Hedge against bond market decline

During the 1998 stock market decline of 21%, I was a managing partner of two convertible arbitrage hedge funds. It should have been a home run for the convertible arbitrage community, but there was also a decline in the fixed income market that happened at the same time.

The long side in the convertible arbitrage position is supposed to decline at a much slower rate than the short side equity decline.  That is where the profit comes from. In 1998, as in today’s market, that is not happening. I was not alone. There was a flight from quality, as that was the most liquid part of the market.

This problem led most of the convertible arbitrage community to try and figure out a way to hedge the long side against fixed income decline at the same time as equity declines.

The futures market offered a partial solution, but many of us did not use it because of various reasons. The main reason was that outside counsel advised us that if we were to use futures we had to register as a commodity pool operator with the CFTC, and we were unwilling to put ourselves in another regulatory situation.

TODAY THERE IS A BETTER WAY:

“The Simplify Interest Rate Hedge ETF (PFIX) seeks to hedge interest rate movements arising from rising long-term interest rates and to benefit from market stress when fixed income volatility increases.

T­he fund holds a large position in over-the-counter (OTC) interest rate options intended to provide a direct and transparent convex exposure to large upward moves in interest rates and interest rate volatility.Using OTC derivatives, usually only available to institutional investors, PFIX is designed to be functionally similar to owning a position in long-dated put options on 20-year US Treasury bonds. Since the option position is held for an extended period, the ETF provides a simple and transparent interest rate hedge.”

For more information, go to the Simplify website.

The following graph portrays PFIX in relation to SPY, the ETF of the S&P 500. Close as of the close of Tuesday, September 27, 2022.

The swap from SPY to PFIX is at the Green vertical lines.

The trade would make an interesting momemtum-based pairs trade.

 

 

 

PayPal versus Visa

I am a subscriber to Seeking Alpha which during the day updates its readers with many blurbs about what the Wall Street research is telling their readers.

This morning, September 21, 2022, I received the following:

  • Bank of America has added PayPal Holdings (NASDAQ:PYPL) and removed Visa (NYSE:V) to its US 1 list, which represents the firms best investment ideas from its Buy-rated, U.S.-listed stocks. BofA keeps its buy rating on Visa.

  • In Wednesday premarket trading, PayPal (PYPL) has gained 0.6%, and Visa (V) was up 0.2%.

  • By contrast, SA’s Quant system, which historically outperforms the market, has a Hold rating on PayPal (PYPL) as well as on Visa (V).

I have charted the relative performance of PYPL vs V over the last few monthe with the results below.

The swap between PYPL and V should have happened on July 22, 2022

 

Swing Trading

Selecting candidates for Swing Trading positions is difficult. I have found that finding moat-type businesses make the best initial candidates. Good financial underpinnings are essential. Joseph Belmonte of Buffett and Beyond has developed a screening tool based on Clean Surplus ROE(Return on Equity). His conclusion is that “portfolios made of stocks with high Clean Surplus ROE’s outperform all other portfolios”. An example is portrayed below. Salesforce (CRM) first qualified with a higher than average Clean Surplus ROE during 2016 when the shares were trading between $70 and $80.                                                                                                                                                                                                                                                                                                                                                                                                                                                         Closing prices are as of the close on Friday, November 5, 2021.                                                                                                                                                First, find the candidates and then use weekly technicals to find the overall trend.  Use the daily as a trend decision trigger. The weekly signaled a buy decision at the end of June 2021. That is, only trade LONG from that date. The daily concurred with a long position on October 13, 2021.

Market Timing Signal

Most investors find that timing the market, which is trying to determine whether to be invested or not, is not something that is within reach.

My experience tells me that not only is it possible, but it is also very important in these volatile times.

The ‘market’ can be illustrated by looking at the performance of the S& P 500 index, which comprises a good section of the United States economy.

The above graph shows the S&P 500 index, ETF: SPY, as of the close on Friday, December 4, 2020. It shows that there was a significant decline beginning at the end of February 2020 with a nice recovery starting in April 2020. It would have been ideal to find some way of getting out of the way of the decline and getting on the right path in April.

There is that kind of early, or at least not so late way, of doing just that!

In the past, which is certainly no predictor of future behavior, the movement of the U.S. Treasury note and bond market, has behaved in an almost opposite manner to the equity market. The avoidance of equity risk has shifted the money flow into the safe haven of U.S. Treasuries and vice versa. In the past then, the equity market has been negatively correlated to the Treasury market. So, when equities are getting strong, Treasuries should be getting weaker, etc.

I have chosen an ETF which is a good indicator of the U.S Treasury market: EDV, the Vanguard Extended Duration Treasury ETF.

Prices reflect the close of December 4, 2020.

 

The following chart shows the relationship between the price movement of SPY and EDV during the period of February 2020t to the close of Friday, December 4, 2020.

SPY is represented by the green line and EDV is represented by the red line in section three of the graph.

The next line shows the relative strength of SPY versus EDV. Green shows that SPY is stronger, Red shows that it is weaker.

The same is true on the bottom part of the illustration. The cross indicator on the individual ETFs show positive or negative momentum of the individual ETF.

 

The answer then is that one could make a market timing decision by watching the relative strength between equities (SPY) and Treasuries (EDV) and act accordingly. Purchase the equity market when it is in a positive relative strength to the Treasury market, which is represented by the Green vertical lines. Stay on the sidelines when it appears that the Treasury market is stronger than the equity market, the Red lines.

 

 

High Volatility versus Low Volatility

There is a fascinating article in today’s Wall Street Journal in its quarterly “Investing In Funds & ETFs on page R3.: The Time to High-Beta?

Once a Quarter.

The thesis is that new research conducted says that: “high -beta stocks tend to outperform in just one week per quarter. Only in that week, therefore, does it make sense that traders bet on high-beta stocks. That week occurs in the quarterly earnings season.

The article goes on to that to test the theory, one would invest, during the first week of earnings season in a high-beta stock ETF while shorting an equal dollar amount of a low ETF.

Their example in the article regarding a high-beta fund is the Invesco High Beta ETF. (SPHV) That ETF  contains the 100 highest beta stocks of the S&P 500 index. The 100 selected have the “highest sensitivity to market movements, or beta, over the past 12 months. The fund and the index are rebalanced and reconstituted quarterly in February, May, August, and November.”

The example of low beta is the Invesco S&P Low Volatility ETF(SPLV) which contains 100 S&P 500 stocks with the lowest realized volatility over the past 12 months. It then weighs each stock based on its volatility(well, lack thereof).

I assume it is rebalanced every month, but was unable to speak to anyone at Invesco to give me that information.

The article begs the question of whether a strategy of ALWAYS having a position in being long/short SPHV versus the reverse in SPLV would be successful?

The following illustration says YES!

The green vertical lines indicate long SPHB and short SPLV. The red vertical lines indicate long SPLV and short SPHB.

 

Swingtrader Suite for Day Trading

Many times I have been asked if the PerfectStorm strategy that works so well for swing trading has any use for the thousands of traders who day trade. Perhaps the following illustrations will be helpful. All graphs are as of the close of business of Friday, June 5, 2020.

The above picture is the daily results of BA versus SPY.

The top is BA, and the next security is SPY. The next line represents the relative strength of BA versus SPY. When the line is going up and GREEN, BA is stronger than SPY. When the line is going down and RED, SPY is stronger than BA.

The Vertical lines represent, when GREEN, that BA should be bought. When the vertical line is BLUE, the trade should be closed. When the vertical line is RED, BA should be short. Many hedge funds, when the trade indicates, will be short the opposite security, that is, when indicated long BA, they will be short SPY and vice versa.

 

The next picture is of BA versus SPY on a twenty-minute basis. I have left off the vertical signal lines, but a careful analysis will dictate the long/short position.

The next picture is of BA versus SPY on a two-minute chart.

There are thousands of “pairs” that can be traded in the same manner. Just ask Medallion Fund, or Citadel, or World Quant or the many other Quant funds.

I can be reached for further information at rfeit@msn.com or (516) 902-7402

Putting It Together

For the past ten years or so I have been putting out a blog on my websites: swingtrader.com, relativevalue.com, and perfectstormtradingstrategy.com.

During that time I have proposed looking at the investing/trading world through a different lens, focusing on relative strength combined with absolute momentum.

Since I started my blogs, I noticed others promoting similar strategies.

A book was written a year ago highlighting some of my thoughts and a global advisory established counseling many of the worlds largest money managers, using many of the tools that I had developed.

Most studies of actively managed funds tell us that only four percent of money managers can outperform, on a risk adjusted basis, the Dow or the S&P 500 averages over a ten year period.

I believe that most, if not all of the poor performance is a result of two factors.

One) The inability of the manager to sell positions that are in decline because of the requirements that the manager has to be fully invested. That is, there is no viable alternative, so the manager stays invested, even in losing positions.

Two) The behavioral problem in admitting that you are wrong. The reason for the initial purchase is no longer valid. Not that you were wrong then, but you are wrong now. It has happened to all of us.

My strategy/system remedies both of these problems.

If you are an investor in equities, commodities, foreign exchange, long term, short term, or day trader, if interested in adding significant value to your investing/and or trading portfolio, please contact me at:

rfeit@msn.com

Pairs Trading Strategy as Proxy for Swing Trading

It should be no surprise to learn that the most successful quantitative hedge fund founders were, at the beginning of their careers, successful convertible arbitrageurs. I was fortunate to be one of the earliest inventors/discoverers of the basic convertible arbitrage strategy.

The basics of convertible arbitrage revolve around the concept of relative value. When the convertible is demonstrably more valuable than the underlying shares, than the convertible arbitrageur purchases the convertible security and shorts the underlying shares. Reversing the trade when the relative values return to normal.

In the early days of the convertible arbitrage strategy, the position carried a positive cash flow and the reversal of the position could take many months until a more favorable opportunity made the position less favorable.

The relative value strategy follows into other quantitative strategies.

Most pairs trading strategies use two securities in the same economic sector that have movements that are highly correlated and co -integrated. They track each other almost perfectly, the ratio of the price of the two such stocks should be almost the same. When their relative movements deviate from their expected behavior, the strategy dictates that the relatively cheaper one be purchased and the more expensive one be sold short. A reversion to the mean relationship. Traders waiting for various deviations, trying to put trades on at maximum deviations. Hundreds if not thousands of pairs traders follow the same highly correlated co-integrated pairs. It becomes a game of chicken. Each trader trying to get the trade on at the best possible time.

Similar to what happened to convertible arbitrage, the returns on the strategy go down as the number of players participating increase. It is a limited universe. The amount of funds devoted to mean reversion pairs trading decreases the amount of profit to be made.

I have developed a swing trading strategy that uses the relative value of the pairs components. Like convertible arbitrage, the strategy uses a large portfolio approach, putting on lots of different positions in differing economic sectors to diversify risk. Many investors may find it useful in a long only portfolio.

Swingtrading for farmers

Corn-Wheat 8-15-2014BTodays(Monday Aug 18, 2014) Wall Street Journal on page C1 has an article “U.S. Farmers Are Up to Ears in Corn”

To no ones surprise, the economic factors that led farmers to plant increasingly more acreage in corn has caused an oversupply of corn just when the demand is declining. This demand fall off is due to a decline in livestock herds and declining purchases from China.

In addition to the supply/demand problem, more farmers in certain parts of the country which have traditional planted wheat have moved to corn due to the changes in weather patterns over the last few years. In other parts of the country, the opposite is happening.

The choice to plant corn or wheat or a new combination of both is happening in farms all over North America.

Fortunately there are ways for farmers to hedge their crops. Traditionally that has been in the futures market.

In September 2011, Teucrium introduced an ETF designed to replicate the returns that mirror the movements in the spot prices of wheat. WEAT. It has developed other commodity ETF’s that follow corn,soybeans and others. The ETF for corn is CORN.  For more information on the construction and costs please go to the Teucrium website.

The following daily chart of CORN versus WEAT illustrates a Swingtrading approach to corn and wheat. Both commodities have been in a decline, but at various times, the better play was to follow the relative momentum. Prices as of the daily close, Friday, August 15,2014

Corn-Wheat 8-15-2014A

and a closer view:

Corn-Wheat 8-15-2014B

For further information on all the topics covered and how you can implement these and many others in your trading plan. Please contact me at rfeit@msn.com See www.relativevalue.com for day trading ideas.

Swing trading using pairs, Emerging versus Frontier Markets

A recent Wall Street Journal article, Saturday/Sunday February 1-2, 2014,tracked the relative performance of ETF’s representing emerging markets and even less developed economies referred to as ‘frontier markets’. The article points out that the frontier markets have seen a ‘steady trickle of investment from fund managers hoping to ride years of steady growth’.

I have used the ETF IEMG to represent emerging markets and the ETF FM to represent frontier markets.

Since the end of 2013, IEMG is down almost eight per-cent while FM has flat performance. The U.S. market as represented by SPY is down a little more than five per-cent.

As a portfolio manager who is looking to diversify into less developed emerging markets, a look at the relative strengths of IEMG versus FM would be of some value.

The following graph illustrates this point.

 

Pairs IEMG-FM 1-31-