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This Is The SP500. This Is The SP500 On Crack

Remember the anti-drug commercials with the frying pan and the egg? As of late it would appear as though investors have forgotten that you are supposed to say NO to drugs, especially during market hours. In the chart below we have a rolling 21-Day Standard Deviation for the SP500 as well as the 50-Day moving average of that number. On a one month basis we are at the second highest reading in over 10 years, second only to the crash of 2008. Looking at the smoothed 50-day moving average we are actually at a new high. The close to close movement is running at an average of 2.34%. (Click on chart to enlarge)

SP500 Rolling 21-Day Standard Deviation

How can you use this information? There are a few trading strategies you can investigate from this such as selling options or putting on some arbitrage positions betting the spreads will come back in. For most investors however the more important thing to see here is that risk management is not only paramount to your investing/trading but it is a moving target. As a general rule when volatility is high, or extremely high as the case may be, you would want to look at using relatively loose stops, scaling down your position sizes, lowering your leverage, raising cash, etc. While most, maybe all, long time traders already use good risk management we have found that far to many new traders don’t adjust their trading when the market gets stoned. Consequently they lose far more money then they have too. Following tools like this can help you to smooth out your returns and stay in the game.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-We always use risk management and own the domain name riskfreak.com.

Take a $1 trial of The Macro Trader to receive unbiased actionable research

Global Macro Versus The SP500 And The Winner Is…….

Today in the Financial Times there was an article entitled “Macro Funds Miss Out On Crisis” where they show how many macro funds are currently lagging their expected performance so far for 2010.  While it is true that many funds are relatively flat e are surprised that the article had nothing good to say.  We being proponents of Global Macro as not only a strategy but as the best strategy across a full market cycle decided to take it upon ourselves to look at Global Macro against the SP500 from the beginning of the crisis October 2007 to now.

What we find is that while the SP500 is down -24.41% from the beginning of the crisis, the HFRXM Global Macro Index is basically flat at +1.04% for that same time.  In fact if you had invested $1000 in each of the HFRXM and the SP500 on October 1, 2007 your investment in the Global Macro Index would be ahead of the SP500 by 33%.  So while you wold not have huge absolute gains, you would also not have huge absolute losses.

$1,000 Invested In HFRXM and SP500

macro-sp500

Of course such comparison offer little real value since the SP500 is a horrible benchmark for a macro trader.  Global macro encompasses stocks, bonds, commodities, and currencies so it should be relatively uncorrelated to any one asset class.  What sets global macro apart from other strategies is that it enables the trader to go wherever they see the best opportunities.  Of course just because they have the flexibility does not mean that they will catch every move, but it does allow them the flexibility needed to avoid large losses.

Happy Trading,

Dave@TheMacroTrader.com

Take a $1 trial of The Macro Trader to receive unbiased actionable research

Macro Trading Using Relative Strength

Since the start of our newsletter we have been using a relative strength table that looked at Fidelity Select Sector Funds to show what industry groups are leading and which groups are lagging. The relative strength calculation is similar to the style used by Bill Oneil and IBD but is slightly shorter term in nature. We used the Fido Funds due the their price history and breadth of different groups. Now that there are not only enough different industry group ETF’s, but also the needed price history we have revamped the model to use ETF’s instead.

We publish one list for United States industry groups and one that is focused on global ETF’s with several country and a few sector specific ETF’s. These tables are valuable in a few ways. One is that we have developed a trading model based upon them that uses the rankings along with buy, sell, and money management rules. Over time this model has beaten the market with far less risk. The other way that these tables are useful is that they show you what is strong and what is weak.

While this concept is not rocket science we are consistently surprised how little attention it is given by other traders. By using relative strength we can see what is really working and where investors are going. Many times the supposed “hot sector” is not really that hot. By looking at the tables we can see what is really working and what is not. For instance looking at the Global RS Ranking table below you can see the leaders and the laggards. While it is no surprise that Brazil is at the top when was the last time you saw someone on CNBC telling you to buy Indonesia or Turkey? Yeah we missed that segment as well. (click on table twice to enlarge)

Global RS Rankings

Global-ETF-Rankings

Right now this table is confirming to us that for the most part developed nations are weak and should be sold and that emerging markets are strong and should be bought. No, this is not the first or the only tool that told us this same thing but it is one way in which we can systematically be long the best areas of the world and short the worst areas of the world. It also gives us a road map of where investors are putting their money and where they are withdrawing it.

Another point worth noting is that while we are starting to run this as a “standalone system,” the system represents only a part of our portfolio. In our trading and our newsletter model portfolio we use several different methods in order to build a less correlated portfolio trading across asset classes.

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-We are long EWZ-Brazil, EWT-Taiwan, and EWM-Malaysia

If you’re getting value out of our posts, you can do us a favor by linking to us and mentioning The Macro Trader to friends and co-workers. Here’s the link information for this article:
Title: Macro Trading Using Relative Stength
URL: http://www.themacrotrader.com/2009/11/10/macro-trading-relative-strength/

Macro Trading vs SP500 1997-September 2009

A lot is made of relative returns and how one strategy or fund does against the SP500.  While not the best benchmark for something like Global Macro it is nonetheless the benchmark that everyone is most familiar with and that is used the most on CNBC and in magazines.  So how does global macro stack up to the SP500?

The chart below shows how $1000 invested in the SP500 and the Barclays Global Macro Index would have done for YTD for 2009.  As you can see the SP500 while getting off to a rocky start is now leading the macro index by 9.68% so far.  While the performance of the SP500 has been impressive the other side of the story is that to get the 18.04% return in the SP500 you first had to go through a -19.56% drawdown in January and February to get it.  Contrast that to the Global Macro Index where you had a -2.06% drawdown and a 6.63% return YTD.  Yeah you are outperforming with the SP500 but the volatility has been huge. (click on chart to enlarge)

Barclays Global Macro Index vs SP500 2009 YTD

barclays-global-macro-index-vs-sp500-2009-ytd

Of course nine months is not usually the best representation of a strategy.  Going from 1997 to the end of September 2009, how has the SP500 done in absolute and relative terms?  Since 1997 the SP500 has given a total return of 42.70% and a CAGR of 3.07%.  The Global Macro Index on the other hand has delivered a total return of 237.91% in the same time and a CAGR of 10.92%.  Looking at the chart below you can see that while the SP500 has periods of serious out performance, over time it has lagged in a big way. (click on chart to enlarge)

Barclays Global Macro Index vs SP500 1997-September 2009

barclays-global-macro-index-vs-sp500-1997-september-2009-1

Not only has the SP500 lagged in total return but when looking at the risk taken to achieve the anemic 42.7% you really have to step back and rethink a long only equity approach.  In fact if you have been in a SP500 index fund since 1997 we excuse you to go bang your head against the wall for a few minutes.  Once you are back look at the chart below of the drawdowns that you had to endure to get that awesome 42.7% total return.  Yes, you see two drawdowns over -45% each.  In 2002 we were down -46.28% and in early 2009 we were down -52.56%.  All this for a return that was not much better then sitting in T-Bills. (click on chart to enlarge)

SP500 Drawdown 1997-September 2009

sp500-drawdown-1997-2009

Looking at the same chart for the Global Macro Index below we can see that the drawdowns are far lower and shorter in duration.  In fact the worst drawdown that we have seen so far is -6.42% in October 2008 and right now we are at new equity highs while the SP500 is still -31.78% below its highs.(click on chart to enlarge)

Barclays Global Macro Index Drawdown 1997-September 2009

barclays-global-macro-index-drawdowns-1997-september-2009

Does this mean that everyone should go out and invest all their money in global macro and buy our weekly global macro newsletter?  No, on the first and yes on the latter.   All kidding aside what this does show is the fallacy of long only equity investing.  While being 100% invested in equities is great when they are moving higher you get absolutely crushed when things come crashing down.  In global macro you are not beholden to the possibility of equity risk premia but instead are able to look for the best risk to reward opportunities out there in any asset class.  This includes stocks, bonds, commodities, currencies, and more.  This flexibility to go where the best opportunities are enables the global macro investor to outperform not in any given year but in a full market cycle.

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-We are a global macro research company and are therefore a bit biased in our investment views.

If you’re getting value out of our posts, you can do us a favor by linking to us and mentioning The Macro Trader to friends and co-workers. Here’s the link information for this article:
Title: macro trading vs SP500 1997-September 2009
URL: http://www.themacrotrader.com/2009/10/07/macro-trading-vs-sp500-1997-september-2009

Is Risk Dead? Or Is This A Bear Market Junk Rally?

In our last post we discussed how we at The Macro Trader think that risk is vastly under-priced.  We looked at several different volatility indexes as well as Bill Luby and VixandMore.com’s JunkDEX.  The JunkDEX shows how well stocks like AIG, FNM, C, CIT, and BAC are doing.  As you can see in our previous post “Volatility Indexes, Risk Appetite, Mispriced Risk, And Where We Think We Are Headed” the JunkDEX  has had a monster rally.  Usually this would signal at least a short term top as speculative fever burns out.   Obviously the rally was not done and we are up since then.

To more quantitatively show the huge run up in risky assets we went looking for some factor based indexes that would show the performance of “good” and “bad” companies.  In our search we came across some custom stock baskets from Goldman Sachs that use Edward Altman’s famous Z-score to separate stocks into strong and weak balance sheet indexes.

The Altman Z-score uses 5 financial ratios.  Altman took the 5 ratios and using statistical techniques was able to build the Z-score which predicts a companies probability of failure.  The higher the score the safer the business is and the lower the score the more danger there is of insolvency.

As was to be expected the performance between the weak and the strong balance sheet stocks has been drastic over the last 6-months.  As you can see in the chart below the low Z-score basket has vastly outperformed the high Z-score basket.  In fact the weak balance sheet basket has done almost twice as good as the strong balance sheet basket of stocks. (click on chart to enlarge)

Goldman Sachs SP500 Strong and Weak Balance Sheet Baskets 6-Months

goldman-custom-strong-weak-balance-sheet-baskets-6-month

While the result is not too surprising it is an example of bad investor behavior.  Academics as well as practitioners have found time and time again that safe low volatility stocks outperform risky volatile stocks over a full market cycle.  In fact if you look at the chart below you can see how the roles between the strong and the weak balance sheet baskets are totally reversed.  The strong balance sheet stocks are positive for the last five years while the weak balance sheet stocks are still very negative.  Another thing to notice is that the junk stocks went down a lot faster and more consistently then the quality stocks when the market tanked over the last two years. (click on chart to enlarge)

Goldman Sachs SP500 Strong and Weak Balance Sheet Baskets 5-Years

goldman-custom-strong-weak-balance-sheet-baskets-5-year

So what are we to take from all of this?  We think that the market is far too speculative given the current economic backdrop.  Earnings while “better then expected” are at record lows, unemployment is at highs not seen since the depression, we are experiencing deflation for the first time in several decades, the consumer is retrenching and not consuming, and really the only true “green shoot” was that it is not yet the end of the world.

Yes, we can go higher from here but the odds do not favor being heavily long right now.  Our basic forecast at The Macro Trader is that in the not too distant future we will have a correction if not worse and we will be able to buy stocks at a better price then where they are currently sitting.

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-In The Macro Trader newsletter we are short some QQQQ-NASDAQ 100 ETF

If you’re getting value out of our posts, you can do us a favor by linking to us and mentioning The Macro Trader to friends and co-workers. Here’s the link information for this article:
Title: Is Risk Dead? Or Is This A Bear Market Junk Rally?
URL: http://www.themacrotrader.com/2009/09/11/is-risk-dead-global-macro-trader/