The TGIF Effect

A few years ago, standard five-day workweek traditionalists were aghast when Forbes magazine published an article titled “Why Every Weekend Should Be A Three Day Weekend“. Based on data that we’ve been tracking for the last several years, Wall Street bulls appear to agree. Take a look at the following data which we updated from a 2014 presentation made to a Chicago-based hedge fund and covered in a recent blog. The table shows the simple sum of the gains for the S&P 500 on each day of the week:

Come Thursday afternoon, clearly Wall Street traders have their minds set (and Model Xs loaded up) for their weekend at the Hamptons. Maybe they’re thinking “I’m up so much already this week, let’s take the profits and head to the beach” or “the week is already down so much, I don’t want to lose anymore”. It’s also possible they simply don’t want to hold the risk over the weekend in fear of some market-crashing headline.

We were able to code this dynamic into our Adagio strategy last weekend and implement it on Thursday, liquidating our QQQ position just before the market close and avoiding the 2% decline in the Nasdaq on Friday. Our computer work showed that it was best to buy back on Friday close, so we did. The impact over the 10-year study was to improve the overall returns by 3%, reduce the drawdown by 50%, and reduce the exposure by 14%.

The table below summarizes our YTD results for 2021:

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

Limited Predictive Value

We noticed the VIX ETFs closed Friday at essentially the same levels as they were back in early December.  These are linked to time-decay of the underlying futures contract and, therefore, inherently decline over-time.  We had a theory that maybe the fact that they had not gone down even though the market has increased during this same time period may have some predictive value (maybe the divergent tension in the market will lead to a sell-off?).

We studied this pattern over prior timeframes going back five years – and reached the conclusion (so far) that there does not appear to be any useful correlation or predictive value.  So, we come back to our blog message from September 27, 2020 (excerpt below):

“We heard a podcast this week hosted by author Michael Covel that reminded us of some of the oldest and wisest perspectives provided by the then CEO of Exxon, Lee Raymond, when he was on CNBC in 1998 discussing the pending merger between Exxon and Mobil.  The commentator asked him what direction he thought oil prices were headed in the near-term.  He replied (paraphrased from memory) ‘We gave up trying to predict the direction of oil price moves a long time ago.  Instead, we have detailed strategies that if the price moves up to some extent, we execute Plan A, and if it goes down to some similar extent, we execute Plan B.’”

Regardless of new theories and (lack of) R&D findings, the recent market volatility reactively triggered the signals for both the VIXY and UVXY trades for the next market open so we will start next week with these hedging positions active (after the opening gap).

Strategy Updates

We will continue to evolve the weekly performance reporting of our blog as the data is available. For this week, we’ve created a table showing the YTD gains, max drawdowns and model correlation to the S&P 500.

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

Making Sense of the Nonsensical

Barry Gibb of the Bee Gees once said “all bubbles have a way of bursting or being deflated in the end”.  I suppose he would know.  With the Winklevoss twins crushing it with their beloved gravity-defying Bitcoin (BTC futures contract is up a whopping 673% since March 2020 lows) and the Nasdaq-100 index cresting an all-time high of 13,000 on Friday (NQ has doubled during that same period), what gives?  Add a Capitol Hill invasion, continued COVID uncertainty and mere days away from a new U.S. President at the helm and some would believe that we’re witnessing yet another cluster of financial bubbles irrationally and exuberantly inflating.  Is anyone concerned?  We certainly are not; we make every effort to avoid forming opinions about market direction, timing, etc.   Our trading models are designed to not only weather selloffs, but also profit by simply reacting to the data in either direction.

On January 1, we launched two additional strategies in Collective 2: Adagio and, as discussed in recent blogs, Maestro which combines three strategies (Forte, Adagio and buy-and-hold) and uses a proven periodic rebalancing approach.  We’re very excited about these new models which are pillars in our ever-growing portfolio of unique, math-driven investment strategies.

 Strategy Updates

We will continue to evolve the weekly performance reporting of our blog in the near future.  For now, here are the results for the first week of the year:

Maestro:         0.3% Loss

Adagio:           3.5% Gain

Forte:              1.4% Loss

S&P 500:         1.8% Gain

The VIXY and UVXY hedging trades were active over the past two weeks, doing a good job of positioning the account for an eventual sell-off and reading the reality of the real-world volatility – even though the bubble continued to inflate regardless of pandemics, social unrest, potential increases in taxation, over-valuations, etc.

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.

Launch of the Comprehensive Maestro Strategy

As mentioned in our recent blog posts, it’s time to launch our new Maestro Strategy that brings together the three key elements we wrote about last week:  a classic buy-n-hold approach, the slow-trading Adagio Strategy (as illustrated in the image below), and our existing Forte Strategy which has proven useful for hedging purposes and to intensify returns during periods of low volatility.

Adagio Strategy Sells on Increase Volatility and Buys Back as Volatility Starts to Decline

Our portfolio analysis has shown that an allocation of 40% to the buy-n-hold approach, 30% to the Adagio Strategy, and 30% to the Forte Strategy provides the optimal trade-off between gains, while keeping drawdowns to less than 15%.  For now, we’ll use the simple SPY S&P 500 tracking ETF for the buy-n-hold allocation and the QQQ Nasdaq-100 tracking ETF for the Adagio strategy.  The Forte Strategy will continue as is with the TQQQ 3X Nasdaq-100 tracking ETF and the VIX// UVXY volatility hedging ETFs.

The graph below shows the comparison between the S&P 500 and the new (theoretical) Maestro Strategy from January 1, 2018 through the end of 2020.

The following table and graphs compare the Maestro Strategy base case study period from January 2018 through August 2020 to the S&P 500 and the Maestro Strategy actual performance for an out-of-sample time period modeled since the end of the optimization studies in September 2020.

We’ll update and continue to evolve this reporting format on a weekly basis in 2021 to compare actual performance of the Maestro Strategy to both the original base case and the S&P 500.  We’ll also continue to report on the three separate strategies (Forte, Adagio, and Maestro) for comparison and track the results available on the Collective2 website for each of the strategies.

Forte Strategy Update

The Forte Strategy ended the year up 3.7% versus 16.3% for the S&P 500 while our drawdown was contained at 9.5% compared to 33.9% for the S&P 500.  The correlation to the general market remained low at 0.137.  We outlined several limitations with the Forte Strategy in our blog from last week and have set up two new C2 strategies (Adagio and Maestro) so subscribers can also have direct access to these strategies for linked accounts.  Admittingly, 2020 was a disappointing year.  We’ve learned from the last several months, gaining further insights, performing a wider spectrum of research and developing new methods as we’ve outlined.  We’re optimistic for 2021 and wish you and your families strong health and prosperity in the coming year.

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.

Forte Findings and The Plan

This year showed some of strengths and weaknesses for the Forte Strategy and unveiled two strong new ideas that we have been performing extensive research around to make sure we are in a strong position for 2021.

After a year of consistent development of Forte Strategy, we landed on a math model that excels at exiting the market at the start of sell-off (marked by an increase in volatility) and then, if the rate-of-change in volatility is high enough, it will enter into “hedging” positions with the VIXY and UVXY to profit from any downside moves.  For example, our last pre-crash long-equity position (TQQQ) was sold at the opening bell on February 28.  At that point, the S&P 500 had declined 14.7% on its way to a total 33.5% drop.  For another example, the market went through correction in September and October for a net loss of 6.5% while the Forte Strategy gained 2.6% in both months through a combination of market timing and VIX hedging trades.  The strategy also does well to intensify gains during low-volatility periods of steady market declines as shown by a run of four consecutive positive months in July through October for a gain of 9.2%; however, the Forte Strategy has several shortcomings that we performed extensive research and development over the past months to overcome for improved results in 2021.

First, the strategy spends too much time in cash with nearly 55% of the account idle on average.  This misses a portion of the natural upward bias of the market driven by innovation, inflation (central bank money-printing) and population growth.  We’ll address this by simply allocating a portion of the strategy to a classic buy-and-hold approach using the highly liquid S&P 500-tracking ETF, SPY.  We proved this idea (covered in our October 10 blog and restated below) using portfolio analysis:

We both listened to The Systematic Investor podcast last week hosted by Niels Kasstrup-Larsen in Switzerland and hit the reverse-replay button a few times to make sure we understood what was said.  He shared some recently completed analysis comparing the long-term returns of the S&P 500 from November 1984 through August 2020 versus his performance using a mechanical trend-following system over a wide-range of markets which provides returns uncorrelated to the S&P 500.

A $1,000 investment in the buy-and-hold S&P 500 strategy would have grown to $48,000 during this 36-year period while using a mechanical trending system, it would have grown to $68,000. 

However, the hard-to-believe part was that he went on to say that if you had allocated the capital 50% to the S&P 500 buy-and-hold strategy and 50% to the mechanical trending system and rebalanced monthly, the amount grew to $102,000 – so the mixed allocation strategy improved results by 30-50% for both strategies.  If proven in our applications, this seems like a simple way to significantly improve returns.

Secondly, the sensitivity to volatility that makes Forte an effective hedging strategy also may cause it to miss large energetic upward movements like we saw in April and early November of this year.  We were able to develop a new strategy, Adagio, that is a slow-trading system with about half the sensitivity to volatility compared to Forte and takes advantage of the volatility profile curve we covered in several of our prior blogs.  We first wrote about this concept on August 10 of this year with excerpts following:

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, then buy back in when the slope of the 10-day moving is down and some type of inflection point in the line occurs.  It’s one approach that we’ll consider to have a model in place for the next sell-off.

Lastly, given the Forte Strategy would occasionally move to a 100% hedged position and by nature the VIX trades are quite volatile, subject to swings of plus/minus 20% or more, we would only take small positions with these; however, when these are applied in the context of an account with a sizeable buy-and-hold position, we can take larger positions on the VIX trades without worrying about the hedging trades themselves contributing to a large drawdown (as we experienced in August 2019).

We have constructed a comprehensive portfolio strategy that blends these three strategies together into one that we simply call the Maestro Strategy which we’ll be setting up on the Collective2 website on January 1 for subscriptions and direct account linkages.  We’ll cover the details of the portfolio analysis and a summary of the full-year Forte performance in our blog next week.

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.

Are We Topping Out?

The last two months of the year are historically two of the most bullish.  However, in 2020, we’re already at toppy levels.  According to the chart below, the S&P 500 is only 2.3% from the all-time year-end two-month high of 13.57% set in 1954 which was during a multi-year period of economic prosperity:

With an increasing number of S&P 500 companies approaching previous, or establishing new, all-time highs while a significant percentage are suffering significant losses and laying off employees, valuations continue to get wildly high.  For example, The Walt Disney Company (NYSE: DIS) recently reported a quarterly loss of $710 million along with another 32,000 layoffs, yet the stock price is a mere 3% from it’s all-time high set a year ago.  Is a significant correction coming soon?  Who knows.  With proprietary trading desks, high-frequency traders and hedge funds increasingly dependent on volatility and panic selloffs to drive returns, it’s likely just a matter of time.  We also believe that a 10% correction at any given time for no particular reason is a common event in the stock market.

Forte Strategy Update

We executed two trades last week for a net loss of 0.3% compared to a gain of 2.3% by the S&P 500. Our YTD  results equal a 4.3% gain compared to a 12.6% gain for the S&P 500. Our YTD max drawdown is 9.5% versus 33.9% for the general market.    We continue to work on an overall portfolio approach to blend together a classic buy-and-hold strategy, our existing Forte strategy, and a new slow-trading Nasdaq strategy we’ve named Adagio.   We’ll launch this new strategy on the Collective2 website soon and provide more details on our portfolio research.

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.

Will the Market Give Thanks this Year?

While the month of November is the 2nd strongest month of the year (and this year the S&P 500 is already up over 8% so far this month), the week of Thanksgiving is particularly strong.   Over the past 68 years, the day before Thanksgiving and the day after Thanksgiving, combined have only been negative 17 times for a 75% success rate (although, in recent history, these two days have had a negative sum in all of the last three years).  

We don’t base trades on such historical findings given the relatively small sample size and generally feel that any kind of market prediction is sheer folly.  In contrast, all of our trading models are reactive in nature – responding to recent price moves and market volatility statistics.  Nonetheless, it’s noteworthy to share and more fodder for any cocktail conversations that may occur over the holiday weekend.

Anyway, regardless of the pandemic and any other headwinds you may face, we hope you enjoy the week of Thanksgiving with friends and family, reflect upon the first eleven months of the year and feel much gratitude.

Forte Strategy Update

We executed two trades last week for a net loss of 0.3% compared to a loss of 0.8% by the S&P 500. Our YTD  results equal a 4.6% gain compared to a 10.1% gain for the S&P 500. Our YTD max drawdown is 9.5% versus 33.9% for the general market.   The account correlation to the S&P 500 remains low at 0.137.  We continue to work on an overall portfolio approach to blend together a classic buy-and-hold strategy, our existing Forte strategy, and a new slow-trading Nasdaq strategy we’ve named Adagio.   We’ll launch this new strategy on the Collective2 website soon and provide more details on our portfolio research.

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.

Past, Present and…Futures

As MCR’s Forte, and soon-to-be-released Adagio, strategies continue to gain momentum, we will inevitably face challenges related to scalability.  There are several reasons the big players (e.g. hedge funds) typically trade futures contracts rather than exchange traded funds (ETFs) for index-centric strategies.  Here are some reasons why:

Tax advantage – Futures traders currently benefit from a more favorable tax treatment than equity traders under Section 1256 of the Internal Revenue Code (IRC) which states that futures contracts are taxed at a 60/40 split of long-term capital gains and short-term capital gains rates respectively—regardless of how long the position is held.  As long as financial industry lobbyists continue to dominate Washington to a hugely disproportionate degree, this will likely remain in place.

Relative volume consistency – Index futures trading volumes are generally more consistent month-to-month than ETFs (large professional speculators and “hedgers” are the biggest players in futures markets).  YTD 2020, the NQ futures contract (NASDAQ-100) average monthly volume variance was only 6% whereas the more panic-susceptible QQQ and TQQQ ETFs clocked in at variances north of 20% (March saw monthly volumes soar 223% on average; arbitrage traders likely exploited this).  More consistent volumes typically translate into more predictable order fills and less slippage.

Scalability – Index futures volumes are not only more consistent, they’re massive compared to ETFs.  The Chicago Mercantile Exchange’s (CME) E-Mini S&P 500 (ES) futures contract is one of the most heavily traded investment vehicles in the world (when factoring in leverage).  An investor trying to enter a $1M position for QQQ or TQQQ would represent as much as 3-5% of the first minute of opening trading activity whereas that same relative position could be entered with a mere 4 NQ contracts.  And what would those 4 contracts represent within the first minute of trading?  The trade size would equal 0.15% of the opening minute’s volume.  That’s the big leagues for you.

Direct correlation – The NQ futures contract is a direct derivative of the NASDAQ-100 Index whereas ETFs QQQ and TQQQ price values, while mostly correlated, do not directly equate to the underlying.  Although maybe less of a concern with higher volume ETFs, there will always be systemic risks (e.g. decay) when investing in long/short index ETFs (especially the leveraged ones).

24/7 (almost) – Most index futures contracts (e.g. ES, NQ, RTY, YM) open at 6pm EST on Sunday and close at 5pm EST on Friday (except for holidays).  Can’t sleep and want to go long the NASDAQ-100 at 2am on a Wednesday?  You certainly can…and the futures market will be liquid enough for most investors.  Although stocks and ETFs have pre- and post- market trading hours, they remain limited and bid/ask spreads are generally unfavorable.

We continue to research and model performance enhancement ideas including those related to futures.  Stay tuned.

Forte Strategy Update

No trades were executed last week as the volatility remained high blocking out new trades with the long equity ETFs while the upward market price moves precluded any VIX trades.   The SP500 gained 2.2% last week and is up 11.0% for the year compared to a gain of 5.3% by our Forte strategy.  While we have proven Forte’s ability to avoid and potentially profit during a declining market, we are doing extensive research to develop a new strategy (Adagio) that will trade with less frequency and be more effective in both avoiding a percentage of a major decline and capture more of the rebounding upside.   And as stated in prior blog emails, we are working on a portfolio approach to blend the strategies together (including a classic buy-n-hold approach) for optimal performance.

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.

Combining Strategies?

As we mentioned in our October 10 blog email (“Potential New Perspective“), we were contemplating the inclusion of a buy-and-hold strategy in our overall approach.  “We will have to pause and consider adding that dimension to our work as part of an investment portfolio. We acknowledge that as accounts become significantly large, the more frequent trading we currently use has limitations due to slippage, impacts from the current bid/ask price spread, etc. So, a strategy with a longer-term horizon and lower trading frequency may also make sense.”

The past 10 weeks have shown the potential benefit as the S&P 500 is exactly flat while the Forte strategy and a 50/50% Combined Strategy show gains of 2.4% and 1.5% respectively.   Perhaps more importantly is how this approach can minimize the emotional gyrations the market can induce; the Combined Strategy had the lowest volatility and drawdown compared to both the S&P 500 buy-and-hold and Forte strategies.   A summary of the performance metrics is shown below:

We used a simple 50/50 allocation for purposes of this blog email.  We’ll continue to research and look for other strategies and investment options, including futures contracts, to add to the mix and then optimize for the best performance in terms of gains, drawdowns, and volatility.

Forte Strategy Update

We executed one trade last week for a loss of 1.5% compared to a gain of 5.6% by the S&P 500. Our YTD results equal a 5.3% gain compared to a 8.6% YTD gain for the S&P 500. The account correlation to the general market dropped slightly and remains low at 0.137.

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.

Review of 3rd Generation Trading Models

The market action of the past two months reminds us of August 2019 when our Collective2 Forte Strategy suffered its worst month of returns along with the biggest drawdown.   When the month ended, we recorded a 10.8% loss with a 21.0% drawdown while the market only dropped a net of 1.7%.   The sell-off wasn’t that bad by historical comparisons, but the trade war news headlines and spurious presidential tweets created wild gyrations in the market which are known to cause trend-following trading systems to lose money.  

Reeling from the poor results, we paused trading activity and overhauled our model mechanics.  Several layers of volatility-based parameters were added and the settings were optimized over a 10-year lookback period.   Extensive portfolio analysis was performed to reduce the S&P 500 correlations and properly size the positions to help mitigate the chance for a drawdown greater than 15%.  We also limited the basket of securities to only include the major, high volume markets and the VIX index leveraged ETFs.

The new 3rd Generation models were implemented in early October 2019.    The results so far are encouraging with a gain of 18.3% and drawdown of 9.5% compared to the S&P 500 gain of 9.8% and drawdown of 33.9% during the same 13-month period.   We also went through a series of smaller-scale innovations over the past few months and continue to perform R&D work on an ongoing basis to further improve the results.

Forte Strategy Update

We executed 7 trades last week for a net gain of 4.5% compared to a loss of 5.6% by the S&P 500. Our YTD net results equal a 6.9% gain compared to a 1.2% YTD gain for the S&P 500. The account correlation to the general market dropped slightly and remains low at 0.144.

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.