Model's Performance - Apr 29, 2016

As of right now, April has been a net neutral month. The rally that we saw in the early part of April fizzled out in the last week or so. And now the market is on the verge of closing the month in the negative territory.

However, at the same time, the Portfolio Enhancement Algorithm performed very well in April. Since the beginning of 2016, we are closely tracking the performance of this model. Following chart shows the performance since Jan 2016.

As one can see the model rallied sharply in Jan/Feb, while market declined. Then it consolidated while market rallied sharply in Feb/March. Interesting aspect of this consolidation was that it was not impacted by the sharp rally of the stock market i.e. it was just a consolidation of the gains versus wiping out all the gains.

Soon after the consolidation was complete, the model rallied again. And this time, the rally was followed by a mini consolidation in April. This brings us to today, where the model is breaking out to new highs. So far in 2016, the model is up 12.9% vs SP500 gain of 1.5% (including dividends).

Although the performance of this model is very impressive and its more impressive in the leverage world, which we continue to monitor (we share the results of leveraged model's performance in May/Jun time frame), there are numerous other benefits of this model based portfolio which we have discussed in following posts over the past few weeks:

1. Benefits of the Model - Part 1
2. Benefits of Model - Part 2
3. Benefits of Model - Part 3

One another benefit of this model is the ability to implement Buy and Hold Strategy, which we will discuss in the next post along with analyzing the portfolio performance quantitative perspective. 

Benefits of Model - Part 3

With Federal Reserves not raising the interest rates and Bank of Japan maintaining negative interest rates, the markets are primed for some interesting action. At this point, one must ask:

• Why is the Fed so uncertain? 

• What are they seeing that even with stock market (SP500 and DJIA) near all time highs, they are not willing to increase the rates?

We know that the economy is not very strong. And it is a good decision from the Fed to not raise rates. However, what type of signal will it send to the investors? Is it time to be wary of the stocks as the economy struggles or is it time to get aggressive?

The question then becomes, even though the Fed has maintained the interest rates for now, how long can they maintain this posture? Will they not increase the rates on the first sign of strengthening economy? In that case, if the May jobs report comes in very strong, which is expected based on last week's extra-ordinarily strong weekly claims data, will that push Fed over the edge to raising rates at June's meeting?

In short, there are so many questions on the fundamental side. Similarly, from a technical perspective there are also several questions. At this time, the best strategy for any individual could be to stay out of the market and wait for the market to show its true direction, which could result in a delayed entry into a good long/short position. Or follow a system that takes out emotion from the investments. Since we have been using the Portfolio Enhancement Algorithm since the start of 2016, we decided to analyze the Q1' 2016 performance.

In the last few blog posts, we have discussed the benefits of Portfolio Enhancement Algorithm based in 2016 based on real-time performance with real money (as of April 12th, model was up ~9%, while SP500 total return index was up ~2.5%. 
Following are some additional benefits that we realized by using the model during Q1' 2016.

1. Benefits of the Model - Part 1
2. Benefits of Model - Part 2

5. Trend/Momentum following ability

Model offers the ability to utilize two of the most basic concepts of investments that help investors in the long run. In fact, hedge funds, which made a lot of money in 2015, were momentum following hedge funds. These funds realized that oil price decline had strong momentum and therefore, continued to hold short positions in oil.

As long as one can stay with the trend, investments pay off in the long run. My 8 years of experience in the financial industry has confirmed the adage that "Trend is your Friend." If a person tries to fight the trend, it’s possible that he might make few good trades but in the long-run the investment account will suffer. 

Although there are indicators and analysis techniques that allow a person to identify potential areas of trend changes and market timing, there is no Holy Grail. Therefore, the best option for investors is to stay with the trend. While staying with the trend, it’s imperative to have risk management facets to guide one about potential upcoming changes in the market structure.

This is similar to regular health checks that one undergoes to see how a person is doing internally. If one doesn't do health checks, they won't get a forecast of what is going on inside his/her body. As a result, it can be too late when one reacts to the new developments. In order to mitigate such risks in the investment world, this model has in-built risk management and market health check mechanisms.

6. Positioning for Next Market Move 

Another key aspect related to risk management and market health check is the ability of the model to position for the upcoming move in the appropriate area. It’s always critical to position one's portfolio before a move happens rather than reacting after a move has started. This not only reduces the stress, but allows one to establish a good position

Since majority of portfolio gains occur at the start of a new rally phase, if a person waits for the rally to begin, they might miss on the lion share of the move. On the other hand, if a person enters too early they might sell before the move actually starts. As a result, it’s always critical to correctly position the portfolio for next moves and have confidence in the allocation.

This is another huge benefit of this model that it allows us to position the portfolio for an upcoming move without taking too much risk and ensuring enough diversification with risk management perimeters. As a result of these benefits, this model can be applied in any portfolio and can be used with leverage to compound returns.

As an example, the model allowed us to position in such a way that we benefited from the Jan/Feb 2016 market decline and then allowed us to mitigate losses through accurate positioning in March, followed by sharp gains during the last week of March and first week of April.

• Buy and Hold features
• Quantitative benefits:
• Beta
• Sharpe Ratio
• Alpha

Gold Consolidation - Apr 24, 2016

As the market continues to gyrate with an upward tilt, gold is consolidating after breaking out. Gold is currently at the same level where it was 2.5 months ago. This consolidation by time is very healthy and shows that gold has a bright future ahead of it.

Gold's consolidation over the past couple of months has traced out an inverted Head and Shoulders pattern, which suggests that once Gold breaks above 1260 level and holds for a few days, we will see significantly higher prices.

The Inverted Head and Shoulders pattern is shown below.

Gold's rally since January has brought it into a bull market. This bull market can last for a long time and price of Gold can increase substantially.

Gold price action has significant implications on the broader economy. Does it mean the US Dollar will devalue or are we going to initially see flight to safety? We shall see...

Benefits of Model - Part 2

2. Less Stress During Volatile Markets

During times of extreme stock market volatility, investors either exit the market out of fear or stay in the market but don't look at their portfolio. Others keep looking at their portfolio and hope that market rises so that they can make-up for losses.

However, model's low correlation with the market ensured that the stress level was significantly reduced during the volatile market moves. Furthermore, it allowed us to withstand market gyrations without making panicky decisions. As a result, model remained invested throughout the downtrend and ensuing rally.

3. Eliminating Emotions

Reduced stress improves the decision making ability. It allows the investor to see the forest from the trees. As panic decisions are avoided, big picture objective investment ideas emerge. Since investments are governed by business rules, systematic approach helps in eliminating emotions from investment. 

One of the key drivers of this reduced stress and minimal emotional interference during market volatility is diversification of portfolio holdings.


3. Diversification

Diversification is the process of allocating capital in a way that reduces the exposure to any one particular asset or risk. A common path towards diversification is to reduce risk or volatility by investing in a variety of assets.

Creating a truly diversified portfolio requires a lot of effort and capital because diversification needs to be performed across stocks to avoid business risk i.e. minimizing the risk of a certain company getting out of business or committing earnings fraud like Enron. However, stock diversification does not address market risk. 

Market risk is addressed by diversifying across asset classes. But asset class diversification again requires significant effort and capital. In other words, this diversification can add a lot of value to the portfolio

In this regard, the Portfolio Enhancement Algorithm has automated diversity through minimum effort and capital usage. This allows us to minimize risk, reduce volatility and have a well diversified portfolio along the way.


We will continue to analyze the model based on Q1 performance and some of the key benefits. Following items will be discussed in the upcoming posts:

• Trend/Momentum following ability
• Buy and Hold features
• Positioning for next market move
• Quantitative benefits:
• Beta
• Sharpe Ratio
• Alpha

Benefits of the Model - Part 1

Since the beginning of 2016, we have been analyzing the performance of the Portfolio Enhancement Algorithm by applying it on a real-time, real-world investment portfolio with real-money to effectively evaluate the marketing beating, hedge fund-like ability of this model.

So far the model is up ~9%, while SP500 (including dividends) is up ~2%. In other words, model has generated Alpha of ~7% over a period of 3.5 months. Although we don't exactly know how thing will pan out in the future because past performance doesn't guarantee future returns, model's performance in an extremely volatile market is very impressive.

Alongside the impressive performance, there are several other feature that make this model very attractive for long-term/short-term retirement and/or aggressive growth investors. These range from peace of mind in times of market volatility to quantitative proof that model will perform better in the long-terms based on model performance metrics like Beta, Sharpe Ratio, Alpha and others.

In the next few posts, we will evaluate the Q1 performance of the model in light of its intangible benefits, which at times are more important than model's absolute performance.

1. Peace of Mind: 

First 1.5 months of 2016 were not only volatile but were one of the worst starts of the year in history of some of the indices. Many investors exited the market in panic, while some stayed but had to deal with extreme volatility. Others who had the money, they bought puts on their long holdings like Mike Cuban. Mark's story was published on Feb 6, while market bottomed on Feb 11th. In other words, if his puts were up to 2 months out, they would have expired worthless by now.

Peace of Mind was realized by the fact that the model based portfolio was positioned in such a way that the Beta was -0.56 during the first 3 months. This ensured that the portfolio was not only not correlated with the market, it was positioned to take advantage of market decline. At the same time, it was not very aggressively negative because it was not concentrated in one asset class. Instead, it was diversified and therefore, it was only half as volatile as the market during this time frame.

Following chart shows portfolio performance since January 1, 2016 till April 13, 2016.

As one can see, the portfolio performed extremely well in January/February till February 11th, when it was beating the market by almost ~20%. However, as the market rallied, the portfolio maintained a substantial gap with the market. In other words, 2 months of sharp market rally wasn't able to fill the gap with the portfolio. 

It is to be noted that if one had purchased an inverse market fund or leveraged market fund, they would have been negative by now. Or if they had gone with options approach and had not exercised their options, these options would have expired worthless. Or if they had shorted the SP500 futures, they would have received margin calls. 

Secondly, the model ensured that excessive trading was avoided, which reduced the stress level for investors during the volatile period. 

In the next few blog posts, we will continue to evaluate the intangible benefits of the model including:

• Less Stress during Market Volatility & Eliminating Emotions
• Trend/Momentum following ability
• Diversification
• Buy and Hold features
• positioning for next market move
• Quantitative benefits:
• Beta
• Sharpe Ratio
• Alpha

Market and Model Performance - April 12, 2016

Market Overview

As we approach the earnings season, SP500 and DJIA is approaching all time highs. Although this has reduced the risk of immediate decline but the market remains in bear territory. US Market entered bear territory, as per our proprietary model, in August. Since then the markets has experienced extreme volatility including a sharp rally in October, one of the worst starts of the year in history and then another rally that started in February.

From the market action, rally that began in February triggered few breadth signals. These breadth signals will work themselves off by the 3rd week of April. Therefore, beginning of the earnings season will have enough technical support to stage another rally before fizzling out.

From an Elliott Wave perspective, market is tracing out a 5-wave structure from Feb 11th bottom. Although 5-waves mean that trend is now up, in case of corrections last waves are also 5-waves in nature. Based on market structure over the past several years, its likely that we are completing a corrective pattern. And once this last leg up is complete, market will decline.


Last 3 Months and Model

Under such volatile circumstances, staying in the market in 2016 has been like being on a nauseating roller coaster ride. Just when one thought that the market was about to break down and many investors exited the markets out of fear in February, markets ripped higher. Now people are confused if this rally can be sustained or is this just the end of the uptrend. In other words, is this a good time to buy or sell?

In order to avoid this question to totally remove emotions from trading, we created the portfolio enhancement model. Although it has a lot of potential and we will keep on updating with new enhancements and IPM timing, its performance in 2016 has been very good.

Following chart shows the performance of the model (till Apr 12) since the beginning of the year, in comparison to the SP500 total return performance.

Performance numbers are provided courtesy of Openfolio and shows performance of actual portfolio in brokerage account.