August was a “hot” month for trend followers
August has historically been an interesting month in the financial markets, but as we mark the 20 year anniversary of the collapse of Long Term Capital Management…its interesting to ask ourselves what we have learned from these events and if investor behavior has changed to avoid making the same mistake again.
According to people on the other side of the LTCM trades, the firm began earlier in the summer of 1998 to “jam” the market with “1 by 2” put spreads and kept adding to it over the summer.
Of course this was not the only position they had on at the time…but in the aftermath of their collapse and when people got a glimpse in to the portfolio they were running…it became clear that there was one big theme within it…it was all Short Volatility!
Fast forward 20 years and we find ourselves in August 2018 where we saw the realized volatility of the S&P for a few days in a row only managing to get to 1%.
So clearly it has been tempting for many investors to go down the rabbit hole and invest in various strategies that have been benefiting from this seemingly “no-risk” environment!…and as we know, that is not trend following.
So it was nice to see, that despite the winds blowing against the trend following crowed, the industry managed to deliver a solid return during an unusually hot August in Europe at least.
Now, let’s look at where the Trend Barometer finished the month;
Despite the positive performance of the CTA community, the Trend Barometer finish below its neutral zone of 40 to 45…at a level of 36.
This is a bit unusual to have such a low reading at the same time as the performance numbers looks to be pretty good…but I think most investors can live with that anomaly.
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 by 1, from 15 to 14 during the month, with another 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 and July, the month of August finished with more markets trending down than up, in particular in the non-Energy Commodity sectors. Grains, Metals and some Soft and Meat markets continued their sliding down trend.
On the more bullish side, we saw markets like Nasdaq, which continued its record breaking run as well as Australian stocks and the German Bund.
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 drop down to 0 out of 10 sectors… a pretty rare sight.
What it is really telling us is that no sector is experience a strong trending behavior from all or most of its market members, hence the sector as a whole does not reach the threshold of being classified as trending…but some of them came pretty close, which explains why the performance for trend based managers was positive.
As can be seen in the chart below, the Trend Barometer stayed in a pretty tight range in August between 30 and 50 for the most part.
But with the summer now officially over, we are in that time of year where things often start moving around and with US mid-term elections coming up in a couple of months, an ever increasing global trade war and the 3 leading Central Banks following completely different policies…I would not be surprised that people who are Short Volatility may be in for a bit of a surprise.
When and How this will play out is anybody's guess, but if you look at the Global Macro picture of the world…it may be worth remembering that in 2009 when Central Banks were trying to save the financial system…Emerging Markets were part of the solution…however today, I fear that they are part of the problem.
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.