A long time ago I evolved into something of a “go with the flow” kind of guy – at least when it comes to the financial markets.  Sure, in my youth I spent a fair amount of time staring into my crystal ball and trying to “pick tops and bottoms with uncanny accuracy.”  Unfortunately, it took me a long time to figure out that my crystal ball was not actually functioning.

So I have long understood the benefit of simply using some objective method to define the trend is either “up” or “down”, and just kind of seeing where it leads.  This approach came in pretty handy in 2013 when the “news” was essentially uniformly bad from start to finish.  But did the stock market care – oh contraire!

Updating the old adage “Don’t Fight the Fed” into today’s jargon:

“If the Fed is pumpin’, the stock market’s jumpin’. ”

And at the moment, there appears to be no end in sight (at least regarding QE2IB, or “Quantitative Easing to Infinity and Beyond”). 

So why do I all of a sudden have a foolish hankering to buy gold stocks?  This makes no sense at all.  In Figure 1 you see four different gold stock related investment vehicles.  Can you say “well established downtrend?”  Sure, I knew you could.  Some have broken down to new lows others are still holding out hope of establishing a double bottom.  And for some inexplicable reason, I feel this urge to play the long side.  Figure 1 – Gold Stock Double Bottom; In the Making or Wishful Thinking? (Courtesy AIQ TradingExpert)

The key hesitation here is the simple fact that on the approximately last 57 times it “looked” like a potential bottom in gold stocks…….it wasn’t.  Will this time around be any different?  Probably not.  Still……….in the immortal words of Glenn Frey, “the lure of easy money, it’s got a very strong appeal.”

 To Give In Or To Fight the Urge?

Investing and trading is a game best played by establishing certain rules (for example, “go with the trend”, “cut your losses”, etc.) and then sticking to them.  But human nature is, well let’s be blunt here, a pain in the butt.  The urge to “pick a bottom” is one of the stronger, more compelling urges that any trader feels. What a coup if you pull it off (which of course you probably won’t)!

So here is the question?  If you feel the urge to “pick a bottom”, should you:

a) Fight the urge in every case?

b) Give into the urge and bet the ranch?

c) Give into the urge and risk a small, acceptable amount of capital?

If you picked answer, b) my frank advice is to let someone else handle your money.

If you picked answer a), more power to you and I greatly respect your discipline.

If you picked answer c) yo, what up dog!?  (Sorry, I inadvertently walked in on some video my kids were watching)

I personally can live with answer c).  For a couple of reasons.  First of let’s establish the fact that choosing answer c will probably lead to your losing money more often than not.  Sorry, that’s just the reality.  However, it can also serve as something of a “release valve”, whereby the occasional small mistake reminds us not to make a big huge mistake (i.e., answer b, somewhere down the line)

So let take a look at one possibility.

Finding a Trade (for better or worse)

I used www.OptionsAnalysis.com to look for long call trades on tickers GDX, GDXJ, XAU, NEM and GG.  Sorting for Bullish percent to double and then among the top trades chose the one with the highest Gamma (long story short, high gamma in my book equals more “bang for the buck”)

The trade I came up with was buying the GDX January14 22 call at $1.06 as shown in Figures 2 and 3.

So is this a good idea?  In all candor, probably not.  But let me just explain what I am looking at.

Let’s say I am a trader with a $25,000 trading account and are willing to risk (throw away?) 2% of our trading capital on a foolhardy attempt to pick a bottom (hey, it’s my account, I can do what I want).

This means I can risk $500 ($25K x .02).  So if the option trades at $1.06, this means I can buy up to 4 contracts and risk $424. Figure 2 – GDX Call Trade (Courtesy: www.Optionsanalysis.com)

Figure 3 – GDX Call Trade Risk Curves (Courtesy: www.Optionsanalysis.com)

So what are the likely (or at least possible) outcomes?

#1) Murphy’s Law being what it is, if I take this trade gold stocks will almost certainly continue to sink.  In this case the worst case scenario is that I hold the calls until January expiration and lose $424.

#2) if somehow, the market gods smile, let’s assume that GDX bounces back up to its early November high near $24.70.  In this case, the trade will generate a profit of $660 to $880 or more, depending on how soon GDX bounces.

Summary

As a rule I would never advocate for someone else to “pick a bottom”.  But let’s face, every once in awhile, the urge strikes.   So if you decide to give into the urge, make sure:

a) You don’t risk very much money.

b) You have enough upside potential to at least make it worth your while to do something that you may well look back upon and say, “Why the heck did I do that?”

As long as you employ a) and b) above, I view it as sort of a win-win situation (depending of course on how you define “win”).

If the underlying security in question does bounce to higher ground, you have the opportunity to generate a nice profit.

On the other hand, if the underlying security continues its current trend, you are served a powerful reminder of why you don’t try very often to “pick tops and bottoms with uncanny accuracy.”

So the bottom line is this: I am NOT telling you that I think gold stocks are about to bounce and that you should buy gold stocks (or options on gold stocks).  What I am telling you is that sometimes the urge to speculate will rise to the surface.

When that urge strikes there is a right way and a wrong way to react.

Happy Thanksgiving

Jay Kaeppel

Under the category of “This is Not a Recommendation, Only an Informational Tidbit” (Note to Myself: Come up with some better categories), keep an eye on real estate stocks in the weeks ahead.

A Seasonal Trend of Note in Real Estate Stocks

A bullish time period for real estate stocks begins at the close of trade on the 14^th trading day of November (this was 11/20/13 this time around) and extends through the 21^st trading day of December (12/31/13).

Figure 1 displays the growth of $1,000 invested in ticker FRESX (Fidelity Select Real Estate) during this time period every year since 1989.

 Figure 1 – Growth of $1000 invested in Fidelity Select Real Estate (FRESX) 1989-Present during Bullish Seasonal Period

FRESX has advanced 20 times during the past 20 years during this time frame, or 83% of the time.

Other potential investment choices beyond FRESX include:

Ticker VNQ – Vanguard REIT Index

Ticker IYR – iShares Dow Jones Real Estate ETF

Ticker URE – ProShares Ultra Real Estate ETF (2 x leverage)

Ticker REPIX – Profunds Real Estate mutual fund

Will real estate stocks rally this time around?  Only time will tell.

Jay Kaeppel

Please find below a complimentary link from MTA (Market Technicians Association) to an archived version of my 11/20/2013 webinar titled “Finding Exceptional Opportunities with ETF, Options and Seasonal Trends.

http://go.mta.org/watch112013

Please find below a complimentary link from MTA (Market Technicians Association) to an archived version of my 11/20/2013 webinar titled “Finding Exceptional Opportunities with ETF, Options and Seasonal Trends.

http://go.mta.org/watch112013

My thanks again to MTA for inviting me to speak and for all those in attendance.

Jay Kaeppel

Hi Jay, welcome back to your own blog.  Yes it has been a little while since I have posted anything new.  Sorry about that.  I was a little busy preparing for a webinar I taught on 11/20 for MTA.  Also, there wasn’t anything really compelling happening in the markets that jumped out at me.

For the record I should probably point out that in a good week I will probably post two new items.  First off, I tend not to write “short” pieces (although, shorter ad more frequent pots is something I am aiming for in the future), plus I don’t foresee ever posting “daily commentary”.

If you took the sum total of all “Daily financial market commentary”, in a nutshell it basically amounts to “blah blah blah.”  No disrespect to anyone writing daily commentary, its jut that there I not always anything meaningful driving the markets on any particular day.  But if your job is to write about the markets today, well, you have to say “something.”  So there tends to be a lot of after the fact causation assigned to random events.  For example:

“The Dow rose 66 points today as investors looked at their checking accounts and found that they actually had a few more dollars there than they thought and were cheered, which somehow resulted in high frequency trading programs kicking into “buy mode” for a good portion of the afternoon, which was really the only time of day that the market did anything all day.  In “economic news”, financial “experts” adjusted their estimates for 4^th quarter GDP growth from +1.2% to +1.2000000001%, which I am also going to claim somehow compelled people to buy stocks aggressively enough to make the market go up, even though as I have already said, today’s action was solely based on high frequency trading programs.”

Insightful or what!?

Anyway, in my MTA presentation one of the things I talked about was the tendency for financial stocks to perform much better during the last 4 and first 2 trading days of the month than during the rest of the month (and when I say “much better”, I mean “MUCH better” – like +1,863% versus -87% over the last 25 years).  Also, one of the points I made in regards to trading in general is the importance of “consistency of returns”.  The more consistent the returns from any trading method the easier it becomes to continue to follow the method without second guessing things based on “current events.”

So one of the questions that an attendee raised was the month-to-month consistency of my seasonal systems for financial stocks.  So here are the figures:

Figures for Jay’s Seasonal Financial Index Trading System

Please attend the free on-line seminar that I will be teaching on Wednesday, November 20th.

Info link: http://tinyurl.com/nys8rqj

To attend live webinar for no cost visit: http://go.mta.org/lobby112013 on 11/20 before Noon EST

One of the long time debates among market analysts is arguing the relative merits of “growth” stocks versus “value” stocks.  Some argue that earnings growth is the name of the game when it comes to great stocks.  Others argue that it is best to buy them when they are “giving ‘em away.”  So who’s right and who’s wrong?  It beats the heck out of me.  In fact, my own analysis suggests that there is a “time for value” and a “time for growth.”  Nevertheless, this article will detail a system I’ve developed that only trades vgrowth stocks – “when the time is right.”

The Benchmarks

Figure 1 displays the growth of $1,000 invested in Vanguard Growth Fund (VIGRX) and $1,000 invested in Vanguard Value Fund (VIVAX) since January 1994.  Some will look at Figure 1 and state that growth stocks are “better” than value stocks because they have generated a greater profit.  But as you can see, through the 2008 decline they were basically even.  Since that time growth has vastly outperformed value.  But history suggests their performance will converge once again somewhere down the road.

 Figure 1 – $1,000 invested in Growth stocks (blue line; ticker VIGRX) versus $1,000 invested in Vale stocks (red line; ticker VIVAX) since January 1994

As it turns out it is possible to build a model that invests only in value stocks, yet outperforms both of these indexes by moving to cash on occasion (roughly 15% of the time).  So here goes:

Jay’s “Show Me the Growth” Model (SMTG)

To those who dislike math all I can say is “just grit your teeth and you can get through this”.  Here are the calculations:

A = Daily close for VIGRX divided by daily close for VIVAX

B = 39-day exponential moving average of A

C = ((A – B) / B) * 100

D = C – 1.2

(That wasn’t so painful, right?)

“Show Me the Value” Trading Rules

-If yesterday’s value for D < 0 then buy Growth stocks at the close today (or continue to hold value stocks if already long).

-If yesterday’s value for D > 0 then sell Value stocks at the close today (or remain in cash if already in cash).

That’s all there is to it.

Now, let’s try it in English and then look at the results.

Figure 2 displays the daily values for variables A and B above.  The blue line is Value A and is derived by dividing growth stock fund (VIGRX) price divided by value stock fund (VIVAX) price.

The red line is Value B or the 39-day exponential moving average of Value A and is arrived at by multiplying yesterday’s value for B times 0.95 and today’s value for A by 0.05 and adding the two together.  When the blue line is above the red it indicates that growth stocks are outperforming value stocks. Figure 2 – VIGRX divided by VIVAX (blue line) and 39-day exponential moving average (red line); August 2012-Present

Figure 3 displays value C which is the difference between the two lines shown in Figure A as a percentage (again, A-B and then that value is divided by B and then multiplied by 100.  Are we having fun yet?) minus 1.2.Figure 3 – “Show Me The Value” Signal Line (Below 0=Long Value Stocks; Above 0=Cash) ; August 2012-Present

As long as the Value D shown in Figure 3 is negative we want to hold growth stocks.  When that value moves to positive territory we move to cash until Value D drops back below 0.

System Results

OK, so what the heck do all these gyrations do for us?  Well, they give a us a pretty decent model for making money in the stock market and does so with lower degree of volatility than experienced using a buy and hold approach.

To make a comparison we will compare the growth of $1,000 invested using the system versus the growth of $1,000 split equaling between VIGRX and VIVAX on a buy and hold basis.  While the system is in cash we will assume a nominal rate of interest of 1% per year. 

Figure 4 – Growth of $1,000 using SMTV System(blue line) versus Buy and Hold (red line) (1994-present)

Figure 5 – Performance Comparison

Figure 6 after the article shows the annual results

In a nutshell, the system has:

-Outperformed a buy-and-hold approach (+14.2% annually and +1,101% in all versus +9.4% annually and +331% in all)

-And has done so with less volatility (annual standard deviation of 15.1% for the system versus 18.4% for buy-and-hold)

-And less risk (maximum drawdown of 33.8% versus -55.9% and a worst calendar year of -10.5% versus -30.9%).

Summary

So should everyone abandon their current investment model and adopt this one?  Should investors completely abandon growth stocks and invest only in values stocks as this system does?  And will this system outperform buy and hold ad infinitum into the future.

The answer to each of these questions is “probably not.”  Still, in the end we are talking about an objective, mechanical system that averages 14% a year, outperforms buy and hold and does so with less volatility.

As a proud graduate of “The School of Whatever Works”, all I can say is “I’ve seen worse.”

Jay Kaeppel

OK I am beginning to become something of a broken record.  I keep talking about following the trend (in case you have not noticed, the trend is “Up”), but then I keep fretting and talk about hedging against a near-term decline using call options on ticker VXX (the exchange-traded fund that tracks the VIX Index).

So which is it Jay, up or down?  Well, I claim it can be both.  You can be a bullish long-term trend follower and still be concerned and take action to hedge against a short-term decline which does not include “selling everything”.

The Good News

The good news is that the stock market is clearly in an uptrend and in addition (and as I wrote about here (http://jayonthemarkets.com/2013/11/04/santa-claus-is-coming-to-town/) the Santa Claus Rally Time Period begins at the close on 11/22.  So in a perfect world one would simply leave well enough alone and enjoy the ride (in case you have not noticed it is not exactly a perfect world).

The Bad News

The bad news is that several indicators that I follow are starting to give warning signs (albeit minor ones) and ticker VXX itself (http://jayonthemarkets.com/2013/10/30/is-vxx-issuing-a-warning/) is currently the picture of complacency.  So I have concerns about the stock market in the very near term.  At the same time I do not want to “sell everything” and load up on short positions.  So what to do?  Man the VIX!

VXX Call Option

The position I am looking at involves buying the December VXX 13 strike price call option.  As this is written ticker VXX is trading at $12.29 a share and the December VXX call is trading at $0.59 (or $59 for a 1-lot).

In Figure 1 we see the utter lackadaisical action of late in ticker VXX.  My own subjective interpretation is that after the shutdown/debt limit “crisis” ended the investment world went “OK, back to the bull market, blah, blah, blah.”    Figure 1 – VXX is the picture of “complacency” (Chart courtesy of AIQ TradingExpert)

The thing to note here is that the Average True Range (shown below the bar chart) is down to a level that preceded the previous to “spikes” in VXX.

The December 13 VXX trade is displayed in Figures 2 and 3. Figure 2 – VXX December 13 call option details (Courtesy: www.OptionsAnalysis.com)

Figure 3 – VXX December 13 call option risk curves (Courtesy: www.OptionsAnalysis.com)

So in light of all of this, you have got to ask yourself two questions:

Question #1: Do you have any concerns about the stock market in the short-term, “yes” or “no”.

If you answered “yes” to Question #1, please proceed to Question #2.

Question #2:  Do you have 59 bucks?

Jay Kaeppel

OK I’ll admit I am a little early with this one.  But maybe not as early as you might think.  In fact, as I was out driving I saw the first house in my neighborhood to have Christmas lights up…and lit.  Hey, desperate times I guess.

While the stock market continues to push to new highs, “morale” is not quite what one might expect.  This may be due in part to the fact that it is near impossible to peruse the financial media these days and not come away with a sense of foreboding, given all of the warnings and admonitions and liberal use of word like “frothy” and “bubble.”  And make no mistake, I have voiced a few concerns recently myself and have gone so far as to suggest that investors consider hedging with VXX call options (http://jayonthemarkets.com/2013/10/30/is-vxx-issuing-a-warning/) from time to time.

Still, as a person who has been involved in the financial markets for a while I understand the power of the trend.  So despite all of my personal concerns about the economy, debt, etc., etc., 2013 has been good to “go with the flow” kind of people.   In the short-term, the stock market does appear to be a bit “overbought” and perhaps “due for a correction.”  But while anything can happen, history suggests that people who are looking for a stock market collapse before the end of the year may be disappointed.  Cue the Christmas music.

The Santa Claus Rally

As I define it, the Santa Claus rally time period:

-Begins at the close of trading on the Friday before Thanksgiving.

-Extends through the close of the third trading day of January.

And that’s all there is to it.

So how has the stock market performed during this period in the past?  I am so glad you asked.

Figure 1 displays the growth of $1,000 invested in the Dow Jones Industrials Average only during the pre-Thanksgiving through post-New Year’s period I just described, starting in November 1949. Figure 1 – Growth of $1,000 invested in Dow Jones Industrials during Santa Claus Rally period (1949-2012)

Figure 2 displays some important figures regarding this performance.

Figure 2 – Stock Market Performance during Santa Claus Rally Time Period

One other thing to note is that this Santa Claus Rally time period has witnessed an advance by the Dow during 26 of the last 28 and 32 of the last 35 years.   It’s tough to the beat that kind of consistency.

 Summary

So does all of this mean that “you can’t lose” trading stocks during this “sure thing” time period guaranteed to generate “above average, risk free” returns?  Ah, if only.  All any of this really means is that stocks have performed well during this time period in the past.  What will happen this year remains to be seen.

Still, the real point is that investors may be wise to give the bullish case every benefit of the doubt starting in late November.

Jay Kaeppel

P.S.  For all of you “numbers geeks” out there, the annual performance during the Santa Claus Rally Time period appears below

This post is more of an FYI than a specific call to action, still a reasonably good trend is a reasonably good trend.

As many investors know by now the November 1^st into May time period has historically been very good for the stock market.  One of the better performing sectors during this time period has tended to be the semiconductor/electronics sectors.  Among tickers worthy of analysis are:

-FSELX (Fidelity Select Electronics mutual fund)

-SMH (HOLDRs Semiconductor ETF)

In a nutshell, the semiconductor/electronics sectors tend to perform well between October 31^st and April 30^th.  The results for FSELX since October 1994 appear in Figure 1.

Figure 1 – FSELX Performance October 31 to April 30

A chart of the annual growth of $1,000 appears in Figure 2.

Figure 2 – $1,000 invested in FSELX 10/31 through 4.30 since 10/1994

In a nutshell:

-FSELX has been up 14 times (74%) and down 5 times (26%).

-The average gain was +18.7% and the median gain was +13.7%.

-The worst declines were -32.9% during 2000 to 2001 and -19.9% during 2007 to 2008, so remember that there is definitely risk involved. Figure 3 – Fidelity Select Electronics (Ticker FSELX)

Summary

Please do not read this post and think “Aha, semiconductor/electronic stocks are sure to rally.”  That is not the implication I am trying to make.  Simply remember that the “trend is your friend” and that this sector tends to perform well during this time period.  As long as these stocks act well it may be wise to give the bullish case the benefit of the doubt.

Jay Kaeppel