reading of the CNN Fear & Greed Index.

Fear and Greed Index

Source: CNN Fear & Greed Index 

As you see in the chart below, it’s now getting close to the Extreme Fear levels that often signal at least a short-term low.

Fear and Greed Over Time

Another publicly available measure of investor sentiment is the AAII Investor Sentiment Survey. The AAII Investor Sentiment Survey measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market for the next six months; individuals are polled from the ranks of the AAII membership on a weekly basis. The most recent weekly survey shows investors are very bearish and again, such pessimism occurs after price declines and at such extremes sometimes precedes a reversal back up.

Survey Results for Week Ending 1/13/2016

AAII Investor Sentiment January 2016

Source: AAII Investor Sentiment Survey

I say again what I said in October: This is the challenge in bear markets. In a bear market, market prices swing up and down along the way. It’s these swings that lead to mistakes. Above was a chart of how the Fear and Greed Index oscillates to high and low points over time. Investors who experience these extremes in emotion have the most trouble and need to modify their behavior so they feel the right feeling at the right time. Or, hire a manager with a real track record who can do it for them and go do something more enjoyable.

The public, as a whole, buys at the wrong time and sells at the wrong time. The average operator, when he sees two or three points profit, takes it; but, if a stock goes against him two or three points, he holds on waiting for the price to recover, with oftentimes, the result of seeing a loss of two or three points run into a loss of ten points.”

idowcha001p1

Charles Dow 

(November 6, 1851 – December 4, 1902) was an American journalist who co-founded Dow Jones & Company

Fear and Greed is Shifting and Models Don’t Avoid the Feelings

Investors are driven by fear and greed. That same fear and greed drives market prices. It’s Economics 101 “Supply and Demand”. Greed drives demand, fear drives selling pressure. In fact, investors are driven by the fear of losing more money when their account is falling and fear missing out if they have cash when markets go up. Most investors tend to experience a stronger feeling from losing money than they do missing out. Some of the most emotional investors oscillate between the fear of missing out and the fear of losing money. These investors have to modify their behavior to avoid making mistakes. Quantitive rules-based systematic models don’t remove the emotion.

Amateur portfolio managers who lack experience sometimes claim things like: “our quantitive rules-based systematic models removes the emotion”. That couldn’t be further from the truth. Those who believe that will eventually find themselves experiencing feelings from their signals they’ve never felt before. I believe it’s a sign of high expectations and those expectations often lead to even stronger reactions. It seems it’s the portfolio managers with very little actual performance beyond a backtest that make these statements. They must believe a backtested model will act to medicate their feelings, but it doesn’t actually work that way. I believe these are the very people who over optimize a backtest to make it perfectly fit historical data. We call it “curve-fitting” or “over-fitting”, but it’s always “data mining”. When we backtest systems to see how they would have acted in the past, it’s always mining the data retroactively with perfect hindsight. I’ve never had anyone show me a bad backtest. If someone backtests entry and exit signals intended to be sold as a managed portfolio you can probably see how they may be motivated to show the one that is most optimized to past data. But, what if the future is very different? When it doesn’t work out so perfectly, I think they’ll experience the very feelings they wish to avoid. I thought I would point this out, since many global markets have been swinging up and down. I’m guessing some may be feeling their feelings.

The CNN Fear & Greed Index shows investor fear and greed shifted to Extreme Fear a month ago as the popular U.S. stock indexes dropped about -12% or more. Many sectors and other markets were worse. Since then, as prices have been trending back up, Greed is now the driver again. I believe fear and greed both drives market prices but also follows price trends. As prices move lower and lower, investors who are losing money get more and more afraid of losing more. As prices move higher and higher, investors get more and more greedy. If they have reduced exposure to avoid loss, they may fear missing out.

CNN Fear and Greed IndexSource: http://money.cnn.com/data/fear-and-greed/

This is the challenge in bear markets. In a bear market, market prices swing up and down along the way. It’s these swings that lead to mistakes. Below is a chart of how the Fear and Greed Index oscillates to high and low points over time. Investors who experience these extremes in emotion have the most trouble and need to modify their behavior so they feel the right feeling at the right time. Or, hire a manager with a real track record who can do it for them and go do something more enjoyable.

Fear and Greed Over time investor sentiment

Source: http://money.cnn.com/data/fear-and-greed/

The four most dangerous words…

Every new moment is necessarily unique – we’ve never been “here” before. Probabilities and potential payoffs change based on the stage of the trend or cycle. For example, the current decline in stocks is no surprise, given the stage and magnitude of the prior trends. A few see evidence of the early stages of a bigger move, others believe it’s different this time. We’ll see how it all unfolds. I don’t have to know what’s going to happen next – I am absolutely certain of what I will do given different conditions.

To quote from fellow Tennessean, Sir John Templeton:

“The four most dangerous words in investing are, it’s different this time.”

Sir John Templeton

Sir John Templeton

source: http://www.templeton.org

The markets always go back up?

Someone recently said: “the markets always go back up!”.

I replied: “Tell that to the Japanese”.

The chart below speaks for itself. Japan was the leading country up until 1990. The NIKKEI 225, the Japanese stock market index, has been in a “Secular Bear Market” for about 25 years now. I believe all markets require active risk management. I suggest avoiding any strategy that requires a market “always go back up” because it is possible that it may not. Or, it may not in your lifetime

Long Term Japan Stock Market Index NIKKEI

Source: http://www.tradingeconomics.com/japan/stock-market

PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS. Investing involves risk a client must be willing to bear.

Gold Isn’t Always A Hedge or Safe Haven: Gold Stock Trends Have Been Even Worse

For several years we often heard investors suggesting to “buy gold”. We could throw in Silver here, too. They provide many theories about how gold bullion or gold stocks are a “safe haven”. I’ve written about the same assumption in Why Dividend Stocks are Not Always a Safe Haven.

In fact, the Market Vectors Gold Miners ETF website specifically says about the gold stock sector:

“A sector that has historically provided a hedge against extreme volatility in the general financial markets”.

Source: http://www.vaneck.com/gdx/

When investors have expectations about an outcome, or expect some cause and effect relationship, they expose themselves in the possibility of a loss trap. I will suggest the only true “safe haven” is cash. 

Below is a 4 year chart of two gold stock ETFs relative to the Gold ETF. First, let’s examine the index ETFs we are looking at. Of course, the nice thing about ETFs in general is they are liquid (traded like a stock) and transparent (we know what they hold).

GLD: SPDR Gold “Shares offer investors an innovative, relatively cost efficient and secure way to access the gold market. SPDR Gold Shares are intended to offer investors a means of participating in the gold bullion market without the necessity of taking physical delivery of gold, and to buy and sell that interest through the trading of a security on a regulated stock exchange.”

GDX: Market Vectors Gold Miners ETF: “The investment seeks to replicate as closely as possible, before fees and expenses, the price and yield performance of the NYSE Arca Gold Miners Index. The fund normally invests at least 80% of its total assets in securities that comprise the Gold Miners Index. The Gold Miners Index is a modified market-capitalization weighted index primarily comprised of publicly traded companies involved in the mining for gold and silver.”

GDXJ: Market Vectors Junior Gold Miners ETF seeks to replicate as closely as possible, before fees and expenses, the price and yield performance of the Market Vectors Global Junior Gold Miners Index. The Index is intended to track the overall performance of the gold mining industry, which may include micro- and small capitalization companies.

Gold stocks vs Gold

Source: Shell Capital Management, LLC created with http://www.stockcharts.com

Clearly, gold has not been a “safe haven” or “provided a hedge against extreme volatility in the general financial markets”. It has instead demonstrated its own extreme volatility within an extreme downward price trend.

Further, gold mining stocks have significantly lagged the gold bullion index itself.

These ETFs have allowed for the trading of gold and gold stocks, SPDR Gold explains it well:

“SPDR Gold Shares represent fractional, undivided beneficial ownership interests in the Trust, the sole assets of which are gold bullion, and, from time to time, cash. SPDR Gold Shares are intended to lower a large number of the barriers preventing investors from using gold as an asset allocation and trading tool. These barriers have included the logistics of buying, storing and insuring gold.”

However, this is a reminder that markets do not always play out as expected. The expectation of a “safe haven” or “hedge against extreme volatility” is not a sure thing. Markets may end up much worst that you imagined they could.  As many global and U.S. markets have been declining, you can probably see why I think it’s important to manage, direct, limit, and control exposure to loss. Though, not everyone does it well. It isn’t a sure thing…

______

For informational and educational purposes only, not a recommendation to buy or sell and security, fund, or strategy. Past performance and does not guarantee future results. Please click the links provide for specific risk information about the ETFs mentioned. Please visit this link for important disclosures, terms, and conditions.

The person who says it cannot be done should not interrupt the person doing it.

– Chinese Proverb

The person who says it cannot be done Should not interupt the person doing it

Source: https://www.pinterest.com/explore/chinese-proverbs/

Uncharted Territory from the Fed Buying Stocks

I remember sometime after 2013 I told someone “The Fed is buying stocks and that’s partly why stocks have risen so surprisingly for so long”. He looked puzzled and didn’t seem to agree, or understand.

The U.S. Federal Reserve (the “Fed”) has been applying “quantitative easing” since the 2007 to 2009 “global financial crisis”. Quantitative easing (QE) is a type of monetary policy used by central banks to stimulate the economy when standard monetary policy has become ineffective. The Fed implements quantitative easing by buying financial assets from banks and other financial institutions. That raises the prices of those financial assets and lowers their interest rate or yield. It also increases the amount of money available in the economy. The magnitude they’ve done this over the past seven years has never been experience before. They are in uncharted territory.

I was reminded of what I said, “the Fed is buying stocks” when I read comments from Bill Gross in “Gross: Fed Slowly Recognizing ZIRP Has Downside Consequences”. He says companies are using easy money to buy their own stock:

Low interest rates have enabled Corporate America to borrow hundreds of billions of dollars “but instead of deploying the funds into the real economy,they have used the proceeds for stock buybacks. Corporate authorizations to buy back their own stock are running at an annual rate of $1.02 trillion so far in 2015, 18 percent above 2007’s record total of $863 billion, Gross said.

You see, if we want to know the truth about market dynamics; we necessarily have to think more deeply about how markets interact. Market dynamics aren’t always simple and obvious. I said, “The Fed is buying stocks” because their actions is driving the behavior of others. By taking actions to increase money supply in the economy and keep extremely low borrowing rates, the Fed has been driving demand for stocks.

But, it isn’t just companies buying their own stock back. It’s also investors buying stocks on margin. Margin is borrowed money that is used to purchase securities. At a brokerage firm it is referred to as “buying on margin”. For example, if we have $1 million in a brokerage account, we could borrow another $1 million “on margin” and invest twice as much. We would pay interest on the “margin loan”, but those rates have been very low for years. Margin interest rates have been 1 – 2%. You can probably see the attraction. If we invested in lower risk bonds earning 5% with $1 million, we would normally earn 5%, or $50,000 annually. If we borrowed another $1 million at 2% interest and invested the full $2 million at 5%, we would earn another 3%, or $30,000. The leverage of margin increased the return to 8%, or $80,000. Of course, when the price falls, the loss is also magnified. When the interest rate goes up, it reduces the profit. But rates have stayed low for so long this has driven margin demand.

While those who have their money sitting in in bank accounts and CDs have been brutally punished by near zero interest rates for many years, aggressive investors have borrowed at those low rates to magnify their return and risk in their investments. The Fed has kept borrowing costs extremely low and that is an incentive for margin.

In the chart below, the blue line is the S&P 500 stock index. The red line is NYSE Margin Debt. You may see the correlation. You may also notice that recessions (the grey area) occur after stock market peaks and high margin debt balances. That’s the downside: margin rates are at new highs, so when stocks do fall those investors will either have to exit their stocks to reduce risk or they’ll be forced to exit due to losses. If they don’t have a predefined exit, their broker has one for them: “a margin call”.

Current Margin Debt Stock MarginSource: http://www.advisorperspectives.com/dshort/charts/markets/nyse-margin-debt.html?NYSE-margin-debt-SPX-since-1995.gif

If you noticed, I said, “They are in uncharted territory”. I am not. I am always in uncharted territory, so I never am. I believe every new moment is unique, so I believe everyone is always in uncharted territory. Because I believe that, I embrace it. I embrace uncertainty and prepare for anything that can happen. It’s like watching a great movie. It would be no fun if we knew the outcome in advance.

 

Human judgment, good and bad, will drive investment decisions and financial-market outcomes for the rest of our lives and beyond.

Source:  http://www.project-syndicate.org/commentary/will-computer-algorithms-replace-humans-in-financial-markets-by-robert-j–shiller-2015-07#hmXdmoDjMyvHOw9U.99

Why So Stock Market Focused?

Most investors and their advisors seem to speak mostly about the stock market. When they mention “the market” and I ask “what market?” they always reply “the stock market”.

Why so stock market centric?

It must be that it gets the most media attention or stocks seem more exciting?. After all, other markets like bonds may seem boring and few know much about the many commodities markets or the foreign exchange markets. There are many different markets and two sides to them all.

If it’s risk-adjusted returns you want, you may be surprised to find where you should have invested your money the past 15 years. To make the point, below is a comparison of the total return of the Vanguard S&P 500 stock index (the orange line) compared to the Vanguard Bond Index (the blue line). Yes, you are seeing that correctly. Using these simple index funds as a proxy, bonds have achieved the same total return as stocks, but with significantly less volatility and drawdowns. This is why we never look at just “average” return data without considering the path it took to get there. A total return percentage gain chart like this one presents a far more telling story. Take a close look at the path they took.

stocks vs. bonds

Created with http://www.ycharts.com

I showed the chart to one investment advisor who commented “It looks like the stock market is catching up”. If that’s what you think of when you view the chart, you may have a bias blind spot: ignoring the vast difference in the risk between the two markets.

Looking at the total return over the period identifies the obvious difference in the path the two return streams took to achieve their results, but below we see the true risk difference. Drawdowns are declines from a higher value to a low value and a visual representation of how long it took to recover the lose of capital. When we observe a drawdown chart like the one below, it’s like a lake. These charts together also help illustrate the flaw of averages. The average return of the stock and bond index have ended at about the same level and have the same average return, but the bond index achieved it with much less drawdown. You wouldn’t know that if you only looked at average returns. If you tried to walk across the stock market lake, you may have drowned if you couldn’t handle swimming in 40′ of water for so long. If that one didn’t get you, the 55′ may have. The stock index declined about -40% from 2000 – 2002 and took years to recover before it declined -55%.

stock and bond market risk historical drawdowns

Created with http://www.ycharts.com

You have to be wondering: why didn’t you just invest in bonds 15 years ago? Maybe you were focused on the prior period huge average returns in stocks?

Before I continue, let me place a very bold disclaimer here: PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. Another way that is stated is that PAST PERFORMANCE IS NO ASSURANCE OF FUTURE RESULTS. One more version is PAST PERFORMANCE MAY NOT BE AN INDICATION OF FUTURE RESULTS. If you remember, the 1990’s were a roaring bull market in stocks. People focus on the past expecting it to continue. That’s probably why you never thought to invest in bonds instead of stocks.

Some of the largest and most successful hedge funds in the world have done that very thing over this period and longer. But, they didn’t just invest in bonds. They leveraged bonds. We’ve seen in this example that a bond index fund has achieved just as much total return as stocks. If you are a stock market centric investor: one that likes the stock market and makes it your focus, then you necessarily had to be willing to endure those -40% to -55% declines and wait many years to recover from the losses. If you are really willing to accept such risk, imagine if you had used margin to leverage bonds. The bond index rarely declined -10% or more. It was generally a falling interest rate period, so bonds gained value. If you were willing to accept -40% to -55% declines in stocks, you could have instead leveraged the bonds 400% or 500%. If you had done that, your return would be 4 or 5 times more with a downside more equal to that of stocks.

Why so stock centric?

Of course, at this stage, the PAST PERFORMANCE IS HIGHLY UNLIKELY TO REPEAT INTO THE FUTURE. Just as the roaring stocks of the 1990’s didn’t repeat. To see why, read Stage and Valuation of the U.S. Stock Market and Bonds: The Final Bubble Frontier?.

From my observations of investors performance and their advisors, most people seem to have poor results the past decade or so, even after this recent bull market. An investment management consultant told me recently that investors and their advisors who are aware of the current stage of stocks and bonds feel there is no place to turn. I believe it’s a very important time to prepare to row, not sail. For me, that means focus on actively managing risk and look for potentially profitable trends across a very global universe of markets; currency, bonds, stocks, commodities, and alternatives like volatility, inverse, etc . That’s my focus in ASYMMETRY® | Managed Accounts.

The Volatility Index (VIX) is Getting Interesting Again

In the last observation I shared on the CBOE Volatlity index (the VIX) I had been pointing out last year the VIX was at a low level and then later started trending up. At that time, many volatility traders seemed to think it was going to stay low and keep going lower – I disagreed. Since then, the VIX has remained at a higher average than it had been – up until now. You can read that in VIX® gained 140%: Investors were too complacent.

Here it is again, closing at 12.45 yesterday, a relatively low level for expected volatility of the S&P 500 stocks. Investors get complacent after trends drift up, so they don’t price in so much fear in options. Below we observe a monthly view to see the bigger picture. The VIX is getting down to levels near the end of the last bull market (2007). It could go lower, but if you look closely, you’ll get my drift.

Chart created by Shell Capital with: http://www.stockcharts.com

Next, we zoom in to the weekly chart to get a loser look.

Chart created by Shell Capital with: http://www.stockcharts.com

Finally, the daily chart zooms in even more.

Chart created by Shell Capital with: http://www.stockcharts.com

The observation?

Options traders have priced in low implied volatility – they expect volatility to be low over the next month. That is happening as headlines are talking about stock indexes hitting all time highs. I think it’s a sign of complacency. That’s often when things change at some point.

It also means that options premiums are generally a good deal (though that is best determined on an individual security basis). Rather than selling premium, it may be a better time to buy it.

Let’s see what happens from here…

Conflicted News

This is a great example of conflicted news. Which news headline is driving down stock prices today?

Below is a snapshot from Google Finance::

conflicted news 2015-04-17_10-21-43

Trying to make decisions based on news seems a very conflicted way, which is why I instead focus on the absolute direction of price trends.

Asymmetric Nature of Losses and Loss Aversion

Loss Aversion:

“In prospect theory, loss aversion refers to the tendency for people to strongly prefer avoiding losses than acquiring gains. Some studies suggest that losses are as much as twice as psychologically powerful as gains. Loss aversion was first convincingly demonstrated by Amos Tversky and Daniel Kahneman.”

For most people, losing $100 is not the same as not winning $100. From a rational point of view are the two things the same or different?

Most economists say the two are the same. They are symmetrical. But I think that ignores some key issues.

If we have only $10 to eat on today and that’s all we have, if we lose it, we’ll be in trouble: hungry.

But if we have $10 to eat on and flip a coin in a bet and double it to $20, we may just eat a little better. We’ll still eat. The base rate: survival.

They say rationally the two are the same, but that isn’t true. They aren’t the same. The loss makes us worse off than we started and it may be totally rational to feel worse when we go backward than we feel good about getting better off. I don’t like to go backward, I prefer to move forward to stay the same.

Prospect Theory, which found people experience a loss more than 2 X greater than an equal gain, discovered the experience of losses are asymmetric.

Actually, the math agrees.

You see, losing 50% requires a 100% gain to get it back. Losing it all is even worse. Losses are indeed asymmetric and exponential on the downside so it may be completely rational and logical to feel the pain of losses asymmetrically. Experience the feeling of loss aversions seems to be the reason a few of us manage investment risk and generate a smoother return stream rather than blow up.

To see what the actual application of asymmetry to portfolio management looks like, see: Shell Capital Management, LLC.

 

asymmetry impact of loss

“We like what’s familiar, and we dislike change. So, we push the familiar until it starts working against us big-time—a crisis. Then, MAYBE we can accept change.”

—Kevin Cameron (Journalist, Cycle World April 2013)

Confirmation Bias: The tendency to search for, interpret, focus on and remember information in a way that confirms one’s preconceptions.

“It is impossible to produce a superior performance unless…

Sir John Templeton

source: http://www.templeton.org

A great quote from my fellow Tennessean, Sir John Templeton:

“It is impossible to produce a superior performance unless you do something different from the majority.”

Sir John Templeton

US Government Bonds Rise on Fed Rate Outlook?

I saw the following headline this morning:

US Government Bonds Rise on Fed Rate Outlook

Wall Street Journal –

“U.S. government bonds strengthened on Monday after posing the biggest price rally in more than three months last week, as investors expect the Federal Reserve to take its time in raising interest rates.”

My focus is on directional price trends, not the news. I focus on what is actually happening, not what people think will happen. Below I drew a 3 month price chart of the 20+ Year Treasury Bond ETF (TLT), I highlighted in green the time period since the Fed decision last week. You may agree that most of price action and directional trend changes happened before that date. In fact, the long-term bond index declined nearly 2 months before the decision, increased a few weeks prior, and has since drifted what I call “sideways”.

fed decision impact on bonds
Charts created with http://www.stockcharts.com

To be sure, in the next chart I included an analog chart including the shorter durations of maturity. iShares 3-7 Year Treasury Bond ETF (IEI) and iShares 7-10 Year Treasury Bond ETF (IEF). Maybe there is some overreaction and under-reaction going on before the big “news”, if anything.

Government bonds Fed decision reaction
Do you still think the Fed news was “new information“?

Fed Decision and Market Reaction: Stocks and Bonds

So, I’m guessing most people would expect if the Fed signaled they are closer to a rate hike the stock and bond markets would fall. Rising interest rates typically drive down stocks along with bonds. Not the case as of 3pm today. Stocks were down about -1% prior to the announcement, reversed, and are now positive 1%. Even bonds are positive. Even the iShares Barclays 20+ Yr Treas.Bond (ETF) is up 1.4% today.

So much for expectations…

Below is snapshot of the headlines and stock price charts from Google Finance:

Fed Decision and Reaction March 18 2015

Source: https://www.google.com/finance?authuser=2

Diversification Alone is No Longer Sufficient to Temper Risk…

That was the lesson you learned the last time stocks became overvalued and the stock market entered into a bear market.

In a Kiplinger article by Fred W. Frailey interviewed Mohamed El-Erian, the PIMCO’s boss, (PIMCO is one of the largest mutual fund companies in the world) he says “he tells how to reduce risk and reap rewards in a fast-changing world.” This article “Shaking up the Investment Mix” was written in March 2009, which turned out the be “the low” of the global market collapse.

It is useful to revisit such writing and thoughts, especially since the U.S. stock market has since been overall rising for 5 years and 10 months. It’s one of the longest uptrends recorded and the S&P 500 stock index is well in “overvalued” territory at 27 times EPS. At the same time, bonds have also been rising in value, which could change quickly when rates eventually rise. At this stage of a trend, asset allocation investors could need a reminder. I can’t think of a better one that this:

Why are you telling investors they need to diversify differently these days?

The traditional approach to diversification, which served us very well, went like this: Adopt a diversified portfolio, be disciplined about rebalancing the asset mix, own very well-defined types of asset classes and favor the home team because the minute you invest outside the U.S., you take on additional risk. A typical mix would then be 60% stocks and 40% bonds, and most of the stocks would be part of Standard & Poor’s 500-stock index.

This approach is fatigued for several reasons. First of all, diversification alone is no longer sufficient to temper risk. In the past year, we saw virtually every asset class hammered. You need something more to manage risk well.

But, you know, they say a picture is worth a thousand words.

Since we are talking about downside risk, something that is commonly hidden when only “average returns” are presented, below is a drawdown chart. I created the drawdown chart using YCharts which uses total return data and the “% off high”. The decline you see from late 2007 to 2010 is a dradown: it’s when the investment value is under water. Think of this like a lake. You can see how the average of the data wouldn’t properly inform you of what happens in between.

First, I show PIMCO’s own allocation fund: PALCX: Allianz Global Allocation Fund. I include an actively managed asset allocation that is very large and popular with $55 billion invested in it: MALOX: BlackRock Global Allocation. Since there are many who instead believe in passive indexing and allocation, I have also included DGSIX: DFA Global Allocation 60/40 and VBINX: Vanguard Balanced Fund. As you can see, they have all done about the same thing. They declined about -30% to -40% from October 2007 to March 2009. They also declined up to -15% in 2011.

Vanguard DFA BlackRock PIMCO Asset Allcation

Charts are courtesy of http://ycharts.com/ drawn by Mike Shell

Going forward, the next bear market may be very different. Historically, investors consider bond holdings to be a buffer or an anchor to a portfolio. When stock prices fall, bonds haven’t been falling nearly as much. To be sure, I show below a “drawdown chart” for the famous actively managed bond fund PIMCO Total Return and for the passive crowd I have included the Vanguard Total Bond Market fund. Keep in mind, about 40% of the allocation of the funds above are invested in bonds. As you see, bonds dropped about -5% to -7% in the past 10 years.

PIMCO Total Return Bond Vanguard Total Bond

Charts are courtesy of http://ycharts.com/ drawn by Mike Shell

You may have noticed the end of the chart is a drop of nearly -2%. Based on the past 10 years, that’s just a minor decline. The trouble going forward is that interest rates have been in an overall downtrend for 30 years, so bond values have been rising. If you rely on bonds being a crutch, as on diversification alone, I agree with Mohamed El-Erian the Chief of the worlds largest bond manager:

“…diversification alone is no longer sufficient to temper risk. In the past year, we saw virtually every asset class hammered. You need something more to manage risk well.”

But, don’t wait until AFTER markets have fallen to believe it.

Instead, I apply active risk management and directional trend systems to a global universe of exchange traded securities (like ETFs). To see what that looks like, click: ASYMMETRY® Managed Accounts

Illusion of Control

illusion_of_control

“The illusion of control is the tendency for people to overestimate their ability to control events; for example, it occurs when someone feels a sense of control over outcomes that they demonstrably do not influence.”

Source: http://en.wikipedia.org/wiki/Illusion_of_control

This is When MPT and VaR Get Asset Allocation and Risk Measurement Wrong

This is When MPT and VaR Get Asset Allocation and Risk Measurement Wrong

I was talking to an investment analyst at an investment advisory firm about my ASYMMETRY® Managed Account and he asked me what the standard deviation was for the portfolio. I thought I would share with you and explain this is how the industry gets “asset allocation” and risk measurement and management wrong. You see, most people have poor results over a full market cycle that includes both rising and falling price trends, like global bull and bear markets, recessions, and expansions. Quantitative Analysis of Investor Behavior, SPIVA, Morningstar, and many academic papers have provided empirical evidence that most investors (including professionals) have poor results over the long periods. For example, they may earn gains in rising conditions but lose their gains when prices decline. I believe the reason is they get too aggressive at peaks and then sell in panic after losses get too large, rather than properly predefine and manage risk.

You may consider, then, to have good results over a long period, I necessarily have to believe and do things very different than most people.

On the “risk measurement” topic, I thought I would share with you a very important concept that is absolutely essential for truly actively controlling loss. The worst drawdown “is” the only risk metric that really matters. Risk is not the loss itself. Once we have a loss, it’s a loss. It’s beyond the realm of risk. Since risk is the possibility of a loss, then how often it has happened in the past and the magnitude of the historical loss is the mathematical expectation. Beyond that, we must assume it could be even worse some day. For example, if the S&P 500 stock index price decline was -56% from 2007 to 2009, then we should expect -56% is the loss potential (or worse). When something has happened before, it suggests it is possible again, and we may have not yet observed the worst decline in the past that we will see in the future.

The use of standard deviation is one of the very serious flaws of investors attempting to measure, direct, and control risk. The problem with standard deviation is that the equation was intentionally created to simplify data. The way it is used draws a straight line through a group of data points, which necessarily ignores how far the data really spreads out. That is, standard deviation is intended to measure how far the data spreads out, but it actually fails to absolutely highlight the true high point and low point. Instead, it’s more of an average of those points. Yet, it’s the worst-case loss that we really need to focus on. I believe in order to direct and control risk, I must focus on “how bad can it really get”. Not just “on average” how bad it can get. The risk in any investment position is at least how much it has declined in the past. And realizing it could be even worse some day. Standard deviation fails to reflect that in the way it is used.

Consider that as prices trend up for years, investors become more and more complacent. As investors become complacent, they also become less indecisive as they believe the recent past upward trend will continue, making them feel more confident. On the other hand, when investors feel unsure about the future, their fear and indecisiveness is reflected as volatility as the price churns up and down more. We are always unsure about the future, but investors feel more confident the past will continue after trends have been rising and volatility gets lower and lower. That is what a peak of a market looks like. As it turns out, that’s just when asset allocation models like Modern Portfolio Theory (MPT) and portfolio risk measures like Value at Risk (VaR) tell them to invest more in that market – right as it reaches it’s peak. They invest more, complacently, because their allocation model and risk measures tell them to. An example of a period like this was October 2007 as global stock markets had been rising since 2003. At that peak, the standard deviation was low and the historical return was at it highest point, so their expected return was high and their expected risk (improperly measured as historical volatility) was low. Volatility reverses the other way at some point

What happens next is that the market eventually peaks and then begins to decline. At the lowest point of the decline, like March 2009, the global stock markets had declined over -50%. My expertise is directional price trends and volatility, so I can tell you from empirical observation that prices drift up slowly, but crash down quickly. The below chart of the S&P 500 is a fine example of this asymmetric risk.

stock index asymmetric distribution and losses

Source: chart is drawn by Mike Shell using http://www.stockcharts.com

At the lowest point after prices had fallen over -50%, in March 2009, the standard deviation was dramatically higher than it was in 2007 after prices had been drifting up. At the lowest point, volatility is very high and past return is very low, telling MPT and VaR to invest less in that asset.

In the 2008 – 2009 declining global markets, you may recall some advisors calling it a “6 sigma event”. That’s because the market index losses were much larger than predicted by standard deviation. For example, if an advisors growth allocation had an average return of 10% in 2007 based on its past returns looking back from the peak and a standard deviation of 12% expected volatility, they only expected the portfolio would decline -26% (3 standard deviations) within a 99.7% confidence level – but the allocation actually lost -40 or -50%. Even if that advisor properly informed his or her client the allocation could decline -26% worse case and the client provided informed consent and acceptance of that risk, their loss was likely much greater than their risk tolerance. When the reach their risk tolerance, they “tap out”. Once they tap out, when do they ever get back in? do they feel better after it falls another -20%? or after it rises 20%? There is no good answer. I want to avoid that situation.

You can see in the chart below, 3 standard deviations is supposed to capture 99.7% of all of the data if the data is a normal distribution. The trouble is, market returns are not a normal distribution. Instead, their gains and losses present an asymmetrical return distribution. Market returns experience much larger gains and losses than expected from a normal distribution – the outliers are critical. However, those outliers don’t occur very often: maybe every 4 or 5 years, so people have time to forget about the last one and become complacent.

symmetry normal distribution bell curve black

Source: http://en.wikipedia.org/wiki/68%E2%80%9395%E2%80%9399.7_rule

My friends, this is where traditional asset allocation like Modern Portfolio Theory (MPT) and risk measures like Value at Risk (VaR) get it wrong. And those methods are the most widely believed and used . You can probably see why most investors do poorly and only a very few do well – an anomaly.

I can tell you that I measure risk by how much I can lose and I control my risk by predefining my absolute risk at the point of entry and my exit point evolves as the positions are held. That is an absolute price point, not some equation that intentionally ignores the outlier losses.

As the stock indexes have now been overall trending up for 5 years and 9 months, the trend is aged. In fact, according to my friend Ed Easterling at Crestmont Research, at around 27 times EPS the stock index seems to be in the range of overvalued. In his latest report, he says:

“The stock market surged over the past quarter, adding to gains during 2014 that far exceed underlying economic growth. As a result, normalized P/E increased to 27.2—well above the levels justified by low inflation and interest rates. The current status is approaching “significantly overvalued.”

At the same time, we shouldn’t be surprised to eventually see rising interest rates drive down bond values at some point. It seems from this starting point that simply allocating to stocks and bonds doesn’t have an attractive expected return. I believe a different strategy is needed, especially form this point forward.

In ASYMMETRY® Global Tactical, I actively manage risk and shift between markets to find profitable directional price trends rather than just allocate to them. For more information, visit http://www.asymmetrymanagedaccounts.com/global-tactical/

 

Tomorrow’s Newspaper: the Future, Part One

People often ask me questions of the future. I guess they figure I have such a strong track record, I must know something about the future.

I paused my time machine, the rest of the world stopped; I took one step forward to see what happens next.

Here is what I saw:

Tomorrows Newspaper What the Future Looks LIke

Source: The Future: a period that doesn’t yet exist.

If anyone sees anything different please take a picture, come back here, now, and post it in the comments for all of us to see.

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