Performance Evaluation - June 24, 2016

Last week saw an unprecedented referendum, with UK deciding to leave the European Union after 50+ years. As UK became the first country to ever leave the EU, global markets roiled with US DJIA declining over 600 points.

The interesting aspect of the referendum results was it was totally out of the blue. No one really expected this to happen. And as a result, a lot of investors were caught off-guard. On the contrary, UST's portfolio allocation algorithm saw a sharp rally (shown below).

YTD model portfolio is up 18.5%, while SP500 is up 0.72% after dividends. Furthermore, the positioning of current portfolio components gives it a Beta of -0.06 i.e. the returns are totally uncorrelated to the markets.

Allocation might change over the next few weeks, as new market data comes out. But overall, the model portfolio has handsomely beaten the market in 2016. A variant of this model portfolio, utilizing leverage and exotic asset classes, is up ~40% since March 2016. We will share results of the leverage portfolio after more data points are gathered.

The portfolio utilizes an algorithm that fuses together multiple market analysis strategies to define optimum portfolio allocation by assets. One of the key proprietary model is "Market Classification Algorithm." We will share the importance of Market Classification Algorithm in the next blog post. 

Brexit and its Social and Economical Impacts!!!

Finally, the United Kingdom has spoken. They want to get out of the European Union - first country to ever leave the EU experiment. Although the EU experiment had a lot of promise, it turned sour when wealthy countries had to bail-out others. While leaders were open to the idea, public clearly opposed it.

Flow of Events going forward:

1. UK's exit will now call more countries to hold REFERENDUMS. 
2. EU might be even more FRACTURED 
3. TRADE will slow down, 
4. Bad for the EU and consequently the GLOBAL ECONOMY 
5. Poor economy will impact the STOCK MARKET
6. Force central banks to infuse more liquidity into the system and hence, keeping the INTEREST RATES LOWER for an extended period of time.

All of this can be summarized into:

• Stocks --> Lower
• Bonds --> Higher
• Gold --> Higher

I wish this was one of those Black Swan events, which brought in panic selling and then markets continued on their merry way. However, our Stock Market Bear Case analysis shows that the trend is about to turn lower. We have been out of stocks since last August (2015), with short allocation in Jan, Feb and March.

Now nothing goes straight down. So its possible that after 2-3 days of panic selling, we might see a relief rally into Q2 earnings. But earnings and all the estimates will be adjusted due to Brexit vote and hence, markets will have a lot of reasons to decline. We will keep evaluating the developing market conditions and share insights.

Under these circumstances, we are keeping our strategic allocation in the portfolio (YTD results till last week). Will share latest results over the weekend. The portfolio is totally uncorrelated to the stock market, and as a result gives a lot of peace of mind, at time of market turbulence.

In the next post, we will discuss impact of Brexit on our social and retirement investing.


  

Stock Market - Bear Case

Although both Bull and Bear scenarios are equally important, I would personally like to see the Bull scenario unfold because it helps everyone and the economy. However, let's first discuss the potential bear setup, especially at a time when the market is rallying ahead of the Brexit results. 

Bull or Bear, market will soon adopt either direction. And July's Q2 earnings will justify the move. 

As of now, markets are in a neutral territory. Last time, our proprietary Bull/Bear model went neutral was in August and since then we have been out of stocks. In January, model went short for 3 months and is now again neutral. We have seen that markets have not managed to break-out in over a year. For some market observers this is a sign of accumulation or digestion of prior gains an will result in further gains, but let's not forget what happened to oil.

Following charts shows SP500 and Oil. Oil went sideways for 3 years (2011-2014). While many believed that this sideways action was a harbinger for future rally, Oil fell off the cliff - from $110 - $25.

Can this happen to stocks? Probably... 

In support of the above argument, following chart shows a potential Elliott Wave count in Global Dow index, which suggests that the markets are about to fall in a big way in 3rd wave down.

Now, Elliott Wave analysis is only valid when its accompanied by market internals and sentiment. As of now, the sentiment indicators are bullish which reduces the market's fuel for a sustained rally. At the same time, Commitment of Traders, especially in Dow Jones Industrial Average, is at a very elevated level. This typically coincides with a top or pause (shown below).

Conclusion

This analysis shows that the market is near the end of its up trend. However, that's just one side of the story. In our prior post, we also highlighted potential Bull reasons and we will discuss these further in the next few posts. 

As for the portfolio allocation, proprietary model will define the allocation based on key proprietary indicators and latest macro-economic developments. In any case, the model will quickly align itself with the new reality and market dynamics. 

Stock Market - Bull and Bear Case

There is a lot of uncertainty in the financial markets right now. Typically such uncertainties help in building a wall of worry, which bull markets like to climb.

However, the problem with focusing on uncertainties is that one loses the better things in the translation. For example, right now global financial media is focused on Brexit, it will then focus on Fed's interest rates, China issues, US elections or some other issue. At the same time, low unemployment, stable economy and a year of sideways gains digestion is totally ignored.

Second set of items listed above clearly highlight the positives going on in the market. Therefore, its paramount to see the markets from an objective perspective. Please note that just seeing is not enough, seeing has to be coupled with action. And that's why many analysts who are right on the overall economy or future market direction, end-up losing money in their portfolios.

As part of this objective analysis, we have been discussing various markets on this blog. This week we will focus on the stock market because there are several reasons for the market to rally and to fall. As a result, I have decided to document following positive and negative aspects of the market in the next few blog posts.

Positives

1. Its been more than a year since last market high. History suggests that if the market rallies after such a development to new highs, we can expect continued gains
2. Narrowing/coiling long-term technical indicators, suggesting fuel is being built-up
3. Elliott Wave analysis
4. Proprietary Bull/Bear model approaching a break-out
5. Rising cash positions in funds and equity outflows
6. No divergence in advance-decline line

Negatives

1. Extremely high Commitment of Traders (COT) bullish bets 
2. Not a lot of pessimism in the sentiment surveys
3. Potential Elliott Wave count

In either case, next market move is upon us. It will be a sharp and sustained move. Therefore, we need to position in a way so that we can benefit for such a move.

The proprietary model portfolio is up ~15% YTD in a year where SP500 is up ~3% after dividends. We will continue to pursue the model and allocate strategically to benefit from sharp market moves. 

Please feel free to add how you feel about the market in the comments section or on twitter @survive_thrive

  

Performance Evaluation - June 17, 2016

Brexit fears continue. Market's declined last week with VIX spiking and generating a buy signal, which is being played out today with a sharp rally.

According to financial media, the catalyst for this rally is easing Brexit fears. However, Brexit is just one part of the equation. There are more fundamental issues with the economy, which people are ignoring. We will talk about these issues in the next few posts.

While the market and economy is now starting to face the reality and is under-performing, our prop portfolio is doing extremely well. As of June 17th, the model is up 17.30% based on real money performance tracked by OpenFolio (seen below). 

This month's gain has triggered a 'Go to Cash' signal for a small portion of the portfolio.

Following are few interesting observations:

• Model rallied back sharply after May's decline
• Model's asset weighted Beta correlation to the market is -0.06, which means that the underlying portfolio components are not linked to the market performance.
• Model's internal risk management metrics allow us to capture gains and adjust portfolio in case of evident anomalies.

Please feel free to contact us with any questions. Feel free to share any questions on @survive_thrive (good place to have conversations!)

Portfolio Performance - June 10, 2016

Next week will be full of market moving news ranging from 3 Federal banks (US Federal Reserves, ECB and B of Japan) to Brexit. In the midst of all of this uncertainty, market is struggling to break the 2130 level, which has acted as a ceiling for the past 12 months.

While economic uncertainty might keep the Fed from raising rates, it will also keep the stocks from rallying. As a result, its time to diversify into other asset classes.

Diversification has allowed the  "Portfolio Enhancement Model" to beat the market by more than 10%. Following chart shows the comparison of SP500 (total return) with Portfolio returns:

This performance is governed by strategic asset allocation, effective risk management and impactful diversification.

Stocks, Bonds and Gold - All Moving Higher

It's an interesting time in the market since last week's employment numbers. Stocks, Bonds and Gold, all are moving in lock-step. Although its very possible because different market dynamics govern each asset class, its unlikely.

Bonds are typically considered safe havens as they are less volatile and move in the opposite direction of the risk assets. At least that's the common perspective. Gold has a similar attribute. Even though historical patterns suggest that this notion of inverse correlation of Bonds and Gold with Stocks is contrary to what actually happens over long periods of time.

Recently these three asset classes are moving together, as shown below:

This correlation started from the Jobs report. It seems like everyone is happy that the Federal Reserves won't raise rates, and therefore, all assets are being purchased. However, this pattern cannot sustain for a longer period of time. And something might give.

Since Gold and Bonds are in a bull market, while stocks aren't in one, according to proprietary indicators, Stocks have the most risk right now. We have Federal Reserve's FOMC meeting next week. This meeting could really shake the markets.

So what does this really mean for investors and traders:

1. STOCKS: Long terms investors be wary of stocks till they can break to new highs. Although US stocks have been doing relatively well, they have huge drag from the global markets. Its unlikely for US market to break-out at a time when global macro conditions are not supporting with positive underlying currents. Therefore, stay away from this risky and over-valued asset class.
2. BONDS:  Uptrend remains intact even in the face of all the negative press that bonds have received over the past few weeks, suggesting that bonds have peaked. However, bonds' short-term peak is approaching. So if you can refinance at this rally, its a good time to do so.
3. METALS: Precious metals entered a bull market after a long bear and have a long way to go.

Let us know if you see any other interesting correlations in the market.

Portfolio Performance - May 2016

In the month of May, portfolio experienced ~5% decline while SP500 return 1.8% including dividends. Even though portfolio under-performed against the SP500, it is still up more than 9% YTD.

Portfolio's YTD performance with daily variation is shown below:

Absolute performance is just one measure of success of any portfolio. there are several other measures used by the finance industry that classify the performance of any portfolio in regards with the amount of risk taken and its correlation to the underlying stock market.

On these measures, the portfolio has outstanding returns. Portfolio's weighted average Beta is -0.05, which means that Portfolio returns are totally uncorrelated with the markets. As a result, portfolio will generate excellent Alpha because the returns are totally independent of the Benchmark returns. Secondly, the portfolio has a Sharpe Ratio of ~3. This shows that the risk adjusted returns are excellent.

Lastly, the portfolio is positioned in a way that it will benefit from upcoming market developments. For example, impact of poor May employment report and its impact of asset classes.

Please note that historical analysis has shows that the model's worst draw down was ~7%. Therefore, it means that we are close to a point where the portfolio will again start to outperform the market.

We will discuss market development in upcoming posts.