Will the stock market hold the line?

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

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

stock market trend following momentum

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

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

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

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

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

Let’s see what it does from here.

Have a Happy Thanksgiving!

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

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

 

 

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

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

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

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

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

Simple > Complex

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

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

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

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

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

head and shoulders pattern recognition

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

head and shoulders bottom patterns recognition

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

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

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

Let’s see how it all unfolds.

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

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

 

Divergence in the Advance-Decline Line May be Bullish

With the stock market swinging up and down with the volatility expansion we’ve seen since February many investors are probably wondering which way stocks are going to trend.

Individual investors should be aware of the big picture.

The primary trend has been up since March 2009 with several declines interrupting it along the way. In fact, there have been eight declines more than -10% and three of them were between -15% and -20%. But, none have been over -20%, which is the level most define as a “bear market”. So, this is the longest bull market in U.S. stocks in history.

Many investors may realize that trends cycle up and down and when a trend moves longer or farther than normal, they may be expected to swing the other way longer and farther. For this reason, the intelligent investor is probably on alert for signs of the beginning of a change in the primary trend from a bull market to a bear market.

Market cycles aren’t just the longer primary trends, they are made up of many smaller trends that may be tradeable swings up and down. Avoiding a large bear market isn’t as simple as predicting it and then exiting the stock market until it’s over. We never know for sure in advance when a primary trend shifts from positive to negative and back to positive. In the real world, we focus on shorter time frames and have to deal with the short-term price swings that happen as a trend unfolds.

Despite the recent volatility and the down days, at this point, the U.S. stock market primary trend remains up. We say that because this two-year chart shows higher highs and higher lows. For that to change, we would need to see the stock index decline and stay below the prior lows. Of course, that is a possibility, but those who are following the trends respond to the actual change of trend.

stock market trend following

One positive confirming indicator is improving breadth during the recent swing up from the October low.

The Advance-Decline Line is a breadth indicator that indicates the level participation of the stocks in an index like the S&P 500. For example, a broad advance shows the internal strength that is lifting most boats, which is bullish. A narrow advance would show a  mixed market that is selective instead of broad participation. So far, we’ve seen the S&P 500 Advance-Decline Line make a higher high in the upswing, even though the S&P 500 index itself has declined the past few days.

bullish divergence advance decline line $spx $spy

One of the characteristics of the Advance-Decline Line is that it treats all 500 stocks the same, giving them equal weight. The standard S&P 500 stock index that investors track is a capitalization-weighted index that weights the largest stocks in the index much more heavily. Since the Advance-Decline Line gives each of the 500 stocks equal power, it emphasizes small and mid-cap stocks more. To get a more accurate view of the Advance-Decline Line relative to the stock index, we can use the S&P 500 Equal Weighted Index. I included it below. As we see, the equal-weighted stock index has trended up more similar to the Advance-Decline Line – and both of them made a higher high.

advance decline bullish divergence spx equal weight

We continue to observe a much more volatile market condition than we saw in 2017. That should be no surprise since the CBOE Volatility Index indicates implied volatility has been elevated as we’ve seen this volatility expansion. However, it’s at 20 today, which is its long-term average.

vix volatlity expansion asymmetric asymmetry

Looking back over two years, the next chart shows how much more elevated implied volatility was over last year.

volatility expansion 2018 vix $VIX trading asymmetry asymmetric

Volatility is mean reverting, which means volatility tends to swing from higher states to lower states. Although the VIX long-term average is 20, it rarely stays at that level. Instead, it swings up and down.

2018 has been a volatile year for stocks by any measure, but it may seem even more volatile since 2017 was so quiet.

So far in 2018, the S&P 500 stock index has been down -1% or more on 21 days.

In 2017, stocks only had a -1% or more down day 4 days the whole year.

By that measure, does it make 2018 a volatile year? Or 2017 a calm year?

2016 had 22 days the S&P 500 stock index was down over -1%

2015 had 32 days the S&P 500 stock index was down over -1%

By this measure, 2017 was an unusually calm year for U.S. stocks. 2018 isn’t a lot different than 2015 and 2016.

Individual down days don’t make a trend unless you are a day trader, which we are not. We measure market risk by actual drawdown. Below is a chart of the drawdowns for the stock index year to date. The S&P 500 has declined -10% twice. A -10% within a year is normal, along with a couple of -5% drops. But, two -10% declines in a 12 month period isn’t all that abnormal, either.

stock market drawdown 2018 $SPX $SPX

One thing that may make the price trend swings and volatility seem unusual this year was the lack of it last year. Below is last year, when we didn’t see any drops more than -4%.

stock market volatility drawdown

On January 24, 2018, I said:

I tell ya what… we haven’t seen a drawdown in the popular stock indexes in nearly a year and a half. We would normally see three or four. Those who don’t think that is important will probably be the investors who are dazed when we do see one.

Markets cycle and swing up and down over time, and so does volatility. At this point, we are observing an overall primary uptrend in U.S. stocks but the shorter-trend trend this year has shown us broader swings of +/- 10% or so as volatility has expanded and price swings have spread out.

Despite the down days Friday and today, the short term trend is relatively positive with positive participation as measured by the Advance-Decline Line. Only time will tell how it all plays out from here.

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

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

The stock market is swinging its way to an inflection point

Trying not to sound like a broken record, I’ll share a few updates from what I said last in Observations of the stock market downtrend. 

The stock market is at an inflection point. An inflection point is a time of meaningful change in a situation; a turning point. The reality is, there are many inflection points within market cycles and price trends. So, we observe different inflection points across different time frames. For those who watch the stock market daily as a professional portfolio manager, we observe every move. But, the overall focus needs to be on the bigger trends. Every market cycle and price trend is made up of smaller cycles as prices swing up and down on their way to forming a directional trend. Market cycles don’t trend straight up or down.

The U.S stock indexes have dropped about -10% in October, giving up gains for the year. Many investors probably believe October is historically the worst month of the year for the stock market because of famous October declines. September is actually the worst month historically, but October is historically a volatile month. It just so happens, this decline occurred inside of October.

I don’t use seasonality as a signal for my decisions, but we’ve all heard of “sell in May and go away.” The period from May through October is supposed to be the weak season and November to April is the stronger season for stocks. The S&P 500 had defied the expectation that stocks would be weak last summer and gained nearly 10% from May through September, then lost the gain in October. Many leading growth stocks that previously showed the strongest momentum declined even more than the stock indexes. I pointed out a few months ago that international stock indexes including both emerging and developed countries were already in downtrends. So, the global equity markets were generally down in October.

That’s the bad news for anyone invested in these markets.

The good news is after those who wanted to sell have sold, prices eventually reach a low enough point to attract new buying interest.

I focus on what the price trends are actually doing, so I’ll share my observations of the trends and update some sentiment and breadth indicators I’ve discussed in previous observations.

First, we look at what the price trend is actually doing. Below is the S&P 500 stock index year-to-date. We see after declining about -10% from its September high, the stock index has reversed back up to the price of the prior low on October 11th.

 

In technical analysis of price trends, we say “prior support may become resistance” and that may be what happens next. We shouldn’t expect prices to trend straight up or down, they swing up and down. Prices making higher highs and higher lows form uptrends or lower lows and lower highs form downtrends. So, it wouldn’t be abnormal to see the stock index trend back down to the low again, or it could pause and continue the recent upward direction.

For a sustained move higher, those who want to sell need to have sold and prices need to have reached a low enough point to attract new buying demand.

Have those who want to sell, sold?

To get an idea for observation of investor sentiment, we can look at a few simple indicators. I explained the thinking behind the Fear & Greed Index in Observations of the stock market downtrend.

The Fear & Greed Index is based on 7 indicators of investors sentiment and can be a useful gauge to help investors keep their own sentiment in check. It currently remains at an “Extreme Fear” level, which is typical after a stock market decline and a high level of bearish sentiment that has historically preceded stock prices reversing back up- as those who want to sell have sold. However, in a prolonged bear market, this oscillating indicator could stay low for a long time or it could swing up and down along with price trends.

But, nothing illustrates buying and selling, supply and demand, better than the actual price trends. Another interesting indicator I’ve shared in recent observations is the percent of stocks in the S&P 500 that are trading above their short-term moving average.

 

It shows us how many stocks have participated in an uptrend or downtrend. When it reaches a high point and most stocks have participated in an uptrend, it may be nearer a reversal back down. Price trends don’t move straight up. When it reaches a low level is indicates most stocks have declined and at an extreme, it can suggest capitulation – those who want to sell may have sold. But, prices don’t trend straight down. Prices swing up and down along the way to drifting directionally. At this point, this indicator has reached the February and April lows and reversed up.

Shorter term, it’s an inflection point as I highlighted. If more stocks trend back up, we’ll see this trend higher.

Let’s see how it all unfolds…

 

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

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

Observations of the stock market downtrend

Observations of the stock market downtrend

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

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

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

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

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

stock market trend

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

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

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

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

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

Fear is the dominant driver. 

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

fear greed index investor sentiment behavioral finance

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

fear and greed back test over time investor sentiment indicator

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

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

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

Speaking of a hedge. 

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

vix hedge volatility expansion asymmetric hedge asymmetry

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

vix volatility expansion trading

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

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

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

vix volatility as a hedge stock market risk management

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

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

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

stock market breadth risk indicator

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

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

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

That’s what stock investors are waiting for now.

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

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

I hope you find my observations interesting and informative.

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

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

The stock market trends up with momentum

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

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

We’ll see.

Well, today we saw.

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

stock market trend sector ETF momentum

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

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

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

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

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

CNN FEAR GREED INDEX SENTIMENT

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

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

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

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

VIX VOLATILITY CONTRACTION EXPANSION ASYMMETRIC RISK HEDGE ASYMMETRY

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

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

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

 

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

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

U. S. Sector Trends

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

Below are the sector trends year-to-date.

SECTOR ETF TRENDS TREND FOLLOWING MOMENTUM RELATIVE STRENGTH

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

SECTOR ETF MOMENTUM TREND FOLLOWING

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

dradown stock market year to date

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

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

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

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

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

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

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

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

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

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

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

 

The Stock Market Trend

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

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

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

stock market decline 2008

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

average length of bear market crash 2008.jpg

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

stock market sector ETF October 10 2018

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

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

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

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

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

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

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

SPX BREADTH PERCENT OF STOCKS ABOVE 200 DAY MOVING AVERAGE

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

stock market SPX 200 day moving average trend following

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

stock market year to date 2018 trend following momentum

 

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

stock market momentum ETF trend following asymmetric

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

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

VIX VOLATILITY EXPANSION

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

SPY SPX VIX ASYMMETRIC RISK REWARD

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

 

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

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

 

Earnings season is tricky for momentum growth stocks

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

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

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

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

Grubhub $GRUB GRUB

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

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

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

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

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

That’s good vol.

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

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

grubhub stock GRUB

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

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

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

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

NetFlix NFLX $NFLX

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

netflix stock risk downside loss

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

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

How much is too much? 

A hint is in the above charts.

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

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

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

 

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

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

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

 

 

 

 

 

Sector Trends are Driving Equity Returns

Sector Trends are Driving Equity Returns

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

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

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

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

growth stock momentum over value morningtar small mid large cap

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

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

sector trend returns 2018

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

iShares Morningstar Large-Cap Growth ETF

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

iShares Morningstar Large-Cap Value ETF

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

iShares Morningstar Mid-Cap Growth ETF

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

 

iShares Morningstar Mid-Cap Value ETF

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

iShares Morningstar Small-Cap Growth ETF

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

iShares Morningstar Small-Cap Value ETF

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

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

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

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

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

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

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

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

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

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

 

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

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

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

 

 

 

 

 

Growth Stocks have Stronger Momentum than Value in 2018

Growth Stocks have Stronger Momentum than Value in 2018

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

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

stock market index returns 2018 SPY DIA

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

Dow was momentum leader

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

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

equity style box

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

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

 

Equity Style and Size Past 12 Months

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

momentum growth stocks 2018

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

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

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

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

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

Why do we care about such divergence?

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

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

 

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

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

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

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

The enthusiasm to sell overwhelmed the desire to buy. The S&P 500 stock index closed down -1.42% today. Stocks trended down most of the day and at 2:35pm it was down -2%. As you can see on the chart, it reversed up in the last 90 minutes and closed with positive directional movement. It almost closed above its Volume Weighted Average Price (VWAP).

There are many notable economic reports out this week, so maybe investors are concerned about to the jobs report and the Fed FOMC Meeting. The options market has priced in a 94% chance of a rate hike, so it shouldn’t be a surprise. But, this week is the first FOMC meeting for the new Chairman Powell.

Implied volatility in recent weeks is one of many signals that suggest a volatility regime change. 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® doesn’t seem to want to go back to those prior low levels, so the expectation is higher volatlity.

At this point, the decline today was nothing too abnormal. The stock index is -3.% off it’s high a few weeks ago and -5.4% off its all-time high. However, as you can see below it is within a normal trading range. Speaking of trading range, notice the bands of realized volatility I added to the chart are drifting sideways rather than trending up or down. I see higher lows, but equal highs in the most recent trend and lower highs looking back to January. The VIX is expected volatility, the blue bands are realized volatility.

My systems define this as a non-trending market. When I factor in how the range of price movement has spread out more than double what it was, I call it a non-trending volatile condition. It is useful for me to identify the market regime because different trend systems have different results based on the situation. For example, non-trending volatile market conditions can be hostile situations for both passive and trend following strategies. However, countertrend systems like the swings of a non-trending volatile market.

Trend following systems thrive in markets that are trending and smooth. When a market is trending and smooth, the trend following system can earn gains without having to deal with significant adverse price action. When a market trend shifts to non-trending and volatile, the trend following signals can result in whipsaws. A whipsaw is when the price was moving in one direction (and the trend follower buys) but then quickly reverses in the opposite direction (and maybe the trend follower exits with a loss). Even if the trend following system doesn’t enter and exit with a loss, in a non-trending volatile market the trend follower has to deal with the same hostile conditions as a passive investor as the market swings up and down.

My U. S. equity exposure since early February has come from my shorter term countertrend systems. My focus and the focus of my systems isn’t to predict the direction of markets but instead to identify when a market is undergoing a regime change or shifts to a distinct environment. I don’t analyze the markets to try to predict what it will do next. I look at what the market is actually doing and react to 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 @MikeWShell

The is no guarantee that any strategy will meet its objective.  Past performance is no guarantee of future results.

 

When I apply different trend systems to ETFs

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

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

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

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

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

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

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

 

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

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

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

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

 

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

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

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

 

 

Asymmetric force was with the buyers

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

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

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

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

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

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

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

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

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

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

Buying demand dominated selling pressure in the stock market

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.

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

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

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

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

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

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

Fear and Greed Over time investor sentiment

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

The Trend of the U.S. Stock Market

When I say “The Trend” that could mean an infinite number of “trends“. The general definition of “trend” is a general tendency or course of events.

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

Many investors are probably wondering about the current trend of the U.S. stock market. So, I will share a quick observation since one of the most popular U.S. stock indexes seems to be right at a potential turning point.

Below is a 6 month price chart of the S&P 500 stock index. The S&P 500® is widely regarded as a gauge of large-cap U.S. equities. Clearly, prior to late August the stock index was drifting sideways. It was oscillating up and down in a range of 3% to 4% swings, but overall it wasn’t making material higher highs or lower lows. That is, until late August when it dropped about -12% below its prior high. Now, we see with today’s action the stock index is attempting reach or breach it’s very recent peak reached on August 27th. If the index moves above this level, we may consider it a short-term uptrend. We can already observe the index has made a higher low.

S&P 500 stock trend

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

You can probably see how the next swing will determine the direction of the trend. If it breaks to the upside, it will be an uptrend as defined by “higher highs and higher lows”. Although, that is a very short-term trend, since it will happen within a more intermediate downtrend.

My point is to observe how trends drift and unfold over time, not to predict which way they will go, but instead to understand and define the direction of “the trend”. And, there are many different time frames we can consider.

If this trend keeps going up, supply and demand will determine for how long and how far. If it keeps drifting up, I would expect it may keep going up until some inertia changes it. Inertia is the resistance to change, including a resistance to change in direction.

But if it instead goes back down to a new low, I bet we’ll see some panic selling driving it even lower.

The real challenge of directional price trends is if this is the early stage of a larger downward trend (like a bear market), there will be many swings along the way. In the last bear market, there were 13 swings that ranged from 10% to 27% as this stock index took about 18 months to decline -56%.

Below is the same stock index charted with a percentage chart to better show the percent changes over the past 6 months. You can probably see how it gives a little different perspective.

S&P 500 stock index percent chart average length of bear markets

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

I don’t necessarily make my tactical decisions based on any of this. I enjoy watching it all unfold and I necessarily need to define the trend and understand it as it all plays out. I want to know what the direction of the trend is based on my time frame, and know when that changes.

I believe world markets require active risk management and defining directional trends. For me, that means predefining my risk in advance in each position and across the portfolio.

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For informational and educational purposes only, not a recommendation to buy or sell and security, fund, or strategy. Past performance and does not guarantee future results. The S&P 500 index is an unmanaged index and cannot be invested into directly. Please visit this link for important disclosures, terms, and conditions.

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