Facebook & GAM shares overheat in July…could this be a sign of what is to come?
July was kind of a strange month. Overall sentiment in the stock markets was good, some indices made new all-time highs whilst the broader US indices are within striking distance of reaching new highs as well. And on the individual stock level, we saw Apple move within a whisker ($65bn to be precise) of being valued at $1,000,000,000,000.
So all is good you would think…right?
Well not if you were long Facebook and GAM Holding stocks, as both companies saw their shares tumble by 20%…in one day!
And observing these contradictory market moves concerns me, as they are not the only contradictions I see at the moment.
I'm not going to get to all the details in this post, but overall, I'm concerned with the amount of money chasing strategies that seem to be low risk and who for the vast majority of them, are all based on a Short Volatility Return Profile.
Investors can't get enough of so-called “Risk Parity” strategies, Machine Learning and Exchange Traded Products as well as many hedge fund strategies that have the exact same Return Profile.
In my humble opinion, I fear that what investors today may see as Alpha is really short volatility in the Emperor's New Clothes.
Yes, it is true that these strategies have done well in the last 10 years or so (whilst trend followers for the most part have struggled)…when correlations between stocks and bonds were predominantly negative. In fact, I ran a simple study that showed that the Rolling 1-Year correlation of 20-Day returns between the S&P and the US-10Y Notes have indeed been negative 87% of the time since 2007.
But the same study revealed that the correlation had been POSITIVE 66% of the time from 1962 to today! So if you are investing in strategies that are dependent on doing well when the correlation between stocks and bonds are negative…you may well be in for some head-wind, should markets return to their long-term behavior.
This post is not meant to suggest that all strategies don't have valuable attributes…but it will hopefully serve as a reminder that the time to be more exposed to strategies that exhibit a “long volatility” return profile may be in for a comeback sooner than we all think.
Now, let’s look at where the Trend Barometer finished the month;
Unlike Facebook, the Trend Barometer did not overheat in July. In fact it finished in the cooler part of its range at 39.
This lowish reading, is confirmed by the initial performance numbers from the industry that looks to be negative regardless of whether you look at medium to long-term strategies or the short-term traders.
The next chart below shows a snapshot of a 44-market portfolio with markets listed in “groups” of market sectors:
The number of markets recorded in a trending state dropped from 19 to 15 during the month, with only 2 ending right at the neutral reading (indicated by the “grey” shade right at the 30% level). Please note that for the individual markets a reading of 30 is considered neutral as opposed to the Trend Barometer itself, where this level is 45.
Like in June, July finished with more markets trending down than up, in particular in the non-Energy Commodity sectors. Softs markets like Cocoa and Sugar showed strong signs of down-trending behavior and Metals continued to be weak with Gold and Silver leading the way down.
On the more bullish side, Swiss stocks were in a buoyant mode along with Australian stocks and the Mexican Peso.
In the chart below, I have grouped the markets into 10 sectors. Since last month, the number of sectors exhibiting an overall trending state managed to hold the fortress at 3 out of 10 sectors… all in down-trends as indicated above.
The strongest overall Sector trends were recorded in Base Metals, followed by Precious Metals and Softs, so 2 out of the 3 sectors this month are new compared to last month.
As can be seen in the chart below, the Trend Barometer hit a high in mid July and from there saw a gradual slide to finish the month near its monthly lows.
What was made by trend based strategies in June, seem to be lost in July…and herein lies the dilemma for investors.
Central banks have exchanged “know unknowns'” for “unknown unknowns' creating the potential for dangerous feedback loops. Markets are pricing the supportive policy response before action is even taken, bad news is good news and vice versa because the intervention is more important than fundamentals.
Pre-emptive strikes on risk are contributing to the massive growth and popularity of any asset or strategy with a short convexity or mean reversion return profile at the cost of those strategies that tend to thrive in a less controlled environment.
The classic trading axiom of “cutting your losers and letting your winners run”, made famous by the Turtle story, is an alternative allowing investors to get positive exposure to change but at the expense of a short-term loss. In other words, these strategies are long convexity.
Central bank policy has taken asset returns from the future and brought them to the present…they have taken tail risk from the present and shifted it into the future, and have turned private risk into public risk. But the risk is not gone…as it can't be destroyed…it can only be shifted through time and redistributed in form.
Do not fool yourself – peace is not the absence of conflict – peace can exist on the very edge of volatility.
So as we begin the 2nd half of 2018, I urge you to make sure that your portfolio has a healthy balance between strategies that have a Short and Long Volatility Return Profile.
PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS
I hope you found the information useful as part of your own evaluation of the trend following part of your investment portfolio. I will continue to do my best to keep you up-to-date with regards to the environment for diversified trend following strategies and would love to discuss any of this information with you. Just reach out to me.