The stock market trends up with momentum

When the stock market indexes swing up or down 1% or more I try to share my observations of the directional trend and changes in volatility. Continuing from my observation yesterday in Observations of the stock market decline and volatility expansion when I shared:

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

We’ll see.

Well, today we saw.

The U. S. stock market gains were broad across all sectors. Communication Services, Consumer Discretionary, Healthcare, and Technology were the relative momentum leaders.

stock market trend sector ETF momentum

Continuing with the % of S&P 500 stocks above their 50 day moving average as breadth indicator was another indication of broad upward momentum. 86% more stocks are trading above their shorter-term trend, an expansion from a low level. For those of us who like to enter trends early in their stage, this is a positive sign of improvement for the stock market.

percent of stocks above below 50 day moving average trend following momentum

We observe the same in the percent of stocks trending back above their longer-term trends. There was a 16% expansion in the stocks in the S&P 500 index trending above their 200 day moving average. The longer-term trend indicators are slower to respond, but this is more evidence of positive directional movement.

stock momentum percent of stocks above 200 day moving average trend following asymmetric

This is happening at a time when many investor sentiment indicators suggest fear has been driving stocks recently. A simple example is the Fear & Greed Index, which reached “Extreme Fear” a week ago.

CNN FEAR GREED INDEX SENTIMENT

As a portfolio manager for the past two decades, I have observed investor sentiment oscillate between fear and greed, but as a contrarian pendulum. Most investors feel the wrong feeling at the wrong time.

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

What happens, though, is market trends move in multiple time frames of cycles up and down. Prices can overreact to the upside and downside and the majority of investors seem to get it wrong.

The level and direction of implied volatility is an indication of investor sentiment. I’ve shared my observations of the volatility expansion and noted some volatility contraction yesterday. So far, the volatility expansion has reversed to contraction, so the expected volatility as implied by options prices now suggests the market expects lower volatility in the weeks ahead.

VIX VOLATILITY CONTRACTION EXPANSION ASYMMETRIC RISK HEDGE ASYMMETRY

But, just as I pointed out on September 25th in VIX level shows market’s expectation of future volatility implied volatility can get it wrong. I pointed out then the implied volatility was very low signaling to me the market may have been wrong to expect such low future volatility, so it can reverse back up again.

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

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

 

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

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

U. S. Sector Trends

Yesterday I shared my observations of the overall stock market in The Stock Market Trend. Here are my observations of U. S. Sector trends to see which sectors are trending, which sectors have experienced declining momentum, and where they are year-to-date. Keep in mind, I use the actual index ETFs for observations since they represent real-world price trends including expenses, none of this is advice to buy or sell any of them for anyone.

Below are the sector trends year-to-date.

SECTOR ETF TRENDS TREND FOLLOWING MOMENTUM RELATIVE STRENGTH

Ok, I know that looks like a hurricane spaghetti chart to show potential cyclone paths, so here is a table showing the year-to-date price trends using the Select Sector SPDRs. In 2018, Healthcare, Consumer Discretionary, and Technology are still the leading sectors. I’ll point out the divergence with sectors like Basic Materials and Consumer Staples lagging in relative momentum.

SECTOR ETF MOMENTUM TREND FOLLOWING

A more interesting view is a visual observation of drawdowns year to date and recently. Here, we see that Basic Materials, Communication Services, Financials, and Consumer Staples are down over -10% from their highs.

dradown stock market year to date

For a stock market decline to stop and reverse, it has to reach a low enough point to attract enough buying demand to support higher prices.

The good news is the stock indexes, and many of these sectors are testing their longer-term trend lines. At the same time, they are reaching a point we could see at least a short-term reversal up from here.

Only time will tell if the recent price declines are just a correction in an ongoing uptrend in the U. S. stock market or the beginning of a more significant downtrend.

As a portfolio manager, I am a risk manager and risk taker.

The only way to create gains is to take some risk. The way to manage risk is to predefine how much I’m willing to lose in advance. My focus is on asymmetric risk/return. So, my objective is to take a risk when it is more likely to result in positive asymmetry.

The essential parts necessary to create asymmetric risk/return are:

Risk manager: decide in advance at what price to exit as a declining trend to manage the size of the loss. Determine how much of our portfolio we are willing to lose to see if price trends will become profitable.

Risk taker: decide when to enter a position to take that predefined risk to see if the potentially profitable trend unfolds in our favor to become a profit.

You can probably see how these market cycles and trends create both the potential for risks and rewards and we can decide how to tactically operate with them.

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

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

 

The Stock Market Trend

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

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

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

stock market decline 2008

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

average length of bear market crash 2008.jpg

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

stock market sector ETF October 10 2018

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

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

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

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

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

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

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

SPX BREADTH PERCENT OF STOCKS ABOVE 200 DAY MOVING AVERAGE

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

stock market SPX 200 day moving average trend following

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

stock market year to date 2018 trend following momentum

 

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

stock market momentum ETF trend following asymmetric

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

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

VIX VOLATILITY EXPANSION

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

SPY SPX VIX ASYMMETRIC RISK REWARD

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

 

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

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

 

Rising Interest Rate Impact on Real Estate and Home Construction

The Federal Reserve raised interest rates today and raised expectations for a fourth rate hike in December. They unanimously agreed to raise the federal funds rate a quarter percentage point, to a range of 2% to 2.25%. The rate helps drive interest rates for mortgages, consumer loans, and credit cards. In 2019, the Fed expects at least three more rate hikes.

The rising trend in interest rates impacts many things beyond consumer credit. Ultimately, when the cost of borrowing increases it can impact real estate, homebuilders, and home construction.

The price trend of homebuilders and home construction stocks is down. The ETF of home builders and home construction stocks is down about -20% from their highs in January.

SPDR® S&P Homebuilders ETF XHB iShares Home Construction ETF $ITB

The price trends in Homebuilders stock ETF (XHB) and Home Construction ETF (ITB) show they really haven’t recovered from the fall that started in 2007.

home builders construction ETF sector ETFs

Below we add the 10-year treasury rate. Rising interest rates may be having some impact on real estate home builders and construction.

rising interest rates impact on housing real estate home builders construction

Rising interest rates are supposed to boost the profit margins of financials like banks and insurance. However, so far we observe the bank stocks and insurance stocks ETFs are trending mostly sideways since interest rates moved higher.

Bank ETF insurance ETFs rising interest rates

Another real estate sector is represented by the Real Estate sector ETF (XLRE), which seeks to provide precise exposure to companies from real estate management and development and REITs, excluding mortgage REITs. I shared some observations about the overall real esate sector earlier this year in Interest Rate Trend and Rate Sensitive Sector Stocks. The impact of rising rates has continued.

rising interest rate impact on real estate REIT

A clearer observation is seen in the chart of homebuilders stocks along with the trend in the 15-year and 30-year mortgage rate.

rising mortgage rate homebuilders home construction

Clearly, there seems to be some correlation between rising rates and falling real estate sector and industry groups like homebuilders and home construction stocks.

This is why I shift between markets and sectors based on their price trends instead of just allocating capital to them regardless of their directional trend. It’s also why we manage our risk in absolute terms with our intention of avoiding large losses created by significant down-trending price trends. I rotate between world markets rather than allocate to them.

 

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

August was a strong month for the U.S. stock market, but the broad S&P 500 stock index and leading sectors have reached short-term overbought extremes that often indicate short-term elevated risk.

My focus is to position capital in the primary direction of trends across different time frames, but trends can reach short-term extremes within the primary trend. We can focus only on the bigger trend, or we can try to take advantage of the short-term moves.

To understand where I am coming from for this observation, let’s define trend and extreme.

Trend is a direction that a price is moving, developing, evolving, or changing. A trend is a directional drift, one way or another. When we speak of price trends, the directional drift of a price trend can be up, down, or sideways. When I say a price is trending, it’s drifting up or down. I call sideways oscillation non-trending.

Extreme is reaching a high or the highest degree; very great, furthest from the center or a given point.

Tactical traders can be either directional traders or non-directional. For example, all investors are necessarily directional: they invest in a thing and want its price to go up.

A tactical trader can be directional: buying a stock, bond, commodity, or currency, hoping it will go up with them or they can sell it short hoping it will trend directionally down. They are directional traders, so they necessarily need to define the direction of the trend. Which way is it drifting?

However, not all traders are directional. Volatility traders who trade volatility through listed options or futures are trading movement itself, so when we trade volatility we aren’t concerned at all with the direction of the trend – we just want movement. Volatility traders may have no bias at all regarding the direction, we focus on volatility expansion or volatility contraction.

Trend Following is a directional strategy that requires the portfolio manager to determine the direction of the trend and enters that trend expecting inertia and momentum to continue in that direction. There are more than 300 published academic studies alone that prove that the most recent 3 to 12-month price momentum tends to continue rather than reverse. That doesn’t include the vast research and testing conducted by actual trading firms and hedge fund managers (like mine) that are not published to the public. These methods rely on directional trends to exploit for profit.

Countertrend is another directional strategy that requires the portfolio manager to determine the directional trend. However, my counter-trend system is designed to identify trends that are more likely to reverse and change direction than to continue. It may seem this strategy is the opposite of trend following, and in some ways it is, but countertrend systems are based on different time frames when executed correctly.

For example, a trend-following strategy that has been profitable has necessarily identified existing trends that have continued and trend following profits from the magnitude of those gains.

A counter trend can also be profitable and even combined with a trend following system. A counter trend system identifies reversals when the trend has changed or likely to change. The time frame, then, is different.

For example, while research shows that directional momentum over the recent 3 – 12 months tends to continue for another 12 months or longer, we also observe that trends have lasted 4-5 years tend to reverse and change trend.

You may notice stock market uptrends (bull markets) last about 4-5 years before they reverse into a downtrend (bear market). You may also notice investors and their advisers have a tendency to buy funds with the highest 5-year returns, only to catch the end of the excellent performance. You can probably see how they are “trend following” but using the wrong time frame. We find that trends actually reverse around the time those performance tables look appealing to investors. Counter trend systems aim to get positioned for big reversals in trend to profit from their directional change. Skilled counter trend portfolio managers develop and operate countertrend systems that are proven and quantified to identify and profit from such changes in trend.

We also observe short-term countertrends within the 30-day time frame.  Sometimes short-term extremes result in at least a temporary countertrend move in the opposite direction. These are shorter trend countertrends within an overall primary trend. Of course, countertrend reversals can also become longer trend changes, too.

Back to August, it was a strong month for U.S. stocks, but the broad indexes and leading sectors have reached higher risk levels in the short term.

sector rotation august 2018 stock market returnThe Technology sector reached a short-term overbought extreme in June and again in July and declined about -4% before resuming an uptrend.

The Consumer Discretionary sector where Amazon (AMZN) has a 25.5% weighting reached an overbought extreme in June and declined about -4% before resuming an uptrend.

The Healthcare sector has also shown strong momentum in its trend. It also reached a short-term overbought level, but only declined about -3%. However, by my measure, the Healthcare sector is more overbought than others.

These shorter trend trends are partly driven by investor sentiment. So, investor sentiment measures can be useful secondary confirming indicators to understand the condition of trends. At this point, most investor sentiment readings are only modestly elevated to levels that suggest greed is driving the market trend. Price could keep trending until enthusiasm is exhausted and sellers become dominant.

This is a very short-term observation of current trends. It’s just a near-term insight that we shouldn’t be surprised to see stocks decline at least a few percents in the weeks ahead.

And… it’s September… for those who follow seasonality, September has historically been one of the weakest months for stocks. I don’t make decisions based on seasonality. If stocks decline this month, the cause will be what I highlighted, not because which month it happens to be.

The bottom line is the broad stock indexes are trending up and led by a few strong sectors, but they’ve reached levels that my countertrend momentum systems suggest the risk of at least a temporary decline is elevated.

 

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.

Earnings season is tricky for momentum growth stocks

Momentum stocks are stocks that show high upside momentum in their price trend. Momentum stocks are trending not only regarding their absolute price gains but also relative strength vs. other stocks or the stock market index.

Momentum stocks are usually high growth stocks. Since momentum stocks are the strongest trending stocks, their trends are often driven by growth in sales and earnings. Growth stocks are companies that are growing earnings at a rate significantly above average. Growth stocks have high increases in earnings per share quarter over quarter, year over year, and may not pay dividends since these companies usually reinvest their strong earnings to accelerate growth.

Now that we have defined what I mean by “momentum stocks,” we can take a look at some examples of momentum stocks and their characteristics like how their prices trend.

Grubhub Inc. ($GRUB) is an online and mobile food-ordering company that connects diners with local restaurants. GrubHub is a great example today of a high momentum growth stock.  GrubHub stock has gained 24% today after smashing Wall Street’s expectations. Earnings grew 92% to 50 cents a share, marking the fifth quarter in a row of accelerating EPS growth. Revenue soared 51% to $239.7 million, a quarterly best.

Grubhub $GRUB GRUB

Before today, GrubHub stock was in a positive trend that developed a flat base since April (highlighted on the chart). GRUB had already gained 60% year to date, but after such as explosive uptrend in momentum, it trended sideways for a while.

It is earnings season, which can be tricky for the highest momentum stocks. Once a stock has already made a big move, it could already have a lot of good news expectations priced in. That concerns some momentum stock traders. In fact, I know some momentum stock traders who exit their stocks before their quarterly earnings announcements. If they had exited GrubHub, they would have missed today’s continuation of its momentum. However, they would avoid the downside of those that trend in the other direction.

I’ve been trading momentum stocks for over two decades. Over the years I’ve observed different regimes of how they act regarding trend strength and volatility. There are periods of volatility expansion and contraction and other periods when momentum is much stronger.

Volatility is how quickly and how far the price spreads out. When price trends are volatile, it’s harder to stick with them because they can move against us. We like upside volatility, but smart investors are loss averse enough to dislike downside volatility that leads to drawdowns. To understand why the smart money is loss averse, read: “Asymmetry of Loss: Why Manage Risk?“.

Strong upward trending stocks are sometimes accompanied by volatility. That’s to be expected because momentum is a kind of volatility expansion. Upward momentum, the kind we like, is an upward expansion in the range of the price – volatility.

That’s good vol.

But, strong trending momentum stocks necessarily may include some bad volatility, too. Bad volatility is the kind investors don’t like – it’s when the price drops, especially if it’s a sharp decline.

I mentioned GrubHub had gained 60% YTD. I like to point out, observe, and understand asymmetries. The asymmetry is the good and the bad, the positive and the negative, I prefer to skew them positively. What I call the Asymmetry® Ratio is a chart of the upside total return vs. the chart of the downside % off high. To achieve the gain for GrubHub, investors would have had to endure its price declines to get it. For GrubHub, the stock has declined -10% to -15% many times over the past year. It has spent much of the time off its high. To have realized all of the gains, investors had to be willing to experience the drawdowns.

grubhub stock GRUB

I point this out because yesterday I wrote “Asymmetry of Loss: Why Manage Risk?” where I discussed the mathematical basis behind the need for me to actively manage the downside risk. To achieve the significant gain, we often have to endure at least some of the drawdowns along the way. The trick is how much, and for me, that depends on many system factors.

Earnings season, when companies are reporting their quarterly earnings, is especially tricky for high momentum stocks because stocks that may be “priced for perfection” may be even more volatile than normal. Accelerating profit growth is attractive to investment managers and institutional investors because increasing profit growth means a company is doing something right and delivering exceptional value to customers. I’m more focused on the direction of the price trend – I like positive momentum. But, earnings are a driver of the price trend for stocks.

Earnings can trend in the other direction, too, or things can happen to cause concern. This information is released in quarterly reports.

Another example of a momentum stock is NetFlix. By my measures, GrubHub is a leading stock in its sector and NetFlix (NFLX) is the leader in its industry group, too, based on its positive momentum and earnings growth. As we see in the chart below, NFLX has gained 88% year to date. That’s astonishing momentum considering the broad stock market measured by the S&P 500 has gained around 5%, and its Consumer Services Sector ETF has gained 11%.

NetFlix NFLX $NFLX

However, NetFlix stock regularly declines as much as -15% as a regular part of its trend. It has fallen over -10% five times in the past year on its way to making huge gains. The latest reason for the decline was information that was released during its quarterly earnings announcement. The stock dropped sharply afterward.

netflix stock risk downside loss

But, as we see in the chart, it’s still within its normal decline that has happened five times the past year.

While some of my other momentum stock trader friends may exit their stocks during the earnings season, I instead focus more on the price trend itself. I predefine my risk in every position, so I determine how much I’ll allow a stock to trend to the downside before I exit. When a stock trends down too far, it’s no longer in a positive trend with the side of momentum we want. To cut losses short, I exit before the damage gets too large.

How much is too much? 

A hint is in the above charts.

If we want to experience a positive trend of a momentum stock, we necessarily have to give it enough room to let it do what it does. When it trends beyond that, it’s time to exit and move on. We can always re-enter it again it if trends back to the right side.

Sure, earnings season can be tricky, but for me, it’s designed into my system. I’m looking for positive Asymmetry® – an asymmetric risk/reward. What we’ve seen above are stocks that may decline as much as -15% as a normal part of their trend when they fall, but have gained over 50% over the same period.

You can probably see how I may be able to create a potentially positive asymmetric risk/reward payoff from such a trend.

 

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.

 

 

 

 

 

Is it a stock pickers market?

Is it a stock pickers market?

Sometimes the stock market is trending so strongly that the rising tide lifts all boats. No matter what stocks or stock fund you invest in, it goes up. That was the case much of 2017.

Then, there are periods when we see more divergence.

When we observe more divergence, it means stocks, sectors, size, or style has become uncorrelated and are trending apart from each other.

I pointed out in Sector Trends are Driving Equity Returns; there is a notable divergence in sector performance, and that is driving divergence in size and style. Growth stocks have been outperformance value, and it’s driven by strong momentum in Technology and Consumer Discretionary sectors.

When specific sectors are showing stronger relative momentum, we can either focus more on those sectors rather than broad stock index exposure. Or, we can look inside the industry to find the leading individual stocks.

For example, Consumer Discretionary includes industries like automobiles and components, consumer durables, apparel, hotels, restaurants, leisure, media, and retailing are primarily represented in this group. The Index includes Amazon, Home Depot, Walt Disney, and Comcast. Consumer Discretionary is the momentum leader having trended up 9.7% so far this year as the S&P 500 has only gained just under 1%.

momentum sectors

If we take a look inside the sector, we see the leaders are diverging farther away from the sector ETF and far beyond the stock market index.

momentum stocks consumer discretionary sector NFLX AMZN AAPL

In fact, all the sectors 80 stock holdings are positive in 2018.

The Consumer Discretionary sector is about 13% of the S&P 500. As you can see, if these top four or five sectors in the S&P 500 aren’t trending up it is a drag on the broad stock index.

ETF Sector Allocation exposure S&P 500

So, Is it a stock pickers market? 

When we see more divergence, it seems to be a better market for “stock pickers” to separate the winners from the losers.

Another way to measure participation in the market is through quantitative breadth indicators. Breadth indicators are a measure of trend direction “participation” of the stocks. For example, the percent of the S&P 500 stocks above or below a moving average is an indication of the momentum of participation.

Below is the percent of stocks above their 50 day moving average tells us how many stocks are trending above their moving average (an uptrend). Right now, the participation is symmetrical; 52% of the stocks in the S&P 500 are in a positive trend as defined by the 50 day moving average. We can also see where that level stands relative to the stock market lows in February and April and the all-time high in January when over 85% of stocks were in an uptrend. By this measure, only half are trending up on a shorter term basis.

SPX SPY PERCENT OF STOCKS ABOVE 50 DAY MOVING AVERAGE 1 YEAR

The 200-day moving average looks back nearly a year to define the direction of a trend, so it takes a greater move in momentum to get the price above or below it. At this point, the participation is symmetrical; 55% of stocks are above their 200-day moving average and by this time frame, it hasn’t recovered as well from the lows. The percent of stocks above their 200-day moving average is materially below the 85% of stocks that were participating in the uptrend last year. That is, 30% fewer stocks are in longer trend uptrends.

SPY SPX PERCENT OF STOCKS ABOVE 200 DAY MOVING AVERGAGE 1 YEAR

In the above charts, I only showed a one-year look back of the trend. Next, we’ll take a step back to view the current level relative to the past three years.

The percent of stocks above their 50 day moving average is still at the upper range of the past three years. The significant stock market declines in August-September 2015 and December-January hammered the stocks down to a very washed out point. During those market declines, the participation was very asymmetric: 90% of the stocks were in downtrends and only about 10% remained in shorter-term uptrends.

SPX SPY PERCENT OF STOCKS ABOVE 50 DAY MOVING AVERAGE 3 YEARS

The percent of stocks above their 200 day moving average also shows a much more asymmetrical situation during the declines in 2015 and 2016 when the stock index dropped around -15% or more. Only 20% of stocks remained in a positive trend.

SPX PERCENT OF STOCKS ABOVE 200 DAY MOVING AVERAGE 3 YEARS

Is it a stock pickers market?

Only about half of the stocks in the index are in uptrends, so the other half isn’t. So, if we avoid the half that are in downtrends and only maintains exposure to stocks in uptrends and the trends continue, we can create alpha.

But, keep in mind, that doesn’t necessarily mean we should have any exposure at all in the S&P 500 stock index because happens to have the highest sector exposure in the leading sectors.

But, for those who want to engage in “stock picking”, the timing has a higher probability now to diverge from the stock index than last year because so fewer stocks are in uptrends and more are in downtrends.

For individual stocks traders willing to look inside the box, this is a good thing.

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.

Interest Rate Trend and Rate Sensitive Sector Stocks

Interest Rate Trend and Rate Sensitive Sector Stocks

The interest rate on the 10 Year Treasury has gained over 20% so far in 2018, but I noticed it’s more recently settled down a little.

interest rate TNX $TNX

One of my ASYMMETRY® systems generated a short-term momentum signal today for the Utility and Real Estate Sectors. This signal indicated the short term trend is up, but it may have reached the point they may pull back before they continue the trend.

We see in the chart below, Utility and Real Estate Sectors are down so far in 2018, but they are gradually covering.

Utilities and Real Estate XLU XLRE $XLRE $XLU TREND MOMENTUM

I find it useful to understand return drivers and how markets interact with each other. The direction of interest rates, the Dollar, inflation, etc. all drive returns for markets.

In the chart below, I drew the black arrow to show where interest rates started declining this month and Utility and Real Estate Sectors trended up.

rising interest rate impact on real estate REIT housing utilities

Utility and Real Estate Sectors are sensitive to interest rates. These sectors use leverage, so as interest rates rise, it increases their cost of capital. Another impact is higher interest rates on bonds compete with them as investments. Utility and Real Estate Sectors are high dividends paying sectors, so as bond yields trend higher investors may start to choose bonds over these equities.

Below is a 1-year chart. You can see how interest rates increasing over 30% over the past year has had some impact on the price trend of the Utility and Real Estate sectors.

interest rate reit utilities sector

But, at the moment, these sectors have trended up, as interest rates have settled down.

 

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.

 

 

 

Sector Trends are Driving Equity Returns

Sector Trends are Driving Equity Returns

In Growth Stocks have Stronger Momentum than Value in 2018 I explained the divergence between the return of the two styles of Growth and Value. I suggest the real return driver between size and style is primarily the index or ETF sector exposure. To be sure, we’ll take a look inside.

As I said before, the reason I care about such divergence is when return streams spread out and become distinctive, we have more opportunity to carve out the parts we want from the piece I don’t. When a difference between price trends is present, it provides more opportunity to capture the positive trend and avoid the negative trend if it continues.

Continuing with the prior observation, I am going to use the same Morningstar size and style ETFs.

Recall the year-to-date price trends are distinctive. Large, mid, and small growth is notably exhibiting positive momentum over large, mid, and small value.

growth stock momentum over value morningtar small mid large cap

To understand how these factors interact, let’s look at their sector exposure. But first, let’s determine the sector relative momentum leaders and laggards for 2018.

The leaders are Consumer Discretionary (stocks like Netflix $NFLX and Amazon $AMZN), Information Technology (Nvidia $NVDA and Google $GOOG). In third place is Energy and then Healthcare. The laggards are Consumer Staples, Industrials, Materials, and Utilities, which are actually down for the year. Clearly, exposure to Consumer Discretionary and Information Technolgy and avoiding most of the rest would lead to more positive asymmetry.

sector trend returns 2018

Below we see strongest momentum Large Growth is heavily weighted (41%) in Technology. The second highest sector weight is Consumer Discretionary, and then Healthcare is third. Large-Cap Growth is the leader just because it has the most exposure in the top sectors.

iShares Morningstar Large-Cap Growth ETF

On the other hand, Large Value, which is down -3% YTD, has its main exposure in the lagging Financial and Consumer Staples sectors.

iShares Morningstar Large-Cap Value ETF

Dropping down to the Mid-Cap Growth style and size, similar to Large-Cap Growth, we see Information Technology and Healthcare are half of the ETFs exposure.

iShares Morningstar Mid-Cap Growth ETF

We are starting to see a trend here. Much like Large-Cap Value, the Mid-Cap Value has top holdings in Financials, Consumer Discretionary, and Utilities sectors.

 

iShares Morningstar Mid-Cap Value ETF

Can you guess the top sectors of Small-Cap Growth? Like both Large and Mid Growth, Small-Cap Growth top sector exposures are Information Technology, Healthcare, and Consumer Discretionary.

iShares Morningstar Small-Cap Growth ETF

And to no surprise, the Financial sector 26% of Small-Cap Value.

iShares Morningstar Small-Cap Value ETF

So, Information Technology, Healthcare, and most Consumer Discretionary tend to be more growth-oriented sectors. Financials, Consumer Staples, Utilities, Real Estate, that is, the higher yielding dividend paying types, tend to be classified as Value. Each sector has both Growth and Value stocks within them, but on average, some sectors tend to include more Growth stocks or more Value stocks.

Value stocks are generally defined as shares of undervalued companies with lower prospects for growth.

A growth stock has higher earnings per share and often trade at a higher multiple since the expectation of future earnings is high. Growth stocks usually don’t pay a dividend, as the company would prefer to reinvest retained earnings back into the company to grow.

The Information Technology sector includes companies that are engaged in the creation, storage, and exchange of digital information. The Information Technology sector offers potential exposure to growth with the emergence of cloud computing, mobile computing, and big data.

Another Growth sector is Consumer Discretionary sector manufactures things or provides services that people want but don’t necessarily need, such as high-definition televisions, new cars, and family vacations. Consumer Discretionary sector performance is closely tied to the strength of the overall economy. Consumer Discretionary tends to perform well at the beginning of a recovery when interest rates are low but can lag during economic slowdowns

The Health Care sector is a Growth sector involved in the production and delivery of medicine and health care-related goods and services. Healthcare companies typically have more stable demand, so they are less sensitive to the economic cycle, though it tends to perform best in the later stages of the economic cycle.

It turns out, the three primary Growth sectors that tend to best strongest at the late stage of an economic cycle have been the recent leaders.

Consumer Staples sector consists of companies that provide goods and services that people use on a daily basis, like food, clothing, or other personal products.

The Financial sector is businesses such as banking and brokerage, mortgage finance, and insurance which are sensitive to changes in the economy and interest rates. They tent to perform best at the beginning of a business cycle.

This is why I prefer to focus my U. S. equity exposure on sectors and maybe the strongest momentum stocks within those sectors. Many traditional asset allocations use style and size to get their exposure to the stock market, but as a tactical portfolio manager, I prefer to get more specific into the trending sectors and their individual stocks.

 

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 this correction and volatility normal?

With perfect hindsight, we now all know that January 26th was the recent price peak in the U.S. stock market. Since then, the S&P 500 has declined about -10% and the Dow Jones Industrial Average about -12%. For simplicity, I’m going to focus on U.S. stock market here.

I wasn’t surprised to see the decline and am not surprised to see “more volatility,” because it would be getting back to “normal.”

But I see recent price action has sure gotten the attention of many on social media. Some even seem dazed and confused.

I’m not surprised about that, either.

On January 11, before stock market declined prices started swinging up and down (volatility), I shared an observation with my friends on Twitter and a warning:

On January 24th, I again warned of complacency. The message was clear:

At this point, this is a normal and expected “correction” of what was an upside overreaction in the prior months. The stock index has declined about -10%, regained some of the loss in March and more recently retested the February 8th low. As long as the lows hold, I consider this a normal correction.

stock market spx

Sure, the decline was sharp and fast, but that’s no surprise for me after such an upside move. I said it was “expected” because, as I pointed out above, 2017 was very abnormal because it lacked the typical -5% to -10% declines we normally see over most 12 month periods in the stock indexes.

Another way I define a “normal correction” is a simple trend line drawn under the price over the past 12 months. Without adding a lot of complicated looking indicators to express it, below we see the stock index has just “reverted to its trend.” The peak in December and January was an abnormal overreaction on the upside, which I pointed out as it was happening. The recent -10% decline has simply put the trend back in a more normal range.

stock market normal correction trend

What is normal, typical, or expected? 

I’m observing a lot of commentaries as if this correction and volatility isn’t normal.  The fact is, many people often include their emotions and feelings along with price action.

Investors perceive what they believe is driving a price trend and what they believe is always true for them.

The February decline was commonly blamed on “the machines,” which got a little silly.

This time, it’s geopolitics.

I believe it’s just the market, doing what it does, and there are so many drivers at the same time I don’t bother to attempt such a narrative. My narrative is simple; the force of sellers took control and outweighed the enthusiasm of buyers.  It is just the market, doing what it does.

I’ve been seeing and experiencing these trends so closely for so long and I remember the regime shifts. I want to share with you my observations of what have been “normal” corrections in terms of drawdowns. A drawdown is the % decline from a prior price high to its low. I show only the period of the past 9 years, which is one of the longest bull markets in history (without a -20% decline).

stock market historical bear market length drawdowns

As you can see, since April 2009, we’ve seen four declines of -15% or more and it took them several months to recover.

These declines of -15% or more are why many people have been unable to hold on to the stock market since the March 2009 low with any meaningful allocation to stocks. When prices fall -10%, investor sentiment shifts from greed to extreme fear. Some of them may even begin to tap out by selling their stock holdings for fear of more losses.

To be sure, here is an investor sentiment indicator at the February 8, 2018 low.

Investor sentiment Februrary 8 2018

In fact, investment managers like me who have dynamic risk management systems may even sell to reduce exposure to loss as an intentional drawdown control. But this time, as I pointed out, the stock market was already at risk of a reversal before this decline. So, a robust risk management system may have reduced exposure before the decline, not after.

We find that declines over -10% get more attention, especially when they get down to -15%. Those can also be more hostile conditions for trend systems, too, as risk management systems cause us to exit and later re-enter.

The point is, over the past 9 years a -15% decline has been a “normal” occurrence and there are many -5% (or more) declines too.

It is only at a -10%, so far, and that’s not unusual.

I intentionally used the last 9 years. Not to show an arbitrary 9 year period, but instead to intentionally leave off March 2009. I did that because the first three months of 2009 was a -24% decline, a continuation of the 2008 waterfall decline. The stock market was still in the bear market that began October 2007. So, this wouldn’t be complete without a reminder of what that period looked like before I go on to show the pre-2008 period.

All bear markets do necessarily begin with declines of  -10%, -15%, -20% . They are actually made of many swings up and down along the way. We often hear people speak of the last bear market as “2008” as though the only loss was the -37% decline in the S&P 500 in 2008.

That is far from reality.

The decline was -56%.

2008 stock market drawdown length of bear market

The drawdowns we’ve seen since 2008 are more than twice what we saw in the bull market from 2003 to 2008 after the “tech wreck.” Below we see the typical decline then was closer to -5% with only a few getting into the -7% or more range. 2004 to 2008 bull market low volatility

Clearly, it was a lot easier to hold a larger allocation of stocks, then.

What is normal and what has changed?

The last 9 years has been more hostile for passive asset allocation investors to hold on to their stock positions because the declines were -15% or so and take months to recover. It’s also been more challenging for active risk managers since a drawdown control system necessarily reduces exposure as prices fall with the intent to control drawdown.

But, to define what is normal today, a -10% to -15% decline is within a normal corrective drawdown.

The recent past matters simply because that’s what investors and traders anchor to. Most people put more emphasis on the recent past. Our experience and how much we’ve studied and observed the trends determine how much we can recall easily. I’ve been an investment manager most of my life, over two decades now. For me, it hasn’t been a hobby or part-time venture, it’s what I do and who I am. So, my memory of these trends and intuitions about what is normal, or not, is what it is.

If you are wondering, here are the drawdowns for the S&P 500 going back about 70 years. I highlighted the -15% declines or more, which obviously gets investors attention.

stock market bear market length and dradowns

Clearly, there are a lot of -15% or greater declines. In fact, there are several -30% and three in the -45% or larger drawdowns.

Knowing this, it’s why I say:

We believe world markets require active risk management to avoid large losses and directional trend systems to position capital in profitable price trends.

And, I also say:

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

But at this point, you can probably see that the current -10% decline is so far within a “normal correction.”

Though, as I shared in The enthusiasm to sell overwhelmed the desire to buy March 19, 2018, I expect to see more swings (volatility) than last year, and that would be “normal” too.

I define this as a non-trending market. When I factor in how the range of price movement has spread out more than double what it was, I call it a non-trending volatile condition.

Markets decline to a low enough point to attract buying demand. Only time will tell how it all plays out from here.

If you enjoyed this, I encourage you to read “What About the Stock Market Has Changed? A Look at Ten Years of Volatility” 

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.

 

Asymmetric force was with the buyers

In Asymmetric force direction and size determines a trend, I explained how the net force of all the forces acting on a trend is the force that determines the direction. The force must be asymmetric as to direction and size to change the price and drive a directional trend.

The asymmetric force was with buyers as they dominated the directional trend on Friday.

Friday’s gain helped to push the stock market to a strong week and every sector gained.

The S&P 500 stock index is about -3% from it’s January high and closed slightly above the prior high last week. I consider this a short-term uptrend that will resume it’s longer-term uptrend if it can break into a new high above the January peak.

After declining sharply -10% to -12%, global equity markets are recovering. The good news for U.S. stocks is the Russell 2000 small company index is closest to its prior high. Small company leadership is considered bullish because it suggests equity investors are taking a risk on the smaller more nimble stocks.

As you can see in the chart, the Dow Jones Industrial Average and International Developed Countries (MSCI EAFE Europe, Australasia and Far East) are lagging so far off their lows but still recovering.

So far, so good, but only time will tell if these markets can exceed their old highs and breakout into new highs, or if they discover some resistance force at those levels and reverse back down. As we discussed in Asymmetric force direction and size determines a trend it’s going to depend on the direction and size of the buyers vs. sellers.

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

After yesterdays 1.1% gain for the S&P 500, it is back in positive territory for the year. It’s been a very volatile start for 2018 with an abnormally strong trend in U.S. stocks late 2017 continued in January only to be wiped out in February. Below is a visual representation, showing the period November 2017 to the low last month. I point that out to show how quickly a trend can change and prior gains of 12% in just a three-month time frame and be erased in a -10% decline over 9 days. Most of the decline was in two days over that period.

With that said, as the broad stock market is lagging in its third month of the year so far, two sectors are leading. Consumer Discretionary (XLY)  and Technology (XLK). At Shell Capital, we monitor global market trends at the broad market level like the S&P 500 which is diversified across 500 stocks that are a part of 10 sectors. These sectors are tradable via ETFs. We can quickly get broad exposure to the overall stock market, or we can get more granular and get exposure to a sector in a low-cost structure with Sector ETFs.  I also monitor the individual stocks inside the sector ETF. When the overall market is in a positive trend, most of the stocks in a sector should be trending up. But, when the overall market has struggled to trend up, like this year-to-date, fewer stocks are trending up inside a sector.

The popular narrative becomes “it’s a stock pickers market.”

I don’t say that myself, I just observe when it is “a stock pickers market” naturally through my daily quantitative research. Here are some examples of my observation.

I pointed out yesterday in Buying demand dominated selling pressure in the stock market that only 32% of the 500 stocks in the S&P 500 are above their 50-day moving average. After yesterdays stock market gain, the participation increased to 40%. The 50-day moving average is a short-term trend indicator, so if 60% of the stocks are below that trend line, we can infer “most stocks are in short-term downtrends.” As of yesterdays close, only 203 (40%) of the S&P 500 are above their 50-day moving average, which means 297 are below it. You can probably see if the price trend continues up, we should see more and more stocks participate in the trend. In fact, if we don’t see more stocks participate, it necessarily means only a few stocks are driving the broad index trend up. I would consider that “a stock pickers market.” Of course, the trick is to see this in advance, or early enough in the stage to capitalize on it. We don’t have to know in advance what’s going to happen next, and we don’t, we just need to observe it soon enough to capture some positive asymmetry (P>L).

I like a visual representation, so here is the chart of the S&P 500 Percent of Stocks Above 50 Day Moving Average. I colored the top part of the chart red and labeled it “Higher Risk Zone” and the lower part green with the label “Lower Risk Zone”. The observation is when 80% of stocks are already trending positive that momentum is a good thing, but as a skilled risk manager, I begin to prepare for change. After most stocks are already trending up, the stock market has been trending up, so a skilled risk manager prepares for a countertrend reversal that is inevitable at some point. As I shared in my observation near the low, Stock Market Analysis of the S&P 500  when nearly all the stocks were already in negative trends as a skilled risk-taker, I look for that to reverse, too.

 

This is only a small glimpse at what I look at for illustration purposes to make the point how I can quantify a “stock pickers market.” After 83% of stocks were already in downtrends I shifted from a risk manager stance to risk-taker mode looking. That is, shifting from a reversal down in January after prices had already trended up to an extreme, to preparing for the decline to end after the stock index quickly dropped -10% and my many indicators were signaling me when and where to pay attention. I shared this to represent that I was not surprised to see certain stocks lead a trend direction when so many had shifted from positive trends to negative trends in a short-term time frame.

This leads me to my main point, which is very simple. A simple way to observe a “stock pickers market” is to see that certain stocks are leading the trend. Because so may stocks were in short-term downtrends, it isn’t a surprise to see a few strong relative strength leaders inside a sector. For example, in the Sector ETF performance table below, two leading sectors are Consumer Discretionary (XLY)  and Technology (XLK). They are up about 6-7% as the broad stock index is up 1.77%. Let’s see what is driving their stronger relative momentum.

Looking inside the Sector for the Leading Stocks 

Reviewing the holdings of the Consumer Discretionary $XLY ETF,  Amazon.com Inc $AMZN is 20.69% of the Consumer Discretionary Sector and has gained +30.28% for the year. A 20% weighting of a stock that has gained 30% results in a 6% contribution to the portfolio return. That is, this one large position has contributed 100% of the sectors return year-to-date. There are 84 stocks in the ETF. This doesn’t mean the other 83 stocks are flat with no price change. Instead, some of them were also positive for the year and some are negative. So far this year, they have offset each other. Some stocks in the sector have gained more than Amazon, but it makes the simple example because it’s exposure is the largest at 20%. Netflix $NFLX, for example, is the sector ETFs biggest gainer up 64%, but it’s 4.63% of the portfolio. However, because it’s gain is so strong this year its contribution at the portfolio level is still significant at 3% of the 5.66% YTD gain in the sector ETF. That is an extreme example. Why is it extreme? Let’s look at price charts of the year-to-date price trend, then the drawdown, which expresses the ASYMMETRY® ratio. The ASYMMETRY® ratio is a ratio between profit and loss, upside vs. downside, or drawdown vs. total return.

First, we observe the price trend for 2018 of the Consumer Discretionary Sector ETF $XLY, Netflix $NFLX, and Amazon $AMZN. The divergence is clear. But, you may notice they all had a drawdown a few weeks ago. All to often I see the upside presented, but not enough about the path we would have to endure to achieve it. To get a complete picture of asymmetric reward to risk, we want to see the drawdown, too, so we understand the ASYMMETRY® ratio.

Those are some big impressive short-term gains in those stocks. Clearly, this past performance may not be an indication of future results.  Too bad we can’t just know for sure in advance which is going to trend up with such velocity.  We can’t catch every trend, but if we look in the right way we may find some. In order to take a position in them, we’d have to be willing to experience some downside risk, too. As a portfolio manager, I decide how much my risk is in my positions and at the portfolio level by predefining when I’ll exit a losing position. But, to understand how much downside is possible in stocks like this and the sector ETF, I can examine the historical drawdown. We’ve seen a drawdown in the stock market already this year. Below we see the Consumer Sector ETF drawdown was about -8% a few weeks ago. Amazon wasn’t more, even though it’s gain is much more than the sector. That’s what I’m calling positive asymmetry and good looking asymmetric reward to risk in regard to the trend dynamics. Netflix declined -13%, but its gain is much higher. This is what leading stocks are supposed to look like. They have their risk and they could decline a lot more than the market if investors lose their enthusiasm for them, but we can manage that risk with our exit and drawdown controls.

I often say that it doesn’t matter how much the return is if the risk and volatility are so high you tap out before it is achieved. To better understand that, I want to show two more charts of these stocks. Below is what the YTD price change looked like at the February low. If investors watch their holdings closely and have emotional reactions, you can see how this would be viewed as “I was up 45% and now only 30%.” Many investors (and professional advisors) have difficulty holding on to strong trends when they experience every move.

One more chart to illustrate how it doesn’t matter how much the return is if the risk and volatility are so high you tap out before it is achieved. I don’t believe we can just buy and hold and reach our objective of asymmetric reward to risk. I believe risk must be managed, directed and controlled. To make the point, below are the historical drawdowns that have been -60% to -90% in these three. It doesn’t matter how much the return is if the risk and volatility are so high you tap out before it is achieved! To extract positive asymmetric reward to risk, we must necessarily do something different than buy and hold.

This may make you wonder: Why buy a sector ETF if you can buy the strongest stocks?

The divergence isn’t normally this wide. In a trending market, more of the other stocks would normally be participating in a trend. This is why I first explained that in an upward trending market we normally see the majority of stocks eventually trending together. When that is true, the sector ETF provides good exposure and limits the selection risk of just one or two stocks. Make no mistake, individual stocks are riskier. Individual stocks are more subject to negative news like disappointing earnings reports, negative product outlook, or key executives leaving the company, etc. So, individual stocks are more volatile and subject to trend in much wider swings both up and down. But for me, I apply the same risk management systems to predefine my risk at the point of entry drawdown controls as the trend unfolds in the stock, up or down.

Yes, it’s been a “stock pickers market” so far and that trend may continue. It just means that fewer stocks are leading the way for now and in a healthy trend more stocks will participate if the short-term uptrend continues to make higher highs and higher lows. As a tactical portfolio manager, my focus is on what seems to offer the positive ASYMMETRY® of a positive asymmetric reward to risk.

 

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.

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

Well, I guess by saying on Tuesday I’m planning to write a comment when the stock index closes up or down 1% or more I’ve turned myself into a regular ole Mark Twain.

If you’ve ever read the “about” page, I poke some fun:

Mark Twain’s mother once said:
“I only wish Mark had spent more time making money rather than just writing about it”.

I go on to say:

Today there is no shortage of writings about the capital markets and portfolio management. Many who write about money and the management of it provide no evidence to suggest their beliefs are useful. That is, they do a lot of talking and writing, a lot less doing. We are left to wonder if they have good results. The author of ASYMMETRY® Observations is no Mark Twain.

Ok, so March isn’t getting off to the best start so far. The stock market as measured by the S&P 500 closed down -1.45% today. Below is the intraday chart. This index was down most of the day, but it did trend up off of its low after 2PM.

stock market spx spy march 1 2018

Zooming out to a few months instead of intraday, the SPY didn’t care at all that I drew that black line to show the prior low. It traded right below it. Of course, we don’t own this index at Shell Capital, so I am just sharing this as an observation.

stock market index asymmetry

We can get more granular by looking at the individual sector changes instead of the broader S&P 500 index that includes some of them all. Below, I show that the Utility sector was the only sector in the green (barely), which is no surprise since it has been the laggard for a while.

sector trend rotation march 2018

We can drill down even more into the sectors and see the ETF subsectors. Here we see some shades of green.

sector trend following

Next, we could look at stocks within the sectors, but that’s enough detail for now.

I will add that today was a global market decline as several other countries stock markets participated. Japan declined more while Mexico, Peru, and Egypt gained. The emerging markets index which includes Mexico only declined -0.19% today.

global ETF trend outlook march 2018

Finally, below is the same table of bar charts I used earlier in February Global Market Trends, but this one is only the past three days. The U.S. stock market has declined the past three days, so I wanted to see what other markets have done over the same period. Let’s just say that a diversified portfolio of global asset allocation wouldn’t have helped since many markets are down like commodities and international markets.

global asset allocation trend

If you haven’t read February Global Market Trends I encourage you to. Near the end, I discussed if an investor should pay too much attention to daily market swings. My purpose of writing this is to summarize what happened and that is always necessarily in the past. The future may be different.

How does this affect us at Shell Capital? I predefine my risk by knowing in advance when I’ll exit my positions if they decline. I do it to control my risk in each position and for drawdown control at the portfolio level. So, I respond accordingly.

If this keeps up, it looks like I’ll be eating dinner at my desk every evening, typing away like Mark Twain 🙂

 

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.

Industrial Sector Pulling Back as RSI Suggested it Could

In “Resolving Conflicts with Relative Strength” I discussed the conflict between high Relative Strength (a trend that is gaining more than others) and a high RSI (a trend that is considered overbought). I used the Industrial Select Sector SPDR ETF as an example. It has taken about five weeks, but the point can be seen clearly now.

Below is part of what I said on September 27, 2017, and following that I’ll share an update.

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”.

That chart was about five weeks ago. Below is an update on the trend in the U.S. Industrial sector. Since the sector got “overbought” based on a RSI reading over 70, the trend continued up (green highlight) and has since trended down about -3%. At this point, it is trading around the same price it was when it first became overbought. Now, it is getting closer to being “oversold” on a short-term basis.

So, as the Industrial sector was one of the strongest sector trends a few weeks ago, it also appeared overbought on a short-term basis. It is now drifting down to what may become a better entry point in what has otherwise been a strong directional trend.

We’ll see how it unfolds.

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.

 

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 Trend of the U.S. Stock Market and Sectors Year-to-Date

As of today, the below table illustrates the year-to-date gains and losses for the S&P 500® Index (SPY) and the 9 Sector SPDRs in the S&P 500®. We observe the current and historical performance to see how the U.S. Sectors match up against the S&P 500 Index.

So far, the S&P 500 Index is down -5.68% year-to-date. Only the Consumer Discretionary (XLY) and Health Care (XLV) are barely positive for the year. Energy (XLE) has entered into its own bear market. Materials (XLB) and Utilities (XLU) are in double-digit declines.

year to date S&P 500 and sector returns 2015-09-10_11-31-05

Source: http://www.sectorspdr.com/sectorspdr/tools/sector-tracker

The trouble with a table like the one above is it fails to show us the path the return streams took along the way. To see that. below we observe the actual price trends of each sector. Not necessarily to point out any individual trend, but we can clearly see Energy (XLE) has been a bear market. I also drew a red line marking the 0% year-to-date so point out that much of this year the sectors have oscillated above and below it and most are well below it now.

year to date stock market sector trends 2015-09-10_11-32-40

Source: http://www.sectorspdr.com/sectorspdr/tools/sector-tracker

Speaking of directional price trends is always in the past, never the future. There are no future trends, today. We can only observe past trends. In fact, a trend is today or some time in the past vs. some other time in the past. In this case, we are looking at today vs. the beginning of 2015. It’s an arbitrary time frame, but still interesting to stop and look to see what is going on.

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 as it isn’t a sure thing…

U.S. Sector Observation

I don’t often comment on a day’s price action in the stock market, but thought I would. The U.S. stock market reversed up somewhat today. Market trends swing up and down on their way to a larger trend. Notice at 3pm the stock indexes almost lost all their gain for the day.

stock market 2015-08-27_16-17-41

Source: https://www.google.com/finance

The interesting observation today was the leadership. Energy and Basic Materials have been the biggest losers the past three months and they moved up the most.

sector rotation returns ETF

Source: https://www.google.com/finance

Below are the U.S. sector returns over the past 3 months after todays close. You can see the two biggest losers were today’s winners.

ETF sector rotation

Source: http://www.stockcharts.com

It will be interesting to see if this is an oversold bounce or it reverses to a lower low.

Trends unfold as swings up and down over time. They don’t go straight up or down…

Why Index ETFs Over Individual Stocks?

A fellow portfolio manager I know was telling me about a sharp price drop in one of his positions that was enough to wipe out the 40% gain he had in the stock. Of course, he had previously told me he had a quick 40% gain in the stock, too. That may have been his signal to sell.  Biogen, Inc (BIIB) recently declined about -30% in about three days. Easy come, easy go. Below is a price chart over the past year.

Biogen BIIB

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

Occasionally investors or advisors will ask: “Why trade index ETFs instead of individual stocks?“. An exchange-traded fund (ETF) is an investment fund traded on stock exchanges, much like stocks. Until ETFs came along the past decade or so, gaining exposure to sectors, countries, bond markets, commodities, and currencies wasn’t so easy. It has taken some time for portfolio managers to adapt to using them, but ETFs are easily tradable on an exchange like stocks. Prior to ETFs, those few of us who applied “Sector Rotation” or “Asset Class Rotation” or any kind of tactical shifts between markets did so with much more expensive mutual funds. ETFs have provided us with low cost, transparent, and tax efficient exposure to a very global universe of stocks, bonds, commodities, currencies, and even alternatives like REITs, private equity, MLP’s, volatility, or inverse (short). Prior to ETFs we would have had to get these exposures with futures or options. I saw the potential of ETFs early, so I developed risk management and trend systems that I’ve applied to ETFs that I would have previously applied to futures.

On the one hand, someone who thinks they are a good stock picker are enticed to want to get more granular into a sector and find what they believe is the “best” stock. In some ways, that seems to make sense if we can weed out the bad ones and only hold the good ones. It really isn’t so simple. I view everything a reward/risk ratio, which I call asymmetric payoffs. There is a tradeoff between the reward/risk of getting more detailed and focused in the exposure vs. having at least some diversification, such as exposure to the whole sector instead of just the stock.

Market Risk, Sector Risk, and Stock Risk

In the big picture, we can break exposures into three simple risks (and those risks can be explored with even more detail). We’ll start with the broad risk and get more detailed. Academic theories break down the risk between “market risk” that can’t be diversified away and “single stock” and sector risk that may be diversified away.

Market Risk: In finance and economics, systematic risk (in economics often called aggregate risk or undiversifiable risk) is vulnerable to events which affect aggregate outcomes such as broad market declines, total economy-wide resource holdings, or aggregate income. Market risk is the risk that comes from the whole market itself. For example, when the stock market index falls -10% most stocks have declined more or less.

Stock and Sector Risk: Unsystematic risk, also known as “specific risk,” “diversifiable risk“, is the type of uncertainty that comes with the company or industry itself. Unsystematic risk can be reduced through diversification. If we hold an index of 50 Biotech stocks in an index ETF its potential and magnitude of a  large gap down in price is less than an individual stock.

You can probably see how holding a single stock like Biogen  has its own individual risks as a single company such as its own earnings reports, results of its drug trials, etc. A biotech stock is especially interesting to use as an example because investing in biotechnology comes with a unique host of risks. In most cases, these companies can live or die based on results of drug trials and the demand for their existing drugs. In fact, the reason Biogen declined so much is they reported disappointing second-quarter results and lowered its guidance for the full year, largely because of lower demand for one of their drugs in the United States and a weaker pricing environment in Europe. That is a risk that is specific to the uncertainty of the company itself. It’s an unsystematic risk and a selection risk that can be reduced through diversification. We don’t have to hold exposure to just one stock.

With index ETFs, we can gain systematic exposure to an industry like biotech or a sector like healthcare or a broader stock market exposure like the S&P 500. The nice thing about an index ETF is we get exposure to a basket of stocks, bond, commodities, or currencies and we know what we’re getting since they disclose their holdings on a daily basis.

ETFs are flexible and easy to trade. We can buy and sell them like stocks, typically through a brokerage account. We can also employ traditional stock trading techniques; including stop orders, limit orders, margin purchases, and short sales using ETFs. They are listed on major US Stock Exchanges.

The iShares Nasdaq Biotechnology ETF objective seeks to track the investment results of an index composed of biotechnology and pharmaceutical equities listed on the NASDAQ. It holds 145 different biotech stocks and is market-cap-weighted, so its exposure is more focused on the larger companies. It therefore has two potential disadvantages: it has less exposure to smaller and possibly faster growing biotech stocks and it only holds those stocks listed on the NASDAQ, so it misses some of the companies that may have moved to the NYSE. According to iShares we can see that Biogen (BIIB) is one of the top 5 holdings in the index ETF.

iShares Biotech ETF HoldingsSource: http://www.ishares.com/us/products/239699/ishares-nasdaq-biotechnology-etf

Below is a price chart of the popular iShares Nasdaq Biotech ETF (IBB: the black line) compared to the individual stock Biogen (BIIB: the blue line). Clearly, the more diversified biotech index has demonstrated a more profitable and smoother trend over the past year. And, notice it didn’t experience the recent -30% drop that wiped out Biogen’s price gain. Though some portfolio managers may perceive we can earn more return with individual stocks, clearly that isn’t always the case. Sometimes getting more granular in exposures can instead lead to worse and more volatile outcomes.

IBB Biotech ETF vs Biogen Stock 2015-07-29_10-34-29

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

The nice thing about index ETFs is we have a wide range of them from which to research and choose to add to our investable universe. For example, when I observe the directional price trend in biotech is strong, I can then look at all of the other biotech index ETFs to determine which would give me the exposure I want to participate in the trend.

Since we’ve observed with Biogen the magnitude of the potential individual risk of a single biotech stock, that also suggests we may not even prefer to have too much overweight in any one stock within an index. Below I have added to the previous chart the SPDR® S&P® Biotech ETF (XBI: the black line) which has about 105 holdings, but the positions are equally-weighted which tilts it toward the smaller companies, not just larger companies.  As you can see by the black line below, over the past year, that equal weighting tilt has resulted in even better relative strength. However, it also had a wider range (volatility) at some points. Though it doesn’t always work out this way, you are probably beginning to see how different exposures create unique return streams and risk/reward profiles.

SPDR Biotech Index ETF XBI IBB and Biogen BIIB 2015-07-29_10-35-46

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

In fact, those who have favored “stock picking” may be fascinated to see the equal-weighted  SPDR® S&P® Biotech ETF (XBI: the black line) has actually performed as good as the best stock of the top 5 largest biotech stocks in the iShares Nasdaq Biotech ETF.

SPDR Biotech vs CELG AMGN BIIB GILD REGN

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

Biotech indexes aren’t just pure biotech industry exposure. They also have exposures to the healthcare sector. For example, iShares Nasdaq Biotech shows about 80% in biotechnology and 20% in sectors categorized in other healthcare industries.

iShares Nasdaq Biotech ETF exposure allocation

Source: www.ishares.com

The brings me to another point I want to make. The broader healthcare sector also includes some biotech. For example, the iShares U.S. Healthcare ETF is one of the most traded and includes 23.22% in biotech.

iShares Healthcare Index ETF exposure allocation

Source: https://www.ishares.com/us/products/239511/IYH?referrer=tickerSearch

It’s always easy to draw charts and look at price trends retroactively in hindsight. If we only knew in advance how trends would play out in the future we could just hold only the very best. In the real world, we can only identify trends based on probability and by definition, that is never a sure thing. Only a very few of us really know what that means and have real experience and a good track record of actually doing it.

I have my own ways I aim to identify potentially profitable directional trends and my methods necessarily needs to have some level of predictive ability or I wouldn’t bother. However, in real world portfolio management, it’s the exit and risk control, not the entry, the ultimately determines the outcome. Since I focus on the exposure to risk at the individual position level and across the portfolio, it doesn’t matter so much to me how I get the exposure. But, by applying my methods to more diversified index ETFs across global markets instead of just U.S. stocks I have fewer individual downside surprises. I believe I take asset management to a new level by dynamically adapting to evolving markets. For example, they say individual selection risk can be diversified away by holding a group of holdings so I can efficiently achieve that through one ETF. However, that still leaves the sector risk of the ETF, so it requires risk management of that ETF position. They say systematic market risk can’t be diversified away, so most investors risk that is left is market risk. I manage both market risk and position risk through my risk control systems and exits. For me, risk tolerance is enforced through my exits and risk control systems.

The performance quoted represents past performance and does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than the original cost. Current performance may be lower or higher than the performance quoted, and numbers may reflect small variances due to rounding. Standardized performance and performance data current to the most recent month end may be obtained by clicking the “Returns” tab above.

Low Volatility and Managed Volatility Smart Beta is Really Just a Shift in Sector Allocation

There is a lot of talk now days about “Smart Beta”. Smart beta refers to an investment style where the manager passively follows an index designed to take advantage of perceived systematic biases or inefficiencies in the market. Smart beta defines a set of investment strategies that emphasize the use of alternative index construction rules to traditional market capitalization based indices.

Low volatility or managed volatility, for example, is considered a version of “smart beta” because its weights the stocks (and therefore sector exposure) differently:

The PowerShares S&P 500® Low Volatility Portfolio (Fund) is based on the S&P 500®Low Volatility Index (Index). The Fund will invest at least 90% of its total assets in common stocks that comprise the Index. The Index is compiled, maintained and calculated by Standard & Poor’s and consists of the 100 stocks from the S&P 500® Index with the lowest realized volatility over the past 12 months. Volatility is a statistical measurement of the magnitude of up and down asset price fluctuations over time. The Fund and the Index are rebalanced and reconstituted quarterly in February, May, August and November.

I bolded the main difference between this index ETF and the traditional capitalization-weighted S&P 500. The S&P 500 everyone knows about weights is 500 stocks holdings based on market capitalization, so the largest stocks are the largest positions in the index.

The Low Volatility Portfolio is really a play on sector allocation. Because it creates its position size based on each stocks past 12 months volatility, it’s weighting will simply depend on what was less volatile the past year. And, it will look back to rebalance and reconstitute quarterly in February, May, August and November. So, you may consider what it really does is shifts the position size and sector weighting.

Below is the index sector allocation for the S&P 500 like what is used for SPDR® S&P 500® ETF so we can see which sectors have the largest position size.

S&P 500 SPY sector weighting

Source: https://www.spdrs.com/product/fund.seam?ticker=spy

Now we observe the sector allocation of the PowerShares S&P 500 Low Volatility Portfolio. Notice is is heavily weighted in Financials (36%) and Consumer Staples (21%). That’s simply because those sectors stocks have demonstrated less realized volatility as measured by standard deviation over the past 12 months.

PowerShares S&P 500 Low Volatility Portfolio SPLV

Source: https://www.invesco.com/portal/site/us/financial-professional/etfs/product-detail?productId=SPLV

Now, let’s observe the difference in return streams. Below is a relative strength comparison of the two since inception of  PowerShares S&P 500® Low Volatility Portfolio in May 2011. As you see, the low volatility index did have a smaller drawdown in 2011, but overall they’ve tracked the same most of the time. The real difference was the lower drawdown from the sector weighting helped reduce the loss in 2011 and that helped smooth out the returns for a few years. Since 2013 U.S. stock volatility declined, so that explains why the two indexes have trended more closely since.

S&P 500 low volatility vs capitalization

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

Over the past year, there is a little more divergence at times as we see below.

S&P 500 Low Volatility

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

You may consider that past realized volatility may not repeat into the future. In fact, it could reverse. But the real difference between these is the trailing realized volatility weighting changes the sector weighting. The sectors are the driver. Which sectors have the lowest 12 month historical volatility will determine the exposure to a volatility weighted index or fund. The risk to volatility weighting is the volatility of markets sometimes reach its lowest point at its peak in price as investors become more and more complacent and less indecisive, which is what causes a wider range in prices. I explained this in This is When MPT and VaR Get Asset Allocation and Risk Measurement Wrong.

Though the widening range of prices up and down gets our attention, it isn’t really volatility that investors want to manage so much as it is the downside loss of capital. I really manage volatility by actively increasing and decreasing exposure to loss.

Why Dividend Stocks are Not Always a Safe Haven

We often hear that high dividend stocks are a “safe haven” in market downtrends. The theory is the yield paid from dividend stocks offset losses in their price. Another theory is that money rotates out of risky assets into those perceived to be less risky: stocks that pay high dividends tend to be older cash rich companies that pay out their cash as dividends. In theory, that sounds “safer”.

I like to point out logical inconsistencies: when beliefs contradict reality.

The above may be true in some cases and it sounds like a good story. In reality, everything changes. The universe is transient, in a constant state of flux. This impermanence, that things are constantly changing and evolving, is one of the few things we can be sure about. It’s a mistake to base too much of an investment strategy on something that has to continue to stay the same. It’s an edge to be adaptive in response to directional trends.

Below is the year-to-date chart iShares Select Dividend ETF that seeks to track the investment results of an index composed of relatively high dividend paying U.S. equities. Notice that I included both the price change by itself (blue) and the total return that includes price plus dividends (orange). The “help” from the dividend over the past six months has helped a little. The price is down -3% but factoring in the dividend leaves the index down -2.33% for the year. The 0.7% is the dividend yield so far.

What has probably gotten investors attention, however, isn’t that their dividend stocks are down over -2% for the year, but that they are down over -4% off their high. That doesn’t sound like a lot: unless you are a conservative investor expecting a “safe haven” from high dividend yielding stocks…

In contrast, the Dow Jones Industrial Average is up about 1% over the same period  – counting dividends. You may be wondering what is causing this divergence? Below is the sector holdings for the iShares Select Dividend ETF.

The position size matters and makes all the difference. Notice in the table above the Utilities, Consumer Staples, and Energy Sectors are the top holdings of the index. As you see below, the Utilities sector is down nearly -9% year-to-date, Energy and Staples are down over -1%. They are the three worst performing sectors…

Source: Created by ASYMMETRY® Observations with www.stockcharts.com 

Wondering what may be driving it? For the Utility sector it’s probably interest rates. You can read about that in What You Need to Know About Long Term Bond Trends. I prefer to rotate between sectors based on their directional price trends rather than just allocate to them with false hope they may do something they may not. 

What You Need to Know About Long Term Bond Trends

There is a lot of talk about interest rates and bonds these days – for good reason. You see, interest rates have been in a downtrend for decades (as you’ll see later). When interest rates are falling, the price of bonds go up. I wrote in “Why So Stock Market Focused?” that you would have actually been better off investing in bonds the past 15 years over the S&P 500 stock index.

However, the risk for bond investors who have a fixed bond allocation is that interest rates eventually trend up for a long time and their bonds fall.

This year we see the impact of rising rates and the impact of falling bond prices in the chart below of the 20+ year Treasury bond. It’s down -15% off its high and since the yield is only around 2.5% the interest only adds about 1% over this period for a total return of -14.1%. Up until now, this long term Treasury index has been a good crutch for a global allocation portfolio. Now it’s more like a broken leg.

But, that’s not my main point today. Let’s look at the bigger picture. Below is the yield (interest rate) on the 10-Year U.S. government bond. Notice that the interest rate was as high as 9.5% in 1990 and has declined to as low as 1.5%. Just recently, it’s risen to 2.62%. If you were going to buy a bond for future interest income payments, would you rather invest in one at 9.5% or 1.5%? If you were going to lend money to someone, which rate would you prefer to receive? What is a “good deal” for you, the lender?

I like trends and being positioned in their direction since trends are more likely to continue than reverse, but they usually do eventually reverse when inertia comes along (like the Fed). If you care about managing downside risk you have to wonder: How much could this trend reverse and what could its impact be on fixed bond holdings? Well, we see below that the yield has declined about -70%. If we want to manage risk, we have to at least expect it could swing the other way.

One more observation. Germany is one of the largest countries in the world. Since April, the 10-year German bond interest rate has reversed up very sharp. What if U.S bonds did the same?

As I detailed in “Allocation to Stocks and Bonds is Unlikely to Give us What We Want” bonds are often considered a crutch for a global asset allocation portfolio. If you care about managing risk, you may consider that negative correlations don’t last forever. All trends change, eventually. You may also consider your risk of any fixed positions you have. I prefer to actively manage risk and shift between global markets based on their directional trends rather than a fixed allocation to them.

The good news is: by my measures, many bond markets have declined in the short term to a point they should at least reserve back up at least temporarily. What happens after that will determine if the longer trend continues or begins to reverse. The point is to avoid complacency and know in advance at what point you’ll exit to cut losses short…

As they say: “Past performance is no guarantee of the future“.

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.

My 2 Cents on the Dollar

The U.S. Dollar ($USD) has gained about 20% in less than a year. We observe it first in the weekly below. The U.S. Dollar is a significant driver of returns of other markets. For example, when the U.S. Dollar is rising, commodities like gold, oil, and foreign currencies like the Euro are usually falling. A rising U.S. Dollar also impacts international stocks priced in U.S. Dollar. When the U.S. Dollar trends up, many international markets priced in U.S. Dollars may trend down (reflecting the exchange rate). The U.S. Dollar may be trending up in anticipation of rising interest rates.

dollar trend weekly 2015-04-23_16-04-40

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

Now, let’s observe a shorter time frame- the daily chart. Here we see an impressive uptrend and since March a non-trending indecisive period. Many trend followers and global macro traders are likely “long the U.S. Dollar” by being long and short other markets like commodities, international stocks, or currencies.

dollar trend daily 2015-04-23_16-05-04

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

This is a good example of understanding what drives returns and risk/reward. I consider how long the U.S. Dollar I am and how that may impact my positions if this uptrend were to reverse. It’s a good time to pay attention to it to see if it breaks back out to the upside to resume the uptrend, or if it instead breaks down to end it. Such a continuation or reversal often occurs from a point like the blue areas I highlighted above.

That’s my two cents on the Dollar…

How long are you? Do you know?

Stock Market Year-to-Date and First Quarter

So far, the U.S. stock market isn’t doing so well. And, the gains and losses over the past quarter have been asymmetric. Consumer Discretionary (12.6% of the S&P 500 index) and Healthcare (14.8% of the S&P 500 index)  have barely offset the losses in four other sectors.

Below are the YTD gain and losses for the popular S&P 500 index and each sector in the index.

stock market first quarter performance 2015-04-02_12-38-10

source: http://www.sectorspdr.com/sectorspdr/tools/sector-tracker

But, that’s just one data point compared to another data point. Such a table would be incomplete without considering the path those gains and losses took to get there.

sector returns 2015 2015-04-02_12-41-15

source: http://www.sectorspdr.com/sectorspdr/tools/sector-tracker/charting

To see the results of asymmetric exposure and risk management in action across a global universe of markets, visit: http://www.asymmetrymanagedaccounts.com/

Performance is historical and does not guarantee future results; current performance may be lower or higher. Investment returns/principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Past performance does not guarantee future results.

Absolute Return as an Investment Strategy

Absolute Return Investment Strategy Fund Manager

In “Absolute Return: The Basic Definition”, I explained an absolute return is the return that an asset achieves over a certain period of time. To me, absolute return is also an investment objective.

In “Absolute Return as an Investment Objective” I explained that absolute return is an investment objective is one that does not try to track or beat an arbitrary benchmark or index, but instead seeks to generate real profits over a complete market cycle regardless of market conditions. That is, it is focused on the actual total return the investor wants to achieve and how much risk the investor will willing to take, rather than a focus on what arbitrary market indexes do.

Absolute return as a strategy: absolute return is sometimes used to define an investment strategy. An absolute return strategy is a plan, method, or series of maneuvers aiming to compound capital positively and to avoid big losses to capital in difficult market conditions. Whereas Relative Return strategies typically measure their success in terms of whether they track or outperform a market benchmark or index, absolute return investment strategies aim to achieve positive returns irrespective of whether the prices of stocks, bonds, or commodities rise or fall over the market cycle.

Whether you think of absolute return as an objective or a strategy, it is a skill-based rather than market-based. That is, the absolute return manager creates his or her results through tactical decision-making as opposed to taking what the market is giving. One can employ a wide range of approaches toward an absolute return objective, from price-based trend following to fundamental analysis. In the ASYMMETRY® Managed Accounts, I believe price-based methods are more robust and lead to a higher probability of a positive expectation. Through my historical precedence, testing, and experience, I find that any fundamental type method that is based on something other than price has the capability to stray far enough from price to put the odds against absolute returns. That is, a manager buying what he or she believes is undervalued and selling short what he believes is overvalued can go very wrong if the position is on the wrong side of the trend. But price cannot deviate from itself. Price is the judge and the jury.

Of course, absolute return and the “All Weather” type portfolio sound great and seem to be what most investors want, but it requires incredible skill to execute. Most investors and advisors seem to underestimate the required skills and experience and most absolute return strategies and funds have very limited and unproven track records. There is no guarantee that these strategies and processes will produce the intended results and no guarantee that an absolute return strategy will achieve its investment objective.

For an example of the application of an absolute return objective, strategy, and return-risk profile,  visit http://www.asymmetrymanagedaccounts.com/

Absolute Return as an Investment Objective

Absolute Return objective fund strategy

In Absolute Return: The Basic Definition, I explained an absolute return is the return that an asset achieves over a certain period of time. To me, absolute return is also an investment objective.

Absolute Return as an investment objective is one that does not try to track or beat an arbitrary benchmark or index, but instead seeks to generate real profits over a complete market cycle regardless of market conditions. That is, an absolute return objective of positive returns on investment over a market cycle of both bull and bear market periods irrespective of the direction of stock, commodity, or bond markets.

Since the U.S. stock market has been generally in a uptrend for 6 years now, other than the -20% decline in the middle of 2011, we’ll now have to expand our time frame for a full market cycle to a longer period. That is, a full market cycle includes both a bull and a bear market.

The investor who has an absolute return objective is concerned about his or her own objectives for total return over a period and tolerance for loss and drawdowns. That is a very different objective than the investor who just wants whatever risk and return a benchmark, allocation, or index provides. Absolute returns require skill and active management of risk and exposure to markets.

Rather than a long article, this is going to be a series of smaller parts, building up to what absolute return really means.

For an example of the application of an absolute return objective, strategy, and return-risk profile,  visit http://www.asymmetrymanagedaccounts.com/

Asymmetric Sector Exposure in Stock Indexes

When you look at the table below and see the sector exposure percents, what do you observe? Do these allocations make sense?

asymmetric sector ETF expsoure S&P 500 2015-03-24_16-39-11

That is the sector exposure of the S&P 500 stock index: I used the iShares S&P 500 ETF for a real-world proxy. The source of each image is the index website on iShares, which you can see by clicking on the name of the index ETF.

  • Asymmetric is an imbalance. That is, more of one thing, less of another.
  • A sector is a specific industry, like Energy (Exxon Mobil) or Telecom (Verizon).
  • Exposure is the amount of the position size or allocation.

Most of the sector exposure in the S&P 500 large company stock index is Technology, Financials, Healthcare, and Consumer Discretionary. Consumer Staples, Energy, Materials, Utilities, and Telecommunications have less than 10% exposure each. Exposure to Materials, Utilities, and Telecommunications are almost non-existent. Combined, those three sectors are less than 10% of the index. Industrial has 10% exposure by itself.  But this index is 500 large companies, what about mid size and small companies?

asymmetric sector expsoure S&P 500 2015-03-24_16-39-11

Below is the iShares Core S&P Mid-Cap ETF. Most of the sector exposure in the S&P Mid size stock index is Technology, Financials, Industrial. Healthcare, and Consumer Discretionary. Consumer Staples, Energy, Materials, Utilities, and Telecommunications have less than 10% exposure each. Exposure to Materials, Utilities, and Telecommunications are almost non-existent.

asymmetric sector exposure  S&P Mid-Cap ETF

We see this same asymmetric sector exposure theme repeat in the iShares S&P Small Cap index. Half of the sectors are make up most of the exposure, the other very little.

asymmetric sector exposure S&P small cap

This is just another asymmetric observation… the next time you hear someone speak of the return of a stock index, consider they are really speaking about the return profile of certain sectors. And, these sector weightings may change over time.

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“?

Trends, Countertrends, in the U.S. Dollar, Gold, Currencies

Trend is a direction that something is moving, developing, evolving, or changing. A trend is a directional drift, one way or another. When I speak of price trends, the directional drift of a price trend can be up, down, or sideways.

Trends trend to continue and are even more likely to continue than to reverse, because of inertia. Inertia is the resistance to change, including a resistance to change in direction. It’s an important physics concept to understand to understand price trends because inertia relates to momentum and velocity. A directional price trend that continues, or doesn’t change or reverse, has inertia. To understand directional price trends, we necessarily need to understand how a trend in motion is affected by external forces. For example, if a price trend is up and continues even with negative external news, in inertia or momentum is even more significant. Inertia is the amount of resistance to change in velocity. We can say that a directional price trend will continue moving at its current velocity until some force causes its speed or direction to change. A directional trend follower, then, wants keep exposure to that trend until its speed or direction does change. When a change happens, we call it a countertrend. A countertrend is a move against the prior or prevailing trend. A countertrend strategy tries to profit from a trend reversal in a directional trend that has moved to such a magnitude it comes more likely to reverse, at least briefly, than to continent. Even the best long-term trends have smaller reversals along the way, so countertrend systems try to profit from the shorter time frame oscillations.

“The one fact pertaining to all conditions is that they will change.”

                                    —Charles Dow, 1900

One significant global macro trend I noticed that did show some “change” yesterday is the U.S. Dollar. The U.S. Dollar has been in a smooth drift up for nearly a year. I use the PowerShares DB US Dollar Index Bullish (UUP). Below, I start with a weekly chart showing a few years so you can see it was non-trending up until last summer. Clearly, the U.S. Dollar has been trending strongly since.

u.s. dollar longer trend UPP

Next, we zoom in for a closer look. The the PowerShares DB US Dollar Index Bullish (UUP) was down about -2% yesterday after the Fed Decision. Notice that I included a 50 day moving average, just to smooth out the price data to help illustrate its path. One day isn’t nearly enough to change a trend, but that one day red bar is greater in magnitude and had heavy volume. On the one hand, it could be the emotional reaction to non trend following traders. On the other, we’ll see over time if that markets a real change that becomes a reversal of this fine trend. The U.S. Dollar may move right back up and resume it’s trend…

U.S. Dollar Trend 2015-03-19_08-21-35

chart source for the following charts: http://www.stockcharts.com

I am using actual ETFs only to illustrate their trends. One unique note about  PowerShares DB US Dollar Index Bullish Fund (Symbol: UUP) is the tax implications for currency limited partnership ETFs are subject to a 60 percent/40 percent blend, regardless of how long the shares are held. They also report on a K-1 instead of a 1099.

Why does the direction of the U.S. Dollar matter? It drives other markets. Understanding how global markets interact is an edge in global tactical trading. Below is a chart of Gold. I used the SPDR Gold Trust ETF as a proxy. Gold tends to trade the opposite of the U.S. Dollar.

gold trend 2015-03-19_08-22-41

When the U.S. Dollar is trending up, it also has an inverse correlation to foreign currencies priced in dollars. Below is the CurrencyShares Euro ETF.

Euro currency trend 2015-03-19_08-23-03

Foreign currencies can have some risk. In January, the Swiss Franc gaped up sharply, but has since drifted back to where it was. Maybe that was an over-reaction? Markets aren’t so efficient. Below is a chart of the CurrencyShares Swiss Franc to illustrate its trend and countertrend moves.

swiss franc trend 2015-03-19_08-23-23

None of this is a suggestion to buy or sell any of these, just an observation about directional trends, how they interact with each other, and countertrend moves (whether short term or long term). Clearly, there are trends…

To see how tactical decisions and understand how markets interacts results in my real performance, visit : ASYMMETRY® Managed Accounts

Sectors Showing Some Divergence…

So far, U.S. sector directional price trends are showing some divergence in 2015.

Rather than all things rising, such divergence may give hints to new return drivers unfolding as well as opportunity for directional trend systems to create some asymmetry by avoiding the trends I don’t want and get exposure to those I do.

Sector ETF Divergence 2015-03-04_11-24-54

For more information about ASYMMETRY®, visit: http://www.asymmetrymanagedaccounts.com/global-tactical/

 

Chart source: http://www.finviz.com/groups.ashx

 

 

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