Finally Some Action

The global stock indexes have been so boring the last few months, at least for me. Finally there appears to be action, and its not only in the stock indexes it is happening in currencies and bonds as well.

I am trying not to get ahead of myself but I think finally there is some economic reality entering into the picture. Of course the market gurus are all saying that we mustn’t compare Greece to Lehman Brothers, and others are trying to dismiss all the current volatility as nothing to be alarmed about.

I have felt for some time that Hyman Minsky’s instability thesis has been gathering fragile energy. Greece in my opinion is a big story as it has archetypal connotations. Greece has been going bust and leaving the Euro forever, but the only way to treat something that is bankrupt on your balance sheet is to accept it is worthless and write it off. We know that creditors with dubious debts simply close their eyes to that reality and make as if it is ok by playing with the terms of the repayment in the hope it will all come good.

I myself have a loan to a company that I value anywhere from zero cents in the dollar to the full amount depending on my mood of the day.  We delude ourselves into believing what we want to believe and what is the most convenient to making us feel good.

Check the sell off of the Shanghai Exchange the last few weeks, I am comparing it to the S&P500 and the FTSE 100. Clearly it has been shooting the lights out over the last year, in fact the last 2 years it has been flying. Could this also be the end of a major cycle.

beeYmRMu

 

Insurance and Getting Cute

When I was 20 yrs old my father introduced me to a guy from the USA and said listen to what this guy has to say and make up your own mind. The guy was a life insurance broker and I guess this was my first experience with buying life insurance. The most unpleasant part of my decision to go for it, was the prostrate exam that the policy forced me to have.

Anyway lets fast forward 23 yrs I can get far cheaper life cover in Australia where I live than the policy in the US is costing me so I decided with the weak Aussie Dollar this would be a good time to cash in the surrender value of the policy. As you can see from the chart below the value in AUD has gone up more than 25% in value in the last year or so.

Here comes the cute part, my wife fancies herself as a currency trader. She tells me that she has heard comments that AUDUSD is heading towards 69 cents so we should not cash the cheque yet. Her trade is already 2 cents in the money but this is where I say be careful not to get too cute. I personally feel very neutral on things at the moment and would happily exchange my USD for AUD now. We are at quite an important technical point should we break the support around the 76 cent level. Should we not break to new lows then I think we can see a decent size multi month bounce from these levels.

I look forward to reporting back the insights I gain from my wife’s new found zest for trading forex.

AUDUSD

 

 

Momentum Traders

We all hear that many institutions look at the momentum strategy where you go long when the 50 day moving average is above the 200 day average. As you will see below from 1993 this has been a pretty effective strategy using daily data applied to the S&P 500. For your information the strategy is still long despite the recent volatility.

Here is a chart showing the moving averages, the yellow is the 50 day and the red is the 200 day.

Rplot07

 

Here are the backtest results:

2015-01-23_1313 Rplot043

For those wanting to see the R code generating these charts and stats here it is:

require(quantmod)
require(PerformanceAnalytics)
 
#get the data and fill out the MA
getSymbols('SPY', from='1950-01-01')
SPY$ma200 <- SMA(Cl(SPY), 200)
SPY$ma50 <- SMA(Cl(SPY), 50)
 
#lets look at it from 1990 to 2015
spy <- SPY['1990/2015']
 
#our baseline, unfiltered results
ret <- ROC(Cl(spy)) 
 
#our comparision, filtered result
ma_sig <- Lag(ifelse(SPY$ma50 > SPY$ma200, 1, 0))
ma_ret <- ROC(Cl(spy)) * ma_sig
 
golden<- cbind(ma_ret,ret)
colnames(golden) = c('GoldCross','Buy&Hold')
 
#Plot to visually see the actual moving averages
chartSeries(spy, 
            type = "line",
            name = "Moving Average : Golden Cross",
            TA= c(addSMA(50, col = 'yellow'), addSMA(200)))
 
# lets see what the latest signals are 1 being a buy signal
tail(ma_sig)
 
maxDrawdown(golden)
table.AnnualizedReturns(golden, Rf= 0.02/252)
charts.PerformanceSummary(golden, Rf = 0.02, main="Golden Cross",geometric=FALSE)

Created by Pretty R at inside-R.org

Swiss Timing

This is my 100th blog post in the short 3 months of going live, and is providing me with a vital outlet for my inner thought processes. I woke up late this Friday morning, as it seems my week has consisted of one late night after another. After turning on my phone, the beeping text alerts beat me to my trusted Bloomberg app to see what happened in the markets over night.

Friday I work from Bondi so before I discuss what I think about the Swiss “shock” take a look at my office for today.

B7bVA4NCEAEtYSf B7bGL5PCUAAVa19

For those who haven’t heard the Swiss “suddenly” removed the peg to the Euro they implemented in 2011 to halt its then increase in value. The reason then was as a safe haven during the global financial crisis people were pouring their money into this tiny country and in so doing killing the countries large export economy. Isn’t life amazing, here is that Kabbalistic Jungian idea of unity of opposites: Good = Bad.

With the recent drop of the EUR to the USD and the likely further demise of the EURO the Swiss bankers decided to not continue buying the EUR to maintain the peg and sit with an enormous pile of EURO “assets” on their balance sheet.

Take a look at how the market reacted. The Swiss currency rose almost 30% at its highest during the day to then correct roughly half that.

20150115_EUEOD2_0

It dropped 3,500 pips at its worst.

The Swiss stock market also went into freefall dropping 15% before recovering to lose about 8% the worst since 1989.

20150115_EUEOD3_0

The question I want to deal with on this my 100th post is whether any of this could be anticipated? I believe YES and NO. So much for getting off the fence.

The reason I say YES, is because in terms of the theme I am developing for my book The Market Complex there was a clear interference by the Swiss Central Bank with the ebb and flow of the natural way of things which most people left unconscious and soon began to treat as natural.

The psychological rule says that when an inner situation is not made conscious, it happens outside, as fate. That is to say, when the individual remains undivided and does not become conscious of his inner opposite, the world must perforce act out the conflict and be torn into opposing halves. Collected Works, A Symbol of the Self.

So yes when a complex is identified it is known that it will produce unpredictable eruptions (read: sudden market dislocations like today). However the answer to whether we could anticipate when this shock would take place the answer is NO. When the energy around a complex amplifies we do know that things are about to become increasingly unpredictable. The news out of Europe and the threat to the Euro’s long term existence is being well played out in the media and political circles. I think it is fair to say that an eruption in this market complex was well overdue and the best thing one could have done in anticipation was buy volatility protection or stand aside from this market.

In conclusion this picture sums it up, you cannot have good without bad, up without down.

swiss

DOW SIGNALS

There are a number of sites that market their signals as great indicators for outperforming the market, let me highlight how careful one needs to be when looking at backtests.

In the strategy I am about to show you we create a ratio between the S&P 500 and the Dow and we trigger a signal to buy the market when the current ratio is above the rolling mean ratio. I will include the code at the bottom for those who want to understand the details, but the table and chart will illustrate my point. A further important point that I must emphasize and will continue to highlight is that I look at risk-adjusted returns as my proxy for out-performance.

So lets begin:

Rplot06 2015-01-15_1532

Yes Sir you beauty, we have here a 24yr backtest where our model handily outperforms a buy and hold with a Sharpe Ratio of 0.32 vs 0.22. So should we bet the farm on this baby? Not so fast I say, lets look at this strategy over some more data, in the table below we look at performance from 1950 a lengthy 64yrs.

2015-01-15_1537

What we see here, is underperformance; so it is very important when considering a model to ensure that the starting date isn’t cherry picked. In this illustration there are very few parameters, and we only tweaked the date. Many people pushing automated models love to “curve-fit” parameters to satisfy the backtest with no basis of reality.

Here is the R code for those that are interested:

require(quantmod)
require(PerformanceAnalytics)
 
getSymbols("^GSPC", from= "1900-01-01")
sp500.weekly <- GSPC[endpoints(GSPC, "weeks"),6]
sp500rets<- ROC(sp500.weekly, type = "discrete", n = 1)
 
DJ<- read.csv('http://www.quandl.com/api/v1/datasets/BCB/UDJIAD1.csv?&auth_token=kvYEqCqKCTyL4anWz5Zv&trim_start=1896-07-14&trim_end=2015-05-12&sort_order=desc', colClasses=c('Date'='Date'))
date<- DJ$Date
values<- DJ[,2]
DJ_xts<- as.xts(values, order.by = as.Date(date, "%d/%m/%Y"))
dj.weekly <- DJ_xts[endpoints(DJ_xts, "weeks"),1]
djrets<- ROC(dj.weekly, type = "discrete", n = 1)
 
data<- merge(sp500.weekly,dj.weekly)
data.sub = data['1950-02-05::']
ratio<- data.sub[,1]/data.sub[,2]
ave.ratio<- rollapply(ratio,20,mean)
lead.lag<- ifelse(ratio >= ave.ratio, "Lead", "Lag")
 
# filtered results investing in S&P500 with the signal
ma_sig <- Lag(ifelse(lead.lag=="Lead", 1, 0))
ma_ret <- sp500rets * ma_sig
 
dowtimer<- cbind(ma_ret,sp500rets) # or
 
colnames(dowtimer) = c('SPX/DJI-Timer','Buy&Hold')
 
maxDrawdown(dowtimer)
table.AnnualizedReturns(dowtimer, Rf= 0.04/52)
charts.PerformanceSummary(dowtimer, Rf = 0.04/52, main="SPX/DJI Timer",geometric=FALSE)

Created by Pretty R at inside-R.org

S&P500

Lets take a closer look at the recent sell-off which is starting to shake some of that bullish belief.

Lets start at a look at the rally from the bottom in March 2009.

Now for a closer look at the retracement. I am not calling this market as I don’t have a clue but to think that this retracement is enough, we havent even started. Was that the top last week, lets wait and see.

China Stock Market Bubble ??

I think we have one on our hands based on the recent price action. In a little over a month we have rallied 34%

You just have to read some of the market chatter to see how dangerous this kind of one sided extreme behaviour is.

From the AFR.

There’s not an available seat or terminal at this public share trading centre in Shanghai and the queue to open new accounts is five deep. China’s first bull market in seven years is in full swing, led by retail investors, who have helped push the Shanghai Composite Index up 18 per cent in just 13 trading sessions.

Every available indicator points to a speculative frenzy, as trading volumes, margin loans and account openings have all spiked over the last month.

Turning to the sharemarket

As the Chinese property market falls away and yields on bank deposits decline, retail investors are once again turning to the sharemarket.

“All shares are worth buying at the moment, as China is entering a long bull market,” says Xie Ming. Between puffs of a cigarette, the 65 year-old retiree says the value of his portfolio has risen 42 per cent in the last eight weeks, to be worth 270,000 yuan ($A53,000).

“I’m fully confident on the outlook for the stock market,” he says.

This confidence took a solid hit on Tuesday, as the market fell 5.4 per cent, posting only its second loss in 14 trading sessions. The volatile day of trading, which saw the market rise 3 per cent in the morning session, shows the extent to which hot money has flown into the market in recent months.

But the longer term confidence of investors is due to government backing for this latest boom.

“China’s government, like everyone else, is aware that the property boom is over,” says Anne Stevenson-Yang, the research director at J Capital in Beijing.

“They hope that driving money back into a rising stock market could replace the household wealth frozen in the property market.”

Finally lets look at the growth in margin loans financing this speculative bubble.

 

It appears valuation is not the big driver here.

Saxo Capital Markets Asia Macro strategist Kay Van-Petersen said China has been one of the cheapest markets in the world for many years, even now after the recent surge, Shanghai is trading on a forward price-to-earnings ratio of 12.46 times, so it’s hard to believe valuation is the key driver.