Market Trends for May 2018

Mamma mia - May saw record highs in Europe and Italian Yields

  With record temperatures being recorded in many places in Europe during May...the Italian Bond market set its own records. What started out as a bit of a rumble in emerging markets...has now moved much closer to the heart of Europe. Perhaps this really is the beginning of the next financial crisis, but even if it isn't, the financial markets continues to surprise us with record moves in different asset classes. In May it was the Italian two-year yield that with a move from -0.07% mid month to +2.77% on May 29th made it into the record books...just like the VIX did back in February.  And if that wasn't enough...on the last day of May the ground for a new trade "war" was also being prepared. 2018 has certainly not been a dull year so far. For trend following strategies, the reversal back to the safety of US treasuries and German Bunds was not welcomed as many models have been shorting the fixed income sector (mostly in the US markets). On top of this, Stocks weakened (again) and the strong uptrend in Energies came to an abrupt end during the last week or so of May. CTAs and Trend Followers were looking good up until this time...but with the big reversals hitting Bonds, Stocks and Energies at the same time, performance hit a brick wall and the month is set to finish well in the RED. The exception will perhaps be the short-term strategies that were able to react more quickly to these events.

Now, let’s look at where the trend Barometer finished the month;

A big drop in the last few days of the month, saw the Trend Barometer nose-dive to a close of just 30...the lowest close since July of 2017, which ended a nice run-up in performance for trend followers who were just getting back to break-even for the year after February's tumble. Now before you get started :-) ...let me just say that this is very typical for trend following strategies. And it is perfectly normal and to be expected that sudden short term moves against a bigger trend will lead to performance being given back. So far in 2018, we have seen a lot of these short-term event's, so it has definitely not been a good environment for medium to long-term trend based strategies. But that also means that other strategies designed to benefit from these type of event's should do well and help the overall performance of a fully diversified multi-asset portfolio.   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 just 10 during the month, with another 3 landing 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. Leading the charge was safe-havens like the German Bund and Bobl with Short Sterling also finishing in an up-trend. The recent revival of the US-Dollar mainly showed up in the GBP and EUR crosses (down-trending) whilst Energies despite OPEC's efforts to curb the price of Oil, still managed to finish in an up-trend. Of other commodities, only Cotton showed signs of trending behavior, finishing with a strong reading of 60.

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 increase from 1 to 2 out of 10 sectors... but this does not tell the full story.

As mentioned above, in the early part of May, we did see much stronger trends and in fact 4 out of 10 sectors were in a trending state during this period...a reading I have not seen for a long long time. But when the scores were in, we finished with a lower reading that seem to have been the norm for some time.

This month I just wanted to focus on 2018 because of the two surprises we have seen so far. As can be seen below, both January and May saw big drops in the Trend Barometer, from 60+ all the way down to below 30. And these really are the most difficult types of environments for trend based strategies. When multiple markets changes trend over a short period of time, these strategies will by definition "have to lose money". I know this may sound counter intuitive to many investors who perhaps are not fully emerged in trend following...but actually trend based models have to lose money in order to make money. So even though some investors may feel disappointed with their trend follower these days...as they did not manage to "hedge" the February and May events...but when you analyze these periods...they were never designed to be a "hedge" for these short-term events. Like so many times before, the models will adapt and positions will be adjusted to any new environment and price action that will evolve from the current fall-out in Europe...

...but one thing that a month like May should have informed all investors about, is the fact that even short-term government bonds can become highly risky investments and you should think twice before you add "return-less risk" assets to your portfolio.

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. P.S. if you want to follow the Trend Barometer on a daily basis, please click here and if you want to see the list of Market Symbols explanations, please click here.