Bank of Japan and Yen

From Bank of Japan perspective, they would like Yen to decline because that was the catalyst to push Nikkei higher couple of years ago. Right now, Commitment Of Trader data (shown below) shows that the market is ripe for another decline in Yen, which means that its likely Japan will reduce interest rates further or introduce some sort of monetary stimulus.

If BoJ stimulates the market and forces a decline in Yen, we can expect a rally in the indices.

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Pre-Federal Reserves and BoJ Analysis

Sideways Action Continues

This week, so far, has been as uneventful as prior week. Yesterday, markets opened higher but then sold-off towards the end to close slightly negative. Today, markets closed slightly positive. Since last Monday, market has gone net sideways without any major directional move.

Following chart shows that today we closed at the level where we close on Sept 9th, when the world was coming to an end and DJIA had just declined ~4%

Markets are like a coiled spring. And it seems like the entire world is waiting for the Central Banks. Bank of Japan is going to announce its policy statement early in the morning, while Fed announcement will come at 2 PM.


Bank of Japan and Yen

From Bank of Japan perspective, they would like Yen to decline because that was the catalyst to push Nikkei higher couple of years ago. Right now, Commitment Of Trader data (shown below) shows that the market is ripe for another decline in Yen, which means that its likely Japan will reduce interest rates further or introduce some sort of monetary stimulus.

If BoJ stimulates the market and forces a decline in Yen, we can expect a rally in the indices.


Technology getting ready for a Break-Out

While the US markets have been going sideways, Nasdaq has traced out an inverted head and shoulders near all time highs (shown below):

These highs are 16 years old and there is vacuum above this level. If this pattern holds, we can expect a sharp rally in the near future. This rally can start in parallel with central banks announcements or it can start after a decline following Federal Reserves announcement. In any case, this is a very positive development for the market.

If Nasdaq can lead the market, we can be sure that the overall market will follow and that the recession talk will substantially subside. According to Market Classification Model, we remain in an uptrend. Uptrend typically results in rallies and market participants find reasons to be bullish even in front of negative news.


Strategy Performance

Our proprietary model has been performing very well so far this year. Even with recent 2.5 month sideways consolidation, model is up 22.1% vs 6.3% rise in SP500. We will continue to monitor the performance of this model and share updates. This model will be available for investors to replicate or invest in towards the end of the year.

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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