Election Fever (Part 2)

Last week we wrote about the shorter-term historical precedent with market performance, specifically the two months leading up to and the two months following the last four election dates.  Now let’s widen the scope to a galactically greater degree: in years rather than days and starting way back with Andrew Jackson’s presidential term (yes, the 1830’s).

We’ve been long-term followers of Jeffrey and Yale Hirsch’s “Stock Trader’s Almanac” which has been published annually in November for the last six decades.  The almanac is full of historical market data observations that can be helpful in providing strategy ideas and unique perspectives on potentially repeatable market patterns.  According to the Hirschs’ research on the last 46 administrations since 1833, the second half of the election term produced a total net market gain of 742.5% versus the 326.6% gain of the first two years of these administrations (NOTE: the charts below do not include Trump’s Pre-Election and Election years, 2019 and 2020):

Wall Street Journal’s Paul Vigna on Friday took it a step further by looking at the S&P 500 since 1929, providing stats on which party produces greater returns.  His primary takeaway?  “Stocks tend to go up regardless of which party controls Washington”.  From single-party control of both Congress and the presidency to a split government, S&P 500 performance has been, on average, very similar (7.45% and 7.26% respectively).

The bottom line: we continue to rely on our optimized models and rules-based logic rather than emotion and political bias.  As you can see from the data, the build-up and outcome of the upcoming election in retrospect will likely lend itself more to theatrics (and timing and cycles) rather than elephants and donkeys.  The above charts and the YTD 2020 market performance, again remind us that anything is possible in any given year with the market.

Forte Strategy Update

We executed 7 trades last week for a net loss of 2.1% compared to a loss of 0.5% by the S&P 500. Our YTD net results equal a 1.4% gain compared to a 7.2% YTD 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 SP500 remains low at 0.154.

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.

Election Fever

With only 11 trading days remaining before November 3, we’d be remiss if we didn’t mention at least something about the upcoming election and the potential impact on the markets. Regardless of your preference toward one side of the aisle versus the other, many agree that more volatility is likely over the coming two weeks (for example, both Robinhood and Interactive Brokers have recently sent client notices indicating higher margin requirements due to anticipated increased volatility). Can we be so sure? Let’s take a look at the last four presidential election periods for possible precedents.

To make sense of all of the arrows and stars and colors (oh my!), allow us to explain. Each of the five individual daily charts above display the two months preceding and the two months following the respective election dates (2004, 2008, 2012, 2016 and 2020) with the S&P 500 (ES=CME E-Mini S&P 500 futures contract) graphed on the top and the volatility index (VX=CBOE volatility/VIX futures contract) shown on the bottom. The mid-October date (relative to today) is identified with the white arrow and the election dates are plotted with gold stars. As you can see, all five charts saw a gradual decline in the S&P 500 as we approached the election date (although we’ve seen an upward move over the last few weeks) with four out of five experiencing declining volatility (the ’08 market meltdown being the exception). Then all four of the last elections periods saw a multi-week bullish move in the markets following the actual election date. Political uncertainty mitigated (regardless of the winning party)? Santa Claus rally? For position traders like us, this is very interesting. Nonetheless, we’ll continue to follow the outputs from our trading models for specific decisions.

Forte Strategy Update

We executed 3 trades last week for a net loss of 0.5% compared to a gain of 0.2% by the S&P 500. Our YTD net results so far equal a 3.6% gain compared to a 7.8% 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.

Potential New Perspective

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 (he was likely referencing either his own track record or that of Dunn Capital), 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.

While neither of us have used a buy-and-hold or fundamental stock-picking strategy for our investment allocations, we will have to pause and consider adding that dimension to our work as part of an investment portfolio. We also acknowledge that as accounts become significantly larger, 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 makes sense.

Forte Strategy Update

We executed 8 trades last week for a net loss of 1.7% compared to a gain of 3.8% by the S&P 500. Our YTD net results equal a 4.1% gain compared to a 7.6% YTD 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 SP500 remains low at 0.154. 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.

The Best and Worst Days

As covered a couple of weeks ago, we frequently assess the robustness of a trading model by comparing out-of-sample data to expected in-sample results.  Two weeks ago, we retrieved analysis prepared for a presentation made to a medium-sized hedge fund in Chicago in September 2014 to see if the negative Friday’s pattern was still as consistent as it was during the 2000-14 study period – which it was.  We’re pulling from the same deck this week to see if the “Best and Worst” days pattern defined in May 2014 may still be in play.

20201004_blog_image

Here’s the table from 2014 showing the sum of the DJ30 gains from January 2000 through August 2014 based on the trading day of the month (the numerical sequence of the days the market was open during the month regardless of the calendar date).  It shows a defined pattern of gains during the first and middle of the month and 3-5 day period of weakness starting just after the 2nd half of the month.  The notes on the bottom show that a strategy that went long on the green highlighted days and short on the orange days would have had a sum gain of 182% over the 14-year period versus 72.3% for the buy and hold strategy.  This is a 2.5X difference (please note that these are simple sum numbers for the purposes of comparison with no attempt to quantify the compounding effects during the 14 years which would further amplify the results).

So how would have this strategy worked during our most recent out-of-sample data set, September 2020?  This simple best 9 days, worst 3 days strategy as outlined in 2014 would have generated a 3.5% gain versus a 2.4% loss for the SP500 in September.  The strategy is easily executed by buying the DIA ETF at the close of the prior day and then replacing this position with the DOG ETF at the close on the 12th trading day of the month.  We’ll provide a longer-term update of this strategy within a few months to see how it performed over multiple years since September 2014.

Forte Strategy Update

We executed one trade last week for a net gain of 1.1% compared to a gain of 1.5% by the S&P 500.  Our YTD net results equal a 5.9% gain compared to a 3.6% YTD gain for the S&P 500. Our YTD max drawdown is 9.5% versus 33.9% for the general market. 

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.

Being Reactive

We heard a podcast this week hosted by author Michael Covel that reminded us of some of the oldest and wisest perspective 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.”

In the Covel podcast, he compared and contrasted technical analysis of the capital markets as either being predictive or reactive in design and gave a clear message that reactive was far better and that it’s impossible to predict the future based on analysis of past numbers. That’s the perspective for the trend-following approach we use which reacts to price moves in either direction and also the degree of volatility of the price moves. The price data is loaded into our math models each night which outputs a simple decision – buy, sell, or adjust the stop loss. We try to mentally approach the market each day with an objective mindset, with no substantive opinion about the short-term direction of the market either way (long-term, however, we believe the market will trend higher due to inflation and innovation). Regardless, we recognize that within the span of the next month or even next year – a substantial move in either direction is possible – so we trade accordingly.

Forte Strategy Update

We executed 6 trades last week for a net gain of 1.1% compared to a loss of 0.6% by the S&P 500. Our YTD net results equal a 4.7% gain compared to a 2.1% YTD 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 0.156.

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.

Fridays are the Worst

We frequently review and revise our trading models to find ways to improve results based on sound reasoning and data-driven justifications.  However, it is important to not add too many parameters with precise settings to avoid curve-fitting of historic datasets.  One way to accomplish this is to compare model performance with out-of-sample data to expected in-sample results.  Sometimes this is as simple as optimizing the model parameters for a time period (e.g. 2015-2020), applying the same parameters to a prior time period (e.g. 2009- 2014) and then comparing the results for consistency.

This week we retrieved analysis performed for a presentation made to a medium-sized hedge fund in Chicago in September 2014 to see if recently observed patterns can be validated by prior time periods.  In this case, the sum of the Dow Jones 30 Index gains on Fridays so far this year are negative 2.3% versus a positive 5.5% for the other four days of the week.  The absolute ratio of these two numbers is 2.4 compared to the same ratio applied to the dataset below for a period of June 2000 through June 2014 of 2.9.  So, there are two independent datasets suggesting that the gains in the DJ30 during the first four days of the week are around 2.5 times in size as the losses that occur on Friday – on average and in general.

We rigorously tested this theory applied to our daily TQQQ 3X leveraged Nasdaq model and did find that it improved results by around 10% if we exited the position on Thursday at market close and then re-entered on Friday market close if the position would have otherwise been open at that time or provides a buy signal for the open on Monday.  However, we were not able to validate this theory for the UPRO 3X leveraged S&P500 ETF model, so we’ll leave that logic out which will provide some measure of diversification by time as one model will be active on Friday and apply new buy signals on Monday at open, and the other will be dormant on Friday and apply new buy signals on Friday at close.

It’s worth noting that the above excerpt from the 2014 PowerPoint presentation indicates that a simple strategy of holding the Dow 30 tracking ETF (DIA) from Friday close to Thursday close and then swapping this for the inverse ETF (DOG) on Thursday close to Friday close may provide results 2X the buy-and-hold DJ 30 strategy (more fodder for your next “you can’t beat the market with active trading methods” conversation).

Lastly, we concluded a multi-month study comparing models based on 15-min data updates versus models using daily data and found that there is not enough (if any) added benefit to using the more complex and time-consuming 15-min models, so these are retired for now.

Forte Strategy Update

We executed 4 trades last week for a net gain of 0.6% compared to a loss of 0.6% by the S&P 500. Our YTD net results equal a 3.6% gain compared to a 2.7% YTD gain for the S&P 500. Our YTD max drawdown is 9.5% versus 33.9% for the general market.

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.

50% More Gains with Half the Risk

As committed to in our July 4 and August 15 email blogs, we are following up with a defined trading system to take advantage of the next spike in volatility.  As we shared before, we believed that there was a way to construct a trading system by exiting a long market position when volatility spikes and then re-enter the position as volatility declines and there is some measure of confidence that the violating peak (market bottom) event had occurred.   We’ve proven this now as a sound theory and that serves well for a mechanical system structure that provides strong results as stated in the headline – 50% more gains with half the risk.

The trading system closely follows our prior analysis by exiting a long market Dow Jones 30 (using the DIA index tracking ETF) position when volatility (defined as the a simple standard deviation calculation of the last 10 days Open-High-Low-Close prices divided by today’s close price) spikes 1.75 times greater than the long-term average (9.4 years in this study) and then re-enters the position when the volatility falls by 50% compared to the maximum value of the prior 50 trading days.

The graph below shows the total gains of this trading system versus a buy-and-hold strategy with the performance statistics summarized in the table beneath the graph.

This model was developed using a simple Excel spreadsheet and round parameter settings (10-Day StDev moving, 1.75X peak,  and 0.50x drop) for illustrative purposes.  The results can likely be improved by using the more volatile NASDAQ-100 index, optimizing the parameters with more robust software (like TradeStation), using a leveraged ETF like DDM or UDOW, and, for some with higher risk tolerance, also short the market when volatility spikes above 1.75 times the long-term average.

As of Friday’s market close, the StDev of the last 10 days is 1.69 times greater than the long-term average – so the model is still long in the market now but will likely exist soon with another day or two of high volatility.

Lastly, we hope this helps in some way – at a minimum, to equip you with hard facts for your next cocktail hour conversation when a boorish market expert tries to convince you that it is impossible to beat the market with a mechanical method or timing.   Here’s one simple example to do that by at least 50% and with half the risk.   The graph even shows that it beat the market within 90 days and then held and extended the gains for the following 9 years.

Forte Strategy Update

We executed 9 trades last week for a net loss of 1.0% compared to a loss of 2.5% by the S&P 500. Our YTD net results equal a 2.9% gain compared to a 3.4% YTD gain for the S&P 500. Our YTD max drawdown is 9.5% versus 33.9% for the general market. 

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.

September Swoon?

Anyone who has followed the markets for even a handful of years knows that the month of September is on average the worst performing month of the year.  September 2020 is starting off to be no different.  Beyond the crazy high multiples of big tech and the overall equity markets, the volatility (or fear) index (VIX), which typically remains low during more placid (and GDP-correlated) upward moves in the markets, has been running up in tandem with stocks ahead of this recent selloff.  Furthermore, a recent CNN Business article pointed out that the VIX relative to new S&P 500 highs are at levels comparable to the tech bubble:

With historically bad vibes in September combined with the upcoming elections, investors may want to fasten their seatbelts (and take some profits).  It will likely be a bumpy ride.

Forte Strategy Update

We executed 11 trades last week for a net gain of 2.0% compared to a loss of 2.3% by the S&P 500. Our YTD net results equal a 4.5% gain compared to a 6.1% YTD gain for the S&P 500. Our YTD max drawdown is 9.5% versus 33.9% for the general market.  Overall, we are pleased with the performance of the models leading up to and during the sell-off.   The VIX ETF models triggered early and served as both a hedge to open long trades and profit generators as the market sold off.   And, the sudden increase in volatility shut down the TQQQ ETF to help avoid losing whipsaw trades.   The net profits for the week came from both the long market trades and the VIX hedging trades – as planned and hoped.  The math models ended the week 100% in cash.

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.

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.