In Case Bonds Bounce…

October 21, 2020Uncategorizedadmin

Despite all of the “pumping” by the Fed, the 30-year treasury bond is roughly 11% off of its high from back in March. The primary models that I use to track the major trend of the bond market are still bearish. So, I have no reason to – and am not – pounding the table about getting bullish on bonds.

That being said, the shorter-term “trader” in me is sensing the potential for a “bounce” in bonds (Important Note: the short-term trader in me is also wrong a lot. So, what follows is NOT a recommendation but an example of one way to play a trading “hunch” but with a relatively low dollar risk).

The Background

Figure 1 from www.Sentimentrader.com displays 30-year bond price action in the top clip and trader sentiment (or Optix) in the bottom clip. Note that sentiment just bounced off of 0%. Previous occurrences are noted by the red dots.

Figure 1 – 30-yr. treasury bonds and trader sentiment (Courtesy Sentimentrader.com)

Figure 2 displays the action of 30-yr. bonds following previous bounces in sentiment from below 5% to above 5%. Note that bonds typically witnessed an advance in the next 1 to 6 months.

Figure 2 – Bond price action following previous “bounces” in sentiment (Courtesy Sentimentrader.com)

In Figure 3 from ProfitSource by HUBB we see that the weekly Elliott Wave chart is suggesting the potential for an advance in the months ahead. For the record, my confidence level with a single weekly EW count in and of itself is moderate at best. However, when sentiment and price action appear to align, I start to pay closer attention. Note that the EW projection is suggesting a potential rally in the next 1 to 6 months – pretty much in line with the sentiment history above.

Figure 3 – Ticker TLT with bullish weekly Elliott Wave count (Courtesy ProfitSource by HUBB)

One Way to Play

In reality there are lots of ways to play. The most straightforward would be to buy a 30-year treasury bond futures contract or to buy 100 shares of the ETF ticker TLT which track the long-term treasury. Both of these positions have inherent risks. T-bond futures trade at $1,000 a point. So, if bonds go south instead of north a fairly large dollar risk can be realized very quickly. Likewise, buying 100 shares of ticker TLT will cost roughly $15,900. So again, not a small commitment.

REMEMBER: What we are attempting to accomplish here is simply to provide an example of one way to play an entirely speculative situation (i.e., betting on a short-term “bounce” in bonds) without having to worry about the potential to lose a lot of money if things go the wrong way.

So, let’s consider a position using options on ticker TLT. The first thing I like to determine is if the options on a given security are “cheap”, “expensive” or somewhere in between, in order to choose the proper strategy. In Figure 4 we see that the implied volatility for options on ticker TLT are not high or low, but rather “somewhere in between.” (High implied volatility means there is a lot of time premium built into the options – i.e., “expensive”, and vice versa).

Figure 4 – Implied volatility for options on ticker TLT (Courtesy www.OptionsAnalysis.com)

The strategy we will consider is called the “out-of-the-money butterfly spread”, or “OTM call fly” as we hip, happening option trader geeks like to call them.

This trade involves:

*Buying 1 Jan2021 160 call @ $4.25

*Selling 2 Jan2021 190 calls @ $0.21

*Buying 1 Jan2021 220 call @ $0.13

NOTE: This example assumes that a “market order” is used and that the order is filled by buying at the ask price for the 160 and 220 calls and selling at the bid price for the 190 call. In reality, us hip, happening option trading geeks would likely put in a limit order attempting to enter closer to the midpoint of the bid/ask spread for each option.

Figure 5 displays the particulars and Figure 6 displays the risk curves.

Figure 5 – TLT OTM Call Fly particulars (Courtesy www.OptionsAnalysis.com)

Figure 6 – TLT OTM Call Fly risk curves (Courtesy www.OptionsAnalysis.com)

Remember, our goal is to make a decent return if bonds do in fact rally in the months directly ahead while NOT risking a lot of money.

*As you can see in Figure 6, profits can accumulate pretty nicely if the price of TLT does in fact rise towards the target shown in Figure 3.

*At the same time, the worst-case scenario is a loss of -$396 on a 1x2x1 spread if it all falls apart.

Two thoughts from a position management point-of-view:

*On the downside a trader might either, a) resolve to hold through expiration and risk the full $396 hoping for a bounce somewhere along the way, or, b) determine a stop-loss point at which point they would “throw in the towel” and salvage whatever they can by exiting the trade early.

*On the upside, note that the risk curves do “roll over” when price approaches $190 a share. In other words, above this price your profit would actually start to get smaller again. So, if the “best case” scenario did in fact unfold and TLT rallied towards the EW target of $189+ a trader MUST be prepared to take some sort of action, i.e., either a) take a profit, or, b) adjust the position.

Summary

Please remember that the proper subtitle for this article is NOT “Pundit predicts massive rally in bonds”. The proper subtitle is more along the lines of “Silly cheapskate speculator gets a hankering to pick a bottom in a downtrend and doesn’t want to lose his shirt.”

The former is more succinct, but the latter is more accurate.

See also Jay Kaeppel Interview in July 2020 issue of Technical Analysis of Stocks and Commodities magazine

Jay Kaeppel

Disclaimer: The information, opinions and ideas expressed herein are for informational and educational purposes only and are based on research conducted and presented solely by the author. The information presented represents the views of the author only and does not constitute a complete description of any investment service. In addition, nothing presented herein should be construed as investment advice, as an advertisement or offering of investment advisory services, or as an offer to sell or a solicitation to buy any security. The data presented herein were obtained from various third-party sources. While the data is believed to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Past performance is no guarantee of future results. There is risk of loss in all trading. Back tested performance does not represent actual performance and should not be interpreted as an indication of such performance. Also, back tested performance results have certain inherent limitations and differs from actual performance because it is achieved with the benefit of hindsight.

Risk-On, Risk Off, Revisited

October 19, 2020Uncategorizedadmin

Buying and holding an S&P 500 Index fund is not my favorite approach to investing. While it is an approach to investing that likely millions of investors follow to one degree or another, I refer to it as a “drifting with the tide” strategy. As long as the sky is blue and the waters are calm, things are swell and things are great. But when the inevitable storm rolls in and the wind picks up and the waves start to crash it becomes an entirely different experience.

Sometimes our mind just needs a break from all of the volatility, turmoil and uncertainty that surrounds the stock market.

But “when” to take those breaks is a question that has confounded market participants since the first time some trader somewhere shouted “Buy” whilst another yelled “Sell”.

The unvarnished truth is that there are no “perfect” methods. But there are things that can “serve a purpose”. Let’s consider one of those today.

The Indicators

We will use 4 data series, using quarterly total return data for each:

A = 3-month t-bills

B = Bloomberg Barclays Aggregate Bond Index

C = Bloomberg Barclays Intermediate Treasury Index

D = S&P 500 Index

E = B – A (i.e., Aggregate bond index minus t-bill quarterly return)

The Trading Rules

At the end of each quarter:

*If E > 0 then hold S&P 500 Index for the next quarter

*If E < 0 then hold Bloomberg Barclays Intermediate Treasury Index

In English:

*If the Aggregate Bond index outperformed t-bills in the most recent quarter we will hold stocks the following quarter.

*If the Aggregate Bond index underperformed t-bills is the most recent quarter we will avoid stocks and linger in the relative safety of intermediate-term treasuries in the following quarter.

The Results

All results use quarterly total return data starting at the end of 1^st quarter of 1976. To make things easier:

*If Aggregate Bond Index outperforms t-bills the next quarter is referred to as a “Favorable” quarter

*If Aggregate Bond Index underperforms t-bills the next quarter is referred to as an “Unfavorable” quarter

Figure 1 displays the cumulative return for the S&P 500 (SPX) and intermediate treasuries (Int. Treas.) if held ONLY during Favorable quarters.

Figure 1 – Stock and bond performance during Favorable Quarters

Figure 2 – Stock and Bond performance during Favorable Quarters

Clearly stocks outperform by an order of significant magnitude during “Favorable” quarters.

Figure 3 displays the cumulative return for the S&P 500 (SPX) and intermediate treasuries (Int. Treas.) if held ONLY during Unfavorable quarters.

Figure 3 – Stock and bond performance during Unfavorable Quarters

Figure 4 – Stock and bond performance during Unfavorable Quarters

During “Unfavorable” quarters stocks are a roller-coaster ride – often up, but also occasionally crashing lower – while bonds appear to offer steady, low volatility returns.

The bottom line:

*Stocks have vastly outperformed during Favorable quarters

*Bonds have returned almost 3 times as much as stocks (with vastly lower volatility) during Unfavorable quarters

Jay’s Risk On/Risk Off Strategy

So, let’s put the pieces of the puzzle together:

*During Favorable quarters we will hold SPX

*During Unfavorable quarters we will hold Intermediate Treasuries

Figure 5 displays the cumulative growth of our “Risk On/Risk Off Strategy” (these are hypothetical results using index data)

Figure 5 – Cumulative return for Jay’s Risk On/Risk Off Strategy versus buying and holding S&P 500 Index (3/31/76-9/30/20)

Figure 6 – Cumulative return for Jay’s Risk On/Risk Off Strategy versus buying and holding S&P 500 Index (3/31/76-9/30/20)

Real-World Application

Here is how I follow this indicator in real-time. Make the measurement after the close on the 3^rd to last trading day of each quarter (ex., if the last day of a quarter is Friday the 30^th, then we measure at the close on Wednesday the 28^th. Any trading action will take place at the close on the 30^th).

As of the close on the 3^rd to last trading day of each quarter:

A = Total return data for ticker BIL as of today

B = Total return data for ticker BIL 63 trading days ago

C = Total return data for ticker VBMFX as of today

D = Total return data for ticker VBMFX 63 trading days ago

E = (A / B) – 1) *100

F = (C / D) – 1) *100

E is the 3-month change for t-bills

F is the 3-month change for the total bond market

The Rules:

*If F >= E (on the 3^rd to last trading day of the quarter), then Risk On for the next 3 months

*If F < E (on the 3^rd to last trading day of the quarter), then Risk Off for the next 3 months

Ticker BIL: SPDR Bloomberg Barclays 1-3 Month T-Bill ETF

Ticker VBMFX: Vanguard Total Bond Market Index Fund Investor Shares

Ticker SPY: SPDR S&P 500 ETF Trust

Ticker IEI: iShares 3-7 Year Treasury Bond ETF

This approach was Risk Off during Q1 of 2020 and has been Risk On since.

Summary

The purpose here is not to suggest an “All In” or “All Out” approach to investing. When the Risk On/Risk Off indicator suggests “Risk Off”, the implication:

*IS NOT that investors should “SELL EVERYTHING” and run for the hills

*IS simply that investors may benefit from “playing some defense” during the ensuing quarter

Nothing more, nothing less.

See also Jay Kaeppel Interview in July 2020 issue of Technical Analysis of Stocks and Commodities magazine

Jay Kaeppel

U.S. vs. Them – An Objective Approach

October 16, 2020Uncategorizedadmin

The U.S. stock market has mostly vastly outperformed the rest of the world’s stock markets in recent years. The longer this trend persists the more investors get “used to” and “comfortable” (i.e., complacent) with this trend as a way of life. But if there is one thing we know for sure when it comes to the markets is that “no trend lasts forever.”

One day, the relationship will turn, and U.S. stock indexes will lag international stock indexes. I firmly expect this change to take place and play out sometime over the next 5 to 10 years. That being said, there is no evidence that this change is in the works at the moment. So, what follows IS NOT a “call to action.” I refer to it as a “call to pay attention.”

SPX vs. EAFE

As our measure we will use the S&P 500 Index as our measure of U.S. stock performance and the MSCI EAFE Index as our measure of international stock performance (using monthly total return data for each index).

Our test data begins on 12/31/1974.

Figure 1 displays the growth of $1,000 invested in each index on a buy-and-hold basis since that time.

Figure 1 – Growth of $1,000 in SPX and EAFE since 12/31/1974

The knee jerk reaction more many investors will be to say “it looks like SPX is the better investment because it made more money.” However, Figure 2 displays the ratio between the two equity curves in Figure 1. Note that there is a definite “back and forth” between the two. When the line in Figure 2 is rising it means that SPX is outperforming and when the line in Figure 2 is declining it means that the EAFE is outperforming.

Figure 2 – SPX growth vs. EAFE growth (1974-2020)

Figure 3 displays the same line as Figure 2 but adds an 11-month exponential moving average.

Figure 3 – SPX vs. EAFE plus 11-month EMA

So far, we have:

A = $1,000 invested in SPX (cumulative growth)

B = $1,000 invested in EAFE (cumulative growth)

C = A/B

D = 11-month EMA

E = C – D

Figure 4 displays the difference between the 2 lines displayed in Figure 3, i.e., Value E above.

Figure 4 – SPX/EAFE Ratio minus 11-month EMA

Figure 5 displays the growth of equity for each index if held ONLY when SPX is outperforming (i.e., when the line in Figure 4 > 0)

Figure 5 – SPX and EAFE performance while SPX/EAFE ratio > EMA11

Figure 6 displays the growth of equity for each index if held ONLY when EAFE is outperforming (i.e., when the line in Figure 4 < 0)

Figure 6 – SPX and EAFE performance while SPX/EAFE ratio < EMA11

Figure 7 displays the results in numbers

Figure 7 – SPX and EAFE performance based on SPX/EAFE ratio versus EMA11

The bottom line: SPX has vastly outperformed when the SPX/EAFE ratio > EMA11. Likewise, EAFE has significantly outperformed when the SPX/EAFE ratio < EMA11.

The Test

Now let’s look at actually using this information to trade.

Trading Rules:

If E > 0* then invest in SPX

If E < 0* then invest in EAFE

*- using a 1-month lag; i.e., a signal generated at the end of January is traded at the end of February

As a benchmark we will split 50/50 between SPX and EAFE with a rebalance to 50/50 at the start of each new year.

Figure 8 displays the growth of $1,000 for both the switching strategy and the Buy/Hold strategy.

Figure 8 – Growth of $1,000 switching versus buy-and-hold (1974-2020)

Figure 9 displays the relevant facts and figures

Figure 9 – Relevant Facts and Figures

Note that from a “risk” perspective, the “switch system” appear slightly worse, with a higher standard deviation and slightly worse worst 12 months and maximum drawdown figures.

But in terms of return there is no comparison. To illustrate, Figure 10 displays the cumulative growth for the “switch strategy” divided by the cumulative growth for the “buy/hold strategy”. Note the steadily upward trending nature of this line.

Figure 10 – Growth of “switch strategy” versus “buy/hold strategy”

Summary

Is this the “be all, end all” of investment strategies? With a maximum drawdown of -54% it obviously is not. But – as always – I am not actively suggesting that anyone adopt this as a trading method. The purpose is threefold:

*Food for thought (anything that outperforms buy-and-hold by a factor of 3.23-to-1 is at least worthy of a “ponder”)

*A reminder that U.S. stocks and international stocks have an ebb and flow

*This is one objective way to keep an eye on which way the wind is blowing

This “strategy” has been in SPX since July 2018 and shows no signs of a switch anytime soon. But the point remains – the day will come. And not many investors are prepared to act when that day does come.

See also Jay Kaeppel Interview in July 2020 issue of Technical Analysis of Stocks and Commodities magazine

Jay Kaeppel

Wanna Get Naked?

October 15, 2020Uncategorizedadmin

In a yield deprived investment world, it is getting harder and harder to generate income from one’s investments. Buying and holding a 10-year treasury note essentially involves locking in a whopping 0.72% annual yield for the next 10 years. Not exactly the type of return most of us are looking for. As a result, many investors are “reaching” for yield. Not surprising. The real question is “how much risk do you have to take in order to generate the yield you desire?”

A lot of investors are turning to the stock market. And this too is not surprising. It is “going up”, you can buy stocks that pay dividends and you don’t lock yourself into a 0.72% annual return. On the flip side, for those who can remember back about 7 months or so, there can be, ahem, a bit of downside risk associated.

Others are looking at closed-end funds – many of which offer tempting yields and often trade at a discount to net-asset value. Yet, here to it is often difficult to get a true handle on risk. “Wait a minute, if yields on bonds are presently in the 0% to 2% range, how exactly is this CEF yielding 8%?” is a fair question. For the record, I actually think there are opportunities in closed-end funds. But you have to be willing to do the hard work of understanding EXACTLY what you are buying and more importantly, to quantify the risks involved. A number of CEFs – MORT, CEFL to name two – had nearly 20% “yields” in early 2020. MORT is still about 44% off of its high and CEFL is out of business. A good rule of thumb – the higher the yield, the greater the risk.

An Alternative “Income Play”

First the caveats. Like everyone else I am trying to figure out how to get by in a low yield world. What I am about to discuss IS NOT the “magic bullet” nor the be all, end all of income investing. It is NOT necessarily the “best way” – it is simply “one way.” To paraphrase Rod Serling, “submitted for your consideration.”

The play is selling naked put options. REEEE!REEEE!REEEE! (que the scary music!)! OK, how about if I call it a “cash secured put”, then it sounds a lot less scary. Here is an example of how it works:

*Stock XYZ is trading $20 a share

*The January 2021 10 strike price put is trading at say $1. There are 93 days left until the option expires.

*An investor sells – or “writes” – a January 2021 10 strike price put for $1. and receives $100 ($1 option price x 100 shares per option) in “premium” from the option buyer.

*To sell or “write” this option an investor must have $1,000 in their account (as we will see in moment, if the stock price drops below $10 a share the investor will need to buy 100 shares of XYZ stock at $10, hence the need for $1,000 in the account to guarantee that the investor can meet his or her obligation).

*As it turns out, because the investor took in $100 of premium, he or she only needs to put up $900 of their own money to cover the $1,000 requirement.

So, let’s do the math: If XYZ remains above $10 a share between trade entry and option expiration in 93 days the investor makes $100 on a $900 investment, or 11.1% in 93 days.

Quantifying Risk

11% in 3 months is something that would get most investors attention. But the cash secured put – like anything else – involves unique risks. An investor MUST understand the risk they are taking BEFORE engaging in any trade. So, let’s consider the potential scenarios:

*If XYZ stays above $10 a share for the next 93 days (i.e., if it does not drop 50% or more in 3 months) the trader earns 11.1%

*If XYZ does drop below $10 a share within 93 days, the investor will wind up owning 100 shares of XYZ stock at an effective price of $9 a share ($10 strike price minus $1 of premium received for writing the put). If the stock rises in price from there the investor makes money and if the stock declines in price from there the investor loses money.

*If XYZ the company goes bankrupt in the next 93 days (our worst-case scenario), the investor loses $900.

BEFORE selling a cash-secured put an investor MUST do some research regarding, a) the company’s fundamentals and b) ideally identifying a support level for the stock price somewhere between the current price of the stock and the strike price of the option sold.

If you are not willing to do these two things prior to any trade then you can stop reading at this point. And DO NOT sell cash-secured puts.

An Important Note

Big moneyed investors may use cash-secured puts as a method for accumulating a position in a given stock, i.e., they sell puts just out-of-the-money. If the stock goes up, they keep the premium, if the stock goes down, they buy the stock. This is NOT what I am advocating in this piece.

What I am talking about is an approach in which – ideally – we would never buy shares of stock. In other words, the goal is to sell far enough out-of-the money puts so that:

*We take in an acceptable level of income

*The stock is highly unlikely to drop to the strike price prior to expiration

This is an “income generating idea”, NOT a “stock accumulation idea.”

The Key Questions

Question #1:

I will be blunt – the first question is harsh: “What is the likelihood that the company will go bankrupt prior to option expiration?”

To explain: Like everywhere else, in the realm of cash-secured puts you will naturally be drawn to those offering the highest potential returns. However, typically the highest returns are associated with higher risk. If you start digging and learn that the company is teetering on the edge and that there is a “major announcement” forthcoming and so on, steer clear. There are ALWAYS plenty more opportunities out there.

Question #2:

“In the event you are required to purchase the shares, are you comfortable holding this company’s stock?”

Analyzing any companies future prospects is of course subjective, but the primary point is this: If a stock is trading now at $20 a share and you ultimately are required to buy it at an effective price of $9 (10 strike price minus $1 premium received from example above), are you OK with that? If you absolutely, positively do not want to own this stock (even at a 50% or more discount from today’s price) then you should not sell a put against that stock.

Remember: Every once in awhile you will end up buying shares of stock. This will happen. But also remember that as long as the company remains in business there is always an opportunity for the stock price to increase after the shares are purchased.

Examples

Below are examples ONLY. I HAVE NOT looked into the answers to the questions above regarding the stocks below and I AM NOT “recommending” these positions, only using them to highlight the concept.

But a useful exercise would be to look into the companies and see what you think.

Ticker INO

*Trade: Sell the INO Feb 5 put for $0.60

*Investor commits $440 ($5 strike x 100 shares minus $60 in premium)

*So here is a position that offers a tempting 13.9% return in 133 days

*The stock is trading at $12.31 a share, the strike price ($5) is 60% lower and the breakeven price is $4.39.

Figure 1 – INO Feb Cash Secured Put (Courtesy www.OptionsAnalysis.com)

The company is in the Covid-19 vaccine sweepstakes.

Relevant links pro and con:

https://markets.businessinsider.com/news/stocks/dont-count-out-inovio-pharmaceuticals-stock-just-yet-1029645064#

https://markets.businessinsider.com/news/stocks/avoid-inovio-ino-stock-like-the-plague-1029670372#

Remember, the question IS NOT “will the stock go up from here?” The question IS “will the stock stay above $5 until February?”

Ticker GME

Gamestop appeared to be left for dead and traded as low as $2.57 a share in early April 2020. Then they signed a deal with Microsoft and the shares soared.

*Trade: Sell the GME Jan 5 put for $0.25

*Investor commits $475 ($5 strike x 100 shares minus $25 in premium)

*If GME holds above $5 a share the return is 5.26% in 93 days

*The stock is trading at $12.25 a share, the strike price ($5) is 59% lower and the breakeven price is $4.75.

Figure 2 – GME Jan Cash Secured Put (Courtesy www.OptionsAnalysis.com)

Relevant links:

https://www.reuters.com/article/us-gamestop-microsoft-idUSKBN26T3CM

https://www.fool.com/investing/2020/10/14/gamestop-stock-has-climbed-too-high/

Again, the analysis that needs to be done does not involved wondering whether GME will continue to rise in price from its current level. Rather, the only thing that matters is “will the stock stay above $5 until January?”

Summary

Selling cash-secured puts may or may not be your “cup of tea.”

The stocks/trades highlighted here might be “perfectly acceptable”, a “question mark”, or “way too speculative” depending on your own view of things.

But the real point is that in a world of little or no yield, it may be worthwhile to at least consider some alternatives for generating income.

See also Jay Kaeppel Interview in July 2020 issue of Technical Analysis of Stocks and Commodities magazine

Jay Kaeppel

When ZROZ is Better than Zero

October 13, 2020Uncategorizedadmin

Ticker ZROZ is the PIMCO 25+ Year Zero Coupon U.S. Treasury Index (do not attempt to say that 3 times fast) ETF. It tracks an index of zero-coupon treasury securities with an effective duration of 20+ years.

Now let’s interpret that into English.

A zero-coupon bond is a bond that pays no interest. Instead it sells at a discount to face value ($1,000) to create a specific rate of return if held until maturity.

Wait, I though you said this was going to be in English.

An example: For a standard interest paying bond you might pay $900 to buy the bond and get paid x% of interest every year for y number of years and then be paid $1,000 at maturity. With a zero-coupon bond of the same duration you might pay only $800 to buy the bond. No interest is paid along the way but you still receive the $1,000 at maturity.

Because no interest is paid along the way, zero coupon bonds are extremely sensitive to changes in interest rates. This does not technically matter if you are planning to hold it until maturity. However, there can be large price fluctuations along the way depending on much time is left until maturity and how large the interest rate swings are along the way.

The present effective yield-to-maturity for a 20-year zero-coupon treasury is somewhere around or slightly below the 2% range. So, if interest rates were to rise in the interim, the value of a 20-year zero coupon bond is likely to get hit hard (granted it will eventually work its way back to $1,000 of face value, still I am not a fan of locking in sub 2% return for 20 years).

So why am I bothering to discuss zero-coupon bonds? Well, there is a time for everything.

Zeroes and the Election Cycle

Many are familiar with the stock market and the apparent impact of the 4-year election cycle. Turns out the stock market is not alone. For testing purposes, we will use the Merrill Lynch Treasury Strips 20+ Year Index to measure the performance of zero-coupon bonds across the 48-month election cycle. The data starts in April 1995.

Figure 1 displays the months during the election cycle that favor 20-year zeroes.

Figure 1 – ZROZ Election Cycle Calendar

Figure 2 displays the cumulative % growth for the index ONLY during the months listed in Figure 1.

Figure 2 – Cumulative % +(-) Merrill Lynch Treasury Strips 20+ Year Index gain ONLY during Favorable Election Cycle Months

To better appreciate the performance displayed in Figure 2, Figure 3 displays the cumulative % return for the index ONLY during all months NOT LISTED in Figure 1.

Figure 3 – Cumulative % +(-) Merrill Lynch Treasury Strips 20+ Year Index gain ONLY during all Non-Favorable Election Cycle Months

ZROZ and the Election Cycle

The first full month of total return data for ticker ZROZ is November 2009.

*The blue line in Figure 4 displays % return for ZROZ held ONLY during the months listed in Figure 1.

*The orange line in Figure 4 displays the % return for ZROZ held only during all months NOT LISTED in Figure 1.

Figure 4 – Cumulative % +(-) for ticker ZROZ during “Favorable” Election Cycle Months (blue) and during “Non-favorable” Election cycle Months (orange)

The next “favorable” election cycle months for ZROZ are November and December of 2020.

Summary

Does any of the above suggest that ZROZ is “guaranteed” to gain ground during November and December? Not at all. In fact, one can certainly question the entire concept of relying on “election cycle months” to actually invest money.

But that’s up to each individual to decide. For now, we are in the “information is (or at least, may be) power” stage. Now you know that some months appear to better than others for zero-coupon bonds.

Seriously though, who knew?

See also Jay Kaeppel Interview in July 2020 issue of Technical Analysis of Stocks and Commodities magazine

Jay Kaeppel

Is it Time to “Get Small”?

October 9, 2020Uncategorizedadmin

Much has been said and written about the underperformance of small-cap stocks relative to large-cap stocks in recent years. Of course, like a lot of things – growth vs. value, U.S. vs. international. Stocks vs. Bonds, etc. – there are no “permanent advantages” in the financial markets. The ebb and flow among assets classes and sectors function much like waves in the ocean. Some are more or less pronounced and/or last longer or shorter than others, but nothing lasts forever.

A Small-Cap “Thrust”

Jason Goepfert of www.Sentimentrader.com highlighted a potentially significant development in the small-cap space. As you can see in Figure 1, previously when the Russell 2000 Index has rallied more than 10% in 10 trading days the index has tended to continue to move higher. Specifically, it has been higher 1 month later 100% of the time.

Figure 1 – Russell 2000 when it rises 10%+ in 10 trading days (Courtesy Sentimentrader.com)

Important Caveat: This IS NOT meant to imply that there is a 100% probability that RUT will be higher 1-month from now “this time around.” It is simply meant to highlight an opportunity with the potential for success and the importance of trying to put the odds in your favor as much as – and whenever – possible.

How to Play

The most straightforward approach to making a play would likely be to simply buy 100 shares of ticker IWM (the iShares ETF that tracks the Russell 2000 Index). Figure 2 displays the risk “curves” for holding long 100 shares of IWM.

Figure 2 – Risk curves for holding long 100 shares of IWM (Courtesy www.OptionsAnalysis.com)

With IWM trading at $161.82 a share, the cost to enter this trade is $16,182. As you can see, for a stock position the risk “curves” are simply a straight line. For each $1 IWM rises in price the position gains $100 ($1 x 100 shares) and for each $1 IWM declines in price the position losses $100. Like I said, pretty straightforward.

Now let’s consider a hypothetical Trader A, who wants to enter a bullish position for 1-month, but does not necessarily want to plunk down $16+ grand for the privilege.

One potential alternative might be to buy the IWN Nov06 151 strike price call. If Trader A buys this call at $13.21 for a 1-lot they would pay $1,321 for a 1-lot (which costs 92% less than buying 100 share).

This position has a “delta” of 76.53 – which means that the profit/loss potential is roughly the same as buying 76 or 77 shares of IWM. Figure 3 displays the particulars for this position.

Figure 3 – Long 1 IWM Nov06 151 call (Courtesy www.OptionsAnalysis.com)

Now let’s compare the two positions. Figure 4 overlays the risk curves for the long 100 shares of IWM position (gray line) versus holding the 151-strike price call (black line).

Figure 4 – Long stock vs. long call option (Courtesy www.OptionsAnalysis.com)

Things to Note:

*The stock position costs $16,182 to enter and offers point-for-point profit with the underlying shares. The breakeven price is $161.82 a share, profit potential is unlimited and the $ loss increases with each point IWM declines.

*The option position costs $1,321 to enter. The breakeven price is $164.21. Above this price the option position enjoys point-for-point movement with the stock. The maximum risk is $1,321.

To put things in perspective, let’s assume that on the day of option expiration that IWM is trading at $175 a share:

Figure 5 – What if? IWM is at $175 a share at option expiration (Courtesy www.OptionsAnalysis.com)

Call option pros:

*The cost is only $1,321 versus $16,182 for the stock position

*Above $164.21 a share, the call offers point-for-point profit with the stock

*Potential % return is much greater

*Worst case: if IWM were to crash the loss is capped at -$1,321 below $151 a share

Call option cons:

*Because of time premium, the call option gives up the first few points of profit potential with a breakeven price of $164.21.

*The option expires in 28 days so IWM must make a move within that time frame in order to generate a profit.

Summary

So, is a bullish trade on small-cap stocks warranted? And if so, which is the better play – shares or a call option?

Neither of these questions are for me to answer.

For the record, I am not recommending small-cap stocks nor options versus shares. The sole purpose is to educate investors and traders about how to spot potential opportunities and how to compare the relative pros and cons of various alternative trading approaches.

Each trader must weigh the pros and cons of both the potential and the risks of the opportunity itself and the various “ways to play” and make their own decisions.

See also Jay Kaeppel Interview in July 2020 issue of Technical Analysis of Stocks and Commodities magazine

Jay Kaeppel

The Calm Before the Bond Storm?

October 7, 2020Uncategorizedadmin

The bond market was very quiet in the 3^rd quarter. Figure 1 displays ticker IEF (7-10 year treasuries ETF) in the to clip and ticker AGG (Aggregate Bond Index ETF) in the bottom clip.

Figure 1 – Tickers IEF and AGG in narrow ranges (Courtesy AIQ TradingExpert)

Essentially the entire bond market has been flat since early June. The market seems to be assuming that “the Fed will take of everything” and keep interest rates low and stable for the foreseeable future so…..ZZZZZZZZ.

But this type of activity often breeds complacency. I am not making any predictions here but I do want to raise a question that investors might wish to ponder, i.e., “what would be more shocking that a spike in interest rates?” OK, yes, I realize it is 2020 and it is pretty much hard to be shocked by anything anymore. But still, on a relative basis how many investors are even thinking about the potential risk of higher interest rates at the moment?

Could it Happen?

The Bond Market VIX (ticker MOVE) recently fell to its lowest level ever (before spiking sharply higher on 10/5/20). As you can see in Figure 2 this type of “quietness” often precedes a significant move in the bond market. For the record, low readings in MOVE can be followed by large up moves in price as easily as large down moves in price. So, a low MOVE reading is not “bearish” per se, but rather merely suggests that we are experiencing the “calm before the storm.”

Figure 2 – Bond Market VIX hit an all-time low (Courtesy Sentimentrader.com)

So why is my “Spidey sense” tingling? Figure 3 displays the yield on 30-year treasuries (ticker TYX) on the bottom and an indicator I refer to as VFAA on the bottom (the calculation appears at the end of this piece). VFAA is a derivative on a Larry William’s indicator he calls VixFix.

Figure 3 – 30-year treasury yields with VFAA suggesting a potential bottoming area (Courtesy AIQ TradingExpert)

As you can see in Figure 3, peaks in the VFAA indicator often occur near intermediate term lows in bond yields (reminder: bond prices move inversely to yield, so a bottom in interest rates indicates a top in bond prices). As you can also see on the far-right hand side, the stage clearly appears to be set for “the next go round.”

Why does this matter? If interest rates do rise in the months ahead bond prices – particularly long-term bond prices can get hit hard. To illustrate the potential risks, Figure 4 displays the action of treasury security ETFs of various maturity during a 5-month rise in rates back in 2016.

Figure 4 – Bond ETF action during rate rise in 2016

Summary

It is possible for long and short-term bonds to “de-couple”. In other words, the possibilities are:

*Short-term rates remain stable (as the Fed keeps pumping) while long-term rates rise (as inflation fears arise as a result of all the Fed pumping)

*Short-term rates remain stable while long-term rates plummet (if the economy appears to be weakening). This would result in gains for long-term bonds only

*None of the above

The bottom line: Bonds have fallen asleep – but DO NOT fall asleep on bonds.

VFAA Formula

Below is the code for VFAA

VixFix is an indicator developed many years ago by Larry Williams which essentially compares the latest low to the highest close in the latest 22 periods (then divides the difference by the highest close in the latest 22 periods). I then multiply this result by 100 and add 50 to get VixFix.

*Next is a 3-period exponential average of VixFix

*Then VFAA is arrived at by calculating a 7-period exponential average of the previous result (essentially, we are “double-smoothing” VixFix)

Are we having fun yet? See code below:

hivalclose is hival([close],22).

vixfix is (((hivalclose-[low])/hivalclose)*100)+50.

vixfixaverage is Expavg(vixfix,3).

vixfixaverageave is Expavg(vixfixaverage,7).

VFAA = vixfixaverageave

See also Jay Kaeppel Interview in July 2020 issue of Technical Analysis of Stocks and Commodities magazine

Jay Kaeppel

Thanks for the Kind Words

October 7, 2020Uncategorizedadmin

Just wanted to post a quick “Thank You” to David Taggart of PDMacro.com for the kind words in his recent tweet.

Shucks folks, I’m speechless.

See also Jay Kaeppel Interview in July 2020 issue of Technical Analysis of Stocks and Commodities magazine

Jay Kaeppel

Good Companies, Troubled Stocks and Potential Opportunity

October 2, 2020Uncategorizedadmin

Truth be told I am not much of a “stock picker”. Oh, I can pick ‘em alright just like anyone else. They just to don’t go the right way as often as I’d like. I also believe that the way to maximize profitability is to follow a momentum type approach that identifies stocks that are performing well and buying them when they breakout to the upside (ala O’Neil, Minervini, Zanger, etc.) and then riding them as long as they continue to perform. Unfortunately, I’m just not very good at it.

Back when I started out, there was such a thing as a “long-term investor.” People would try to find good companies selling at a decent price and they would buy them and hold them for, well, the long-term. Crazy talk, right? As I have already stated, I am not claiming that that is a better approach. I am just pointing out that it was “a thing.”

An Indicator

There is an indicator (I will call it VFAA, which is short for vixfixaverageave, which – lets face it – is a terrible name) that I follow that was developed as an extension of Larry William’s VixFix Indicator. There is nothing magic about it. Its purpose is to identify when price has reached an exceptionally oversold level and “may” be due to rally. The code for this indicator appears later.

For the record, I DO NOT systematically use this indicator in the manner I am about to describe, nor am I recommending that you do. Still, it seems to have some potential value, so what follows is merely an illustration for informational purposes only.

The Rules

*We will look at a monthly bar chart for a given stock

*A “buy signal” occurs when VFAA reaches or exceeds 80 and then turns down for one month

*A “sell (or exit) signal” occurs when VFAA subsequently rises by at least 0.25 from a monthly closing low

Seeing as how this is based solely on monthly closes it obviously this is not going to be a “precision market timing tool.”

Some “Good Companies” with “Troubled Stocks”

So now let’s apply this VFAA indicator to some actual stocks. Again, I AM NOT recommending that anyone use this approach mechanically. The real goal is merely to try to identify situations where a stock has been washed out, reversed and MAY be ready to run for a while.

Ticker BA

Figure 1 displays a monthly chart for Boeing (BA) with VFAA at the bottom. The numbers on the chart represent the hypothetical + (-) % achieved by applying the rules above (although once again, to be clear I am not necessarily suggesting anyone use it exactly this way).

Figure 1 – Ticker BA with VFAA (Courtesy AIQ TradingExpert)

From March 2019 into March 2020 BA declined -80%. It has since bounced around and VFAA has soared to 110.88. VFAA has yet to rollover on a month-end basis, so nothing to do here except exhibit – what’s that word again – oh right, “patience.”

Ticker GD

Figure 2 displays a monthly chart for General Dynamics (GD) with VFAA at the bottom.

Figure 2 – Ticker GD with VFAA (Courtesy AIQ TradingExpert)

Are these “world-beating numbers”? Not really. But in terms of helping to identify potential opportunities, not so bad. VFAA gave a “buy signal” for GD at the end of July. So far, not so good as the stock is down about -6%.

Ticker WFC

Figure 3 displays a monthly chart for Wells Fargo (WFC) with VFAA at the bottom.

Figure 3 – Ticker WFC with VFAA (Courtesy AIQ TradingExpert)

There are not many “signals” but the ones that occurred have been useful. Between 2018 and 2020 WFC declined -65%. It has since bounced around and VFAA has soared to 102.44. VFAA has yet to rollover on a month-end basis. But at some point it will, and a potential opportunity may arise.

VFAA Formula

Below is the code for VFAA

*Next is a 3-period exponential average of VixFix

*Then VFAA is arrived at by calculating a 7-period exponential average of the previous result (essentially, we are “double-smoothing” VixFix)

Are we having fun yet? See code below:

hivalclose is hival([close],22).

vixfix is (((hivalclose-[low])/hivalclose)*100)+50.

vixfixaverage is Expavg(vixfix,3).

vixfixaverageave is Expavg(vixfixaverage,7).

VFAA = vixfixaverageave

Summary

One thing to note is that VFAA “signals” on a monthly chart don’t come around very often. So, you can’t really sit around and wait for a signal to form on your “favorite company”. You have to look for opportunity wherever it might exist.

One last time let me reiterate that I am not suggesting using VFAA as a standalone systematic approach to investing. But when a signal does occur – especially when applied to quality companies that have recently been “whacked”, it can help to identify a potential opportunity.

See also Jay Kaeppel Interview in July 2020 issue of Technical Analysis of Stocks and Commodities magazine

Jay Kaeppel

Buy Energy Stocks – But Not Right Now

October 1, 2020Uncategorizedadmin

Jason Goepfert, the Editor of www.Sentimentrader.com has done yeoman’s work in chronicling just how ugly things have gotten in the energy sector, how much the sector is loathed and how this type of action – usually – leads to a rally. More on that a little later.

I highlighted some info from www.Sentimentrader.com regarding energy executive insider buying here. So, is this the exact right time to take the plunge and dive headlong into the deep end of the energy pool? It beats me. I certainly do find the “washed out” case to be compelling. But I for one will be waiting at least until December 1^st.

Figure 1 displays the cumulative % gain for Fidelity Select Energy Services (used as a proxy for the energy industry) ONLY during the months of October and November every year since 1986. It’s not pretty.

Figure 1 – FSESX Oct-Nov ONLY cumulative %; 1986-2019

Figure 2 displays the relevant facts and figures.

Figure 2 – Relevant Facts and Figures

Figure 3 displays year-by-year total return results for FSESX during the months of October and November.

Year	FSESX Oct/Nov % +(-)
1986	(0.2)
1987	(42.7)
1988	(7.5)
1989	3.2
1990	(11.2)
1991	(10.7)
1992	(7.1)
1993	(11.8)
1994	(1.4)
1995	(3.5)
1996	15.6
1997	(8.9)
1998	(12.7)
1999	2.4
2000	(24.2)
2001	23.3
2002	12.2
2003	(3.0)
2004	5.8
2005	(0.7)
2006	13.4
2007	(4.7)
2008	(44.2)
2009	(0.8)
2010	16.1
2011	24.3
2012	(4.6)
2013	1.9
2014	(22.1)
2015	10.0
2016	10.5
2017	(5.8)
2018	(27.8)
2019	(0.4)

Figure 3 – FSESX October-November Year-by-Year

Summary

In 2001 FSESX advanced +23.3% during Oct/Nov and in 2011 it rallied +24.3% during Oct/Nov. So, there is no reason energy stocks cannot surprise the investment world and launch a rip-roaring rally in the months directly ahead, especially given how beaten down and unloved they are at the moment.

Still, investing is a game of odds. Given that energy stocks have showed a gain only 35% of the time during October and November, I for one intend to “exhibit a bit more patience.”

For a possible glimpse of the future however, please consider Figure 4 from www.Sentimentrader.com, which displays what has happened in the past after a flurry of dividend cuts in this sector. 6 months to 2-year returns have been positive 100% of the time.