Realized volatility has reached an extreme low.
See the implications at Volatility Expansions Eventually Follow Periods of Low Volatility.
From an investor sentiment perspective, is this what 2017 felt like? (before the crash in 2018)
Someone asked, “From a sentiment perspective, is this what 2017 felt like?”
My observation:
VIX as a Companion for Hedge Fund Portfolios
Volatility in general, and VIX in particular, is widely thought to influence hedge fund returns. This article shows that not only is VIX negatively correlated to hedge fund returns, the correlation profile is asymmetric with the correlation being more negative in negative months for hedge funds. When hedge funds are delivering the worst quartile returns, the diversification benefit is best. Equally interestingly, when the diversification or protection is least needed, i.e. in highest quartile months, the correlation is positive. It is explored whether a small allocation to VIX can be constructively used for risk reduction or downside protection in broad based hedge fund portfolios. Standard mean variance measures suggest a static allocation of 0% to 10%, which is consistent with the common sense approach of allocation only a very small portion of the portfolio to volatility. This range, together with the mean reverting property of VIX, and the asymmetric correlation of VIX and hedge fund returns is used to explore a tactical allocation strategy that outperforms a simple static allocation of VIX or a portfolio with no VIX allocation on a risk adjusted basis, while reducing downside risks.
Read: VIX as a Companion for Hedge Fund Portfolios
Here’s What the Federal Reserve is Most Likely to do at Future FOMC Meetings
Asymmetry isn’t just about asymmetric risk/reward for asymmetric investment returns, it’s also the probability of one outcome over another when it’s skewed.
I share my latest observation of the Federal Reserve FOMC decision yesterday in the FOMC Meeting Review: Likely the Last Interest Rate Hike.
US Dollar and Gold Trend
See this observation here: US Dollar is in a Downtrend but Statistically Oversold Short-Term as Gold Turns Up
Lower Odds of a US Recession
See the note:
Using Volatility for Asymmetric Risk Reward
Volatility trading may be used for asymmetric risk/reward when the odds are in our favor.
That’s the proposition of:
When Trend Analysis and Options Positioning Collide
This observation was originally published at This is Where Trend Analysis and Options Positioning Gets Interesting
Up until now, the trend S&P 500 index has failed to break above the 4200 level.
I highlighted 4200 in yellow on the chart to point out the SPX has trended around 4200 several times over the last two years, but until this week, these higher levels were met with selling pressure. The selling pressure was enough to provide overhead resistance, selling pressure not allowing the index to move to a higher high.
Such resistance is caused by investors and traders who may have been trapped at lower prices after adding exposure around this level.
Once the index gets back to the level it tapped multiple times, those who wished they’d sold sooner (before the down-trends below 4200) sell to break even.
But that’s just one example of the thinking behind the concept of resistance from selling pressure preventing a new high breakout.
Another resistance has been a large wall of call options.
A Call Wall is the strike with the largest net call option gamma. Market maker (dealer) positioning can create some of the biggest resistance levels and holds a lot of the time when a Call Wall defines the upper boundary of the probable range.
Below is a recent example. The grey bars are a lot of call options on the SPX.
We expect the price to slow down as it reaches the Call Wall level, but it sometimes trends above it, then drifts back below within a few days. So, it takes more than a few days to confirm the wall of calls has increased to a higher level.
No market analysis is ever perfect.
It’s always probabilistic, never a sure thing.
Call Walls can have a sticky gamma effect, making it difficult for the price to break out. When market makers are long gamma, it accelerates their directional exposure favorably as the size of their positions dynamically increases when they are positioned in the right direction creating an open profit. When these designated market makers have a large profit from being positioned on the correct side of the trend, they can sell some of the underlying positions (like SPX) to get their directional exposure closer to neutral and realize a profit. That’s why market makers trade in the opposite direction of the underlying (like SPX) when they are positive gamma, and this suppresses volatility and creates a pin.
So, up until now, the large Call Wall at 4200 was hard to break out of because there are so many calls the dealers were hedging and/or taking profits as the level was reached.
This form of derivatives resistance matched up with the aforementioned technical trend resistance can create a formidable overhead supply of sellers.
The selling pressure has been enough to mute the SPX, for now.
But, looking at the SPX today, up 1.5% to 4286 as of the time of this writing, the index is pushing up and may be enough to clear out all this overhang.
What could go wrong?
There is no shortage of negative macro risks, but that’s beyond the scope of this technical observation.
Next week, the SPX will see another big test with a large number of calls set to expire.
Interestingly, today I noticed a very bullish flow into VIX options betting on a volatility expansion with VIX down to 14.80 for the first time since 2021.
Meanwhile, the VIX term structure is 11% contango between July and June, so ETFs like VXX are rolling from 16.8 to 18.7 (aka selling low, buying high) which is a headwind even if VIX spikes.
So, the stock market index is trending up and trying to print higher highs and higher lows, and implied (expected) volatility is contracting.
Can the S&P 500 gain enough momentum to keep trending up?
One way to view the directional trend is the price channel the stock index is creating. with higher lows and higher highs.
I see this and wonder if the SPX will reach the 4400 level it’s trending toward.
To see if it has enough momentum left to move up that far, I look at recent velocity.
Its relative strength suggests it could move up enough to tap the 4300 level before it starts to get overbought, but then it will be overbought.
So, 4400 may be a resistance without a flat base or ~5% correction.
Only time will tell if the Call Wall, expirations, and long-vol positioning today has more impact or if there’s enough momentum to drive it higher, but we’ll be watching to see how it all unfolds.
Mike Shell is the founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as investment advice to buy or sell any security. This information does not suggest in any way that any graph, chart, or formula offered can solely guide an investor as to which securities to buy or sell, or when to buy or sell them. Securities reflected are not intended to represent any client holdings or recommendations made by the firm. In the event any past specific recommendations are referred to inadvertently, a list of all recommendations made by the company within at least the prior one-year period may be furnished upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities on the list. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is not advice and is subject to change without notice. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations and Asymmetric Investment Returns are those of the authors and do not necessarily reflect the position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.
Bridgewater Co-CIO: The Market is Very Asymmetric Right Now
Bridgewater Associates, Inc.Co-CIO Karen Karniol-Tambour joins Positive Sum CEO Patrick O’Shaughnessy at the 2023 Sohn Investment Conference. Below is the interview she says the market is very asymmetric right now because of the asymmetry between the upside vs. the downside, and I agree.
I’ll summarize:
If the economy enters a recession, it’s very bad for stocks, and this time the Fed is unlikely to immediately respond by lowering rates since inflation is a problem. So, the downside risk is large. It’s already priced-in to the stock market, so it won’t be a big surprise. Not a lot of upside potential.
If the economy doesn’t enter a recession, the Fed will be in a tough decision point, because inflation is unlikely to come down without a recession. If the Fed doesn’t ease like it’s already price-in, the market is going to be disappointed.
It’s asymmetric because the downside potential is greater than the upside.
The interview:
Patrick O’Shaughnessy:
What do you think that prevailing valuations, let’s say, just on like the big asset classes tell us about what the market thinks is going on? Like, what does it seem like is in prices right now, if you will, as you look at S&P 500 you know, multiples or something very basic like that?
Bridgewater Co-CIO Karen Karniol-Tambour:
WellI think the stock market is telling you that there’s going to be a modest economic slowdown, a pretty contained economic slowdown, nothing like you know a significant recession or anything like that, With that slowdown alone, the Federal Reserve is going to find that sufficient to go ease from you know, 5% to 3% extremely quickly, and that its going to do that despite where inflation is today because inflation is going to go back to totally reasonable levels that they want very very quickly. You see that kind of across stock and bond pricing you know bond pricing is telling you in places to be fine we’re not there’s no inflation from anything like resembling long term and the Fed’s about to ease pretty significantly without a significant slowdown.
Where that sort of leaves you is if the market I believe is asymmetric it’s very asymmetric because it you actually get an economic slowdown; that’s obviously very bad for stocks. I don’t have to tell you that that would be you know pretty bad for stocks. But there’s really not much of a recession priced into them it would be pretty bad. Usually the way you get out of that (as I was saying) is that every time there’s a slowdown the Central Bank just comes and eases right away. Now, not only will it be much harder for them to ease because inflation’s been more a problem. Tension is there, but that easing is already priced in and so even if they do kind of bite the bullet and say “I’m not going to worry about inflation” and ease, it’s already in the market prices it’s not going to surprise the market so much.
Then, on the other hand, if the market doesn’t slow, if the economy doesn’t slow so much, if we don’t get that kind of recession if the equity prices are right that you’re not going to get a big recession and the fed’s going to be a tough spot because I don’t really see why inflation’s going to come down with no recession. You have a very very strong labor market if nothing slows and so if they don’t ease like it’s already price they’re going to be disappointing. So, every day once we hit summer the Federal Reserve doesn’t pivot and ease that’s effectively a tightening relative to what’s priced in that’s also disappointing.
That’s a lot of room for disappointment that can happen whether the economy is strong or weak.
Patrick O’Shaughnessy:
That’s all sort of like what I’ll call you know relatively near to intermediate term future how do you think about portfolio positioning in light of that general view when you know like you for a long time it’s paid to just be long risk and have a very simple portfolio because of everything you’ve discussed. How’s that different today like how would you how do you think about positioning against this asymmetric setup that you described
Karen Karniol-Tambour:
I think it’s one of the toughest times to be an investor in many years because you know as you’re saying risk assets has been so good and I think risk assets are about as unattractive as we’ve seen a very long time and they’ve and that’s we’re seeing that come to fruition they don’t just bounce back you don’t just get kind of automatic rallies no matter what so it’s a hard time to be an investor I think as an investor you have to think about diversification in a different way diversification just wasn’t that important because the one asset people hold “equities” was just the strongest outperformer and the different places investors can kind of look they can look at geographically so they can look at geographies that have less of this tension places like Japan or China where you’re in a different situation you’re not about to hit a big Central Bank tension Japanese Central Bankers are pretty excited about getting higher inflation they’ve won for a long time and it’s far from, you know, out of control.
She basically suggests U.S. stocks are overrated and Japan stocks, Emerging Markets stocks, and Gold, are underrated.
Is the Market Telling Us How to Invest Our Money for Asymmetric Investment Returns?
My latest observation:
The Market Telling Us How to Invest Our Money for Asymmetric Investment Returns
A Market Wizard on Waiting for Asymmetric Risk/Reward
“Although the cheetah is the fastest animal in the world and can catch any animal on the plains, it will wait until it is absolutely sure it can catch its prey. It may hide in the bush for a week, waiting for just the right moment.
It will wait for a baby antelope, and not just any baby antelope, but preferably one that is also sick or lame; only then, when there is no chance it can lose its prey, does it attack.
That, to me, is the epitome of professional trading.
When I trade at home, I often watch the sparrows in my garden.
When I feed them bread, they take just a little piece at a time and fly away. They keep on flying back and forth, taking small bits of bread. They may have to make a hundred stabs at a piece of bread to get what a pigeon gets at one time, but that is why a pigeon is a pigeon.
You will never be able to shoot a sparrow, it is just too fast.
That is the way I day trade.
For example, there are times during the day when I am sure that the S&P is going up, but I don’t try to pick the bottom, and I am out before it tops. I just take the mid-range where the momentum is greatest.
That, to me, is trading like a sparrow eats.
– Mark Weinstein in Schwager, Jack D.. Market Wizards, Updated: Interviews With Top Traders (p. 329). Wiley.
The market climbs a wall of worry
I Know You Want a Good Story, But Here’s the Deal on the Stock Market
That was my first idea, and “Whipsaws are Common in Bear Markets” was my third pick for the title of my latest observation, published on our main website, which you can read here: When the trends change direction, I change my direction; what do you do?
I may be indecisive about semantics, but I’m always clear about the numbers.
The U.S. Stock Market Resumes its Trend
Linear Regression Suggests Interest Rates Have Entered a New Higher Regime
In statistics, linear regression is a linear approach for modeling the relationship between variables.
Linear regression analyzes two separate variables in order to define a single relationship.
When we apply linear regression to capital market trends we are looking at price and time.
Renaissance Technologies, Considered the “Best Money Manager on Earth”, Uses Technical Indicators to Drive its Automated Trading Systems
Technical indicators get a bad rap among some groups in the quantitative trading profession, but many of the most famous profitable investment managers apply technical indicators to global markets.
Trend Following U.S. Sectors February 2023
U.S. Stock Market Trend Following Update
I just shared my latest observations of the U.S. stock market trend in U.S. Stock Market Trend Following as of February 18, 2023.
Click here to read it.
We Could Strangle the VIX!
According to Cboe, the objective of a strangle is to capture the volatility premium inbedded in option prices, but with less risk than in a straddle, another established premium capture strategy.
We shared this observation on Asymmetric Investment Returns “We Could Strangle the VIX“
Trend Following Natural Gas and Heating Oil
Nat gas, short street name for Natural Gas, has crashed since December.
I discuss it in: Trend Following Natural Gas and Heating Oil
Nothing Changes Investor Enthusiasm Like a Price Trend
Investor sentiment is trend following.
Investors get more bullish as stock prices trend up, and more bearish as the stock market trends down.
See what I mean in Nothing Like a Price Trend to Change Investor Sentiment.
Oops a whipsaw
I tend to focus on risk management in these occasional observations I share.
My focus is on risk management because that’s my edge.
If I can direct and control my possibility of loss through tactical trading decisions, then I’m left to focus on the upside of profits.
I pinned that on my wall twenty years ago when I was testing asymmetric trading systems for asymmetric risk/reward and asymmetric investment returns.
As I intensely studied the mathematical expectation of trading systems, I concluded the downside drawdown is the part I have the potential to control.
If a position is trending down, I can exit, and reduce my exposure to zero.
I could also use exchange-traded options for defined risk. ie. if I buy a call option for $5 that’s all I can lose if the position doesn’t become profitable.
I could instead place a stop loss exit $5 below the entry price for a similar effect, but the position could gap down $10, and the loss would be larger than the limited call option would have been.
These are the kind of portfolio management decisions we get to choose from as investment portfolio managers.
I discuss this more in How is trend following with a stop loss optionality similar to a call option?
Our issue at hand today is the trendline whipsaw of the stock market index.
In Stock Market Resumes Downtrend I shared the observation the U.S. stock market as measured by the S&P 500 stock index, has trended down from a lower high.
Here’s the chart:
I went on to point out the stock index wasn’t yet oversold, and the number of stocks in the 500 in an uptrend was trending down.
Trend lines aren’t magic; they’re just a general trend guide.
I wasn’t seeing heavy selling pressure, so I thought “we’ll see.”
Here’s an update. See below for the context of the numbers.
- The downtrend line for the S&P 500 is now negated as the stock market has reversed back up and the index easily trended above the trendline and broke out to the upside. This will likely drive some to call the bear market over and suggest a new bull market has begun.
- Momentum, as measured by 14-day relative strength, indicates the SPX isn’t yet overbought at 62, and I’d only consider it so above 80. Read: there’s still room to run if it wants. There will be little resistance from velocity moving too far too fast.
- The percent of SPX 500 stocks trending above their 200-day moving averages is at 67%, so 33% of the stocks could still trend up, and 67% isn’t a level I consider resistance. That is, if it were at 80% it would indicate most stocks have already trended up, so the desire to buy may be getting exhausted.
- The average true range of the past 15 days shows a visual representation that realized volatility is declining. In fact, realized vol has declined to the August 2022 level.
I’ll stop there to keep this succinct.
The bottom line is the stock market was trending down, and it’s now reversed back up into a notable uptrend.
I started with observations of risk management because no indicator is ever perfect, they’ll all imperfect.
When every new moment is unique, and we’ve never been “here” before, anything can happen.
The best we can do is define the direction of the trend and follow it, until it reaches an extreme, or reverses down.
Ironically, as the realized volatility is now as low as it was in August 2022, that’s also when I shared Whipsaw and warned I have a hunch we’re going to hear the word “whipsaw” a lot in the coming months.
For the past year, we’ve survived and thrived through a prolonged bear market that may be much longer and deeper if the U.S. economy enters a recession.
Only time will tell if the U.S. is in a recession, or if we’ll instead see the soft landing our friends at Goldman Sachs expect.
But for now, the U.S. equities trend is back up again, and the Fed’s interest rate decision next week will likely be the driver of what happens next.
I expect 2023 to be a very challenging year for macro economics, and it’ll be fun to watch.
At Shell Capital, we just want to repeat another profitable year like last year, or better.
Mike Shell is the founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as investment advice to buy or sell any security. This information does not suggest in any way that any graph, chart, or formula offered can solely guide an investor as to which securities to buy or sell, or when to buy or sell them. Securities reflected are not intended to represent any client holdings or recommendations made by the firm. In the event any past specific recommendations are referred to inadvertently, a list of all recommendations made by the company within at least the prior one-year period may be furnished upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities on the list. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is not advice and is subject to change without notice. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect the position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.
Stock Market Resumes Downtrend
The U.S. stock market as measured by the S&P 500 stock index, has trended down from a lower high.
The S&P is not yet oversold, and implied volatility is around 20%, which is the prior lows over the past year.
At the recent high, 60% of the stocks in the index were trending above their 200-day average and about 80% of the stocks were trending above their 50-day average, both of which have now turned down as an increasing number of stocks are trending down.
Trend lines aren’t magic; they’re just a general trend guide.
I’m not seeing heavy selling pressure, so we’ll see.
Mike Shell is the founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as investment advice to buy or sell any security. This information does not suggest in any way that any graph, chart, or formula offered can solely guide an investor as to which securities to buy or sell, or when to buy or sell them. Securities reflected are not intended to represent any client holdings or recommendations made by the firm. In the event any past specific recommendations are referred to inadvertently, a list of all recommendations made by the company within at least the prior one-year period may be furnished upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities on the list. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is not advice and is subject to change without notice. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect the position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.
The stock market is entering a short-term higher risk level
We’re entering a point in the stock market trend that could be an inflection point. My market risk indicators are elevated, suggesting DEFENSE, but they’re imperfect. In bear markets, we’ll see lots of whipsaws and head fakes, and OVERBOUGHT and EXTENDED can continue.
We published this observation on the Shell Capital website. To read it, see: The Stock Market is Entering an Elevated Risk Level
U.S. Sector Trend, Momentum, and Breadth Through October 2022
Our objective is asymmetric risk/reward for asymmetric investment returns; we are unconstrained as to strategy or market.
A skillful trend follower wants to catch a trend early in its stage and capitalize on it until it ends, so if we want to identify them early, we must necessarily focus on short-term trends to see if they can become longer-term trends and asymmetric profits.
With that said, in the month of October 2022, eight of the eleven sectors tracked by S&P sector indices are in the green, and three are in the red.
To read the complete observation, see U.S. Sector Trend, Momentum, and Breadth Through October 2022
Stock Market Volatility Remains Elevated
Volatility measures the frequency and magnitude of price movements, both up and down, that a financial instrument experiences over a certain period of time. The more dramatic the price swings in that instrument, the higher the level of volatility. Volatility can be measured using actual historical price changes (realized volatility) or it can be a measure of expected future volatility that is implied by option prices.
To read the full observation, see: Stock Market Volatility Remains Elevated.
Investing in stocks involves risks you must be willing to bear, or actively manage and hedge
It is widely accepted that a portfolio diversified across a number of stocks will provide an inherent return over time, that buying and holding stocks for the long term is virtuous and pragmatic, and that the longer your perspective, the lower your investment risk.
This strategy is flawed because it is based on a single set of baseline conditions and return drivers, and there is no guarantee that the future will not deviate significantly from the past.
In fact, “past performance is no guarantee of future results” is a required regulatory statement for registered investment advisors like my firm.
Year to date the widely followed S&P 500 stock index that tracks 500 stocks, fully invested, all the time, is down -25% for 2022.
In the chart, we show the index is about 9% below its 50-day average and 14% below the 200-day average. These simple trend-following indicators have signaled defense most of the year, and you can see the red when they’re underwater.
Though it’s oversold on a short-term basis and could see some countertrend follow-through from yesterday’s radical swing, the primary trend is clearly down. So, we declined to participate in its descent like a passive investor does.
Investments and markets require active risk management to avoid larger losses and to create the positive risk-adjusted investment returns people want.
Active risk management and hedging aren’t a sure thing, either, but for me, it’s far better than just sitting there doing nothing.
You can probably see why I’ve preached active risk management and dynamic hedging for drawdown control for over two decades.
More importantly, I’ve done it.
Investing involves risks of loss you must be willing to bear, or actively manage and hedge.
All our endeavors involve some degree of risk, but we all get to tactically decide which risks we want, and which we prefer to hedge off.
Check out our new website, which is a work in progress. We’ll eventually transfer these observations to the new site. https://shell-capital.com/
Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as investment advice to buy or sell any security. This information does not suggest in any way that any graph, chart, or formula offered can solely guide an investor as to which securities to buy or sell, or when to buy or sell them. Securities reflected are not intended to represent any client holdings or recommendations made by the firm. In the event any past specific recommendations are referred to inadvertently, a list of all recommendations made by the company within at least the prior one-year period may be furnished upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities on the list. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is not advice and is subject to change without notice. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect the position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.
Whipsaw
A whipsaw in trading and investment management is when you enter a trend and it almost immediately reverses in the other direction, resulting in a loss.
Whipsaws are a normal part of any trend system because trends do reverse, and sometimes sooner than you expect.
In The stock market trend is being tested I said,
“The breadth thrusts we’ve seen are typical of a new uptrend — unless* it’s a prolonged bear market. *IF this is the early stage of a prolonged bear market that is likely accompanied by a recession, then we’ll see many swings like this as it unfolds along the way.”
The stock index and the most weighted sectors like technology and consumer discretionary are very close to breaking price levels that should be short-term support.
Any further decline will increase the odds the U.S. is in the early stage of a prolonged bear market, which will include many swings up and down of 10 to 20% lasting several weeks.
Such swings lead to whipsaws for many tactical traders as they enter just in time to catch the top, and/or sell just in time the trend reverses in the other direction.
I’ve tactically operated through this many times before over more than two decades, and I’ve historically shown my edge during these conditions.
I have a hunch we’re going to hear the word “whipsaw” a lot in the coming months, so let’s go ahead and kick it off with The Whipsaw Song I had fun with back in April 2008 when Ed Seykota published it.
Give it a listen!
Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as investment advice to buy or sell any security. This information does not suggest in any way that any graph, chart, or formula offered can solely guide an investor as to which securities to buy or sell, or when to buy or sell them. Securities reflected are not intended to represent any client holdings or recommendations made by the firm. In the event any past specific recommendations are referred to inadvertently, a list of all recommendations made by the company within at least the prior one-year period may be furnished upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities on the list. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is not advice and is subject to change without notice. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect the position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.
The stock market trend is being tested
The stock market is now reaching its first short-term higher probability of a countertrend pullback.
The S&P 500 stock index tapped its 200-day average and reached a short-term overbought level based on relative strength and volatility and is now stalling.
The S&P 500 Equal Weight, which gives an equal weighting to all 500 stocks instead of more exposure to the largest companies based on capitalization, crossed above its 200-day average but was reaching an overbought level at the same time.
So, it’s not surprising to see these market proxies roll over at this level.
Two weeks ago I pointed out in The stock market is at an inflection point the S&P 500 was stalling as if there is resistance at this price level, and there’s a lot of potential supply for those in a loss trap, and it was getting overbought as measured by the relative strength index. The index trended up a few more percent before pulling back today.
I don’t normally trade the S&P 500 index, I just use it as a proxy for the overall stock market.
For portfolio management, I get more granular into the sectors inside, and the stocks.
I also include global markets like commodities, bonds, and other alternatives, to provide a global unconstrained opportunity set to find potentially profitable trends.
Trend systems just want to be fed some trends, so the system can extract the parts it wants from the parts it doesn’t want. It’s best to provide a wide range of uncorrelated price trends for trend systems to create a unique return stream from them.
From the broad index like the S&P 500 it’s useful to look inside to see the percentage of stocks that are trending above their 50-day and 200-day averages to gauge the strength of participation in the uptrend.
The percent of S&P 500 stocks trending above the 50-day average has quickly trended up to the red zone.
The breadth thrusts we’ve seen are typical of a new uptrend — unless* it’s a prolonged bear market. *IF this is the early stage of a prolonged bear market that is likely accompanied by a recession, then we’ll see many swings like this as it unfolds along the way.
However, once most stocks are already in uptrends, the enthusiasm to buy may have run out, so I consider the level above 80% to be a higher risk zone. If we are looking for a lower risk entry, it’s below 30%. A strong breadth thrust like this is bullish when it starts and is typical off the lows after stocks have already trended down as much as they have.
At this point, despite the S&P 500 being down 1.5% today, it appears to be a normal pullback from overbought levels. Our relative strength index signals the index was moving up with such velocity it was a little too far, too fast, which is good in the longer term but increased the odds of a retrench in the short term.
I reduced exposure earlier this week, and the price action next week will determine if we reduce further or buy the dip at lower prices.
In the big picture, we’re strolling into the seasonally weakest month for the stock market after a big rally and no shortage of risks to the short-term uptrend, so it’s essential to determine an exit, hedge, or reduce exposure.
On the positive side, the recent decline in volatility and new uptrends suggest systematic trend-following investment programs could provide inflows of several billion dollars a day in stocks for the next few months if it continues.
While everyone else is trying to figure out what’s going to happen next with inflation, rates, and other global macro issues, we focus on keeping our hard-earned capital invested in the direction of the trend.
If the trends change, so will we.
Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as investment advice to buy or sell any security. This information does not suggest in any way that any graph, chart, or formula offered can solely guide an investor as to which securities to buy or sell, or when to buy or sell them. Securities reflected are not intended to represent any client holdings or recommendations made by the firm. In the event any past specific recommendations are referred to inadvertently, a list of all recommendations made by the company within at least the prior one-year period may be furnished upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities on the list. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is not advice and is subject to change without notice. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect the position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.
The stock market is at an inflection point
The S&P 500 is stalling as if there is resistance at this price level, and there’s a lot of potential supply for those in a loss trap.
It’s also getting overbought as measured by the relative strength index.
The yellow horizontal highlight denotes the price range with the most volume, which you can see in the Volume by Price bars on the right which show the volume at each price level that could be support or resistence.
At the current price level, you can see the yellow highlighted area is the price range of the highest volume of the past three months.
In February, the SPY declined and found support, or buying demand, at this level. Afterward, it trended up before trending down to this level again and once again was met with enough buying enthusiasm to hold it for several days, then the support failed and the S&P 500 Index ETF declined.
At that point, those who bought earlier at higher prices around the price level or higher carried a loss.
In May the stock market trended up against but selling pressure dominated and the index once again trended sideways for several days of indecision before finally breaking down in a waterfall decline for several days.
The stock market finally got oversold again and investor sentiment was extremely bearish, and it’s since climbed a wall or worry.
Now the price has trended up to this price level again that has been both support and resistance in the past three months and it seems to be stalling.
Today started off strong, up 1% or more, only to fade by the end of the day.
The stock market is at an inflection point.
If the stock market gets enough buying demand to keep prices trending up this bear market could be over sooner than later. However, with the Federal Reserve increasing interest rates because the annual inflation rate in the US has accelerated to 9.1% and economic growth is slowing, if the US is in a recession, as noted in “Bear Markets with an Economic Recession Last Longer and are More Severe” bear markets typically last much longer and trend down more.
Investors should be cautious this may not be over yet, and far from it.
We’ll see, and probably sooner than later.
The inflation report this week may be a market mover.
Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as investment advice to buy or sell any security. This information does not suggest in any way that any graph, chart, or formula offered can solely guide an investor as to which securities to buy or sell, or when to buy or sell them. Securities reflected are not intended to represent any client holdings or recommendations made by the firm. In the event any past specific recommendations are referred to inadvertently, a list of all recommendations made by the company within at least the prior one-year period may be furnished upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities on the list. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is not advice and is subject to change without notice. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect the position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.
Every new price trend begins with a countertrend
Every new price trend begins with a countertrend, and that’s true for uptrends that roll over into downtrends and downtrends that reverse into uptrends, so trend following starts with a countertrend.
Technology-weighted Nasdaq 100 changed the short-term trend, breaking out above its 50-day average, now in a short-term uptrend.
Past performance is never a guarantee of future performance, but if the Nasdaq uptrend follows through, it’ll need to trend up more than 12% to trade above the longer-term 200-day average.
Nasdaq meets first overhead supply as potential resistant around 13,000.
All the areas above current prices are the hurdle of a trend trying to recover from losses.
Why?
Because many investors and traders may be trapped in losses around those prior lows and highs, the price levels attracted much historical trading.
Many tactical traders mistakenly claim resistance “is” at these levels, but we don’t know if there is resistance to further prices trending up until the price range is reached.
If a price trend reaches a level and reverses back, then we know there was “resistance” to that price level, which means there was selling pressure once the price got to that higher level.
Only time will tell if that is the case here, but we’ll be watching to see if new uptrends are met with selling prior price levels of interest, then we’ll know how much trouble these trends will have trending up into areas investors may have wished they had sold before taking on heavy losses.
To see what I mean, the Nasdaq 100 index was down -33% year to date a few weeks ago, and after a series of higher lows and higher highs (an uptrend) it’s still down -25%.
If you were invested in the Nasdaq type investment this year, or a portfolio of similar stocks, you’ve been in a loss trap.
As prices trend back up, trapped holders may start to tap out, although others may hold on until they get back to breakeven.
This is the kind of price action we’ll observe unfold from here to see which market dynamics are more dominant.
Overhead supply of shares wanting to be sold becoming at least some pressure as resistance is why price trends look so rough and volatile after a downtrend.
At every level the trend reaches, other investors and traders are deciding to buy, hold, or sell.
It’s what makes a market.
For now, we have an uptrend in enough of the high-growth stocks as measured by the Nasdaq 100 index to clear the 50-day average, so no resistance there.
Every new price trends begin with a countertrend and a follow-through.
Let’s see how it goes from here.
Giddy up!
Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as investment advice to buy or sell any security. This information does not suggest in any way that any graph, chart, or formula offered can solely guide an investor as to which securities to buy or sell, or when to buy or sell them. Securities reflected are not intended to represent any client holdings or recommendations made by the firm. In the event any past specific recommendations are referred to inadvertently, a list of all recommendations made by the company within at least the prior one-year period may be furnished upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities on the list. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is not advice and is subject to change without notice. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect the position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.
After Selling Pressure Drives Stock Price Trends to a Low Enough Level, We’ll See Sentiment Shift
Once the stock market catches a break and trends up enough, we’ll probably see short covering keep it going for a while.
The percent of stocks trading above their 50 and 200 day averages is a useful signal of market breadth to gauge the participation in uptrends and downtrends.
I’ve been monitoring these statistical measures of trend and momentum for more than two decades, and long concluded after most stock prices have already trended up, I start to wonder where the next demand will come from to keep the uptrend going.
After prices have already fallen to an extremely low level, it starts to signal those who want to sell may have already sold.
But, it takes falling prices to drive the downtrend to a low enough point to attract long-term value investors as stock prices get cheaper and cheaper, to them.
At this point, below is the percent of S&P 500 stocks trading above their past 200-day average. We see only about 19% of the stocks in the S&P 500 are in intermediate-term to longer-term uptrends.
Can it get worse? Can stocks trend lower? and more stocks trend lower?
Yes, it can.
A visual of the same chart above in logarithmic scale helps to highlight the lower end of the range.
In October and November 2008 only 7% of stocks were in uptrends.
In March 2020 only 10% of the S&P 500 stocks were in uptrends.
Keeping in mind the stock index has some exposure to sectors considered to be defensive like utilities, REITs, and consumer staples, it took a serious waterfall decline like -56% in 2008 to shift most of the 500 stocks into downtrends.
The point now is, that about 80% of stocks in the S&P 500 index are already in downtrends and at some point, the selling will dry up and new buying demand will take over.
I’m seeing other evidence that correlates with these price trends.
According to the investment bank Deutsche Bank, there’s a record short in equity futures positioning of asset managers. That means investment managers have high short exposure, hoping to profit from falling prices, or at least hoping to hedge off their risk in stocks they hold.
Goldman Sachs is the prime broker for many hedge funds and investment managers, including my firm, and Goldman Sachs reports long positioning aiming to profit from uptrends in stocks is off the chart.
Once the stock market catches a break and trends up enough, we’ll probably see short covering keep it going for a while.
This doesn’t suggest we buy and hold passively, but it suggests stocks have already declined into downtrends and big institutional money is positioned for further declines, so we have to wonder who is going to keep selling stocks?
Economics 101 is what drives prices, and that’s supply and demand.
There’s been a supply of stock selling that has been dominant over the desire to buy, so prices are in downtrends.
This is when I am looking for the negative sentiment to change.
Last week I shared my observations of fundamentals in Fundamental Valuation: Is the Stock Market Cheap or Expensive? and more granular that some important sectors have reached undervalued status according to CRFA in Are Growth Sectors Technology, Consumer Cyclicals, and Communication Services more Undervalued than Value?.
But the big risk for long-term investors who passively hold stocks, index funds, or mutual funds is I showed in Bear Markets with an Economic Recession Last Longer and are More Severe that if we are in a recession, this bear market will likely eventually get much deeper.
You can probably see why are Shell Capital, we row, not sail, when the wind stops blowing in our preferred direction.
Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as investment advice to buy or sell any security. This information does not suggest in any way that any graph, chart, or formula offered can solely guide an investor as to which securities to buy or sell, or when to buy or sell them. Securities reflected are not intended to represent any client holdings or recommendations made by the firm. In the event any past specific recommendations are referred to inadvertently, a list of all recommendations made by the company within at least the prior one-year period may be furnished upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities on the list. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is not advice and is subject to change without notice. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect the position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.
Inflation is Declining According to this Trend Analysis of Commodities
In economics, inflation is an increase in the prices of goods and services in an economy.
When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduction in the purchasing power of money.
You may not see the value of your money change online like you do with your investment fund values changing daily, but it’s changing.
Inflation is a real risk for everyone, but it’s worse for people who have their money earning a low rate of interest at a bank or another low-yield fixed asset.
If someone believes they are being a “conservative investor” by investing money in an interest-bearing bank account, it’s only because the bank statement doesn’t show the real value of money after inflation.
The latest inflation report shows U.S. Inflation is 9%, three times higher than the long-term average of 3.25%, so if someone is only earning 3% on a CD, the value of their money is 6% less than it was.
That is, they “lost” 6% of buying power.
But that’s not the main point of this observation, it’s just one of many reasons the trend in prices is important.
The US Inflation Rate is the percentage a chosen basket of goods and services purchased in the US increases in price over a year. Inflation is one of the metrics used by the US Federal Reserve to gauge the health of the economy. Since 2012, the Federal Reserve has targeted a 2% inflation rate for the US economy and may make changes to monetary policy if inflation is not within that range. A notable time for inflation was the early 1980’s during the recession. Inflation rates went as high as 14.93%, causing the Federal Reserve led by Paul Volcker to take dramatic actions.
As an investment manager applying trend systems to global markets, I see it much more granular. I’m applying computerized trend systems to a wide range of global currencies, commodities, stocks, and bond markets, so I see the directional trend changes and shifts in momentum. Although I’ve automated the process of monitoring all these global markets, I still like to review the pictures as charts to see what is going on.
I ranked the S&P GSCI Indices by short-term momentum to see which are trending up the most, so we’ll start there.
I think it’s well known that many commodities markets had been trending up this year, but as we’ll see, many of these markets are now in downtrends.
I’ll share these trends in a way that makes it obvious that commodities aren’t just tradable markets, but they impact all of us, and commodities are interconnected. For example, the price of soybeans impacts livestock.
The S&P GSCI Feeder Cattle Index provides investors with a reliable and publicly available benchmark for investment performance in the feeder cattle market. S&P GSCI Feeder Cattle Index is in an uptrend as defined by above the 50 and 200-day moving averages. In fact, in the lower two frames, I include the percent above or below the 50 and 200-day average, and Feeder Cattle is about 5% above its 50-day average and 8% above its 200-day average price.
Feeder Cattle is the strongest uptrend over the past three months. It only gets worse from here.
S&P GSCI All Cattle Index is a broader basket of cattle, and it too is in an uptrend after breaking out of a multi-month base.
Live Cattle represented by S&P GSCI Live Cattle Index looks very similar, and is an uptrend, but not an all-time new high as it’s still below the February high.
Here’s where the weakness in these commodities trends begins. The S&P GSCI Gas Oil Index is in an intermediate-term uptrend; It’s 20% above the 200-day average. But the recent decline pushed it 6% below the 50-day average. The Gas & Oil index is in a primary uptrend, but short-term pullback. Longer-term trends begin with a shorter-term trend, so we’ll see how it trends from here.
Heating oil is represented by the S&P GSCI Heating Oil Index. Like gas and oil, it’s in a primary uptrend, but a short-term downtrend.
Now we’re getting into commodities with a negative price momentum over the past 3 months.
S&P GSCI Sugar Index is in a non-trending, volatile period over the past year, and it’s right at the 50 and 200-day average.
The S&P GSCI Livestock Index, a sub-index of the S&P GSCI, provides investors with a reliable and publicly available benchmark for investment performance in the livestock commodity market. Livestock is another market that’s lost its upward momentum over the past three months, and one to watch for a breakout.
S&P GSCI Natural Gas Index is in a primary uptrend, but recent downtrend in the short term. It tapped its 200-day average and is trending back up, but nearly 7% below where it was three months ago.
I ranked these trends by three-month momentum, so all of the commodities up to this point were outperforming the broad commodity index we know as S&P GSCI Total Return Index. My three-month momentum ranking is completely arbitrary, but it signaled many of these trends had changed recently.
The S&P GSCI Total Return Index is in a primary uptrend as defined by a level above its 200-day average, but it’s in a downtrend since it peaked in June.
S&P GSCI Total Return Index is what many global macro asset managers managing global macro hedge funds use as a benchmark for commodities, so the rest of these trends are more granular looking inside this broader index made up of these other indices.
S&P GSCI Energy Index is in a primary uptrend but has declined materially over the past month.
S&P GSCI Unleaded Gasoline Index is a big one that impacts Americans and our personal economy. S&P GSCI Unleaded Gasoline Index is in a primary uptrend but has corrected a lot these past five weeks. Once again, we see a commodity trend tapping the 200-day moving average, so a breakout below it will signal a changing primary trend.
Coffee is in a downtrend. S&P GSCI Coffee Index is below the 50 and 200 average, signaling it’s in both a short-term and intermediate-term downtrend. This may help explain why Latin American countries like Brazil’s stock index is down, too. Latin America makes a lot of the world’s coffee.
Unless you’re a long/short commodity trader like a CTA trend follower who aims to capitalize on these downtrends as much as the uptrends, this is one of the rare times downtrends are something to cheer on.
S&P GSCI Crude Oil Index is in a short-term downtrend, but a primary uptrend.
Meanwhile, S&P GSCI Cocoa Index is in a downtrend across both time frames.
Hey Crude, as in Brent Crude. We have a downtrend in S&P GSCI Brent Crude Index over the short run after a volatile non-trending period.
An interesting Intermarket analysis this year has been the trend in Gold. Gold is seen by many market participants as a store of value and a safe haven, but S&P GSCI Gold Index is in a downtrend after a sharp uptrend around March. You can probably see how applying multiple time frames can be useful in observing these trends.
By and large, the metals like precision metals are in downtrends.
S&P GSCI Platinum Index is in a downtrend.
Soft commodities, or softs, are commodities such as coffee, cocoa, sugar, corn, wheat, soybean, fruit and livestock. The term generally refers to commodities that are grown, rather than mined. You can see how some of the commodity markets tracked by indices are very granular focused on one single market trend, and others are a basket of commodities within a sector.
S&P GSCI Softs Index has shifted from a quiet uptrend to a volatile downtrend.
A biofuel is any fuel that is derived from biomass, that is, plant or algae material or animal waste.
After an uptrend breakout around March, S&P GSCI Biofuel Index has trended back to the same level it started.
Some of the most common products produced with soybeans are tofu, soy milk, soy sauce, and soy flour. Approximately 85% of soybeans grown around the world are used to make vegetable oils that are either sold to consumers or used commercially according to The Spruce Eats. The USDA says “Just over 70 percent of the soybeans grown in the United States are used for animal feed, with poultry being the number one livestock sector consuming soybeans, followed by hogs, dairy, beef and aquaculture.”
You can probably see how interconnected all this stuff is.
S&P GSCI Soybeans Index is in a downtrend after an uptrend started at the beginning of this year. Hopefully, this lower animal feed cost will help lower the prices of the livestock that are in uptrends.
Lead is still widely used for car batteries, pigments, ammunition, cable sheathing, weights for lifting, weight belts for diving, lead crystal glass, radiation protection and in some solders, according to RSC.org.
S&P GSCI Lead Index is in a downtrend, so I guess we’ll eventually see the price of ammo and car batteries decline, too. Overall, lead has been a non-trending volatile market the past year, but it’s now more decisively in a dowtrend.
Lean Hog is a type of hog (pork) futures contract that can be used to hedge and to speculate on pork prices.
S&P GSCI Lean Hogs Index has trended into a downtrend, so your bacon price may improve.
Palladium is one of a number of metals starting to be used in the fuel cells to power things like cars and buses as well as in jewelry and in dental fillings and crowns.
S&P GSCI Palladium Index is in a downtrend.
Grains are used around the world and are also called cereals, and are the most important staple food. According to NatGeo, humans get an average of 48 percent of their calories, or food energy, from grains. Grains are also used to feed livestock and to manufacture some cooking oils, fuels, cosmetics, and alcohols.
S&P GSCI Grains Index is in a downtrend after it broke up with momentum going into this year. If you like to eat and drink alcohol, this is great news as it seems the prices should drift back to where they were.
Wheat is used for white bread, pastries, pasta, and pizza, so this downtrend in S&P GSCI Wheat Index is a welcome change.
Dr. Copper is market lingo for the base metal that is reputed to have a “Ph. D. in economics” because of its ability to predict turning points in the global economy.
S&P GSCI Copper Index is in a strong downtrend, so if its reputation holds true, the Ph. D. in economics suggests a global economic slowdown is ahead.
The Royal Society of Chemistry says aluminum is used in a huge variety of products including cans, foils, kitchen utensils, window frames, beer kegs and airplane parts.
If the trend in S&P GSCI Aluminum Index is a guide, the price of your next beer keg or airplane should drift lower. Aluminum is in a downtrend.
Industrial Metal alloys are known for their strength, durability, and corrosion resistance, so engineers, architects, and others in the industrial field use these alloys to construct buildings, wires, pipes, bridges, machines, and much more according to Wieland.
S&P GSCI Industrial Metals Index shows industrial metals are in a downtrend with great momentum.
Industrial metals are down so much I’ll show a two-year chart to see the price is back to 2020 levels.
Last but not least is cotton. I think we all know what cotton is used for. The price of clothes should see some decline with S&P GSCI Cotton Index in such a downtrend.
What we’ve observed is many commodity markets were in uptrends, but have more recently trended down. Not all of these necessarily impact the Consumer Price Index, but we certainly use most if not all of them one way or another.
Commodities are real “stuff”, and the prices of much of this stuff are no longer as elevated as it was. If this flows into lowering prices of the stuff we buy, then we’ll see inflation fall from here.
If inflation trends down from here, it’ll be positive for stocks and bonds and may result in the Federal Reserve pausing its aggressive interest rate hikes.
Now you know why we aren’t long commodities at this point.
Investor sentiment (about stocks) is so negative right now, that any slight improvement in inflation may spark an uptrend, then the extremely bearish positioning may drive short covering to keep the trend going a while.
Let’s see how it all unfolds.
Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as investment advice to buy or sell any security. This information does not suggest in any way that any graph, chart, or formula offered can solely guide an investor as to which securities to buy or sell, or when to buy or sell them. Securities reflected are not intended to represent any client holdings or recommendations made by the firm. In the event any past specific recommendations are referred to inadvertently, a list of all recommendations made by the company within at least the prior one-year period may be furnished upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities on the list. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is not advice and is subject to change without notice. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect the position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.
Bear Markets with an Economic Recession Last Longer and are More Severe
Bear markets that occur in economic recessions last longer and are more severe than bear markets without an economic recession.
The non-recession bears are clustered in the upper left quadrant (lower decline, recovered sooner) and the big bear markets with recession are red dots.
Source: NDR
Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as investment advice to buy or sell any security. This information does not suggest in any way that any graph, chart, or formula offered can solely guide an investor as to which securities to buy or sell, or when to buy or sell them. Securities reflected are not intended to represent any client holdings or recommendations made by the firm. In the event any past specific recommendations are referred to inadvertently, a list of all recommendations made by the company within at least the prior one-year period may be furnished upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities on the list. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is not advice and is subject to change without notice. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect the position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.
Are Growth Sectors Technology, Consumer Cyclicals, and Communication Services more Undervalued than Value?
Growth sectors like technology, consumer cyclical, and communications have seen the brunt of the selling this year, and growth is now more “undervalued” than value sectors per CFRA.
According to CFRA: Stocks are ranked in accordance with the following ranking methodologies. Qualitative STARS recommendations are determined and assigned by equity analysts, with 5 being the highest rating.
But as stated in Fundamental Valuation: Is the Stock Market Cheap or Expensive? undervalued stocks can get much more undervalued (prices fall more) in a recessionary bear market.
Risk management is essential in bear markets.
For example, the S&P 500 is down about -23% so far and needs a 30% gain to get back to the prior high.
Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as investment advice to buy or sell any security. This information does not suggest in any way that any graph, chart, or formula offered can solely guide an investor as to which securities to buy or sell, or when to buy or sell them. Securities reflected are not intended to represent any client holdings or recommendations made by the firm. In the event any past specific recommendations are referred to inadvertently, a list of all recommendations made by the company within at least the prior one-year period may be furnished upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities on the list. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is not advice and is subject to change without notice. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect the position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.
Systematic Put Protection Hedging Strategies Have Struggled or Failed in this Bear Market
During the waterfall decline in March 2020, the Cboe S&P 500 5% Put Protection IndexSM (PPUT) successfully hedged off stock market beta, but it hasn’t done the same in 2022.
The green highlight shows the Cboe S&P 500 5% Put Protection IndexSM in black and S&P 500 stock index in red. Clearly, the systematic put protection index helped to hedge off downside risk in the SPX during the waterfall decline of March 2020, but that same hedge hasn’t protected long beta portfolios in 2022.
Cboe S&P 500 5% Put Protection IndexSM (PPUT) tracks the value of a hypothetical portfolio of securities (PPUT portfolio) designed to protect an investor from negative S&P 500 returns. The PPUT portfolio is composed of S&P 500® stocks and of a long position in a one-month 5% out-of-the-money put option on the S&P 500 (SPX put).
Let’s see what happened over these two very different outcomes, and I’ll share my observations of what changed that impacted the outcomes.
Using data from YCharts, we see the full year 2020 in the chart comparing the S&P 500 Total Return Index (SPX) to the Cboe S&P 500 5% Put Protection IndexSM (PPUT) which is long the SPX, but adds one-month 5% out-of-the-money put option on the S&P 500 (SPX puts) options to hedge.
For the systematic put hedge strategy, 2020 was a fine example of risk management resulting in not only drawdown control, but also how avoiding large losses can increase the portfolio return in some conditions.
The S&P 500 declined over -30% around March 2020 as COVID spread, but the 5% SPX put lowered the drawdown to -16.52%.
That’s asymmetry and a key part of creating asymmetric investment returns.
The 5% put hedging strategy limited the downside by 50%, then went on to allow the long-only exposure to the S&P 500 to nearly double the stock index.
This is what I look for in the pursuit of asymmetric payoffs to produce asymmetric returns.
Naturally, the incredible performance of this very simple systematic hedging strategy tracked by PPUT got some attention after it performed so well. But, no method is perfect, and all strategies are fallible.
Fast forward to 2022, and the outcome has been completely different. Investors and traders who relied on a 5% monthly put option have fully participated in the downside of the SPX this year.
This phenomenon has driven many to ask, why such a radically different outcome?
I’ll attempt to explain my observations as succinctly as possible because understanding derivatives like options is the most complex task in the capital markets for most people.
For more than two decades, I’ve focused on alternative trading strategies in pursuit of asymmetric payoffs that lead to asymmetric investment returns.
Asymmetry isn’t just about finding low-risk positions that offer a higher expected payoff, like a 2-to-1 reward to risk.
Instead, asymmetry is even more focused on limiting the downside in hopes to avoid the negative asymmetry of loss.
Losses compound against us exponentially the deeper we allow losses to get.
So, my focus has been actively trading momentum growth stocks, tactically trading more systematically a global universe of ETFs, and volatility trading/hedging, all of which are unconstrained in my primary portfolio.
So, I have a unique perspective on this topic.
The short and sweet answer to why this time was so different than 2020 is a function of these issues.
- During the waterfall decline of March 2020, prices spread out (to the downside) very quickly. It was one of the sharpest waterfalls in history. When prices spread out, I call it a volatility expansion, and rising vol increases the premium for options. For the same reason, the VIX spiked to > 80 in March 2020, but it’s been constrained under 40 so far in 2022.
- This year, the stock indices have declined over -20%, but it’s been a much slower grind down. SPX is down about -20% over six months instead of down over -30% in three weeks. The speed of prices spreading out is volatility, and volatility is a significant driver of option premiums. Think of it this way: home insurance in Florida is expected to be cheaper before a catastrophic hurricane when people are complacent than after the hurricane does its damage. The good news is, that options pricing allows for better timing of relative value if you have a system for it.
- Another difference is the luck of roll and expiration dates for this systematic strategy that executes about every 30 days. My friend Russell Rhoads, who is one of the most well-known VIX experts, pointed out to me that the ability to use a series that expires on days that don’t contribute to the VIX calculation would have been helpful this year. That is, the systematic strategy of buying 30-day SPX put options has the potential to fall on days that aren’t efficient. The roll is a risk.
- Finally, we believe most institutional money managers were already hedged. This has been a long drawn-out decline, a lower vol downtrend, so it’s given time for money managers to add protection, so demand for puts hasn’t been a spike, but instead more methodical.
The bottom line is the asymmetric volatility phenomenon has impacted the put option hedging strategy.
The asymmetric volatility phenomenon suggests that prices trend down faster and sharper than they trend up, which can be an advantage of put option hedging, or a disadvantage when it’s calmer like this year.
All of the above has also kept the VIX below 40 this year.
Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as investment advice to buy or sell any security. This information does not suggest in any way that any graph, chart, or formula offered can solely guide an investor as to which securities to buy or sell, or when to buy or sell them. Securities reflected are not intended to represent any client holdings or recommendations made by the firm. In the event any past specific recommendations are referred to inadvertently, a list of all recommendations made by the company within at least the prior one-year period may be furnished upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities on the list. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is not advice and is subject to change without notice. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect the position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.
Fundamental Valuation: Is the Stock Market Cheap or Expensive?
For me, and everyone else even if they don’t realize it, the price trend is the final arbiter.
For more than two decades, I’ve focused my efforts on developing systems to identify trends early in their stage to capitalize on trends as they continue and exit a trend if it reverses.
It all started in business school, where I earned a Bachelor of Applied Science degree in advanced accounting. It was “advanced” because I took the extra advanced classes above a typical accounting major required to sit for the CPA exam in Tennessee. It basically results in a master’s in accounting, but not really, but it’s just the same 150 credit hours.
I rarely speak of my formal college simply because I haven’t considered it a source of edge for investment management.
But maybe it has.
In some conversations recently, people have asked about my background and how I got started as an investment manager and founder of an investment firm. After further review, I’ve come to realize the knowledge I have of financial statements, and the vast details and fundamental information that make them up, is what drove me to observe very little of it really drives the market price in an auction market.
That’s something I’ve always believed, but it occurred to me during business school.
To be succinct; I very quickly discovered undervalued stocks are trading at a cheap multiple of earnings for a reason, and that’s more likely to continue than to reverse.
I didn’t have a lot of capital to play with, and it was hard earned capital. I worked as a Sheriffs’ Officer full time through college fully time, so it took me a few extra years to complete. I wasn’t about to lose too much of what I had in the stock market, so I aimed to cut my losses short early on.
I’ve focused on cutting my losses short ever since, so now I have about 25 years experience as a tactical trader with an emphasis on the one thing I believe I can best limit or control; the downside of my losers.
When I focus on limiting the downside of loss, I am left to enjoy the upside of gains.
But we can’t do that with fundamentals and valuation. Risk can only be directed, limited, managed, and controlled, by focusing on the price trend.
The price trend is more likely to continue than to reverse, as evidenced even by vast academic studies of momentum.
Because a price trend is more likely to continue than to reverse, it’s essential to realize if you attempt to buy stocks that are in downtrends, you’ll likely experience more downtrend.
So, buying what you perceive are “undervalued” stocks is like catching a falling knife they say.
I’d rather wait for the knife to fall, stab the ground or someone’s foot, then pick it up safely.
Knives a dangerous, and up close, even more dangerous than a gun, so govern yourself accordingly.
Nevertheless, the valuation of stocks and overall valuation of the market by and large can be useful to observe at the extremes in valuation.
The chart below tells the story based on Morningstar’s fair value estimates for individual stocks.
The chart shows the ratio price to fair value for the median stock in Morningstar’s selected coverage universe over time.
- A ratio above 1.00 indicates that the stock’s price is higher than Morningstar’s estimate of its fair value.
- The further the price/fair value ratio rises above 1.00, the more the median stock is overvalued.
- A ratio below 1.00 indicates that the stock’s price is lower than our estimate of its fair value.
- The further it moves below 1.00, the more the median stock is undervalued.
It shows stocks are as undervalued as they were at the low in 2011, nearly as undervalued stocks were March 2020, but not as undervalued as stocks reached in the 2008 stock market crash when the S&P 500 lost -56% from October 2007 to March 2009.
If I were to overall a drawdown chart of the stock index it would mirror the undervalued readings in the chart.
As prices fall, stocks become more undervalued by this measure.
My observation is by and large stocks are relatively undervalued, but they can get much more undervalued if they haven’t yet reached a low enough point to attract institutional buying demand.
To be sure, in 2011 when stocks were as undervalued as Morningstar suggests they are now, the stock index had declined about -19%, similar to the current drawdown of -23%.
The waterfall decline in stock prices March 2020 was -34%, although it recovered quickly in a v-shaped reversal, so it didn’t get as much attention as the current bear market which is down 10% less, but has lasted for seven months without a quick recovery.
Time allows the losses to sink in for those who are holding their stocks.
This time the average stock is down much more than the stock indexes, too, so if you’re holding the weakest stocks your drawdown is worse than the index.
In that case, you’re probably wondering how low it can go.
If stock prices haven’t yet be driven down to a low enough level to attract big institutional capital to buy these lower prices, stocks can certainly trend down a lot lower from here.
For example, in the 2007 – 2009 bear market known as the 2008 Financial Crisis, one I successfully operated through as a tactical trader and risk manager, the stock index dropped -56% over 16 grueling months.
The infamous 2008 crash included many swings up and down on its way to printing a -56% decline from its high in October 2007.
That’s how bad it could get.
It’s also largely the cause of the situation the U.S. finds itself in today.
Since the 2008 Global Financial Crisis, the U.S. Treasury and Federal Reserve Open Market Committee have provided unprecedented support for the equity market and the bond market.
Passive investors and asset allocators have been provided a windfall from the Fed and Treasury, but it’s time to pay the debt.
For passive investors, they’ve been hammered with large losses this year and risk losing more if stock and bond prices keep trending down.
Stocks are already undervalued, but they can get much more undervalued.
Even worse, as my experience tactically operating through many declines like this since the 1990s reflects, are the paranna bites along with the shark bites.
The shark bite is from a passive asset allocator holding on through a prolonged deep bear market in stock prices as they fall -20%, -30%, -40%, -50% or more.
Because losses are so asymemtric and geometically compound aginast you, these capital losses become harder and harder to recover from.
If you lose -50%, it takes a 100% gain to get it back.
Stock market trends are asymmetric; they trend up much lower than they crash down, so that larger gain needed often takes longer, too.
So your emotional capital is at risk.
When you’re down a lot, you’re thinking and decision-making becomes cloudy and stressed because you[‘re under pressure like a pressure cooker.
You don’t know how low it can go.
If you are a buy and hold asset allocator, your loss is unlimited, as there is not point in which you would exit but zero.
Zero may be unlikely, but -50% or more isn’t, as evidenced by history.
And you’ve not been here before.
You’ve not seen this before.
The Fed has never stretched its open market operations this far before.
We just don’t know what’s going to happen next.
But, I’m prepared to tactically execute through whatever unfolds.
I’m having a great year relatively speaking. I’ve been positive most of the year and haven’t ventured far below our all-time new high.
Times like these are when my skillset is designed to show an edge.
Like many tactical investment managers like trend followers, hedge funds, global macro, I too had a period of relative underperformance of the long-only stock indexes. I held my ground but learned some new tricks during the many swings the past decade, and sharpened my countertrend axe to chip away some of the bad parts we don’t want.
But relative outperformance has never been my objective, especially not against a stock index for stock fund that’s fully invested in stocks all the time.
My objective has always been absolute return, not relative return.
My absolute return objective is what drives me to actively manage risk for drawdown control.
Like a good doctor, I aim to first do no harm… as best I can as a risk taker.
Looking at the Shiller PE ratio for the S&P 500, a long-term observation, the U.S. stock market is still grossly overvalued.
The S&P 500 was the second-highest most expensive valuation in 140 years, and even after the decline this year, the stock index is still twice the valuation of Black Monday in October 1987 and
only down to its extremely overvalued level it was on Black Monday Oct. 19, 1987, when the Dow Jones Industrial Average fell -22% in a single day and just now down to the valuation level the stock index was on Black Tuesday in the 1929 crash.
If you believe in fundamental valuation as a gauge and a guide, anything can happen, so please govern yourself accordingly.
If you need help or have questions, contact us here.
Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as investment advice to buy or sell any security. This information does not suggest in any way that any graph, chart, or formula offered can solely guide an investor as to which securities to buy or sell, or when to buy or sell them. Securities reflected are not intended to represent any client holdings or recommendations made by the firm. In the event any past specific recommendations are referred to inadvertently, a list of all recommendations made by the company within at least the prior one-year period may be furnished upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities on the list. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is not advice and is subject to change without notice. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect the position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.
Observations of the Stock Market Trend, Bond Market, and Investor Sentiment
Nothing drives investor sentiment like a strong price trend.
The S&P 500 stock index is down over -20% this year, and it was down -24% YTD just two weeks ago.
The stock index peaked at the end of last year and is down about -13% over the past 12 months.
But that’s not all.
This time it’s different.
I’ve been warning here for years all the Fed intervention would eventually have to stop, and it would also drive down bond prices, too.
The ICE US Treasury 20+ Year Index is down -23% this year, so long-term U.S. Treasury bonds are down even more than the stock index.
The ICE US Treasury 20+ Year Index peaked July 27, 2020, and has since declined by -32%, far more than stocks.
As warned, bonds are no longer a crutch for declining stocks.
Bonds have been worse.
The Federal Reserve FOMC and U.S. Treasury are no longer accommodating higher stock and bond prices, or applying the “Fed Put” as we call it.
Since 2008, the Feds have stepped in to support the economy and the markets by providing unpreceded liquidity, which has eased selling pressure in waterfall declines and made the market more optimistic.
Fed intervention has resulted in a windfall for stock and bond investors since.
You can no longer rely on the Fed to step in to support market prices.
The challenge today is we’ve never seen the Fed provide such support for stocks and bonds as it has post-2008, so the windfall stock/bond investors have received has now come due.
I had been warning of it:
It’s eventually going to be payback time for the windfall stock market investors have received over the last decade – if you don’t actively manage risk for drawdown control.
Stocks had reached the second-highest most expensive valuation in 140 years, and as you can see in the above chart, and stayed there for the last decade.
High valuations could previously be justified by low inflation, but clearly, that’s no longer the case.
Nothing drives investor sentiment like a strong price trend.
As prices are trending up, investors and traders get more and more bullish, optimistic, and confident.
As prices fall into downtrends, investors and traders get more and more bearish, pessimistic, unsure, doubtful, and outright scared.
Although we tilt more optimistic or pessimistic as a personality trait, by and large investor behavior changes more in downtrends than uptrends.
The prospect theory says that investors value gains and losses differently, placing more weight on perceived gains versus perceived losses.
Prospect theory is also known as the loss-aversion theory.
With Prospect Theory, the work for which Daniel Kahneman won the Nobel Prize, he proposed a change to the way we think about decisions when facing risk, especially financial. Alongside Tversky, they found that people aren’t first and the optimal utility maximizes, but instead react to changes in terms of gains and losses.
In short, Prospect Theory suggests investors are loss-averse, so our risk reward preferences are asymmetric.
We prefer asymmetric investment returns; we want more of the upside, and less of the downside.
Clearly, want can’t receive asymmetric investment returns from just buying and holding risky markets, bonds included.
I believe asymmetric investment returns are pursued by our focus on asymmetric payoffs and positive mathematical expectation over many trades.
ASYMMETRY® is about more upside than downside, an average, over a period of many buys and sells.
ASYMMETRY® is about producing higher average gains than losses, or a positive expectancy.
Back to investor sentiment.
AAII Investor Sentiment remains very asymmetric, though it has shifted more neutral, it remains BEARISH.
The Fear & Greed IndexFear & Greed Index, which is driven by 7 market indicators instead of a sentiment survey, remains in the EXTREME FEAR zone.
EXTREME levels of FEAR or GREED are usually a contrary indicator, but in a prolonged bear market, bearish sentiment is like a pressure cooker.
Investors who hold their losses too long get caught in a LOSS TRAP.
A loss trap is like the Chinese Finger Pull game.
The harder you pull, the tighter the loss trap.
It’s why I predefined my risk in advance, to cut losses short rather than allow losses to grow large and larger.
The LOSS TRAP is not fun, and can be very costly.
Don’t let smaller losses become larger and larger losses, or you’ll be caught in the trap, and the harder you resist, the tighter it gets.
The Fear & Greed Index peaked on November 9th and has since printed lower highs and lower lows; a downtrend.
At this point, the prolonged trend in investor fear suggests this may be the early stages of a prolonged bear market, so govern yourself accordingly.
It’s why I tactically trade market trends.
It’s why I actively manage my risk in each position and across the entire portfolio for drawdown control.
The windfall buy-and-hold passive investors have received from the U.S. stock market from Fed action is due for payback.
Our ASYMMETRY Managed Portfolio has been positive for the year.
Though past performance is never a guarantee of future results, this is when I’ve historically revealed an edge.
When the wind is blowing, we can cast the sail ride and enjoy the ride.
But when the wind stops blowing, we have to get out the oars or risk sinking.
At Shell Capital, we row, not sail.
We are here to help if you need it, contact us.
We are a fiduciary money manager fully committed to guiding our clients.
Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as investment advice to buy or sell any security. This information does not suggest in any way that any graph, chart, or formula offered can solely guide an investor as to which securities to buy or sell, or when to buy or sell them. Securities reflected are not intended to represent any client holdings or recommendations made by the firm. In the event any past specific recommendations are referred to inadvertently, a list of all recommendations made by the company within at least the prior one-year period may be furnished upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities on the list. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is not advice and is subject to change without notice. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect the position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.
Does Trend Following Work on Stocks?
Some recent conversations prompted me to revisit some of the return capture and loss avoidance conclusions from the 2005 paper, Does Trend Following Work on Stocks?
Conclusions:
The evidence suggests that trend following can work well on stocks. Buying stocks at new all time highs and exiting them after they’ve fallen below a 10 ATR trailing stop would have yielded a significant return on average. The evidence also suggests that such trading would not have resulted in significant tax burdens relative to buy & hold investing. Test results show the potential for diversification exceeding that of the typical mutual fund. The trade results distribution shows significant right skew, indicating that large outlier trades would have been concentrated among winning trades rather than losing trades. At this stage, we are comfortable answering the question “Does trend following work on stocks?” The evidence strongly suggests that it does.
Does Trend Following Work on Stocks?
Stock Market Ahead of the Fed, and What’s Likely to Happen Next
In the last observation, I shared “Implied volatility is indicating another possible volatility expansion” I pointed out that Implied volatility is indicating another possible volatility expansion.
The Volatility Index VIX was at 21, implying a range of stock prices (S&P 500) intraday of about 1.3% over the next 30 days.
On that same day, April 5th, my measure of realized, actual, historical near-term volatility was 1.6%.
Today the VIX is at 29, implying a 1.8% intraday range, and my measure of realized, actual, historical near-term volatility is 2% down a little from its 2.2% peak over the last 30 days.
Clearly, the options market is still pricing in a volatility expansion or a wider range of stock prices.
Today is a big day for stock, bond, and commodity investors and traders as the Fed FOMC will announce its plans. According to data from CME, the Fed funds futures imply an expected 99.8% chance of a 0.50% interest rate increase. So, the market is clear about its expectations of the direction of short-term interest rates.
Individual investors are more bearish than they were in March 2020.
News eventually turns negative and the environment becomes hostile. The levels of bullish sentiment and risk-taking prove to be excessive. As prices trend down it drives bearish sentiment and selling, putting further downward pressure on prices.
There is certainly cause for concern by many measures.
For example, I’ve been saying; it’s eventually going to be payback time for the windfall stock market investors have received over the last decade if you don’t actively manage risk for drawdown control.
I say it’s eventually going to be payback time for the windfall stock market investors have received over the last decade because the Shiller PE Ratio has been extremely elevated, indicating stocks are generally expensive and overvalued.
The Shiller PE ratio for the S&P 500 is a price-to-earnings ratio based on average inflation-adjusted earnings from the previous 10 years, known as the Cyclically Adjusted PE Ratio (CAPE Ratio), Shiller PE Ratio, or PE 10.
The highest the Shiller PE Ratio reached was 44 at the Tech Bubble peak in 2000, now it’s at 35, the second-highest level in 140 years, and double the average and median.
This long-term valuation measure is very bearish for the big picture.
Up until now, the high multiple of earnings prices was trading could be justified because of the very low level of inflation over the past decade.
That is no longer the case, and stock prices have trended down to reflect a new trend in inflation (rising prices.)
We haven’t seen the prices of things we buy increase this much, or the rate of change, in a long time.
The Fed has been employing radical policies to stimulate the economy and prop up the stock market since the 2008 “Global Financial Crisis”, and it’s time to pay the piper.
The windfall investors received from buying and holding stocks and bonds is an anomaly, not their skill, so govern yourself accordingly.
Past performance does not assure future returns.
At times like this, it’s more likely the opposite.
That’s the big picture, here are some observations I see when I zoom in to the here, and now.
I’ve already pointed out that individual investors are very bearish according to the AAII survey and even more bearish than at the start of the global pandemic and waterfall decline in stocks in March 2020.
By waterfall decline, I’m referring to the -34% decline in the S&P 500 in the first part of March 2020 alone.
You can probably see it’s a big deal that individual investors surveyed are more bearish now than they were then. In comparison, here is a drawdown chart from YCharts showing the S&P is currently “only” down -13% from its high, far from the waterfall decline in 2020.
In the short run, though, there are some negatives becoming more positive, at least temporarily.
The Technology Sector has earned the top weighting of over 27% of the capitalization-weighted S&P 500 stock index.
Below is the price trend for the S&P 500 Information Technology Index, which shows it has found support, or buying interest, around the current level several times this year.
While the S&P 500 Information Technology Index is a sell from a trend following perspective, it has the potential for a countertrend if it can continue to hold the line. If it doesn’t and breaks below the lows, it’s probably going to get real ugly.
Looking inside the S&P 500 Information Technology Index, I monitor the percent of stocks above/below the trend-following moving averages.
At this moment, 38% of the S&P 500 Information Technology Index stocks are above the 5-day average, 23% are above the 20 day, and only 17% are above the 50-day average and the 200-day average.
Here’s what the percent of S&P 500 Information Technology Index stocks above the 50-day moving average looks like.
Yes, it’s pretty washed out as most of the technology stocks are already in downtrends, but that doesn’t imply they can’t go lower, but instead that selling pressure has already pushed the prices down to a level we normally see at lows.
Healthcare is the second-largest exposure in the S&P 500 at 14% of the index. While isn’t only about half of the Technology allocation, it’s material position size in the index.
The S&P 500 Health Care Sector Index has also trended down to near its prior low earlier this year, and its volatility has expanded as we can see in the volatility Bollinger Band around the price trend spreading out.
Like the Technology sector, it’s bearish looking from a trend following perspective, but after prices move to an extremely high or low, we start to wonder if the buying/selling has exhausted.
To get a clue, I look at the percent of stocks in the sector relative to their trend-following moving averages.
I also measure their momentum, volatility, and relative strength for overbought oversold, relative value of options prices, but for brevity, I’m showing only the basics.
As of right now, the S&P 500 Health Care Sector Index shows 51% are above the 5-day average price, 9% above the 20-day, 23% above the 50-day, and 33% of health stocks are above the 200-day average.
Here’s the visual on a chart.
Healthcare stocks have been under selling pressure, so the question is have those with a desire to sell already sold? What we know is it is reaching a level we’ve historically seen the downtrends start to shift back to uptrends, but it could always go lower.
Past performance is no guarantee of future results.
Next up is the S&P 500 Consumer Discretionary Sector Index, which has earned a weighting of 11.5% in the S&P 500 index, after these three sectors are reviewed, these three of eleven sectors are 53% of the overall allocation in the broad-based index.
The recent price trend of the S&P 500 Consumer Discretionary Sector Index looks similar to the others, as selling pressure has pushed down the prices to the prior low reached earlier this year.
Historically the S&P 500 Consumer Discretionary Sector Index has found buying interest at this level, but we’ll soon see if buyers continue to support this level or higher, or if it trends down to a lower low and a downtrend.
Below is the breadth trend of the stocks in the S&P 500 Consumer Discretionary Sector Index as defined as the percent of stocks above the 50-day average.
Once again, we see a washed-out condition, as 75% of the S&P 500 Consumer Discretionary Sector stocks are below the 50-day average price, and only 25% are above the 50-day average.
My interpretation is the stock market has already been dominated by sellers.
Sellers have already pushed stocks down near the low levels they have historically bottomed and reversed back up.
But, this time is different.
We now have high and rising inflation, and that’s not great for the multiple of earnings stocks trade.
I believe in the weeks after this Fed announcement today, we’re going to see what we got.
If these price trends keep trending lower, it’s likely to be a very ugly long drawn out bear market without the Fed providing its life support.
And then there’s the bond situation, but we’d do that later.
I expect to see some bounce, but what the price trends do in the coming weeks is more telling.
If we don’t see a bounce, look out below.
Sellers haven’t capitulated, but they will.
We’ve been very busy at Shell Capital coming off the best year in 2021 we’ve had in a decade and another great year in 2022 thanks to some asymmetric risk/reward payoffs from tactical trading and long exposure to commodities and other alternatives.
Individual investors are facing the most hostile conditions in decades right now with no place to hide for stock and bond investors, so we have decided to open our door to new clients for the first time in many years. The ASYMMETRY® Managed Portfolios program provides independent custody at Folio Institutional® by Goldman Sachs. Our clients own their accounts titled in their own name at Goldman Sachs, independent of us, and they give us the authority to trade their managed accounts via our investment management agreement.
If you need help, don’t hesitate to contact us.
We couldn’t be more prepared for whatever happens next, and we’ve tactically executed through challenging conditions many times over more than two decades.
Although we can’t assure future success, we’ve stacked the odds in our favor and can do the same for you.
Send us an email to see how we can help guide you in the right direction.
Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as investment advice to buy or sell any security. This information does not suggest in any way that any graph, chart, or formula offered can solely guide an investor as to which securities to buy or sell, or when to buy or sell them. Securities reflected are not intended to represent any client holdings or recommendations made by the firm. In the event any past specific recommendations are referred to inadvertently, a list of all recommendations made by the company within at least the prior one-year period may be furnished upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities on the list. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is not advice and is subject to change without notice. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect the position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.
Implied volatility is indicating another possible volatility expansion
Implied volatility is indicating another possible volatility expansion.
The VIX index is a calculation designed to produce a measure of a constant 30-day expected volatility of the U.S. stock market, derived from real-time, mid-quote prices of S&P 500® Index (SPX) call and put options.
The VIX had drifted below its long-term average of around 20, but as you can see in the chart, it’s printed a lower high.
As the VIX remains elevated and in an uptrend as defined as higher lows and higher highs, it suggests the market expects stock prices to be more volatile.
The 10-2 Year Treasury Yield Spread Continues to Indicate a Warning of a Possible Recession
In Following the Trend of Inflation and Risk of Bonds I mentioned we are closely monitoring the 10-2 Year Treasury Yield Spread because an inverted yield curve has a track record of predicting future recessions 6 – 24 months in advance.
The 10-2 Year Treasury Yield Spread is declining fast and has now trended to 0.24%, meaning the 2 Year U.S. Treasury Yield is nearly the same yield as the Year 10 U.S. Treasury Yield.
For more context, read: How We’ll Know if a Recession is Imminent.
For information about our proactive investment management, active risk management, hedging your risks, and ASYMMETRY® Managed Portfolios, contact us.
Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.
Extreme Bearish Investor Sentiment Eventually Becomes Bullish for the Stock Market
We measure investor sentiment in many ways from indicators that illustrate the result of investor actions from trading such as the Cboe Volatility Index® (VIX®), the first index to measure the market’s expectation of future volatility. Volatility can be measured using actual historical price changes (realized volatility) or it can be a measure of expected future volatility that is implied by option prices. The VIX Index is a measure of expected future volatility as implied by options.
The VIX Index is a calculation designed to produce a measure of constant 30-day expected volatility of the U.S. stock market, derived from real-time, mid-quote prices of S&P 500® Index (SPX℠) call and put options. On a global basis, it is one of the most recognized measures of volatility — widely reported by financial media and closely followed by a variety of market participants as a daily market indicator.
Currently, the VIX has trended around 30, which I consider a volatility expansion. As you can see in the chart, the long-term average is around 20, so levels above average are periods expected to see a wider range of prices as prices, and more indecision.
When the VIX is elevated, it suggests the market is paying more for the protection of options, so many consider the VIX a “fear gauge.”
The good news is stock market returns have historically been higher after VIX trends above 30. Because it’s a sentiment indicator, the market eventually gets so bearish investors who desire to sell have already sold, and those who want to hedge (with options) have hedged.
Today’s VIX at 30 is far from an extreme spike we’ve seen before, but still elevated.
We’re going to venture far beyond the VIX today.
The VIX is one of 7 indicators included in the CNN Fear & Greed Index we have been monitoring for years. The Fear & Greed Index isn’t designed for market timing per se, but it can be a useful reminder of your own sentiment. At the extremes, you may consider feeling more contrarian and following the most famous contrarians mantra:
“Be fearful when others are greedy, and greedy when others are fearful.” – Warren Buffett
Right now, the Fear & Greed Index suggests Extreme Fear is driving the stock market.
Looking inside the Fear & Greed Index the CBOE Volatility Index (VIX) at 30 is part of the weight of the evidence used to drive the gauge. It uses a moving average applied to the VIX level and as of yesterday, it has changed from “Extreme Fear” to Neutral as implied volatility declined.
Another option-related indicator included is the CBOE 5-day average Put/Call Ratio. It now says, “during the last five trading days, volume in put options has lagged volume in call options by 65.73% as investors make bullish bets in their portfolios. This is a lower level of put buying than has been the norm during the last two years and is a neutral indication.”
Put options are used mostly to hedge portfolios against price declines. When investors hedge more, it’s a signal they are bearish, and when they hedge less, it’s assumed by and large they are less bearish.
Below is the trend of the Fear & Greed over time. As you can see, it’s down to the Extreme Fear level, which proceeds a low in the stock market, and eventually a new uptrend.
Once investors who want to sell have sold, we eventually see prices trend down to a low enough level it attracts buying demand.
To get an indication of when this may be near, we look at a wide range of investor/trader sentiment indicators, but also the price chart itself for clues.
I like to use the Fear & Greed Index here because it’s publically and freely available so anyone can observe and follow it, but there are many more we monitor that isn’t.
Advisor Sentiment from Investors Intelligence is one of my favorite investor sentiment indicators.
As you can see in the chart, bearish investment advisors now outnumber the bulls. The bull-bear spread narrowed to -4.6% and the first negative level since early April 2020. This is an extreme reading of bearishness, and historically precedes a reversal of a downtrend as it suggests those who have sold have sold, leaving buying demand in the dominant position.
According to Investors Intelligence, this extreme reading signals a lower risk level than before for tactical trading opportunities.
However, the caveat is it could absolutely get much worse because every eventual -50% decline in the stock market necessarily involves such extreme fear to drive prices lower. So, it’s essential to understand contrarian indicators are a windsock, but no indicator is flawless.
Sentiment indicators could remain extremely bearish for months in a long-lasting waterfall decline.
It’s essential to realize bearish sentiment necessarily proceeds large declines in the stock market, but eventually, the extreme pessimism signals the desire to sell may have faded enough for the demand to buy to become dominant.
When a market is falling, the prices trends are eventually driven down to a low enough point to attract new buying demand, and the trend reverses.
Indicators can be helpful to gauge sentiment and behavior, but nothing drives sentiment like a change it the price trend.
The price trend is the final arbiter.
“The trend is your friend until the end when it bends.” – Ed Seykota
Aguing with the trend is like arguing with a guard rail on a motorcycle. You can test it and try it, but it’s probably going to be a bad outcome.
A simple interpretation of the price trend of the stock market using the S&P 500 Index as a proxy is what was a low volatility primary uptrend has changed to a downtrend as defined by its lower highs, and lower lows.
Below we see my line in the sand, which shows the index is at a level it’s seen several times before.
For now, the stock market is attempting an uptrend.
If the S&P 500 declines below 4200 I’ll consider it a continuation of the downtrend.
The moving average of the price is a common technical indicator used for trend following. The 50 day and 200 day are the most popular. As you can see, the S&P 500 is also defined as a downtrend using these trend following indicators.
The SPX is down about -9% from its high, and was down as much as -12% as of last week. That’s far from a major decline, but enough to help drive a lot of fear of a further loss of value.
The bottom line is investor and advisor sentiment has reached an extreme level of pessimism that could proceed at least a short-term retracement of the stock market decline.
However, there is plenty of potential catalysts that could result in a price shock, or waterfall decline, such as a nuclear threat from Russia. For example, The New York Times reports “Putin Is Brandishing the Nuclear Option. How Serious Is the Threat?”
“Over the weekend, as his military laid siege to Ukraine for the fourth day, President Vladimir Putin ordered Russia’s nuclear forces into a higher state of alert, the first time the Kremlin has done so since the Russian Federation was established in 1991.”
And then there are actions from The Federal Open Market Committee (FOMC) of the Federal Reserve. Few things drive prices and sentiment more than changing interest rates.
Next up, I’ll take a look at what the stocks inside the index is doing to gauge how far they’ve trended and how far they may go.
Let’s see how it all plays out, but right now, we’re seeing early evidence of a possible capitulation, at least in the short term, barring no unknown, unknown, or nuclear attack.
In the meantime, I’m taking advance of some asymmetric risk-reward opportunities in our tactical trading.
For information about our proactive investment management, active risk management, hedging your risks, and ASYMMETRY® Managed Portfolios, contact us.
Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.
Following the Trend of Inflation and Risk of Bonds
In How We’ll Know if a Recession is Imminent I said if the 10-2 Year Treasury Yield Spread crosses below zero, and the yield curve becomes inverted, that’s what will signal a recession is probably imminent, but a recession may not be identified until 6 – 24 months later.
We can’t wait until a recession is called to manage our investment risks; the stock market has historically been the leading indicator, declining well in advance.
After U. S. inflation was reported today that inflation accelerated last month to a 7.5% annual rate to a 40-year high, U.S. Treasury Yields trended up to 2%.
Since the 10-2 Year Treasury Yield Spread is the difference between the 2 year U. S. Treasury and the 10 year U. S. Treasury, the spread will tighten as the shorter-term interest rate converges with the longer-term rate.
Recently both yields have been increasing, but the 10-2 Year Treasury Yield Spread is still falling.
The U.S. inflation momentum is driven by rising price trends for autos, household furniture, appliances, as well as for other long-lasting goods we buy.
For example, here is the U. S. Consumer Price Index for used cars and trucks.
It is well known certain consumer prices have been trending up since the pandemic, so the question for the second-level thinker is whether or not these rising inflation trends are already reflected in the prices of stocks and bonds.
So far this year, 2022 has started off with stock markets trending down.
For example, the S&P 500 declined nearly -10% in the few weeks before retracing about half the loss over the past two weeks.
Longer downtrends often retrace about half of their decline before turning down again, so we’ll soon see if this is the early stage of a deeper decline for stocks or a continuation of the primary uptrend.
The Nasdaq 100, which is weighted heavier in large-cap growth stocks and the technology sector, has reacted to more selling pressure down -14% before retracing some of the decline.
Emerging country stocks as measured by the MSCI Emerging Markets Index have finally shown some relative strength against U. S. stocks.
The MSCI Emerging Markets Index trended up at first, then only declined about -3%, and is now positive YTD.
Rising interest rates have a direct negative impact on bond prices, and that is especially true for longer-term bonds.
For example, the ICE U.S. Treasury 20+ Year Bond Index shows the bond price is down over -6% already in 2022.
If you buy and hold bonds, you’re going to learn the risks of bonds and bond funds in a rising rate regime.
Many investors today haven’t invested long enough to have experienced the possible losses that can be driven by this kind of rising inflation, rising interest rates, regime.
Investing involves risks you must be willing to bear, and if you aren’t willing and able to take the risk, you may consider reducing or hedging your risks.
For information about our proactive investment management, active risk management, hedging your risks, and ASYMMETRY® Managed Portfolios, contact us.
Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.
How We’ll Know if a Recession is Imminent
Recessions are officially announced long after they begin.
It usually takes nine to twelve months before the National Bureau of Economic Research (NBER) to announce when a recession started.
For example, on June 8, 2020, the National Bureau of Economic Research announced the U.S. economy was officially in a recession. The COVID lockdown-driven recession was so obvious NBER’s Business Cycle Dating Committee didn’t need the typical time frame to decide.
Here’s the Unemployment Rate with NBER-dated recessions in gray, for an example of business cycle dating.
Who is the National Bureau of Economic Research and its Business Cycle Dating Committee?
The NBER’s Business Cycle Dating Committee maintains a chronology of US business cycles. The chronology identifies the dates of peaks and troughs that frame economic recessions and expansions. A recession is the period between a peak of economic activity and its subsequent trough, or lowest point. Between trough and peak, the economy is in an expansion. Expansion is the normal state of the economy; most recessions are brief. However, the time that it takes for the economy to return to its previous peak level of activity or its previous trend path may be quite extended.
According to the NBER chronology, the most recent peak occurred in February 2020. The most recent trough occurred in April 2020.
That was quick!
But the NBER’s Business Cycle Dating Committee maintains a chronology of US business cycles in the past, which tells us nothing about here, now.
I follow the 10-2 Treasury Yield Spread as an early warning signal of an imminent recession.
The 10-2 Treasury Yield Spread is the difference between the 10 year treasury rate and the 2 year treasury rate. This yield spread is commonly used as the main indicator of the steepness of the yield curve.
A yield curve is a visual representation of yields (interest rates) on U. S. Treasury bonds across a range of different maturities. In normal circumstances, the shape of the trend is upward; short-term rates are lower than long-term rates. It makes sense because if we are investing in bonds to earn interest, we should expect a higher rate for investing for a longer period. Another reason is a risk premium longer-term bonds as longer term durations are exposed to a greater probability interest rates will change over its remaining duration, causing the price to fluctuate.
If you invest in a bond that doesn’t mature for 10 or 20 years and rates of new bonds being issued increase, as they are now, the price of the bonds you hold will decline in price so their yield matches about what the market is paying now. This is a risk for bond holders in a rising interest rate environment as we are in now, driving by rising inflation.
As the 10-2 Treasury spread approaches zero it signals a “flattening” of the yield curve. Here is the spread today, and it’s history over the past few decades. I shaded in gray the historical recessions to see how the 10-2 Treasury spread preceded historical recessions several months in advance. I also highlighted the area below zero where the signal occurs as the yield curve is flat. Right now, because short term interest rates are trending up driven by the U. S. Federal Reserve, the yield curve is trending toward flattening.
Only time will tell if the yield curve goes flat, where the short term (2 year) rate is the same as the longer term (10 year) yield, but we see its the directional trend at this point.
But what’s the 10-2 Treasury spread signal?
A negative 10-2 yield spread has historically been considered a precursor to a recessionary period.
A negative 10-2 spread has predicted every recession from 1955 to 2020, but has inverted 6 – 24 months before the recession occurring, so it is a far-leading indicator.
The 10-2 spread reached a high of 2.91% in 2011, and went as low as -2.41% in 1980.
10-2 Year Treasury Yield Spread is currently at 0.62%, compared to 1.01% last year, and its lower than the long term average of 0.93%.
If the 10-2 Year Treasury Yield Spread crosses below zero, and the yield curve becomes inverted, that’s what will signal a recession is probably imminent, but a recession may not be identified until 6 – 24 months later.
Or, it could be very fast, like 2020.
Until then, I’m systematically monitoring the 10-2 Year Treasury Yield Spread for the advance warning.
For information about our proactive investment management, active risk management, hedging your risks, and ASYMMETRY® Managed Portfolios, contact us.
Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.
Nasdaq Resumes Downtrend
The Nasdaq 100 Index has failed to hold above the 200-day moving average, a longer-term trend indicator.
Breadth of the Stock Market Indicates Internal Weakness and a Stealth Bear Market
I focus most of my attention on my own positions or those on my lists for portfolio management.
Nothing is more telling than what the stocks on my lists that meet certain fundamental earnings growth and technical criteria are doing.
Nothing is more important than the trend, momentum, and volatility of our actual positions.
However, it doesn’t mean we don’t also observe all the other stocks, bonds, commodities, and currencies for signs of strength or weakness.
Even though it may not impact my exposures or drive any change in our positions, I still enjoy taking the time to see what “the market” is doing, overall, in the big picture. That’s what I mostly share here, for informational purposes only.
Below is a chart of the percent of U. S. stocks trending about the 50-day moving average, an intermediate-term trend signal.
A few observations of asymmetry are:
- Only 30% of stocks are trending above the 50 day moving average.
- As we can see in the charge giong back 20 years, its at the low end of its historical range.
- In signficant stock market declines, it gets much worse. For example, in March 2020, more than 90% of stocks were in downtrends, the worst in two decades, including 2008.
- About 8 times this Market Breadth indicator stopped at this level before trending back up, as stocks trended back up.
- About 13 times this Market Breadth indicator didn’t stop here at this level, but instead kept trending loweer as stocks trended lower.
Overall, my observation from this asymmetry (imbalance) is many stocks have already entered downtrends.
Overall, stock market participation started showing weakness after the May 2020 advance, then improved into late 2010 before reaching a peak, and it’s been trending down since.
We may start to hear some call it a “Stealth Bear Market,” a phrase used to describe stock market conditions when the overall indexes are by and large trending higher, but many stocks are trending lower.
A “Stealth Bear Market” may define a trend like this because the S&P 500 stock index has been trending up, as the percent of stocks participating in the uptrend has declined.
Regardless of what we call it, the bottom line is most stocks are already in downtrends, so we’ve been stalking to see when they start trending back up again.
I think it’s essential to actively manage risk and adapt to changing market trends. If you need help, contact us. We manage accounts titled in your own name at an independent custodian of Goldman Sachs.
Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Any opinions expressed may change as subsequent conditions change. Do not make any investment decisions based on such information, as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.
The U. S. Stock Market Bubble
What do I think about the U. S. stock market?
It’s in a bubble, so I’m getting prepared.
And time is different, too, because of rising inflation and interest rates, which means falling bond prices.
So bonds aren’t going to be a crutch in a falling stock market.
Why do I think it’s a bubble?
A picture is worth 1,000 words.
S&P 500 Shiller CAPE Ratio was created by Yale University economist Robert Shiller as a way to understand long-term stock market valuations.
The S&P 500 Shiller CAPE Ratio, also known as the Cyclically Adjusted Price-Earnings ratio, is calculated as the ratio of the S&P 500’s current level divided by the 10-year moving average of inflation-adjusted earnings.
The S&P 500 Shiller CAPE Ratio may be used as a valuation method to forecast future expected returns.
– Higher CAPE ratio could indicate lower returns over the next couple of decades,
– Lower CAPE ratio could reflect higher returns over the next couple of decades, as the ratio reverts back to the mean.
S&P 500 Shiller CAPE Ratio is at a current level of 39.60, and as you can see in the chart, it suggests the stock market is the second most expensive since 1881, the last 140 years. It’s more than 200% higher than its long-term average, and far from the low levels that historically preceded long-term bull markets.
The current risk for investors is it plays out similar to the past but without bonds trending up, acting as a crutch to hedge some of the stock market losses.
There’s never been a more critical time to row, not sail, so we’ve got out the oars.
It’s an exciting time to be an investment advisor and portfolio manager. We are empowered with a broader, more robust suite of tools to define and manage risk than at any other time in history.
Is this the beginning of a bear market?
Maybe, we’ll see, only time will tell.
Even if it is the early stage of a bear market, it’ll likely unfold with many swings up and down along the way.
But I think we’ll see all the speculation unwind in the years ahead.
For the tactical trader, investment success isn’t so much what the market is doing to you, but what you are doing with the market.
I think that’s the case for everyone.
If you need help, contact us.
Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Any opinions expressed may change as subsequent conditions change. Do not make any investment decisions based on such information, as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.
Market Action Discounts Everything
The philosophy and rationale of technical analysis is there are three premises on which the technical approach is based:
- Market action discounts everything.
- Prices move in trends.
- History repeats itself.
“The statement “market action discounts everything” forms what is probably the cornerstone of technical analysis. Unless the full significance of this first premise is fully understood and accepted, nothing else that follows makes much sense. The technician believes that anything that can possibly affect the price—fundamentally, politically, psychologically, or otherwise—is actually reflected in the price of that market. It follows, therefore, that a study of price action is all that is required. While this claim may seem presumptuous, it is hard to disagree with if one takes the time to consider its true meaning.
All the technician is really claiming is that price action should reflect shifts in supply and demand.
If demand exceeds supply, prices should rise.
If supply exceeds demand, prices should fall.
This action is the basis of all economic and fundamental forecasting. The technician then turns this statement around to arrive at the conclusion that if prices are rising, for whatever the specific reasons, demand must exceed supply and the fundamentals must be bullish. If prices fall, the fundamentals must be bearish. If this last comment about fundamentals seems surprising in the context of a discussion of technical analysis, it shouldn’t. After all, the technician is indirectly studying fundamentals. Most technicians would probably agree that it is the underlying forces of supply and demand, the economic fundamentals of a market, that cause bull and bear markets.
The charts do not in themselves cause markets to move up or down. They simply reflect the bullish or bearish psychology of the marketplace.
As a rule, chartists do not concern themselves with the reasons why prices rise or fall. Very often, in the early stages of a price trend or at critical turning points, no one seems to know exactly why a market is performing a certain way. While the technical approach may sometimes seem overly simplistic in its claims, the logic behind this first premise—that markets discount everything—becomes more compelling the more market experience one gains. It follows then that if everything that affects market price is ultimately reflected in market price, then the study of that market price is all that is necessary. By studying price charts and a host of supporting technical indicators, the chartist in effect lets the market tell him or her which way it is most likely to go. The chartist does not necessarily try to outsmart or outguess the market. All of the technical tools discussed later on are simply techniques used to aid the chartist in the process of studying market action.
The chartist knows there are reasons why markets go up or down. He or she just doesn’t believe that knowing what those reasons are is necessary in the forecasting process.
Prices Move in Trends
The concept of trend is absolutely essential to the technical approach.
Here again, unless one accepts the premise that markets do in fact trend, there’s no point in reading any further.
The whole purpose of charting the price action of a market is to identify trends in early stages of their development for the purpose of trading in the direction of those trends. In fact, most of the techniques used in this approach are trend-following in nature, meaning that their intent is to identify and follow existing trends.“
Purpose is a more powerful motivator than money.
“Purpose is a more powerful motivator than money. When you are not paid as much as you would like, your purpose will provide you a reason to continue producing excellence in your work. When you have more money than you ever thought possible, your purpose will provide you with a reason to continue producing excellence in your work.” – William J. O’Neil
ASYMMETRY® Observations 
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