Random Thoughts and Observations

We are fortunate in life to have been so drawn to the study of the capital markets at an early age which provides an endless opportunity for reward, challenge, commentary, and amusements. This week seemed to be an exceptional example which we’ll share and hope you also find interesting, maybe even entertaining.

• After being included for 92 years (the longest of any company), someone decided to remove Exxon Mobil from the Dow Jones Industrial Average. One journalist wrote that this was caused by the 5 for 1 split in Apple stock effective on Monday and to rotate in Salesforce.com. Where is the “Industrial” component of the Salesforce.com, Nike, United Health, and Walgreen’s business models? And we’re not sure we understand how a stock split by one company justifies the jettison of another?

• The Federal Reserve Bank, after amassing an enormous and ever-growing mound of debt, felt it was a good idea now to target an inflation rate greater than the longer-standing threshold of 2.0%. There are some advantages to this strategy: it shrinks the relative size of existing debt, increases the paper value of hard assets, facilitates price equilibrium and wage adjustments, etc. In this case too, it’s likely that interest rates will remain quite low and the Fed money printing will continue – both favorable for the equity and commodity markets for the long-term.

• I had a 30-something year old colleague share the news that he made 133% in one day with an option contract after positive news was released about a company. Wow – impressive for sure and I hope his string of luck continues. No doubt the epic bull market since March has created quite a few genius-caliber experts in the markets (for now). I reminded him again that it’s hard enough to predict the direction of the market, let alone the direction and the timing necessary to be long-term successful as an options trader.

• Listening to a podcast from Switzerland on systematic investing, the guest speaker suggested that the stock market has progressed from a bubble to a mania. After researching the distinction between the two terms, we found this except from a 2009 book by Peter Kendall called The Mania Chronicles:

1. There is no upside resistance, and rising prices seem to be perpetual.
2. Everyone in the market looks like an expert.
3. There is a flight from quality investments to riskier investments.
4. As financial bubbles pop in one area, they bubble up in others.
5. The crash after the peak takes back all the gains the mania made.

Maybe one example is shares of Tesla will also have a 5 to 1 split on Monday gaining 61% since August 11 news and quintupling in price so far this year. If that is not manic enough, the ratio of put options bought to call options also hit a record low a few days ago, so the majority of option traders seem to comply with 1, 2, and 3 above.

Forte Strategy Update

We executed 8 trades last week for a net gain of 0.2% compared to a gain of 3.3% by the S&P 500. Our YTD net results so far equal a 2.4% gain compared to an 8.6% YTD gain for the S&P 500. Our YTD max drawdown is 9.5% versus 33.9% for the S&P 500. We added two new models (UPRO 3X S&P500 Index ETF and VIXY VIX Futures tracking ETF) into the mix to better accommodate the software automation and to diversify across time. These models actuate based on daily price updates whereas the TQQQ and UVXY are updated at 15 minute intervals.

More details about our trading activity can be found by registering on the Collective2 website and searching for Forte Strategy. A running list of these email blogs and general information about Maestro Capital Research can be found at maestrocapitalresearch.com.

Masters of the Universe

Should governments have a central banking authority or not? It’s an economic question for the ages. Here in the US, it’s been nearly 107 years since the Federal Reserve was born, an entity which was created in part to limit the frequency and severity of financial crises. Throughout the 20th century and over the last two decades, “The Fed” has been credited for saving our economy and further bolstering our global economic superpower status. The Federal Reserve has also been blamed for fostering monopolies (e.g. banking, technology), destroying the middle class through socialist-tinged bailouts for the wealthy and even providing the air that inflates financial bubbles…then ironically called upon to heroically clean up the mess after the bubble bursts.

History may look back at 2020 as simply another year when the Fed came to the rescue. Most will agree that the seismic impact that the pandemic continues to have on the economy warranted Fed action. The approach, scale and magnitude of intervention is, however, debatable. The incessant and ever-increasing degrees of intervention that have occurred over the last few recessions may have dire consequences. As an example, take a look at the following graph:

20200822_chart1_sp500_gdp_ratio

During the mid/late 90’s, equity valuations ran far ahead of the pace of economic growth. Fast forward to today and we’ve surpassed that 2000 peak. Back then, it was “irrational exuberance”, financial industry deregulation, and other factors. Now it’s largely Fed intervention.

During the last few recessions, the Fed has chosen to directly and indirectly assist corporations which, lacking confidence, opportunities and creative energy to reinvest, simply buy back shares (despite the Fed’s efforts to throttle this impulse). Unless more focus is made on boosting the GDP part of the equation, the Fed is merely inflating another bubble.

The federal deficit has also been creeping upwards, but the increase in the rate of change and the correlation between equities and the deficit are accelerating at an alarming (and far too coincidental) rate:

20200822_chart2_sp500_deficit

To a large degree, the Fed now holds the power to further goose (or tank) the stock market, the performance of which is directly correlated to the success (or failure) of a president. Sadly, the Fed appears to have backed themselves into a corner and are unable to tighten monetary policy without wrecking the economy.

What’s an investor to do? It’s long equities until the trend inevitably reverses. Additionally, the rallying cry for gold is growing louder. In his book “The Great Devaluation”, author Adam Baratta provides an exceptionally strong case for going long the precious metal. Even Warren Buffett, who for years said that gold “has no utility”, recently purchased 21 million shares of miner Barrick Gold Corporation.

The bottom line: as long as the Federal Reserve continues with aggressive and consistent interventions, expect irrational valuations and the deferral of “creative destruction”. What is creative destruction you might ask? Stay tuned…we’ll explain in a future blog!

Forte Strategy Update

We executed 10 trades last week using the Nasdaq 3X leveraged ETF (TQQQ) and the volatility index ETF (UVXY) for a net gain of 1.7% compared to a gain of 0.7% by the S&P 500. Our YTD net results so far equal a 1.7% gain compared to a 5.1% YTD gain for the S&P 500. Our YTD max drawdown is 9.5% compared to 33.9% for the S&P 500. We implemented a new optimized dimension to our math models that allows new trades to only be entered during certain time slots during the day. Extensive retrospective math modeling proved the adage “amateurs trade in the morning and professionals trade in the afternoon”. This new code will reduce the number of trades, reduce exposure to market risk and should directionally improve results.

More details about our trading activity can be found by registering on the Collective2 website and searching for Forte Strategy. A running list of these email blogs and general information about Maestro Capital Research can be found at maestrocapitalresearch.com.

120 Days after the Massive Peak in Volatility

It’s been over 120 days now since the market volatility peaked so we wanted to update the analysis and add in new thoughts and observations. Recall that we focused on market sell-off events that had a volatility spike 7X greater than the total average volatility of the Dow Jones 30 for a period from 1985 to the present pandemic. We also used a simple definition of volatility as the 10-day moving average of the standard deviation of open-high-low-close prices divided by today’s closing price.

The graph below has been updated to show the data for the last few weeks. The green line shows the volatility indicator for the COVID19 sell-off when the numbers were elevated 10% above the historical average (this is an arbitrary cut-off we used to mark the beginning and end of the lines and definition of the volatility event). The volatility returned to normal levels on July 27 which is exactly 100 trading days after the peak on March 18, so we’ll end the graph there.

20200815_chart1

As you can see, the lines look quite similar in shape and timing with the volatility returning to normal levels around 100 days after the peak (with the exception being the second wave of the 2008 financial crisis).

20200815_chart2

As we covered in our July 4 email blog, the significant difference with this recovery is that the market is 20% or more higher than the prior two events (even though many economic indicators are significantly more negative). This reality is likely related to a wide array of actions taken by central bankers around the world pumping trillions into the economy through various (creative) mechanisms and delivery systems. This time may actually be different. The central banker tactics developed and employed during the 2008 financial crises may become the new normal. Here’s at least one data point suggesting the answer is maybe, and it may actually work (in the short-term).

20200815_chart3

As we committed to in a prior email blog, we’ll work on developing some type of mechanical trading system to take advantage of the next spike in volatility. The year-to-date Forte results show that we were successful in avoiding the big sell-off, but how can we now capture the rapid recovery typically shown in the above table when future opportunities occur? We sometimes use a simple graph as a starting point for a math model. The graph below zooms in on the peak events.

A simple model that may work would be to buy the Dow Jones 30 tracking ETF (DIA) when the market volatility is no more than 10% above the long range average and sell it when volatility exceeds 10% of the average. Then, if a large spike 4-7X higher than average occurs, buy back when the slope of the 10-day moving average is down and some type of inflection point in the line occurs. It’s simply one approach that we’ll consider having a model in place for ahead of the next sell-off.

After returning to normal levels of volatility on July 27 and staying there for 8 trading days, the market returned to higher levels of volatility and has remained there since August 6.

20200815_chart4

Forte Strategy Update

We executed 11 trades last week using the Nasdaq 3X leveraged ETF (TQQQ) for a net loss of 2.1% compared to a gain of 0.6% in the S&P 500. Our YTD net results so far are a 0.2% gain compared to a 4.4% YTD gain for the S&P 500. Our YTD max drawdown is 9.5% compared to 33.9% for the S&P 500.

More details about our trading activity can be found by registering on the Collective2 website and searching for Forte Strategy. A running list of these email blogs and general information about Maestro Capital Research can be found at maestrocapitalresearch.com.

Fundamentally Wrong Again

I was reminded again this week why I have spent so many hours developing computer math models to objectively execute trading plans with a goal of earning superior investment results over the long-run when BP (formerly British Petroleum) announced a 50% cut to its dividend. This move may not have been surprising to some, but this is a company I watched closely and had done a fair amount of corporate business with in prior roles. My experience in the oil & gas industry includes working in an oil refinery as a chemical engineer, forming diesel price hedging contracts, and sourcing a wide array of refinery and petrochemical products in prior corporate strategic sourcing positions. I had stated consistently in recent years that I thought the BP dividend was “safe” due to their close linkage to the British government and the reliance of British pensioners on the dividend payment. The theory is that the BP dividend was politically “too big to cut” and would somehow be propped up by profuse central bank money printing of the pound. I really had no firm basis for this opinion, but it sounded reasonable at the time and seemed to resonate with several that listened. This idea was proven wrong this week.

Secondly, conventional wisdom and standard college-level finance courses would say that when a company cuts its dividend, then the share price should go down given the expected future cash-flows are less – in this case, 50% less. Wrong again – after the announcement, the stock surged 7.5% the next day.

We can refer to Alan Greenspan’s “Irrational Exuberance” comments in December 1996 as another example of errant fundamental analysis. Back then, he was implying that the market was significantly overvalued by his indicators and the council of advisors. During the three years that followed, it became even more delusional by gaining 31% in 1997, 26% in 1998, and almost 20% in 1999 before the dot-com bubble burst in 2000. Even with the intellect and resources of Alan Greenspan, making investment decisions based on fundamental premises is a challenge.

We instead simply use price movements inputted into a math model framework as the basis for our trading decisions. One of the key goals is to eliminate the need to form an opinion and ignore influences from the media, financial reports and forecasts. We try to approach the markets with a “blank page” and simply focus on executing the trading models as precise as possible based on the math. In parallel, the R&D efforts continue to refine the math models and look for more consistent patterns and portfolio effects to minimize the drawdowns and variation in the returns. There is a certain calm confidence in this approach that provides an emotional center of stability that is important for successful traders.

Forte Strategy Update

We executed 10 trades this week using both the NASDAQ 3X leveraged ETF (TQQQ) and the 1.5X leveraged VIX index ETF (UVXY) for a net loss of 0.4% compared to a gain of 2.4% by the S&P 500. Our YTD net results are a 2.4% gain compared to a 3.7% YTD gain for the S&P 500. Our YTD max drawdown is 9.5% vs 33.9% for the market and the correlation between the two data sets is 0.154 – so essentially no correlation.

We successfully moved the Forte Strategy to the more robust TradeStation platform and fully enabled the auto-trading functionality needed to consistently execute the 15-min trading models.

Forte Futures Strategy Update

After three months of executing trades for our Forte Futures Strategy and achieving very respectable returns, we made the decision to close the strategy. Given that the Forte Futures strategy was mostly based on 2-minute charts and required fast execution scalping techniques, it was determined that the latency between TradeStation, Collective2 and subscriber Interactive Broker accounts was too significant given the ultra-short timeframes (versus 15-minute to daily charts used with the Forte Strategy). We will continue to research ways to integrate futures swing trading strategies into our flagship Forte Strategy. At some point down the road, we may also offer seminars or classes on how to successfully trade futures utilizing scalping techniques to achieve superior returns. Stay tuned!

Trading Like It’s 1999

“Idle hands are the devil’s workshop.” Chaucer’s haunting words echoing from the 14th-century may aptly describe the current reasoning behind the unprecedented number of remote, under and unemployed workers who have opened trading accounts over the last several months. Major online brokers including Charles Schwab, TD Ameritrade, E-Trade (which is soon to be acquired by Morgan Stanley) and relative newcomer and millennial favorite, Robinhood, have all recently reported record new account openings and a surge in the total number of stock positions.

20200731_blog_image_1

20200731_blog_image_2

Take boredom, mix it with commission-free trading, fractional shares (which means one can trade any dollar amount regardless of the high per share price), a narrow big-name tech rally and conviction that the stock market is a guaranteed road to riches and you have a recipe for irrational exuberance that closely resembles the late 1990’s dot com run-up. Those of us over the age of forty remember when every investor was a genius and the stock market could only go in one direction: up…and forever, right? Some may remember the TV commercials with hairdressers getting Blackberry trade alerts and bragging about their trading profits while cutting a client’s hair. Most were convinced that it was “the new economy”, far different from what their parents invested in. Sadly only a few seasoned experts, those keenly aware of the inevitable, planned for something catastrophic.

Fast forward to today and a similar blind exuberance is fueling the equity markets. This time, however, it’s an unwavering conviction that the Federal Reserve and governments all over the world will from now until eternity funnel endless amounts of stimulus into the economy, moral hazard be damned. So currently the market is like having a license to print money in which any inexperienced participant can generate a return. However, as with the now infamous tech bubble, the housing market collapse and the many other boom and bust scenarios that have played out throughout the years (and even centuries), euphoric investors seldom anticipate an end to the bullish long-only game. Bubble-bursting catalysts can come in the most unimaginable forms. And what looms on the horizon will likely result in severe pain for the average retail investor.

Rather than continue to party…err, trade…like it’s 1999 with reckless abandon, we choose to trade methodically and objectively while positioning ourselves to profit when the music does finally stop. And history tells us that it will.

Forte Strategy Update

We executed five trades this week using both the Nasdaq 3X leveraged ETF (TQQQ) and the 1.5X leveraged VIX index ETF (UVXY) for a net gain of 3.3% compared to a gain of 1.7% by the S&P 500. Our YTD net results are a 2.7% gain compared to a 0.5% YTD loss for the S&P 500. Our YTD max drawdown is 9.5% vs 33.9% for the market and the correlation between the two data sets is 0.154 – so essentially no correlation. For the month of July, the Forte Strategy generated a gain of 5.4% compared to a gain of 3.7% for the S&P 500.

We made a lot of progress this week moving the Forte Strategy to the more robust TradeStation platform currently being employed by the Forte Futures Strategy. This was a key step in enabling the auto-trading functionality needed to consistently execute the 15-min trading models (These were not used this week due to business travel, but will be auto-traded and/or professionally executed soon. The respective math models continue to show that adding these short-cycle models into the arsenal will improve returns and reduce the magnitude of drawdowns.)

Forte Futures Update

Our Forte Futures strategy ended the month of July with a 4.1% gain and a cumulative 5.7% return and 4.6% drawdown since May 2020 inception. We continue to be optimistic that we can sustain and even further improve these returns. Stay tuned!