The market climbs a wall of worry

April 29, 2020 By Mike Shell in Absolute Return, Asymmetric Risk Reward, Drawdown Control, Tactical Asset Allocation, Tactical ETF Managed Portfolio, tactical risk management Leave a comment

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

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

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

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

That’s exactly what we’re seeing now.

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

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

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

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

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

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

Just like you are, now.

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

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

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

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

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

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

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

I doubt it.

The headlines are blood red.

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

Then, there it goes.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Nothing changes investor sentiment the a price trend.

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

Global Asset Allocation had a strong year in 2019, but…

December 24, 2019 By Mike Shell in Asymmetric Observation, Global Asset Allocation, Global Directional Trends, Global ETF, Global Macro, Global Tactical Rotation, Systematic Global Macro, Tactical Asset Allocation, Tactical ETF Managed Portfolio Leave a comment

People don’t usually invest all their money in equities, even though the stock market is mostly what we talk about. Large institutional investors like pensions and endowments don’t invest all their capital in the stock market, either. Instead, they invest in allocation to stocks and bonds globally diversified across world markets.

One of my favorite examples of the stock and bond part of this global asset allocation is the S&P Dow Jones Indices’ Target Risk index series.

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

global asset allocation ETF ETFs ishares S&P target risk

For example, after a positive year for stocks and bonds, most investors will pay more attention to the one that gained the most. After stocks outperform bonds, the best gains are naturally going to be the global allocation that held the most stock exposure.

The S&P Target Risk Aggressive® Index is one of four multi-asset class indices that compose the S&P Target Risk Series. The S&P Target Risk Aggressive Index emphasizes exposure to equities, maximizing opportunities for long-term capital accumulation. It may include small allocations to fixed income to enhance portfolio efficiency. In a positive year like 2019, it was the clear winner on the upside. The aggressive allocation gained 19% so far in 2019. On the other end of the spectrum, even the conservative allocation gained 10%.

But, risk isn’t a knob.

Asset allocators don’t get to dial it up or down, and it always work out the way they want.

The reward isn’t a knob, either.

Just because a portfolio is dialed up with risk to “aggressive” doesn’t mean you get the reward from it.

That’s especially true in the short term. Had you believed risk and reward is a knob you turn to get what you want in January a year ago, you could have experienced the aggressive allocation resulted in the more aggressive loss.

The conservative model lost the least, but that isn’t a sure thing, either. In global asset allocation, conservative means more allocation to bonds for fixed income. If bonds fall and stocks rise, the conservative model could lose money and the more stock weighted aggressive could gain.

Diversification is often presented by advisors as a risk management strategy that mixes a wide variety of investments within a portfolio. But, diversification does not assure a profit or protect against loss. The outcome of asset allocation is driven by the exposure to stocks vs. bonds and their gain and loss.

That’s not what I do.

A global asset allocation of exposures that otherwise remain static is very different from dynamic exposures that change based on asymmetric risk-reward driving tactical decisions.

My outcome is decided by my tactical increase and decreases in exposure to risk-reward as I focus on asymmetric risk-reward. I believe there is a time for offense and a time for defense.

But, for everyone else, there’s global asset allocation. It’s what most people do. They allocate capital, I rotate capital. I rotate, rather than allocate.

If I were going to invest in static, long-only, fully invested all the time global asset allocation, it would look like these S&P Target Risk indexes. When it comes to a simple allocation of capital, who’s going to do it better than S&P? Many advisors are charging their clients 0.50% to 1% for a simple asset allocation like this. I personally believe the risk of a disaster is so high it makes the unmanaged risk imprudent, so we don’t offer fixed, long-only, fully invested all the time global asset allocation at Shell Capital. If we did, we’d probably manage billions because investors want “market returns” until they are big losses. We could also spend our time selling instead of analyzing. But we would constantly be apologizing for market behavior instead of embracing up and downtrends. In my opinion, it’s a difficult business model, but it’s still the easiest for financial advisors. They allocate to the funds, rebalance routinely, maybe do some tax-loss harvesting, and write a commentary about what the market did that lead to their results. Admittedly, it’s a lot easier than tactical portfolio management. When the market doesn’t do what they wanted, it’s the market’s fault. In 2008, they said let’s “hunker down.”

From my perspective, the investment advisory firms with the largest assets under management tend to be asset allocation firms. They advise clients to invest in global asset allocation models similar to these. Since they aren’t doing constant research and making tactical trading decisions, their time is freed up for the golf course, where they meet more and more clients.

Why do I think it’s a challenging advisory business model?

Global asset allocation doesn’t give me what I want, nor does it give our clients what they want. We want active risk management. We want a point in which we’ll reduce our exposure to loss and maybe even reverse it so as prices fall we profit from it. Sure, like global asset allocation, tactical portfolio management does not assure a profit or guarantee protection against a loss, either. But, like any other action in life vs. inaction, it’s an attempt, which to me, is better than no attempt at all.

What I know is this: global markets can and do all fall together in times of crisis when investors who held their losses too long keep tapping out as prices fall.

global asset allocation diversification failed 2008

Even the most respected global allocation funds participated in the waterfall decline enough to tap out most investors I know if they had invested in them – we didn’t.

I know some advisors and media have been criticizing the “hedge fund” side of the investment industry for years now because total returns haven’t been as high as the past. I don’t think passive indexing advisors have all that much to speak about themselves. Even the most aggressive index allocation that assumes no fees is a 26% gain in the past three years. That’s not an average gain, it’s a gain in capital.

More importantly, those numbers haven’t changed over the past 5 years. So, the past 5 years haven’t been so outstanding for anyone, especially factoring in the volatility.

In fact, it’s caused by volaltity. Volatility eats away at compounding capital positively.

Speaking of volatility, it’s the downside volatility we don’t like. Here are the historical drawdowns of these indexes since they launched in 2011.

If you look close, to get the return of global asset allocation, you’d have to hold through declines of -10% to -20% routinely. In a big bear market will be worse, which hasn’t happened since these indexes weRE made available.

That’s why I believe even a passive global asset allocation is a risky business and not an investment model I’m willing to offer. If people we know want global asset allocation, we show them a way to get it without us. We only offer what we believe is of value.

I can’t imagine what it would be like in 2011 when these global allocations were falling and all we can say is “Hopefully it stops falling?”

But, what if it doesn’t?

What if it keeps falling?

I believe everyone has a tap-out point. We can either determine it in advance or find out the hard way. The tap-out point will be tested over and over with global asset allocation.

But, 2019 wasn’t one of those years, so everyone has something to celebrate this year.

When the wind is blowing, we can let out the sail and enjoy the ride.

When the wind stops blowing, we have to row, not sail, or risk sinking.

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

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

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

August 13, 2019 By Mike Shell in Absolute Return, Asymmetric ETF, Asymmetric Observation, Asymmetric Risk Reward, Asymmetry ETF, Global Asset Allocation, Global Directional Trends, Global ETF, Global Macro, Global Tactical Rotation, Systematic Global Macro, Tactical Asset Allocation, Tactical ETF, Tactical ETF Managed Portfolio, tactical risk management Leave a comment

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

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

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

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

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

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

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

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

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

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

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

Bloomberg goes on to say:

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

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

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

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

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

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

All investors are market timers

August 6, 2019 By Mike Shell in Absolute Return, Active Risk Management, Actively Manage Risk, Asymmetric Observation, Asymmetric Risk Reward, Average Length of Bull Bear Market, Global Asset Allocation, Tactical Asset Allocation, U.S. Stock Market Leave a comment

All investors are market timers.

It isn’t just tactical traders.

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

But they are.

We all are.

And timing is everything. Like it or not.

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

According to Wikipedia:

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

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

Next is Investopedia:

“What Is Market Timing?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Past performance is no guarantee of future results.

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

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

Global Asset Allocation hasn’t done any better

August 6, 2019 By Mike Shell in Absolute Return, Asymmetric Hedge, Asymmetric Observation, Asymmetric Risk Reward, Global Asset Allocation, Global Directional Trends, Global Tactical Rotation, Systematic Global Macro, Tactical Asset Allocation, Tactical ETF Managed Portfolio, tactical risk management Leave a comment

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

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

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

Each ETF has a fixed allocation to stocks and bonds.

ishares global allocation ETF

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

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

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

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

I don’t believe I know anyone who does.

Why?

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

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

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

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

Shiller PE Ratio

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

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

May as well be honest and realistic about it.

Not convinced?

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

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

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

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

It isn’t going to last forever.

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

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

A few observations on Global Macro and Trend Following

July 23, 2019 By Mike Shell in Absolute Return, Active Risk Management, Actively Manage Risk, Asymmetric Investment Returns, Asymmetric Observation, Asymmetric Payoff, Asymmetric Risk Reward, Asymmetry ETF, Asymmetry Ratio, Global Asset Allocation, Global Directional Trends, Global ETF, Global Macro, Global Tactical Rotation, Positive Asymmetry, Risk Asymmetry, Systematic Global Macro, Tactical Asset Allocation, Tactical ETF, Tactical ETF Managed Portfolio, Tactical ETF Portfolio Management, tactical risk management, Trend Following Leave a comment

A few observations on #GlobalMacro and #TrendFollowing

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

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

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

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

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

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

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

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

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

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

Global asset allocation takes a beating in 2018

December 18, 2018 By Mike Shell in Absolute Return, Active Risk Management, Asymmetric Observation, Global Asset Allocation, Global Directional Trends, Global Macro, Global Tactical Rotation, Hedge Funds, Tactical Asset Allocation, Tactical ETF Managed Portfolio 1 Comment

Most financial advisors and financial planners recommend to their clients some type of global asset allocation. Their global asset allocation models usually include a range of bonds, U.S. stocks, and International stocks. Some may include what are considered alternative investments like real estate (REITs), private equity, or tactical trading, but most of them keep it plain vanilla. This asset allocation method is called “strategic asset allocation” since it usually applies some form of portfolio optimization of historical returns and volatility to determine the weight between stocks and bonds.

Who can blame them? asset allocation and diversification is easy to sell and easy to defend. If someone sells their business or retires with a large 401(k), it’s easy to sell them on diversifying their assets. If the markets go down it isn’t their fault, it’s the market that’s doing it. Is it too much drawdown or volatility? They just recommend a change to less stocks and more bonds. Of course, that only works when bonds aren’t falling too.

Since many actively managed mutual funds failed to avoid losses during the last bear market 2007 to 2009, many advisors shifted their strategic asset allocation from actively managed mutual funds to index funds. It’s easy to see why; their clients lost a lot of money, even as much as -40% for a balanced portfolio of 60% stocks and 40% bonds. If they were more invested in stocks, it was as much as -50% or more.

If a mutual fund was supposed to be “active,” I can see how such losses would be unacceptable. If an investor is paying more for portfolio management, they probably expect to have a more asymmetric risk/return profile than what long-only exposure to stock indexes all the time would provide for less cost. Index funds and ETFs are cheap because they simply provide exposure to market risks and rewards. They provide this exposure all the time, so when markets fall as they do in a bear market, they lose value and have no stop loss for risk management.

I also use index ETFs to gain exposure to markets, countries, and sectors, but I don’t just buy and hold them, I increase and decrease my exposure to actively manage my risk/reward. My objective is an asymmetric risk/reward, so I want to avoid the larger losses as I try to capture gains. For me, it starts at the individual position level and flows through to the portfolio level. I’m entering positions we expect to result in an asymmetric risk/reward payoff; positions with a higher expected gain than its potential loss. I do this over and over, and they don’t all have to result in asymmetry. We just need the average gains to exceed the average losses over time to achieve a positive asymmetric risk-return profile. It’s an absolute return objective, meaning our focus is on our own payoffs and risk-reward profile, not trying to track what a stock index is doing. My strategy is unconstrained from the limitations of a fixed benchmark. Our objective is more about making money with a predetermined amount of absolute risk, not relative returns and tracking indexes. As such, the return stream is expected to be unique.

That isn’t what active mutual fund managers do.

The typical active mutual fund has an objective of relative return vs. an index benchmark. As I’ve been an investment manager for over two decades, I’ve seen the relative return comparisons become more and more intense. Brokerage firms and investment advisors have created sophisticated performance reporting programs to compare their performance to chosen benchmarks. Active mutual funds have a mandate to “beat” and index. For example, some of them aim to beat the large growth, mid value, or small growth asset classes. Most of them attempt to beat their benchmark by filtering through the stocks in the index and picking better stocks. If a relative return is their objective, they are not focused on managing downside risk. Instead, they are focused on tracking the benchmark and getting ahead of it. Many of them probably attempt it by holding a more focused portfolio or with a portfolio of the higher momentum stocks relative to the benchmark. Since risk management isn’t their objective, they view any overweight in cash as a risk of underperformance. That’s what traditional “active managers” do. What I do is typically called “tactical management” since my objective is absolute return, not relative return, and I want to actively control my drawdowns through risk management. For example, I could be positioned in all cash in a bear market, hedged, short, or long volatility.

So, there is an important distinction between “active managers” with a relative return benchmark-beating objective and those of us with an unconstrained strategy and focus on absolute returns. Mutual funds are typically relative return managers trying to beat a benchmark, hedge funds are typically absolute return managers creating their own unique return stream. Although, typically means that isn’t always the case.

Ok, so, the headline was about the performance of Global Asset Allocation this year.

Back to global asset allocation.

Some financial advisors and media enjoy disparaging all types of active management. They talk about how relative return managers like most mutual funds don’t beat their benchmarks. They’ll point out how absolute return hedge fund type strategies may manage downside risk, but don’t earn as much return as an all-stock portfolio. Most of the time, it isn’t a reasonable comparison. For example, saying the Barclays Hedge Fund Index underperformed the S&P 500 the past decade isn’t complete without also considering the drawdowns. In the last bear market, the S&P 500 declined -56% while the Barclays Hedge Fund Index that includes a composite of thousands of hedge funds declined only -24%. I will suggest the stock index loss was so large most tapped out while the Barclays Hedge Fund Index was low enough that investors could have held on.

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

This year has been a challenging and hostile year for all investment strategies. While those who adhere to a long-only fully invested asset allocation all the time will talk about the performance of active managers, theirs isn’t much to speak of, either. I know a lot of advisors, and we work with some who invest in my portfolio. Most of their global asset allocations are very simple, and now many of them use index funds and charge an advisory fee for the asset allocation and rebalancing.

There are some mutual funds that offer a varying method of asset allocation. I am not recommending any of these funds, this is for educational and informational purposes only. Some popular ones that come to mind are BlackRock Global Allocation (MDLOX), Arrow DWA Balanced. PIMCO All Asset All Authority (PAUAX), DFA Global Allocation 60/40 (DGSIX). BlackRock Global Allocation, Arrow DWA Balanced, and PIMCO All Asset All Authority are active allocation funds while DFA Global Allocation is a passive allocation fund managed by Dimensional Fund Advisors. Below are their year-to-date total returns, including dividends. (To see their full history click on the links in their names above.)

Global Asset Allocation Funds

I know financial advisors who are big advocates of large asset managers like Dimensional Fund Advisors (DFA), PIMCO, and BlackRock. Advisors often tout how large they are and how many academics or how many analysts and portfolios managers they have on staff. I included the Arrow DWA Balanced fund because it’s managed by Dorsey Wright, which isn’t as large, but I know advisors use it. Most advisors who offer asset allocation models are doing their own asset allocations for their clients. The above returns are the result of each of these asset managers doing the allocation and investment selection. So, I would expect when it comes to global asset allocation, those funds should be as good as it gets. How is a financial planner who isn’t a portfolio manager going to do better?

Some may say “What about Vanguard? They are some of the cheapest funds you can buy?”. I don’t know of a Vanguard global asset allocation fund like the DFA fund, but they do have a balanced 60/40 fund that doesn’t include exposure to international. Below is their balanced allocation fund along with their International stock fund. Though their fund isn’t down -7% like the global allocation funds, if you added 20% of their International to make it “global,” we can see it would be similar.

vanguard asset allocation funds

Since indexing and ETFs have become more popular than mutual funds, today we have some interesting ETFs that track global asset allocation indexes so we can better understand the return streams of global asset allocation.

iShares is a BlackRock company, the world’s largest asset manager with $6.29 trillion in assets under management. If an investor thinks a large size with many professionals is the key to investment success, they would probably BlackRock is the best. Of course, I don’t agree, since the most skilled portfolio managers I know are small, focused, specialized firms with all their skin in the game. BlackRock’s iShares offers the iShares Core Allocation Funds, which are ETF allocations of ETFs. Each iShares Core Allocation Fund offers exposure to U.S. stocks, international stocks, and bonds at fixed weights and holds an underlying portfolio of iShares Core Funds. Investors can choose the portfolio that aligns with their specific risk considerations like investment time horizon and risk tolerance; for example, those with longer investment time horizons and higher risk tolerance may consider the iShares Core Aggressive Allocation ETF.

More specifically, the iShares Core Allocation Funds track the S&P Target Risk Indexes. So, not only do you have BlackRock’s portfolio management managing the fund, but they are tracking S&P Target Risk Indexes. Here is their description:

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

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

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

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

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

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

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

Global Allocation Index Construction

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

Now that we know what they are, below are their total returns including dividends year to date in 2018. (To see the full history click: iShares)

global asset allocation fund ETF

The % off high chart shows their drawdowns from their price high.

global asset allocation ETF ETFs

Global asset allocation is having a challenging year in 2018 because U.S. stocks, International stocks, and bonds are all down this year.

Of course, a calendar year doesn’t mean a lot. What we do over 15 or 20 years or more is what matters. But, as low-cost index asset allocation advisors talk about the performance of active managers and hedge fund type managers, 2018 has included conditions that have been hostile for all kinds of strategies.

As I said yesterday if this market volatility and correction develops into a full bear market, the asset allocations that are fully exposed to downside risk will test investors’ tolerance for drawdowns.

How deep can drawdowns be for such a globally diversified portfolio? Looking at the historical % off high of DFA Global Allocation and Vanguard Balanced gives a historical example. Even two of the efficient allocation funds available had drawdowns of around -35% to -40% in the last bear market. If it’s done it before, it can certainly happen again.

DFA Global Allocation Vanguard Balanced

Those of us applying active risk management and hedging strategies aim to limit the drawdowns within a tolerable amount rather than allowing them to become too large. For me, more than -20% becomes exponentially more difficult to tolerate and recover from. We have to deal with the -10% or so drawdowns sometimes since we can’t avoid them all. We necessarily have to take some risk to gain exposure to the possibility of gains.

Ok, so my headline was a little exaggerated. Drawdowns of -5% to -12% isn’t exactly a “beating”, but that’s the kind of headline we often see about active management and hedge funds.

You can probably see why I believe it’s essential to actively manage risk and position capital in the direction of price trends.

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.

Momentum stocks need to find some buying interest

November 19, 2018 By Mike Shell in Active Risk Management, Asymmetry ETF, ETF Strategist, Global Tactical Rotation, Sector Rotation, Sector Trends, Systematic Global Macro, Tactical Asset Allocation, Tactical ETF Managed Portfolio, Trend Following 1 Comment

The U.S. stock indexes were down nearly -2% today.

Prior to today, it appeared more likely the stock market would attempt to trend higher. The only positive about today’s price action was the volume was lighter. The S&P 500 stock index is now 2% above its October low and 5.4% above its February low.

To reverse the downtrend, selling pressure must be exhausted as buying demand becomes dominant. If we don’t see selling exhausted and buying interest in the coming days, it appears we may see the October lows revisited in the large-cap stock index. It’s only 2% away.

Looking at the bigger picture, a 2-year chart of the S&P 500 stock index shows its primary trend is still up with higher highs and higher lows, despite the volatile trading range in 2018. Nevertheless, the +/- 10% swings we’ve observed this year is a much higher range than we saw last year.

The stock market is seasonally in its best period of the year. That is especially true for November and December. Although, that hasn’t been the case yet with the S&P 500 down over -4% so far in November. For example, the seasonality chart shows the SPX has closed higher than it opened 70% of the time in November and 74% of the time in December. We’ll see if this matches the favorable odds or if it’s one of the 30% of times it doesn’t close positive.

The technology sector was the weakest today and it broke just below its October low. If its price has trended down low enough to attracting buying demand it could form a double bottom reversal and trend back up. If it continues to trend down enough, it could change its primary trend from up to down. Up until now, the tech sector has been the momentum leader. Technology is also the largest weight in the S&P 500 at 20%.

It could turn out to be positive that the former leading tech sector has lead the downtrend. Reversing leadership doesn’t normally sound like a good thing, except it is one of the main sectors weighing down the overall stock market the past week. Since it’s reached its October low already, we’ll see in the days and weeks ahead if it’s reached a low enough point to attract enough buying to overwhelm the selling.

In fact, momentum stocks have become the laggards recently. The S&P 500® Momentum Index is designed to measure the performance of securities in the S&P 500 universe that exhibit persistence in their relative performance. The momentum index is an index of stocks whose price trend momentum has outperformed other stocks. Indexes can’t be invested in directly, but we can use them to observe their trends. Here we see an index of stocks that were considered the leading momentum stocks have declined nearly -14% off its high, even more than the S&P 500 large-cap stock index. The technology sector overwhelms this momentum index with a 35.4% weighting. Tech had been so strong its weight is more than double the second largest weighted sector (Consumer Discretionary 15.4%).

You can probably see why I prefer to increase and decrease my exposure to the possibility of loss rather than just buying and holding an allocation with no predetermined exit. Because we know there is a point we’ll exit losers rather than let the losses become larger, we won’t wait for losses to get too large and become the panic sellers. We observe many investors believe in buy and hold and passive asset allocation until they realize their losses get much larger than they expected and they respond more emotionally than they thought they would. I call it panic selling when they tap out because of fear rather than a predetermined exit point based on drawdown control.

The U.S. stock market remains in the range of an inflection point and we’ll soon see if it’s going to turn down into more of a downtrend or reverse back up. We’ll see how it all unfolds from here.

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

Observations of the stock market downtrend

October 24, 2018 By Mike Shell in Active Risk Management, Actively Manage Risk, Asymmetric Hedge, Asymmetric Observation, Asymmetric Risk, Asymmetric Risk Reward, Global Directional Trends, Global Tactical Rotation, Investor Behavior Modification, Investor Sentiment, Managed Volatility, Sector Trends, Tactical Asset Allocation, Tactical ETF Managed Portfolio, tactical risk management, Trend Following, U.S. Stock Market, VIX CBOE Volatility Index, VIX ETF ETN ETP, Volatility Expansion, Volatility Hedging, Volatility Trading 1 Comment

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

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

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

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

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

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

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

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

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

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

Fear is the dominant driver.

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

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

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

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

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

Speaking of a hedge.

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

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

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

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

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

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

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

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

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

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

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

That’s what stock investors are waiting for now.

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

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

I hope you find my observations interesting and informative.

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

Global Market ETF Trends

August 9, 2018 By Mike Shell in Absolute Return, ETF Strategist, Global Asset Allocation, Global Directional Trends, Global Macro, Global Tactical Rotation, Investor Behavior Modification, Systematic Global Macro, Tactical Asset Allocation, Tactical ETF, Tactical ETF Managed Portfolio, Tactical ETF Portfolio Management, Technical Analysis, Trend Following Leave a comment

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

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

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

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

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

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

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

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

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

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

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

March 7, 2018 By Mike Shell in Absolute Return, Actively Manage Risk, Adapting to Change, Asymmetric Investment Returns, Asymmetric Risk Reward, Business Cycle, ETF Strategist, Family Office, Global Directional Trends, Global Macro, Global Tactical Rotation, Hedge Funds, Hiring a Portfolio Manager, Investor Behavior Modification, Mathematical Expectation, Momentum Relative Strength, Quantitative Evidence-Based Rearch, Risk Asymmetry, Sector Trends, Secular Bear Market, Secular Bull Market, Systematic Global Macro, Tactical Asset Allocation, Tactical ETF Managed Portfolio, Trend Following Leave a comment

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

March 6, 2018 By Mike Shell in Absolute Return, Actively Manage Risk, Asymmetric Investment Returns, Asymmetric Observation, Asymmetric Risk, Asymmetric Risk Reward, Asymmetric Sector Exposure, Global Directional Trends, Momentum Relative Strength, S&P 500, Sector ETF, Sector Rotation, Sector Trends, Systematic Global Macro, Tactical Asset Allocation, Tactical ETF Managed Portfolio, Trend Following Leave a comment

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.

Buying demand dominated selling pressure in the stock market

March 5, 2018 By Mike Shell in Asymmetric Observation, S&P 500, Sector ETF, Sector Rotation, Short Term Market Commentary, Systematic Global Macro, Tactical Asset Allocation, Tactical ETF Managed Portfolio, Tactical ETF Portfolio Management, Trend Following, U.S. Stock Market 1 Comment

Past performance is no guarantee of future results and that was the case today. After last weeks Selling pressure overwhelms buying demand for stocks for the third day in a row the enthusiasm to buy overwhelmed the desire to sell. Market prices are driven by simple Economics 101: when buying enthusiasm overwhelms sellers, prices rise. The S&P 500 gained 1.16% today and seems to have found some buying interest at the prior range I highlighted in green.

stock market florida investment advisor

Sector breadth was strong with Utilities, Real Estate, and Financials leading the way.

Sector rotation trend following

We don’t just invest and trade in U.S. stocks and sectors, I look for trends globally across the world. Though the Global ETF Trends monitor below shows many international countries were in the green, the good ole USA was one of the biggest gainers today.

global tactical asset allocation trend following global tactical rotation

Back to the U.S. stock market, in the chart below, I added Kelner Channels to illustrate a few things.

Keltner Channels are volatility-based envelopes set above and below an exponential moving average. This indicator is similar to Bollinger Bands, which use the standard deviation to set the bands. Instead of using the standard deviation, Keltner Channels use the Average True Range (ATR) to set channel distance.

Kelner Channels show the range of volatility has spread out and got wider since the stock market price trend trended above the upper channel in January, suggesting its uptrend was abnormal. Since then, the trend reversed down and again traded outside the range of the Kelner Channel on the downside. It’s a good example of how the market can overreact on both the upside and downside.

stock market trading range ATR

In the chart above, I also include the Relative Strength Index, which is on its 50-yard line. You can see how it was reading “overbought” in January (and had been for months), then after that extreme it became oversold. This kind of price action presented us with an opportunity to turn on the swing trading systems. My countertrend systems signaled short-term entries in several stocks and ETFs very near the low prices.

I pointed out in Stock Market Analysis of the S&P 500 on February 9th near the lows the breadth of the stock market was oversold at a lower risk. Market analysis is best used as a weight of the evidence. You can probably see how these different indicators signaled a countertrend move was possible and this time that has happened so far. I say this time because it’s always probabilistic, never a sure thing. If the stock market were going to trend down -50% over a two year period it would start off this way being “oversold” and look “washed out”, only to get worse as it swings up and down on it’s way to a lower low. During times like this, a skilled swing trader or countertrend systems can help to generate profits as price trends swing up and down.

Below is an updated chart of the percent of stocks in the S&P 500 that are trading above their 50-day moving average. 12% more stocks are trading above their 50-day moving average after today, bringing it to 32%. I point this out because it gives us an idea of how many stocks are still left to trend back up. That is, based on this breadth indicator, there is room for stocks to keep trending up if buyers continue their enthusiasm. This is the opposite of the condition in the last months of 2017 and January when 80% or more stocks were already in positive trends. To revisit this concept I encourage you to read Stock Market Analysis of the S&P 500.

SPX S&P 500 stocks above the 50 day moving average SPY

The bottom line is, the supply and demand for the stock market seems to be shifting back in control of buyers for now. Only time will tell if it continues in the days and weeks ahead. This is just a quick market analysis to look at what is going on, not investment advice. Our investment management and advice are only offered through an investment management agreement. If you want investment management or advice, contact us.

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.

February Global Market Trends

March 1, 2018 By Mike Shell in Absolute Return, Absolute vs. Relatative Return, Active Risk Management, Alternative Investment, Asymmetric Observation, Asymmetric Risk Reward, ETF Strategist, Global Asset Allocation, Global Directional Trends, Global Macro, Global Tactical Rotation, Hiring a Portfolio Manager, S&P 500, Systematic Global Macro, Tactical Asset Allocation, Tactical ETF Managed Portfolio 1 Comment

After a very positive January for U.S. and international stocks, in February it only took 10 days for the S&P 500 to decline -12% intraday and a -10% drawdown based on closing price.

stock market decline drawdown februrary 2018

Yet, February ended with the S&P 500 only down -3.5% after that -12% intra-month drawdown. For the month, International (MSCI EAFE) and Emerging Markets declined the most viewing the below board based indexes. The U.S. Dollar gained 1.8%.

global market returns february 2018 loss drawdown

Next, we view February global market returns relative to the S&P 500 stock index by holding it constant. This visual shows us how much markets gained/lost net of the S&P 500, Though in the absolute trend table above I showed bonds declined in absolute return, they gained relative to the S&P 500,

global market trend returns relative to spx spy S&P 500

Of course, one month isn’t a trend. In fact, I’m going to explain how this is an intentional logical inconsistency. Speaking of one time period in isolation, be it a month, year, or series of years is just an arbitrary time frame. What’s worse is viewing just the result over a time frame, like the month of February above, in just a table format.

A return stream is precisely that; a stream. A return stream is a continuous price trend in a continuous specified direction. Continuous is forming an unbroken whole; without interruption. So, I like to view return streams as price trends on a chart so I can see how the trend really unfolded over the period. Observed as a visual price trend, we see both the good and the bad of the price action along the way. You can probably see how it does that better than a simple performance table, monthly return % of the period or the bar chart above.

stock market decline februrary 2018

In the chart above, we see how much the price trends of those markets declined along the way before closing the month yesterday. I wrote about the short-term risk reversal in Stock Market Analysis of the S&P 500 suggesting it may reverse back up at least temporarily and retrace some loss and it did.

Now, what is essential about looking at performance data and trends is what the investor experiences. Investors experience what they choose to experience. For example, suppose and the investor is fully invested in the stock market, they could experience the month one of three ways.

If the investor only looks at his or her month-end statement, they would experience either the month end “-3.5%”.
If the investor watches their account or market indexes closely every day, they experienced every daily move and the full -12% decline and then some recovery.
Some may not pay any attention at all either because they are disinterested or they have an investment manager they trust to manage their risk-taking and risk management for them.

Investors and traders get to choose what time frame they watch things. I’ve always observed that “watching it too closely” can lead to emotional mistakes for many. For me, I’m paying attention and may zoom in and pay more attention when trends get more volatile or seem to reach an extreme. But, I’m a tactical portfolio manager, it’s what I do. I can view short term or long term trends alike with self-discipline. I have an edge that has been quantified by a long track record of 14 years in the current portfolio I manage.

I said this recently on Twitter:

For a skilled tactical trader who has an edge & discipline, "watching it closely" is useful when the short-term market trend changes and becomes volatile. But, for the investor who isn't making decisions, or trader who lacks edge/discipline, it can lead to bad feelings/mistakes.

— Mike Shell 🇺🇸 (@MikeWShell) February 15, 2018

If the investor doesn’t like to see such losses like those experienced in many markets in February, they may choose to instead not be fully invested in stocks all the time. That’s what I do. I’m not invested in any specific market all the time. My exposure to risk and return increases and decreases over time based on trends and my risk systems. I intentionally increase and decrease my exposure to the possibility of loss and gain. I’m also unconstrained so I can do it across any global market like bonds, currency, stocks, commodities, or alternatives like REITs, inverse (shorting), or volatility.

According to the American Association of Individual Investors, the decline was so quick most individual investors didn’t seem to respond:

Majority of Investors Avoided Taking Action in Recent Market Correction

“This week’s Sentiment Survey special question asked AAII members what portfolio action, if any, they took in response to the recent market correction. The majority of respondents (62%) said they didn’t make any change or only made a small change. Many of these respondents described themselves as being focused on the long term, viewing this month’s correction as being only temporary in nature or not severe enough to warrant any action. A few of these respondents described the correction as lasting too short of a time for them to take advantage of it. Nearly 33% respondents said they took advantage of the decline to buy stocks or funds. Some said they took advantage of the reduced prices to either add to current positions or buy new holdings. Just 7% of respondents said they sold stocks during the correction. A small number of respondents said they sold some positions and then bought new positions.”

I say investors should find and do what helps them, not make it worse. Know yourself, know your risk, and know your risk tolerance. That’s what we do.

So, that is what happened during the month of February, and a little asymmetric observation to go with it.

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

November 10, 2017 By Mike Shell in Absolute vs. Relative Return, Investment Thought Leadership, Sector Rotation, Sector Trends, Tactical Asset Allocation, Tactical ETF Managed Portfolio, Trend Following Leave a comment

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.

Is this the Inflection Point for Stocks?

April 28, 2017 By Mike Shell in Absolute Return Strategy, Active Risk Management, Actively Manage Risk, Adapting to Change, Asymmetric Observation, Business Cycle, Counter trend, Critical Thinking, Crowd Psychology, Global Asset Allocation, Global Directional Trends, Global Macro, Investor Sentiment, Quantitative Evidence-Based Rearch, Tactical Asset Allocation, Trend Following 1 Comment

As if the election result wasn’t enough, the U.S. stock market has surprised most people by trending up since last November.

But, it has been stalling since March. The S&P 500 drifted down about -3% into March and April.

The stock market seems to be at an inflection point now.

Understanding the market state is an examination of the weight of the evidence.

The weight of the evidence seems to suggest defense.

My first indicator is always the actual price trend itself. If we want to know what is going on, there is no better observation than the actual price trend. The price action tells us what force is in control: supply or demand. And, we can see the potential for the inflection point – when the direction is changing. In the chart below, I highlight a recent point of “resistance”. I call it resistance because the stock index hasn’t broken above the March high and is instead drifting sideways.

average age of bull market top

Investors sometime assume a prior price high will automatically become “resistance” just because it’s the price range they expect to see the price trend stall. Resistance is the price level where selling is expected to be strong enough to prevent the price from rising further. We can see that recently in the chart. As the price advances towards the prior peak, supply may overcome demand and prevent the price from rising above resistance. For example, it may be driven by investors who wished they had sold near the prior peak and had to wait as the price recovered again. They anchor to that prior high. Once it gets back to the prior peak, they exit. Prior highs don’t always become “resistance” as expected. Sometimes demand is strong enough to break through and keep trending up. At this point, we see there has been some resistance at the prior high. I highlighted it in yellow in the chart above. So, we shouldn’t be surprised to see the price decline if this resistance holds for a while. Or, it could be an inflection point.

The S&P 500 stock index is mainly large companies. Smaller companies tend to lead larger companies. Their price trends move in a wider range and they sometimes move faster, so they get to a point sooner. That’s why we say small company stocks “lead” large company stocks. In that case, I highlight below that the small company stock index, the S&P 600 Small Cap ETF, reached its prior, but found resistance and reversed down. The soldiers may lead the way for the Generals.

Small Cap

It seems that the stock index is stalling at a time when investors are complacent. When investors are complacent or overly optimistic an inflection point is more likely. The CBOE Volatility Index^® (VIX^® Index) is very low. The CBOE Volatility Index^® (VIX^® Index^®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. The VIX^® historically trends between a long-term range. When the VIX^® gets to an extreme, it becomes more likely to eventually reverse. In the chart below I show the price level of the VIX^® since its inception in 1993. We can see its long-term average is around 20. I highlighted in red its low range is around 12 and it has historically spiked as high as 25 or 60. This means the traders of options are expecting lower volatility in the weeks ahead at a time when other things seem to suggest otherwise.

As I continue sharing some observations, I’m going to get farther away from my main decision maker which is the directional price trend, but you’ll see how these indicators help to quantify the state of the trend and the potential for an inflection point. As we keep going, keep in mind that indicators are a derivative of the price at best or a derivate of something unrelated to the directional price trend. In the case of the VIX^® Index index above, it’s a measure of options (a derivative) on the stocks in the S&P 500. When we start looking at things like economic growth and valuations we are necessarily looking at things that are a derivative of price, but not as absolute as the price trend itself. The direction of the price trend is the arbiter.

Another signal of an inflection point is breadth. That is, what percent of stocks are rising or falling. Since I have mentioned the S&P 500 stock index, I’ll show the S&P 500 Bullish Percent Index below. The Bullish Percent is a breadth indicator based on the number of stocks on Point & Figure buy signals. Developed by Abe Cohen in the mid-1950s, the Bullish Percent Index was originally applied to NYSE stocks. Cohen was the first editor of ChartCraft, which later became Investors Intelligence. BP signals were further refined by Earl Blumenthal in the mid 70’s and Mike Burke in the early 80’s. The S&P 500 Bullish Percent shows a composite of the 500 stocks in the S&P 500 index that are in a positive trend. The S&P 500 Bullish Percent recently reversed to a column of O’s from a high point of 80, which means about 80% of the S&P 500 stocks were in a positive trend and about 8% of them are now in a negative trend. In addition to the direction, the level is important because we consider the level above 70% or 80% to be a higher risk (red zone) and the levels below 30% to be lower risk (green zone). So, more and more stocks within the index are starting to decline. This weak “breadth” or participation could be a signal of a change in trend.

Bullish Percent

I’m not necessarily a big user of economic indicators. I believe the stock indexes are the leading indicator for the economy, so that’s my guide. However, I have a strong sense of situational awareness so I like to understand what in the world is going on. The total return of stocks is a function of three things: earnings growth + dividend yield + P/E ratio expansion or contraction. Since earnings growth has made up nearly 5% of the historical total return of the S&P 500 since 1926, it does matter in the big picture in regard to expected return. Today, we observe the headline in the Wall Street Journal:

GDP Slows to Weakest Growth in Three Years

The U.S. economy’s output grew at the slowest pace in three years during the first quarter, underscoring the challenges facing the Trump administration as it seeks to rev up growth.

The New York Times says:

G.D.P. Report Shows U.S. Economy Off to Slow Start in 2017

■ The economy barely grew, expanding at an annual rate of only 0.7 percent.

■ The growth was a sharp decline from the 2.1 percent annual rate recorded in the final quarter of last year. It was the weakest quarterly showing in three years.

■ Consumption, the component reflecting individual spending, rose by only 0.3 percent, well below the 3.5 percent rate in the previous quarter.

The Takeaway

The first-quarter performance upset expectations for a Trump bump at the start of 2017.

If you want an economic catalyst for why prices could stall or reverse down, there you go. You see, earnings growth of stocks is part of GDP. GDP is the sales of all U.S. companies, private and public. The earnings growth of the S&P 500 is the earnings of those 500 companies. In other words, GDP of the economy is highly connected to EPS of an index of 500 stocks.

This recent stall in the price trend and economic growth along with a dash of complacency comes at a time when stocks are “significantly overvalued”, according to my friend Ed Easterling at Crestmont Research:

“In the first quarter the stock market surged 5.5%, well more than underlying economic growth. As a result, normalized P/E increased to 29.4—significantly above the level justified by low inflation and low interest rates. The current status remains “significantly overvalued.” The level of volatility plunged over the past quarter and is now in the lowest 4% of all periods since 1950. The trend in reported earnings for the S&P 500 Index reflects a repeating pattern of overly-optimistic analysts’ forecasts. Earnings and volatility should be watched closely and investors should heighten their sensitivity to the risks confronting an increasingly vulnerable market.”

Oh, and one more thing: Monday will be May. I’m not a huge fan of using seasonality as an indicator to enter or exit the stock market, but there is some tendency for certain periods to gain or lose value historically. For example, a common seasonality is “Sell in May and go away”. Depending on the historical time frame you look and which index, some periods show a “summer slump”. One theory is many investors and traders go on vacation in the summer, so volume is light. They return after the summer and take more action.

So, maybe this will be a good time to sell in May and go away. Not because it’s May, but instead because the weight of the evidence suggests this could be an inflection point.

We’ll see.

Stock Market Decline is Broad

September 2, 2015 By Mike Shell in Absolute Return Objective, Absolute Return Strategy, Absolute Returns, Absolute vs. Relative Return, Actively Manage Risk, Adapting to Change, Alternative Investment Strategy, Asymmetric Investment Returns, Data Driven Rearch, ETF Strategist, Global Asset Allocation, Global Directional Trends, Hiring a Portfolio Manager, Liquid Alternative, Managed Momentum, Managed Volatility, Market Breadth, Momentum Relative Strength, Relative Returns, Tactical Asset Allocation, Tactical ETF Managed Portfolio, Trend Following Leave a comment

We typically expect to see small company stocks decline first and decline the most. The theory is that smaller companies, especially micro companies, are more risky so their value may disappear faster. Below, we view the recent price trends of four market capitalization indexes: micro, small, mid, and mega. We’ll use the following index ETFs.

Since we are focused on the downside move, we’ll only observe the % off high chart. This shows what percentage the index ETF had declined off its recent highest price (the drawdown). We’ll also observe different look-back periods.

We first look back 3 months, which captures the full extent of the biggest loser: as expected, the micro cap index. The iShares Micro-Cap ETF (IWC: Green Line) seeks to track the investment results of an index composed of micro-capitalization U.S. equities. Over the past 3 months (or anytime frame we look) it is -13% below its prior high. The second largest decline is indeed the small cap index. The Vanguard Small-Cap ETF (VB: Orange Line) seeks to track the performance of the CRSP US Small Cap Index, which measures the investment return of small-capitalization stocks. The small cap index has declined -11.5%. The Vanguard Mega Cap ETF (MGC) seeks to track the performance of a benchmark index that measures the investment return of the largest-capitalization stocks in the United States and has declined -9.65%. The Vanguard Mid-Cap ETF (VO) seeks to track the performance of a benchmark index that measures the investment return of mid-capitalization stocks and has declined -9.41%. So, the smaller stocks have declined a little more than larger stocks.

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

Many active or tactical strategies may shift from smaller to large company stocks, hoping they don’t fall as much. For example, in a declining market relative strength strategies would rotate from those that declined the most to those that didn’t. The trouble with that is they may still end up losing capital and may end up positioned in the laggards long after a low is reached. They do that even though we may often observe the smallest company stocks rebound the most off a low. Such a strategy is focused on “relative returns” rather than “absolute returns“. An absolute return strategy will instead exit falling trends early in the decline with the intention of avoiding more loss. We call that “trend following” which has the objective of “cutting your losses short”. Some trend followers may allow more losses than others. You can probably see how there is a big difference between relative strength (focusing on relative trends and relative returns) and trend following (focusing on actual price trends and absolute returns).

So, what if we look at the these stock market indexes over just the past month instead of the three months above? The losses are the same and they are very correlated. So much for diversification. Diversification across many different stocks, even difference sizes, doesn’t seem to help in declining markets on a short-term basis. These indexes combined represent thousands of stocks; micro, small, medium, and large. All of them declined over -11%, rebounded together, and are trending down together again.

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

If a portfolio manager is trying to “beat the market” index, he or she may focus on relative strength or even relative value (buy the largest loser) as they are hoping for relative returns compared to an index. But a portfolio manager who is focused on absolute returns may pay more attention to the actual downside loss and therefore focuses on the actual direction of the price trend itself. And, a key part is predefining risk with exits.

You can probably see how different investment managers do different things based on our objectives. We have to decide what we want, and focus on tactics for getting that.

Why Index ETFs Over Individual Stocks?

August 8, 2015 By Mike Shell in Absolute Return, Actively Manage Risk, Adapting to Change, Alternative Investment, Asymmetric Observation, Asymmetric Payoff, Asymmetric Risk, Asymmetric Risk Reward, Asymmetric Sector Exposure, Empirical Observation, ETF Strategist, Global Asset Allocation, Global Directional Trends, Managed Momentum, Managed Volatility, Momentum Relative Strength, Sector ETF, Sector Rotation, Sector Trends, Tactical Asset Allocation, Tactical ETF Portfolio Management, Trend Following Leave a comment

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.

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.

Source: 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.

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.

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.

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.

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.

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.

Why Dividend Stocks are Not Always a Safe Haven

June 8, 2015 By Mike Shell in Absolute Return, Actively Manage Risk, Adapting to Change, Asymmetric Investment Returns, Global Directional Trends, Independent Thinking, Sector Rotation, Sector Trends, Systematic Global Macro, Tactical Asset Allocation, Tactical ETF Managed Portfolio, Trend Following 2 Comments

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.

A Random Walker on Stock and Bond Valuation

June 2, 2015 By Mike Shell in Absolute Return, Absolute Return Strategy, Absolute vs. Relatative Return, Actively Manage Risk, Adapting to Change, Asymmetric Investment Returns, Global Directional Trends, Global Macro, Global Tactical Rotation, Liquid Alternative, Sector ETF, Tactical Asset Allocation, Tactical ETF Managed Portfolio Tags: Bond Market Valuation, Stock Market Valuation Leave a comment

Burton Malkiel is a passive buy and hold investor who believes markets are random. To believe markets are random is to believe there are no directional trends, or high or low valuations. He is the author of “A Random Walk Down Wall Street“. But in today’s Wall Street Journal even the ” Random Walker” sees that stock valuations are high and future expected returns low, but believes if there is a bubble it’s in bonds.

BURTON G. MALKIEL

June 1, 2015 6:58 p.m. ET

“Stock valuations are well above their average valuation metrics of the past, and future returns are likely to be below historical averages. But even as Ms. Yellen talks of gradually ending the Fed’s near-zero interest rate policy, interest rates remain well below historical norms. If there is a market bubble today, it is in the bond market and the Fed is complicit in the “overvaluation.”

Source: http://www.wsj.com/articles/janet-yellen-is-no-stock-market-sage-1433199503

When someone invests in bonds for the long term they mainly intend to earn interest. So, bond investors want to buy bonds when yields are high. In the chart below, I show the iShares iBoxx $ Investment Grade Corporate Bond index ETF that seeks to track the investment results of an index composed of U.S. dollar-denominated, investment grade corporate bonds. The blue line is its price trend, the orange line is the index yield. We observe the highest yield was around 5.33% during a spike in 2008 when the price declined. Fixed income has interest-rate risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Since 2008, interest rates and the yield of this bond index has declined. Clearly, the rate of “fixed income” from bonds depends on when you buy them. Today, the yield is only 2.8%, so for “long term allocations” bonds aren’t nearly as attractive as they where.

Another observation is the iShares 20+ Year Treasury Bond ETF, which seeks to track the investment results of an index composed of U.S. Treasury bonds with remaining maturities greater than twenty years. So, this index is long term government bonds. Below we see its yield was 4.75% a decade ago and is now only 2.27%. Buying it to get a 4.75% yield is a very different expected return than 2.27%.

However, that doesn’t mean we can’t tactically rotate between these bond markets trying to capture price trends rather than allocate to them.

Chart source: http://www.ycharts.com

Why So Stock Market Focused?

April 25, 2015 By Mike Shell in Absolute Return, Absolute Return Fund, Absolute Return Investing, Absolute Return Investment, Absolute Return Objective, Absolute Return Strategy, Absolute Returns, Adapting to Change, Alternative Investment Strategy, Alternative Trading Strategy, Asymmetric Investment Returns, Asymmetric Observation, Asymmetric Risk, Asymmetric Risk Reward, Global Directional Trends, Global Macro, Hiring a Portfolio Manager, Independent Thinking, Investor Behavior Modification, Investor Sentiment, Liquid Alternative, Managed Volatility, Sector Rotation, Sector Trends, Secular Bear Market, Secular Bull Market, Systematic Global Macro, Tactical Asset Allocation, Tactical ETF Portfolio Management Leave a comment

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.

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%.

Created with http://www.ycharts.com

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

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

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

Why so stock centric?

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

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

The Volatility Index (VIX) is Getting Interesting Again

April 24, 2015 By Mike Shell in Absolute Return, Absolute Return Fund, Absolute Return Investing, Absolute Return Investment, Absolute Return Objective, Absolute Return Strategy, Absolute Returns, Absolute vs. Relatative Return, Absolute vs. Relative Return, Actively Manage Risk, Adapting to Change, Alternative Investment Strategy, Alternative Trading Strategy, Asymmetric Observation, Asymmetric Payoff, Asymmetric Risk, Asymmetric Risk Reward, Asymmetric Sector Exposure, Asymmetric Thinking, Counter trend, Critical Thinking, Dynamic Hedging, ETF Strategist, Global Asset Allocation, Global Directional Trends, Global Macro, Global Tactical Rotation, Hedge Funds, Hiring a Portfolio Manager, Independent Thinking, Investor Behavior Modification, Investor Sentiment, Liquid Alternative, Managed Momentum, Managed Volatility, Mean Reversion, Momentum Relative Strength, Risk Asymmetry, Sector Rotation, Systematic Global Macro, Tactical Asset Allocation, Tactical ETF Managed Portfolio, Tactical ETF Portfolio Management, VIX CBOE Volatility Index, Volatility Trading 1 Comment

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

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

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

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

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

Finally, the daily chart zooms in even more.

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

The observation?

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

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

Let’s see what happens from here…

My 2 Cents on the Dollar

April 23, 2015 By Mike Shell in Absolute Return, Absolute Return Fund, Absolute Return Investing, Absolute Return Investment, Absolute Return Objective, Absolute Return Strategy, Absolute Returns, Absolute vs. Relatative Return, Absolute vs. Relative Return, Actively Manage Risk, Adapting to Change, Alternative Investment, Alternative Trading Strategy, Asymmetric Hedging, Asymmetric Investment Returns, Asymmetric Observation, Asymmetric Payoff, Asymmetric Risk, Asymmetric Risk Reward, Asymmetric Sector Exposure, Business Cycle, Counter trend, Critical Thinking, Dynamic Hedging, ETF Strategist, Global Asset Allocation, Global Directional Trends, Global Macro, Global Tactical Rotation, Hiring a Portfolio Manager, Independent Thinking, Liquid Alternative, Managed Momentum, Managed Volatility, Mean Reversion, Momentum Relative Strength, Positive Asymmetry, Risk Asymmetry, Sector ETF, Sector Rotation, Sector Trends, Systematic Global Macro, Tactical Asset Allocation, Tactical ETF Portfolio Management, Trend Following 2 Comments

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.

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.

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?

Conflicted News

April 17, 2015 By Mike Shell in Absolute Return, Absolute Return Fund, Absolute Return Investing, Absolute Return Investment, Absolute Return Objective, Absolute Return Strategy, Absolute Returns, Actively Manage Risk, Adapting to Change, Asymmetric Thinking, Business Cycle, Counter trend, Crowd Psychology, ETF Strategist, Global Directional Trends, Hiring a Portfolio Manager, Independent Thinking, Information Asymmetry, Investor Behavior Modification, Investor Sentiment, Tactical Asset Allocation, Tactical ETF Managed Portfolio, Trend Following Leave a comment

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

Below is a snapshot from Google Finance::

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

Absolute Return as an Investment Objective

March 26, 2015 By Mike Shell in Absolute Return, Absolute Return Fund, Absolute Return Investing, Absolute Return Investment, Absolute Return Objective, Absolute Return Strategy, Absolute Returns, Absolute vs. Relatative Return, Absolute vs. Relative Return, Actively Manage Risk, Alternative Investment, Alternative Trading Strategy, Asymmetric Investment Returns, ETF Strategist, Global Asset Allocation, Global Macro, Global Tactical Rotation, Hedge Funds, Hiring a Portfolio Manager, Liquid Alternative, Relative Returns, Sector Rotation, Sector Trends, Tactical Asset Allocation, Tactical ETF Portfolio Management 1 Comment

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/

US Government Bonds Rise on Fed Rate Outlook?

March 23, 2015 By Mike Shell in Absolute Returns, Asymmetric Observation, Counter trend, Critical Thinking, Crowd Psychology, Data Driven Rearch, Fed Decision, Global Asset Allocation, Global Directional Trends, Global Macro, Global Tactical Rotation, Independent Thinking, Investor Behavior Modification, Investor Sentiment, Liquid Alternative, Quantitative Evidence-Based Rearch, Sector ETF, Sector Trends, Systematic Global Macro, Tactical Asset Allocation, Tactical ETF Portfolio Management, The Fed (FOMC), Trend Following Leave a comment

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”.

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.

Do you still think the Fed news was “new information“?

Diversification Alone is No Longer Sufficient to Temper Risk…

March 9, 2015 By Mike Shell in Absolute Returns, Actively Manage Risk, Adapting to Change, Alternative Investment, Alternative Trading Strategy, Asymmetric Hedging, Asymmetric Investment Returns, Asymmetric Observation, Asymmetric Payoff, Asymmetric Risk, Asymmetric Risk Reward, Asymmetric Thinking, Business Cycle, Critical Thinking, Empirical Observation, ETF Strategist, Global Asset Allocation, Global Directional Trends, Global Macro, Global Tactical Rotation, Hiring a Portfolio Manager, Independent Thinking, Investor Behavior Modification, Liquid Alternative, Managed Momentum, Managed Volatility, Momentum Relative Strength, Quantitative Evidence-Based Rearch, Risk Asymmetry, Sector ETF, Sector Rotation, Systematic Global Macro, Tactical Asset Allocation, Tactical ETF Managed Portfolio, Tactical ETF Portfolio Management, Trend Following Leave a comment

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Sectors Showing Some Divergence…

March 4, 2015 By Mike Shell in Actively Manage Risk, Adapting to Change, Alternative Investment Strategy, Asymmetric Investment Returns, Asymmetric Payoff, Asymmetric Risk, Asymmetric Risk Reward, Asymmetric Thinking, Empirical Observation, ETF Strategist, Global Asset Allocation, Global Directional Trends, Global Macro, Global Tactical Rotation, Liquid Alternative, Managed Momentum, Managed Volatility, Momentum Relative Strength, Sector ETF, Sector Rotation, Sector Trends, Systematic Global Macro, Tactical Asset Allocation, Tactical ETF Managed Portfolio, Trend Following Leave a comment

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.

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

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

“There is always a disposition in people’s minds to think that existing conditions will be permanent …

January 12, 2015 By Mike Shell in Actively Manage Risk, Adapting to Change, Asymmetric Hedging, Asymmetric Risk, Asymmetric Risk Reward, Business Cycle, Counter trend, Crowd Psychology, Dynamic Hedging, Empirical Observation, Global Directional Trends, Global Macro, Investor Sentiment, Mean Reversion, Momentum Relative Strength, Risk Asymmetry, Tactical Asset Allocation, Trend Following Leave a comment

“There is always a disposition in people’s minds to think the existing conditions will be permanent,” Dow wrote, and went on to say: “When the market is down and dull, it is hard to make people believe that this is the prelude to a period of activity and advance. When the prices are up and the country is prosperous, it is always said that while preceding booms have not lasted, there are circumstances connected with this one, which make it unlike its predecessors and give assurance of permanency. The fact pertaining to all conditions is that they will change.” – Charles Dow, 1900

Source: Lo, Andrew W.; Hasanhodzic, Jasmina (2010-08-26). The Evolution of Technical Analysis: Financial Prediction from Babylonian Tablets to Bloomberg Terminals (Kindle Locations 1419-1423). Wiley. Kindle Edition.

You can probably see from Dow’s quote how trends do tend to continue, just because enough people think they will. However, price trends can continue into an extreme or a “bubble” just because people think they will continue forever. I like to ride a trend to the end when it bends and then be prepared to exit when it does finally reverse, or maybe reduce or hedge off some risk when the probability seems high of a change.

Image source: Wikipedia

Charles Henry Dow; November 6, 1851 – December 4, 1902) was an American journalist who co-founded Dow Jones & Company. Dow also founded The Wall Street Journal, which has become one of the most respected financial publications in the world. He also invented the Dow Jones Industrial Average as part of his research into market movements. He developed a series of principles for understanding and analyzing market behavior which later became known as Dow theory, the groundwork for technical analysis.

The Mistake is Not Taking the Loss: Cut Your Losses and Move on

November 15, 2014 By Mike Shell in Actively Manage Risk, Adapting to Change, Asymmetric Risk, Book Review, Empirical Observation, Great Quotes, Hiring a Portfolio Manager, Investor Behavior Modification, Position Sizing, Risk Asymmetry, Tactical Asset Allocation, Trend Following Leave a comment

One of the keys to managing investment risk is cutting losers before they become large losses. Many people have difficulty selling at a loss because they believe it’s admitting a mistake. The mistake isn’t taking a loss, the mistake is to NOT take the loss. I cut losses short all the time, that’s why I don’t have large ones. I’ve never taken a loss that was a mistake. I predetermine my risk by determining before I even buy something at what point I’ll get out if I am wrong. If I enter at $50, my methods may determine if it falls to $45 that trend I wanted to get in is no longer in place and I should get out. So when I enter a position in any market, I know how I’ll cut my loss short before I even get in. It’s the exit, not the entry, that determines the outcome. I don’t know in advance which will be a winner or loser or how much it will gain or lose. For me, not taking the loss, would be the mistake.

I thought of this when a self-proclaimed old-timer admitted to me he still holds some of the popular stocks he bought the late 90’s. Many of those stocks are no longer in business, but below we revisit the price trend and total return of some of the largest and most popular stocks promoted in the late 90’s. The black line is Cisco Systems (CSC), Blue is AT&T (T), Red is Pfizer (PFE), and green is Microsoft (MSFT). AT&T’s roots stretch back to 1875, with founder Alexander Graham Bell’s invention of the telephone. Pfizer started in 1849 “With $2,500 borrowed from Charles Pfizer’s father, cousins Charles Pfizer and Charles Erhart, young entrepreneurs from Germany, opened Charles Pfizer & Company as a fine-chemicals business”. At one point during the late 90’s “tech bubble” Microsoft and Cisco Systems were valued more than many countries. But the chart below shows if you did buy and held these stocks nearly 20 years later you would have held losses for many years and many of them are just now showing a profit.

chart courtesy of http://www.stockcharts.com

The lesson to cut losses short rather than allow them to become large losses came from a book published in 1923.

“Money does not give a trader more comfort, because, rich or poor, he can make mistakes and it is never comfortable to be wrong. And when a millionaire is right his money is merely one of his several servants. Losing money is the least of my troubles. A loss never bothers me after I take it. I forget it overnight. But being wrong – not taking the loss – that is what does the damage to the pocketbook and to the soul.”

-Reminiscences of a Stock Operator (1923)

If you are unfamiliar with the classic, according to Amazon:

Reminiscences of a Stock Operator is a fictionalized account of the life of the securities trader Jesse Livermore. Despite the book’s age, it continues to offer insights into the art of trading and speculation. In Jack Schwagers Market Wizards, Reminiscences was quoted as a major source of stock trading learning material for experienced and new traders by many of the traders who Schwager interviewed. The book tells the story of Livermore’s progression from day trading in the then so-called “New England bucket shops,” to market speculator, market maker, and market manipulator, and finally to Wall Street where he made and lost his fortune several times over. Along the way, Livermore learns many lessons, which he happily shares with the reader.

Small vs. Large Stocks: A Tale of Two Markets (Continued)

November 13, 2014 By Mike Shell in Adapting to Change, Asymmetric Observation, Counter trend, Critical Thinking, Data Driven Rearch, Empirical Observation, Global Directional Trends, Global Tactical Rotation, Hiring a Portfolio Manager, Managed Momentum, Momentum Relative Strength, Tactical Asset Allocation, Tactical ETF Managed Portfolio, Trend Following Leave a comment

A quick follow up to my recent comments about the down trend in smaller company stocks in Playing with Relative Strength and Stock Market Peak? A Tale of Two Markets below is a chart and a few observations:

Source: Bloomberg/KCG

A few observations of the trend direction, momentum, and relative strength.

The S&P 500 index (the orange line) of large company stocks has been in a rising trend of higher highs and higher lows (though that will not continue forever).
The white line is the Russell 2000 small company index has been in a downtrend of lower highs and lower lows, though just recently you may observe in the price chart that it is at least slightly higher than its August high. But it remains below the prior two peaks over the past year. From the time frame in the chart, we could also consider it a “non-trending” and volatile period, but its the lower highs make it a downtrend.
The green chart at the bottom shows the relative strength between S&P 500 index of large company stocks and the Russell 2000 small company index. Clearly, it hasn’t taken all year to figure out which was trending up and the stronger trend.
Such periods take different tactical trading skills to be able to shift profitability. When markets get choppy, you find out who really knows what they’re doing and has an edge. I shared this changing trend back in May in Stock Market Peak? A Tale of Two Markets.

If you are unsure about the relevance of the big picture regarding these things, read Playing with Relative Strength and Stock Market Trend: reverse back down or continuation? and Stock Market Peak? A Tale of Two Markets.

Is market timing [short-term trading back and forth among asset classes] really a good idea?

March 7, 2014 By Mike Shell in Global Macro, Global Tactical Rotation, Great Quotes, Tactical Asset Allocation, Tactical ETF Portfolio Management, Trend Following Leave a comment

In October 2004, Jason Zweig interviewed Peter Bernstein for MONEY Magazine. The title was Peter Bernstein interview: He may know more about investing than anyone alive. Peter L. Bernstein was an early pioneer of tactical asset allocation thinking. He wrote about valuation-based asset allocation and being tactical in decisions rather than passive. He believed what I believe: we should take more risk when its likely to be rewarded and less risk when it is less likely to be rewarded. He published several books about it.

In the interview, Zweig asked:

“Is market timing [short-term trading back and forth among asset classes] really a good idea?”

Bernstein answered:

“For institutional investors, the policy portfolio [a rigid allocation like 60% stocks, 40% bonds] had become a way of passing the buck and avoiding decisions. The problem was that institutions had settled on a [mostly stock] asset allocation because in the long run, they concluded, that’s the only place to be. And I think the long run ain’t what it used to be. Stocks don’t have to do well in the future because they did well in the past. In fact, the opposite may be more likely.”

Source: http://money.cnn.com/2004/10/11/markets/benstein_bonus_0411/

Based on the chart below, which shows the Dow Jones Industrial Average (a stock index that cannot not be invested in directly) since that interview in 2004, I’d say Bernstein was right. Over the next decade, the stock index went on to gain 65%, but it dropped nearly that much along the way. That doesn’t seem to be the kind of asymmetry® that investors are looking for. If you look at it close enough, you can probably see why it makes sense to take more risk at some points, less risk at others. Though, it’s probably at the opposite times most investors do. So, most will advise investors not to try to do it. Like most things in life, some do it much better than others and have active track records that reflect it.

source: https://stockcharts.com/freecharts/perf.php?$indu

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The Takeaway

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