I am not great with predictions, but I am 100% confident that the title of this piece will prove entirely accurate. Now how many of us will actually die from contracting Coronavirus remains to be seen. I am hoping it will be far less than we are being led to believe (Yes, I am a bit incensed about the fact that whatever the ultimate number ends up being, the media will do everything in their power to make it seem 1,000 times worse).
Like everyone else, I have to battle to keep emotions in check. And repeating what I said here, do whatever it is you think you need to do in terms of surviving what we are told is an “inevitable” pandemic. Stock up on food, water, supplies, masks, whatever.
When it comes to investing however….. I argued here and here that a bear market is likely between 12/31/2019 and 6/30/2022. In the here and now, things appear to be getting a bit overdone.
Getting
to Oversold
I
follow a version of the McClellan Oscillator using NASDAQ advances and declines
instead of the NYSE. In simple terms,
the MO measures the difference between the 19-day exponential average and the
39-day exponential average of daily advances minus declines. Extreme low readings indicate an “oversold”
market – which can often be seen as a buying opportunity.
One
extreme level that I look for is a daily MO reading of -300 or less. This level was pierced as of the close on
2/27/2020. Figure 1 displays the Nasdaq
Composite Index since 1988 with the McClellan Oscillator below it. As you can see, readings below -300 are
fairly rare.
Figure
1 – Nasdaq Composite Index with Nasdaq McClellan Oscillator (1988-2020)
To
get a better picture, Figure 2 displays the worst decline – using closing
prices – experienced in the six months following each previous -300 MO
reading. In other words, “How much worse
did it get, after the first sign of an oversold situation?”
Figure
2 – Worst Nasdaq 100 declines in 6 months average McClellan Oscillator < -300
In 8 of the 9 cases, the maximum close to close decline from the first “oversold” reading was -6.5% or less. The exception of course was 2008, when the market plunged another 18+% before bottoming out.
The charts that follow displays the Nasdaq 100 Index during the six months after the 1st MO -300 reading
*Regarding
pandemics and stock markets, adopt a “hope for the best, prepare for the worst
mentality”
*If
you believe you are overexposed in the market then make a plan for when and
what and how much you should sell. Then
follow your plan and DO NOT look back in regret
*If
you want to put your head in the sand and just hold on forever, fight that urge
(again I refer you to the articles linked above)
*If
you have cash to invest – don’t try to be a hero, but don’t be a total wimp
either
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 does not represent
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.
The problem with situations like the current one – besides the angst and real-life implications of having your net worth decrease quickly – is that people tend to get wrapped up in tangential issues. Turn on the cable news and you will likely here breathless speculation about how seriously the coronoavirus will impact the U.S. – and the world – both in terms of how many people may die in the shorter term and how badly the economy might tank as everyone hides in their homes in the longer run.
Blah,
blah, blah.
Looks
folks, do whatever it is you think you need to do in terms of surviving what we
are told is an “inevitable” pandemic. Stock up on food, water, supplies, masks, whatever. But this is an investment blog. So, let’s get down to the only question that
really matters right now for investors: “What to do now.”
And the answers depends on the following: Are you fully invested or do you have cash to invest?
If
You Are Fully Invested
While the ferocity of the decline is quite unsettling, the reality is that this market has been overdue for “a whack.” During the rally in the last year, cash levels fell substantially, confidence rose significantly, volatility fell to barely a beep, and the number of investors adopting the “I should just put all my money in an index fund and forget about it” approach seemed to accelerate (speaking anecdotally on that last point). So not really a surprise that the market would “shake the trees.”
Just
to put the current decline in perspective, please take a quick glance at the
monthly chart of the S&P 500 Index in Figure 1.
Figure
1 – S&P 500 Index Monthly (1971-present)
If
you are fully invested, you have 3 basic choices:
*Sell everything – While I cannot predict what will happen next, I will just mention that dumping your entire portfolio in a panic on the sixth consecutive day of a decline just sounds like one of those things you may well look back on with regret. If you are contemplating this approach (and even if you are not) please read this article, this article and this article regarding how long-term tops typically form.
*Sell some – While the comment about doing so this well into a panic selling decline applies here also, the reality is that if you are completely uncomfortable with your exposure to the stock market, there is nothing wrong with “playing defense” – as long as you understand that doing so may cost you in the long run. If you sell – and I am just making up a number here – 25% of your portfolio you can say, “OK, I have less exposure if things get worse and I have some cash I can put to work at lower levels if that is the case.” Fine. Just remember that if the market does turn back up you may end up kicking yourself somewhere down the road.
*Hold On – Buying and holding forever with 100% of your capital is not my favorite strategy. Please take a moment to review Figures 3 and 4 in this article. There is a time to “play defense.” When the Dow, S&P 500, Nasdaq 100 and Russell 2000 all drop below their 200-day moving averages (the Dow and Russell already have) and especially if those averages start to roll over the risk of a significant bear market increases significantly. But once again please read this article, this article and this article to get a little “non panic induced” historical perspective.
If
You Have Cash
If
you have cash to invest, then situations like this can prove to be a buying
opportunity. Unfortunately, they can
also prove to be a “trying to catch a falling safe” opportunity (Sorry, I don’t
make the rules). So, I suggest one of
two approaches:
*Be
patient and wait for, a) a reflex rally, b) another decline, and c) a reversal
back to the upside – especially if it involves anything resembling a double bottom.
*Put some cash to work now (or at least soon) and hold back some for another opportunity later.
Totally
off the beaten path comment: For
the record I have not “taken the plunge” yet and am NOT “recommending” that you
do, but my gut says that now (or at least soon) is going to be a terrific
buying opportunity for the loathed, hated and utterly bombed out energy sector
(my favorite is HAL unless and until it takes out it recent low of $16.97 a
share).
Summary
*Keep
your head screwed on straight
*Regarding pandemics and stock markets, adopt a “hope for the best, prepare for the worst” mentality
*If
you believe you are overexposed in the market then make a plan for when and
what and how much you should sell. Then
follow your plan and DO NOT look back in regret
*If
you want to put your head in the sand and just hold on forever, fight that urge
(again I refer you to the articles linked above)
*If you have cash to invest – don’t try to be a hero, but don’t be a total wimp either
Um, have a nice day(?)
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 does not represent
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.
Well that got ugly quick. For the record, if you have been in the markets for any length of time you have seen this kind of action plenty of times. An index, or stock, or commodity or whatever, trends and trends and trend steadily and relentlessly higher over a period of time. And just when it seems like its going to last forever – BAM. It gives back all or much of its recent rally gains very quickly. Welcome to the exciting world of investing.
I make no claims of “calling the top” – because I never have actually (correctly) called one and I don’t expect that I ever will. But having written Part I and Part II of articles titled “Please Take a Moment to Locate the Nearest Exit” in the last week, I was probably one of the least surprised people at what transpired in the stock market in the last few sessions.
Of
course the question on everyone’s lips – as always in this type of panic or
near panic situation – is, “where to from here?” And folks if I knew the answer, I swear I
would tell you. But like everyone else,
I can only assess the situation, formulate a plan of action – or inaction, as
the case may be – and act accordingly. But
some random thoughts:
*Long
periods of relative calm followed by extreme drops are more often than not
followed by periods of volatility. So,
look for a sharp rebound for at least a few days followed by another downdraft
and so on and so forth, until either:
a)
The market bottoms out and resumes an uptrend
b)
The major indexes (think Dow, S&P 500, Nasdaq 100, Russell 2000) drop below
their 200-day moving averages. As of the
close on 2/25 both the Dow and the Russell 2000 were below their 200-day moving
average. That would set up another a) or
b) scenario.
If
the major indexes break below their long-term moving averages it will either:
a)
End up being a whipsaw – i.e., the market reverses quickly to the upside
b)
Or will be a sign of more serious trouble
The
main point is that you should be paying close attention in the days and weeks
ahead to the indexes in Figure 1.
One
reason for potential optimism is that the two-month period of March and April
has historically been one of the more favorable two-month periods on an annual
basis. Figure 2 displays the cumulative
price gain achieved by the S&P 500 Index ONLY during March and April every
year since 1945. The long-term trend is unmistakable,
but year-to-year results can of course, vary greatly.
Figure
2 – S&P 500 cumulative price gain March-April ONLY (1945-2019)
For
the record:
S&P 500 March-April
Result
Number of times UP
55 (73%)
Number of times DOWN
20 (27%)
Average UP%
+5.0%
Average DOWN%
(-3.4%)
Figure
3 – Facts and Figures
Will
March and April bail us out? Here’s
hoping.
As an aside, this strategy is having a great week so far.
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 does not represent
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.
To put this piece in context please refer to Part I here.
Part I detailed the Good News (the stock market is still very much in a bullish trend and may very well continue to be for some time) and touched on one piece of Bad News (the market is overvalued on a long-term valuation basis).
The
Next Piece of Bad News: The “Early Lull”
In my book, Seasonal Stock Market Trends, I wrote about something called the Decennial Pattern, that highlights the action of the stock market in a “typical” decade.
The Four Parts of the “Typical Decade” are:
The Early Lull: Market often struggles in first 2.5 years of a decade
The Mid-Decade Rally: Market typically rallies in the middle of a decade – particularly between Oct 1 Year “4” and Mar 31 Year “6”
The 7-8 Decline: Market often experiences a sharp decline somewhere in the Year “7” to Year “8” period
The Late Rally: Market often rallies strongly into the end of the decade.
We
are now in the “Early Lull” period. This
in no way “guarantees” trouble in the stock market in the next two years. But it does offer a strong “suggestion”,
particularly when we focus only on decades since 1900 that started with an
Election Year (which is where we are now) – 1900, 1920, 1940, 1960, 1980, 2000.
As
you can see in Figures 5 and 6, each of these 6 2.5-year decade opening periods
witnessed a market decline – -14% on average and -63% cumulative. Once again, no guarantee that 2020 into mid
2022 will show weakness, but….. the warning sign is there
Figure
5 – Dow price performance first 2.5 years of decades that open with a
Presidential Election Year (1900-present)
Figure
6 – Cumulative Dow price performance first 2.5 years of decades that open with
a Presidential Election Year (1900-present)
Summary
Repeating now: the trend of the stock market is presently “Up”.
Therefore:
*The most prudent thing to do today is to avoid all of the “news generated” worry and angst and enjoy the trend.
*The second most prudent thing to do is to acknowledge that this up trend will NOT last forever, and to prepare – at least mentally – for what you will do when that eventuality transpires, i.e., take a moment to locate the nearest exit.
Stay
tuned for Part III
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 does not represent
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.
Well that sounds like a pretty alarming headline, doesn’t it? But before you actually take a moment to locate the nearest exit please note the important difference between the words “Please locate the nearest exit” and “Oh My God, it’s the top, sell everything!!!”
You see the difference, right? Good. Let’s continue. First, a true confession – I am not all that great at “market timing”, i.e., consistently buying at the bottom and/or selling at the top (I console myself with the knowledge that neither is anyone else). On the other hand, I am reasonably good at identifying trends and at recognizing risk. Fortunately, as it turns out, this can be a pretty useful skill.
So,
while I may not be good at market timing, I can still make certain reasonable
predictions. Like for example, “at some
point this bull market will run out of steam and now is as good a time as any
to start making plans about how one will deal with this inevitable eventuality
– whenever it may come”. (Again, please
notice the crucial difference between that sentence and “Oh My God, it’s the
top, sell everything!!”)
First
the Good News
The
trend in the stock market is bullish.
Duh. Is anyone surprised by that
statement? Again, we are talking
subtleties here. We are not talking
about predictions, forecasts, projected scenarios, implications of current
action for the future, etc. We are just
talking about pure trend-following and looking at the market as it is
today. Figure 1 displays the S&P 500
Index monthly since 1971 and Figure 2 displays four major indexes (Dow, S&P
500, Nasdaq 100, Russell 2000) versus their respective 200-day moving averages.
Figure 2 – Dow, S&P 500, Nasdaq 100, Russell 2000 w respective 200-day moving average (Courtesy AIQ TradingExpert)
It is impossible to look at the current status of “things” displayed in Figures 1 and 2 and state “we are in a bear market”. The trend – at the moment – is “Up”. The truth is that in the long run many investors would benefit from ignoring all of the day to day “predictions, forecasts, projected scenarios, implications of current action for the future, etc.” that emanates from financial news and just sticking to the rudimentary analysis just applied to Figures 1 and 2.
In short, stop worrying and learn to love the trend. Still, no trend lasts forever, which is kind of the point of this article.
So now let’s talk about the “Bad News”. But before we do, I want to point out the following: the time to actually worry and/or do something regarding the Bad News will be when the price action in Figure 2 changes for the worse. Let me spell it out as clearly and as realistically as possible.
If (or should I say when?) the major U.S. stock indexes break below their respective 200-day moving averages (and especially if those moving average start to roll over and trend down):
*It could be a whipsaw that will be followed by another rally (sorry folks, but for the record I did mention that I am not that good at market timing and that I was going to speak as realistically as possible – and a whipsaw is always a realistic possibility when it comes to trend-following)
*It could be the beginning of a significant decline in the stock market (think -30% or possibly even much more)
So, the proper response to reading the impending discussion of the Bad News is not “I should do something”. The proper response is “I need to resolve myself to doing something when the time comes that something truly needs to be done.”
You see the difference, right? Good. Let’s continue.
The
Bad News
The first piece of Bad News is that stocks are overvalued. Now that fact hardly scares anybody anymore – which actually is understandable since the stock market has technically been overvalued for some time now AND has not been officially “undervalued” since the early 1980’s. Also, valuation is NOT a timing tool, only a perspective tool. So high valuation levels a re pretty easy to ignore at this point.
Still, here is some “perspective” to consider:
*Recession
=> Economic equivalent of jumping out the window
*P/E Ratio => What floor you are on at the time you jump
Therefore:
*A
high P/E ratio DOES NOT tell you WHEN a bear market will occur
*A high P/E ratio DOES WARN you that when the next bear market does occur it will be one of the painful kind (i.e., don’t say you were not warned)
Figure 3 displays the Shiller P/E Ratio plus (in red numbers) the magnitude of the bear market that followed important peaks in the Shiller P/E Ratio.
Repeating
now: Figure 3 does not tell us that a bear market is imminent. It does however, strongly suggest that
whenever the next bear market does unfold, it will be, ahem, significant in
nature. To drive this point home, a
brief history:
1929: P/E peak followed by -89% Dow decline in 3 years
1937: P/E peak followed by -49% Dow decline in 7 months(!?)
1965: P/E peak followed by 17 years of sideways price
action with a -40% Dow decline along the way
2000: P/E peak followed by -83% Nasdaq 100 decline in 2
years
2007: P/E peak followed by -54% Dow decline in 17 months
Following
next peak: ??
As you can see, history suggests that the next bear market – whenever it may come – will quite likely be severe. There is actually another associated problem to consider. Drawdowns are one thing – some investors are resolved to never try to time anything and are thus resigned to the fact that they will have to “ride ‘em out” once in awhile. OK fine – strap yourself in and, um, enjoy the ride. But another problem associated with high valuation levels is the potential (likelihood?) for going an exceedingly long period of time without making any money at all. Most investors have pretty much forgotten – or have never experienced – what this is like.
Figure
4 displays three such historical periods – the first associated with the 1929 peak,
the second with the 1965 peak and the third with the 2000 peak.
Figure
4 – Long sideways periods often follow high P/E ratios
*From 1927 to 1949: the stock market went sideways for 22 years. Some random guy in 1947 – “Hey Honey, remember that money we put to work in the stock market back in 1927? Great News! We’re back to breakeven! (I can’t speak for anyone else, but personally I would prefer to avoid having THAT conversation.)
*From 1965 to 1982: the stock market went sideways. While this is technically a 0% return over 17 years (with drawdows of -20%, -30% and -40% interspersed along the way – just to make it less boring), it was actually worse than that. Because of high inflation during this period, purchasing power declined a fairly shocking -75%. So that money you “put to work” in that S&P 500 Index fund in 1965, 17 years later had only 25% as much purchasing power (but hey, this couldn’t possibly happen again, right!?).
*From 2000 to 2012: the stock market went sideways. With the market presently at much higher all-time highs most investors have forgotten all about this. Still, it is interesting to note that from 8/31/2000 through 1/31/2020 (19 years and 5 months), the average annual compounded total return for the Vanguard S&P 500 Index fund (ticker VFINX) was just +5.75%. Not exactly a stellar rate of return for almost 20 years of a “ride ’em out” in an S&P 500 Index fund approach).
The Point: When valuations are high, future long-term returns tend to be subpar – and YES, valuations are currently high.
You have been warned.
Stay tuned for Part II…
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 does not represent
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.
Trading
options can be just about as simple or complex as one would like it to be. Today, let’s go the “simple” route.
Figure
1 displays a daily bar chart of Disney (DIS).
Different viewers will see different things. Some will see a stock that is pulling back
and testing support at the 200-day moving average setting up for the next up
leg of a bullish trend. Others will see
a stock that tried to break out and failed and is now rolling over and above to
break below its 200-day moving average into a bearish trend. I can’t tell you
who will be right and who will be wrong.
But
let’s suppose you fall into the bullish camp.
The most direct play would be to buy 100 shares of DIS and hope the
stock rises in price back towards its previous high of $153.41 a share. As I write the stock is trading at $139.14 a
share, so the trader would need to pony up $13,914. For the average investor this is not a small
commitment. If DIS rallied back to its
previous high the trader would make a little over 10%. Is this a good idea or a bad idea? That’s not for me to say. I will simply offer up a potential
alternative and you can decide for yourself.
A simple alternative would be to buy one April2020 120 calls for $20.00 each (for the record, the bid is $19.80 and the ask is $20.00. Most serious traders would consider placing a limit order to try to buy somewhere near the middle of the bid/ask spread. For our illustrative purposes, we are just going to assume that a “market” order is placed and that the call is bought at $20.00).
Figure 2 displays the particulars and Figure 3 displays the risk curves.
*The
cost to enter – and maximum risk – is $2,000.
*The
trade has until April (59 calendar days, or roughly two months) to work out
*The
breakeven price at expiration is $140.00 (in other words if DIS does not rise,
this trade is certain to lose money
*The
trade has a “delta” of 91.36, which means it will act much like a position of 91
shares of stock
The
Comparison
Now
let’s compare the two trades. Figure 4
displays the expected % return on investment as of April 20 based on the share
price for DIS.
Figure 4 – % Profit or Loss at Option Expiration at various prices for DIS
Figure 5 overlays the risk curves for holding 100 shares of DIS stock (cost = $13,914 with a delta of 100) versus holding 2 June 140 calls (cost = $1,340 with a delta of 91)
Figure 5 – Risk curves
for April2020 120 call option versus buying 100 shares of DIS stock (Courtesy www.OptionsAnalysis.com)
Things
to note:
*Because
the option has a high delta, the $ profit/loss for the option trade will track
very closely with the stock trade, even though it costs only 14.4% as much
($2,000 versus $13,941) to enter
*Below
the strike price of 120, losses are limited for the option trade to the premium
paid ($2,000). Losses would continue to
grow for the trader holding shares of stock (see grey line in Figure 5).
*This
is essentially a “stock replacement” trade – in other words, we use the option
as a proxy for buying the stock and commit roughly 86% less capital
Summary
As always, this trade is not a “recommendation”, and I am offering no opinion as to whether DIS will rise or fall in the months ahead. The point of this example is to point out the potential to achieve virtually the same reward/risk profile while committing a great deal less capital by buying an option rather than 100 shares of stock.
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 does not represent
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.
I have written in the past about how long-term treasury bonds perform better during certain days of the month than others. The strategy discussed herein is an extremely “aggressive” (remembering that one man’s “aggressive” is another man’s “way too risky”) approach to playing this pattern.
The
Good Days
The
“Good Days” for bonds are:
*Trading
Days of the Month #’s 10, 11 and 12
*The
last 5 trading days of the month
Figure
1 displays the hypothetical growth of equity from holding long 1 t-bond futures
contract ($1,000 per point) on “Good Days” versus “All Other Days”
Figure
1 – Long 1 t-bond futures contract on “Good Days” (blue) versus “All Other Days”
(red); 1984-2020
The
long-term results pretty much speak for themselves. So now, let’s get “aggressive.”
Ticker
TMF is intended to return 3 times the daily return for the long-term treasury
bond. So, if the long bond goes up 1%
today then TMF should go up roughly 3%.
And vice versa. To put it another
way – “You’d better be right” about your timing or losses are going to accrue
very quickly.
So,
what happens if we trade our TDM Strategy using ticker TMF (i.e., holding TMF
for the 8 trading days of month listed above every month)? As a benchmark we will also track buying and
holding ticker TLT, an ETF which tracks the long-term treasury bond but with no
leverage. Figure 2 displays the hypothetical
growth of $1,000 invested in both the TDM Strategy (blue) and the TLT
buy-and-hold strategy (red line) since April 2009 when TMF started trading.
NOTE:
The results represent price action only and DO NOT include any dividends.
Figure
2 – Growth of $1,000 in TDM Strategy versus TLT Buy/Hold; 2009-2020
For
the record:
*The
TDM Strategy grew to $24,758 and the TLT Buy/Hold Strategy grew to $1,406.
*The
average 12-mo % return for the TDM Strategy is +35.9% versus +3.4% for TLT
Buy/Hold (remember that TLT results here are price only and DO NOT include
dividends which would boost results)
Sounds
pretty great, right? So, what’s the
catch? Two things: 1) extreme risk/volatility
and, 2) the thing may be due for a drawdown.
*Note
that the average 12-month standard deviation for the TDM Strategy is 27.8%
versus 11.4% for buying-and-holding ticker TLT.
Lot’s of people look at the overall return for a given strategy and
simply ignore the day-to-day volatility.
In the case of the TDM Strategy it is also easy to forget that you have
to make four trades every month without fail (no matter how the strategy has
been performing of late) in order to garner any long-term benefit.
IMPORTANT
NOTE: Lots of people think they can handle
constant volatility and continuing to trade on a regular basis even when things
are going poorly (which they absolutely, positively will from time to
time). The TDM Strategy definitely fits
in this category.
Regarding
Drawdowns
Figure
3 displays the drawdowns for the TDM Strategy.
The key thing to note is that drawdowns of -15% are a regular occurrence. You have been warned.
Figure
3 – TDM Strategy % Drawdowns
On
the other hand, Figure 4 displays the drawdowns for both the TDM Strategy and
TLT Buy/Hold. While the TDM Strategy (because of 3x leverage) always hold the
potential for larger drawdowns, the overall performance is not really much
different than the drawdowns for the TLT Buy/Hold approach.
Figure
4 – % Drawdowns for both TDM Strategy (blue) and TLT Buy/Hold (red)
Due for a Pause?
Figure
5 displays the 12-month % return for the TDM Strategy. As you can see, results in the past year or
so have been terrific. Unfortunately, you
can also see that these types of returns don’t last forever. So, it is important to avoid the “Wow, I am
going to make a lot of money quickly” mindset on the way in.
Figure
5 – TDM Strategy 12-month % +(-)
Summary
Would a trader have made money in the past using the TDM Strategy with ticker TMF? According to hypothetical results, the answer is “presumably so”. Will a trader make money doing so going forward? That is an entirely different question. Beyond the standard “past performance does not guarantee future results” disclaimers, simply note that while “big returns” can put stars in people’s eyes, the ongoing act of engaging in “the nitty gritty of trading” (in this hypothetical case, making two buys and two sells each and every month NO MATTER WHAT and with no exceptions) can be a far different experience.
Again,
you have been warned.
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 does not represent
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.
In this article I wrote about an extreme case in volatility. This piece discusses another “interesting opportunity” available only to option traders.
Ticker
NVAX is the symbol for a company called Novovax. I know absolutely nothing about the
company. But I know opportunity when I
see it. Fortunately, I also recognize
risk when I see it. What follows is NOT
a “recommended” trade, just an example of a unique opportunity available to
traders who know where to look.
The
Trade
The
strategy is referred to as a Modidor, which essentially stands for “modified
condor”. The trade involves selling an
out-of-the-money call and an out-of-the money put and also buying a further
out-of-the-money call and a further out-of-the-money put. The trick is that the difference between the
strike prices of the two calls and the puts are different AND the distance between
the stock price and the short options is different. Rather than attempting to explain let’s just
go to the example.
The
trade involves:
*Buying
1 NVAX Mar20 15 call @ $0.45
*Selling
1 NVAX Mar20 14 call @ $0.52
*Selling
1 NVAX Mar20 7 put @ $1.52
*Buying
1 NVAX Mar20 2 put @ $0.05
Figure
1 displays the particulars and Figure 2 displays the risk curves.
With
NVAX trading at $7.89 a share, things to note:
*The
cost to enter the trade (and the maximum risk) is $346
*The
maximum loss of -$346 would only occur if NVAX is at $2 a share or below on
March 20
*The
breakeven price for the trade is $5.46 a share (in other words, as long as the
stock does ANYTHING better than falling -31% in the next 36 days the trade shows
a profit. That being said, this is
extremely volatile stock and such a decline would not be unusual, i.e., this is
a speculative trade, period, full stop).
*The
maximum profit is $154 (44.5% of capital risked) and would accrue if NVAX is
between $7 and $14 a share on March 20
*If
NVAX rises above $15 a share the maximum profit is roughly $54 (16% of capital
risked).
Summary
Is
this a “good trade”? That’s not for me
to say. On paper it looks pretty good,
but this is wildly volatile stock AND these are very thinly traded options.
Getting
filled at favorable prices on the way in would require the use of limit orders. And getting filled at favorable prices if one
decides to exit prior to expiration could also be challenging.
But
like the title says, “opportunity is where you find it.”
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 does not represent
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.
In
the long run the stock market goes up. Of
course, there are some harrowing declines – not to mention long periods of time
when no forward progress is made – along the way. At the same time gold holds a certain allure
for many investors as a “store of value” during times of crisis. Nevertheless, it too can be a performance “dog”
for surprisingly long period of time.
And
“yes”, there is some – forgive me for using some highly complex and technical terms
here – ying and yang to their relative performance. In other words, sometimes SPX significantly
outperforms and other times gold outperforms.
What follows is NOT intended to be a trading “system”, but rather just a
simple tool that can allow the average investor to get a handle on where the
ongoing SPX/Gold battle stands.
The
Indicator
We
are going to use a very simple tool to track the SPX/Gold trend, by applying a
60-month exponential moving average:
a)
At the end of each month divide the price of the S&P 500 Index (SPX) by the
price of gold bullion
b)
Multiply last month’s moving average by 0.9672
c)
Multiply this month’s ratio (value “a” above) by 0.0328
d)
Add b and c together to get this month’s updated moving average
e) (a – d)
If
“e” is positive it means stocks are outperforming and if “e” is negative it
means gold is outperforming.
Again,
I do not necessarily recommend using this systematically for trading purposes,
however, it can be very helpful in terms of helping to filter out a lot of the “noise”
that surrounds the markets. If value “e”
is trending higher there is typically not much reason to pay attention to all
the voices of gloom and doom shouting that you should “pile into gold” before
its too late. And likewise, if value “e”
goes negative it may strongly suggest that now is a good time to cut back on
stock market exposure and/or to allocate to other types of assets.
The
Present
As
of the end of January 2020 – according to the data I use:
a)
3225.52 (SPX) / 1,573.80 (Gold) = 2.0495
b)
Last month’s moving average (1.9367) x .9672 = 1.8732
c)
This month’s ratio (2.0495) times 0.0328 = 0.0672
d) 1.873 + 0.0672 (b + c) = 1.9449
e) 2.0495 – 1.9449 (a – d) = 0.1046
OK, that was fun. Anyway, in a nutshell, value “e” is positive so this indicator favors stocks.
Does
this matter?
The
History
Figure
1 displays the SPX/Gold ratio going back to 1978 along with the 60-month exponential
moving average
Figure
1 – SPX/Gold Ratio with 60-month EMA (1978-present)
Figure
2 displays the history of value “e”. As
you can see while there are inevitable whipsaws, the value will tend to stay
above 0 for long periods of time and then hold below 0 for a period of time.
Figure
2 – SPX/Gold Ratio minus its 60-month EMA
When
the SPX/Gold Indicator > 0 versus When the SPX/Gold Indicator < 0
Figure
3 displays the total return for SPX and the total return for Gold ONLY during
those months when value “e” was greater than 0 at the end of the previous
months.
Figure
3 – Total Cumulative % return for SPX and Gold when Indicator > 0
Figure
4 displays the total return for SPX and the total return for Gold ONLY during
those months when value “e” was less than or equal than 0 at the end of the
previous months.
Figure
4 – Total Cumulative % return for SPX and Gold when Indicator <= 0
Figure 5 contains the values displayed in Figures 3 and 4.
Figure 5 – SPX and Gold performance based on whether SPX/Gold Ratio minus 60-month EMA is > 0 or <= 0 (1978-2020)
As
I said, I wouldn’t shift my entire portfolio from stocks to gold automatically –
and vice versa – every time this indicator flips from positive to negative and
vice versa. But the historical reality
is that:
Stocks
have vastly outperformed gold when the SPX/Gold Ratio is above its 60-month EMA
Gold
has significantly outperformed stocks when the SPX/Gold Ratio is below it’s
60-month EMA
With
the indicator still firmly ensconced in positive territory, it still favors
stocks over gold. But the day will come
when this will change. Tracking this
indicator gives investors a way to know when that day has arrived.
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 does not represent
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.
The energy sector is getting a lot of attention these days. And not much of it in a good way. I do think that there is a chance that that will soon change. That being said, that statement is not a “call to action”, but rather it is simply me informing you of an opinion that even I have not acted on yet.
The
Case for Energies
First off, I recommend that you see this article written my Thomas Hayes of www.HedgeFundTips.com, which offers some excellent points regarding why a bullish stance on energies is warranted. Two other pieces of the puzzle are sentiment and seasonality.
Figure 1 displays the recent sentiment reading for ticker XOP from one of my favorite websites, www.sentimentrader.com.
Figure
1 – Sentiment for ticker XOP (SPDR S&P Oil & Gas Exploration &
Production ETF) (Courtesy Sentimentrader.com)
Figure 2 – also from Sentimentrader.com – displays the typical annual seasonal pattern for ticker XOP, which clearly shows that March and April have historically – though importantly, not always – been the best months for energy stocks.
*Strong earnings in the energy sector (per the linked article)
*A recent extreme in bearish sentiment (Figure 1), typically a bullish contrarian sign
*A pending favorable seasonal period (Figure 2)
That’s
about as favorable of a trifecta as you will find as it relates to an individual
market sector. That’s the Good
News. The Bad News is that this in no
way guarantees that energy stocks are going to rally anytime soon. With the overall “investment world” focused
on large cap stocks and tech stocks and so on, “buying the Dogs” is not a high
priority for most investors.
But
consider the following. Figure 3
displays the cumulative total return achieved by holding Fidelity Select Energy
Services (which has a roughly 90% correlation to ticker XOP and started trading
in 1986) ONLY during the months of March and April every year since 1986.
Figure
3 – Growth of $1,000 invested in ticker FSESX ONLY during March and April since
1986
A
few things to note:
*#
of years showing a Mar-Apr gain = 24 (71% of the time)
*#
of years showing a Mar-Apr gain = 10 (29% of the time)
*Average
UP Mar-Apr gain = +13.9%
*Average
DOWN Mar-Apr loss = (-4.7%)
By
no means a “sure thing”, but if you had to bet, you would likely bet “bullish”
Will Mar-Apr 2020 witness a gain in the energy sector? And more importantly, is its worth risking money on? That’s up to each investor to decide for themselves.
One more “food for thought” item for those so inclined. Ticker ERX is the Direxion: EnergyBull 3X ETF. For the record I am not a huge fan of 3X leveraged funds (really, really bad things can happen if your timing is off), but for what it’s worth Figure 4 displays the growth of $1,000 invested in ticker ERX only during March and April every year since ERX started trading (Dec 2008).
Figure
4 – Growth of $1,000 invested in ticker ERX ONLY during March and April since
2009
A
few things to note:
*#
of years showing a Mar-Apr gain = 9 (82% of the time)
*#
of years showing a Mar-Apr gain = 2 (18% of the time)
*Average
UP Mar-Apr gain = +21.5%
*Average
DOWN Mar-Apr loss = (-14.1%)
The cumulative growth from holding ERX for 22 months (2 months times 11 years) was +285.3%. But make no mistake, this is a highly volatile and risky approach. Note that 2012 and 2017 saw ERX lose -14.1% and -14.2% respectively, during March and April – so not for the faint of heart.
Figure
5 displays the year-by-year Mar-Apr total return for FSESX.
Figure 6 displays the year-by-year Mar-Apr total return for ERX.
Year
FSESX
Mar-Apr
1986
(2.1)
1987
9.5
1988
8.0
1989
11.4
1990
(0.7)
1991
(7.3)
1992
0.5
1993
13.7
1994
(2.7)
1995
11.9
1996
16.0
1997
5.7
1998
16.4
1999
63.7
2000
15.7
2001
6.1
2002
17.4
2003
(3.0)
2004
(2.8)
2005
(8.5)
2006
15.7
2007
16.8
2008
13.4
2009
28.0
2010
8.1
2011
1.7
2012
(6.2)
2013
0.6
2014
6.2
2015
10.6
2016
24.6
2017
(10.2)
2018
12.7
2019
(3.4)
Figure
5 – FSESX year-by-year March-April total return
Year
ERX
Mar-Apr
2009
20.4
2010
22.8
2011
6.6
2012
(14.1)
2013
1.1
2014
23.2
2015
14.7
2016
66.4
2017
(14.2)
2018
33.8
2019
4.2
Figure
6 – ERX year-by-year March-April total return
Summary
I personally have not pulled the trigger and committed money specifically to the energy sector based on an expectation that it will soon turn around. As an “Old Dog” I guess I am looking for some sort of catalyst or at least some signs of life first. Shoot, I guess I won’t be buying the bottom (hey, why break precedent now?).
But I will be watching especially closely as the month of March draws closer.
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 does not represent
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.
