The Proper Way Of Gauging the State of the Market
What is the proper way of gauging the state of the market?
I will start with the wrong ways of doing it, a non-exhaustive list:
- Drawing lines on charts, for example, trendlines.
- Trying to identify chart patterns, like a head and shoulders.
- Dividing the price of one security by the price of another security.
- Attempting to interpret macroeconomic indicators.
- Inferring, or worse, calculating, social media sentiment.
- Listening to financial media narratives.
- Paying attention to some fund managers who talk their book.
- Reading reports from the sell-side.
- Joining forums and some online groups.
- Having discussions with strangers, friends, or family.
All of the above are in many cases signs of a lack of understanding of markets, naivety, and in worst cases, a reckless attitude towards markets.
“Are you nuts? What’s left out there for me to understand the market?
“Strategies, and their performance.”
It is through strategies that savvy market professionals and some investors accumulate wealth in the long term. The market will not reward anyone for following an account on social media with a large follower base; there is no edge to that. The edge comes from the discipline and exercising strict risk and money management rules from following sound strategies. It is not easy; any Commodity Trading Adviser who’s been around for decades, or Hedge Fund manager, with skin in the game, would confirm this.
Before we look at the performance of some strategies, we will first look at the performance of assets and sectors year-to-date.
Year-to-Date Asset Performance
As traders and investors know already, commodities are the only assets that are up year-to-date. Crude Oil (USO) is up 67.5%. Gold (GLD) is up less than 1% but still in the black. Equities (VEU, SPY, EEM) are down in the range -12.8% to -15.8%. Bonds (TLT) are down the most at -22.2%.
The asset performance chart offers a good market perspective. Moving to sectors offers a more detailed view of the equity markets.
All sectors are down except Energy (XLE) and Utilities (XLU), with the former up 64.1% and the latter up 1%. The chart is revealing about the market state. Discretionaries (XLY) is down 26.2% and Tech (XLK) is down 21.4%. Retail (XRT) is down 18.1%.
We will look at both passive and active strategies and allocations.
- 60/40 Allocation in SPY and AGG
This is perceived as a conservative allocation but year-to-date it is down 13%. This is a large loss for conservative investors. The loss is due to SPY being down 15.2% and AGG being down 9.8%. Usually, investors expect these to be anti-correlated but this year they are correlated and losses are mounting.
2. SPY Trend Following with 12-Month Moving Average (Long-Only)
Since the inception of SPY ETF, this successful price-series momentum strategy is down the most year-to-date with a loss of 13%. Equities trend-following has not behaved well this year.
3. All-Weather (Seasons) Strategic Allocation
Another surprise is the heavy losses of this well-known strategic allocation. Year-to-date the allocation is down 11.4%. ETF Weights are: TLT 40% VTI 30% IEF 15% DBC 7.5% GLD 7.5%
We also look at our proprietary strategies for clues about the state of the market. The next one is revealing.
4. ETF Cross-Sectional Momentum
This strategy is up 11% year-to-date and after a closer look, the reason is it is invested in commodities. This is one strategy in a group of six we use in our Systematic Market Signals reports. Two strategies are up year to date and the average performance of all six strategies is -3%.
5. ETF Mean-reversion
Mean reversion is one of the best ways to gauge the market state. Our proprietary mean-reversion algo with SPY, QQQ, and IWM ETFs with equal allocation is nearly flat year-to-date. This is because mean-reversion strength has increased recently. Note that the worst year for mean-reversion was 2018 and this year is nowhere close compared to that.
Strategies offer a better way of gauging the state of the market than random technical and macro analysis. Strategies may reveal the profit potential of disciplined market participants and the state of the market.
Year-to-date, strategic allocation and trend-following have been a big disappointment and this is due to the market not rewarding “lazy” behavior.
On the other hand, tactical cross-sectional momentum and mean-reversion have been doing well year-to-date due to their adaptability to market conditions.
More articles and information about our premium services can be found on our blog. There are many free articles to read and also a free PDF book to download.