Can You Time the Market Without Crying?

We’ve all seen pictures like this one from Putnam showing how bad of an idea it is to miss the 10 best days in the stock market

Missing the Best DaysChart Courtesy: Putnam

But we read an interesting post on trying to time trading systems (that’s like timing market timing) that seemed to approach this in a bit more logical way. You see – it doesn’t make much sense to talk about missing the 10, or 20, or 40 best single days in the stock market. Most market timers aren’t trying to avoid a single bad day,  and get back in the next day. Most are looking at things like Price to Earnings ratios and the rest are trying to avoid bad periods… not just bad days. Plus, nobody is that unlucky trying to time the market that they miss just the 10 best days over a few decades. On the flip-side, nobody is that lucky that they would magically miss the worst market days over 10 to 20 years, only to get right back in the next day.

It makes much more sense to us to talk about what missing the best streaks of days looks like. The best 10 and 30 days periods, for instance. That would be a lot more interesting; to see how bad/good you would have been if you picked the exact wrong/right time.

Here’s what we found:

(Note: These figures do not represent actual trading, and were not taken from real experiences)

Missing the Best Trading Days

Missing the Worst Trading Days(Disclaimer: Past performance is not necessarily indicative of future results)
(Note: The figures and charts above are an example and do not represent actual trading)

In our opinion, the better argument for not trying to time would go something like this:

Trying to time the market?

  • If you’re incredibly smart, or lucky, or both – missing the worst 10 day streak would save you 549%
  • If you’re incredibly dumb, unlucky, or both – missing the best 10 day streak would cost you 212%
  • If you’re somewhere in between smart and dumb and have average luck – you’ll likely not miss anything… with missing the average 10 day streak resulting in 4%

We’re not sure if this supports timing or not – but it sure seems a better way to talk about it, rather than the more prevalent narrative about the big danger of missing the best 10 days in the stock market – like they come one right after the other or you’re the unluckiest person on the planet.  The whole thing is kind of silly anyway – as it is backwards looking, and would need to be completely thrown out the window if the next 30 years were the negative image of the past 30 years, with stocks returning –70% over the span. If that happens, then timing would do no good, again – it would be better to not be involved at all…

 

 

Performance of 40 Futures Markets Mid-Year

We’ve officially made it half way through the year, meaning those who did well will likely be mentally doubling their first half success in imagining where their year will end, while those who struggled will act like a weekend golfer making the turn – saying ‘ok, let’s turn it around now… let’s get it done on the back nine’.

Without further ado, the front nine scores across 40 different futures markets courtesy of Finviz:

Futures Performance 2014 Q2(Disclaimer: past performance is not necessarily indicative of future results)
Chart Courtesy: Finviz.com

Some of our thoughts:

• 65% of the markets are positive of the year, down from 75% last quarter.

• Corn and Wheat went from number 4 & 8 on the leader board last quarter, to a negative performance on the year thanks to an ongoing multi-month down trend.

• Coffee and Hogs continue to hold their position as the top commodity performers. However, coffee is down considerably (-19%) from its 2014 highs, while hogs have been hitting new highs.

• Nikkei is the only stock futures index that remains negative of the year

• CHF, CAD, USD, and EUR are almost unchanged on the year

• The S&P 500 & the 30 Year Bond’s YTD performance are almost identical.

 

Natural Gas ETFs – Heads You Lose, Tails You Lose More:

We did our monthly look at how various commodity ETFs track the futures markets they’re designed to follow recently, and found a rather interesting data point in Natural Gas.

Natural Gas(Disclaimer: Past performance is not necessarily indicative of future results)

Nautural Gas VAMI(Disclaimer: Past performance is not necessarily indicative of future results)
Natural Gas Futures = Selling the December Futures contract the last week of November (including exit costs), then using the following December contract numbers)

We’ve talked before about “3 Big Reasons Commodity ETF’s Aren’t Getting the Job Done,” and the usual picture is of the ETF underperforming the asset they track because of prices being in contango and a little thing called roll yield, which the ETFs have to pay if further out prices are more expensive than nearby prices, and if you look back at UNG since inception, it’s clear that the ETF underperforms a simple strategy of rolling the December futures annually:

Natural Gas Compare(Disclaimer: Past performance is not necessarily indicative of future results)

So why is UNG suddenly outperforming the December futures strategy?  You guessed it… Natural Gas has moved ever so slightly into Backwardation – the condition opposite ‘Contango’, where the near prices are more expensive than the further out prices. In that scenario, the ETF earns the roll yield instead of paying it. Here’s a nice graphic and stats from Hard Assets Investor: showing the 5yr annualized roll cost has been 10.37% (a cost of 10%), while the current roll cost is -2.5% (a benefit of 2.5%).

Natural Gas Backwardation detailsNatural Gas Chart Real Hard Investor
Charts Courtesy: Hard Assets Investor

But whether or not the futures are down -67% since 2009 or the worst ETF ever is down -78%, does it really matter. It’s kind of like being the cleanest dirty shirt or skinniest fat kid. You’ve still lost a boat load of money betting on the “energy of the future”.  And I guess that’s what the folks at Direxion and VelocityShares and ProShares were thinking when they launched Inverse Natural Gas products… and not just inverse, but 2x and 3x inverse. Why just go short, when you can double and triple your leverage? Direxion even got the great ticker – GASX – seemingly unconcerned with the link to the world’s number 1 brand for flatulence and bloating relief.

If you had to guess when these guys launched their inverse Natural Gas ETFs, what would you choose:

A. In mid-2008 when Natural Gas had risen ~100% over the last 12 months

B. In 2011 and 2012 when Natural Gas had fallen between 60% and 80% from its highs

Pat yourself on the back if you chose B. These funds were launched in a hurry to capitalize on the big move down in Natural Gas prices, just in time for prices to rally about 130% from their 2012 lows, just like the long Natural Gas ETF (UNG) launched just in time for Natural Gas to fall 80%.  A look at the all time charts for these ETFs is like watching a race to see who the first one to hit -100%.

Inverse Natural Gas(Disclaimer: Past performance is not necessarily indicative of future results)

We’re not sure if this is a commentary on the volatility of Natural Gas, on the dangers of turning futures markets into ‘safe looking’ ETFs, or on the age old problem of investors getting in exactly at the wrong point… but it sure is a weird set of circumstances when investors buying the long ETF are down about the same amount since inception as those buying the short ETF. They can’t win for losing. Here’s the sad performance since inception of the various Natural Gas ETFs:

ETFs that "Make" Money when Nat. Gas goes UP

Cashtag
Name
Total Return
Launched
GAZiPath DJ-UBS Natural Gas TR Sub-Idx ETN-94.21%
Oct'07
UNGU.S. Natural Gas Fund-93.83%
Apr'07
BOILProShares Ultra DJ UBS Natural (2X)-76.01%
Oct'11
UNLU.S. 12 Month Natural Gas Fund-64.60%
Jan'10
UGAZVelocityShares 3X Long Natural Gas-49.17%
Feb'12
NAGSTeucrium Natural Gas Fund (25% weighted)-45.58%
Feb'11
DCNGiPath Seasonal Natural Gas-39.32%
Apr'11
GASLDirexion Daily Nat Gas Rltd Bull 2X Shrs24.61%
Jul'10

ETFs that "Make" Money when Nat. Gas goes Down

Cashtag
Name
Total Return
Launched
DGAZVelocityShares 3x Inverse Natural Gas -94.16%
Feb'12
GASXDirexion Daily Nat Gas Rltd Bear 2X Shrs -90.95%
Jul'10
KOLDUltraShort DJ-UBS Natural Gas-26.98%
Oct'11
GASZETRACS Natural Gas Futures Contago 6.38%Jun'11

(Disclaimer: Past performance is not necessarily indicative of future results)
Source: Google & Yahoo Finance

 

The Commodity Performance Scoreboard

Here’s our monthly look at the various commodity ETFs and how they track a simple strategy of buying December futures and rolling them annually. Plus, a comparison to Ag Traders and an overall commodity index.  C’mon futures…

(Disclaimer: Performance as of 5/30/2014)

Commodity ETF Over/Under Performance 2014

Commodity
Futures
ETF
Difference
Crude Oil$CL_F
5.75%
$USO
6.68%
0.93%
Brent Oil$NBZ_F
0.03%
$BNO
0.32%
0.29%
Natural Gas$NG_F
6.82%
$UNG
21.80%
14.98%
Cocoa$CC_F
13.24%
$NIB
11.71%
-1.53%
Coffee$KC_F
52.54%
$JO
60.97%
8.43%
Corn$ZC_F
1.59%
$CORN
3.24%
1.65%
Cotton$CT_F
1.22%
$BAL
-0.64%
0.58%
Live Cattle$LE_F
10.54%
$CATL
4.48%
-6.06%
Lean Hogs$LH_F
19.25%
$HOGS
19.47%
0.22%
Sugar$SB_F
6.69%
$CANE
6.02%
-0.67%
Soybeans$ZS_F
8.69%
$SOYB
12.30%
3.61%
Wheat$ZW_F
3.11%
$WEAT
2.10%
-1.01%
Average10.58%12.37%1.79%
Commodity Index $DBC1.48%
Long/Short Ag Trader CTAs-2.23%

(Disclaimer: past performance is not necessarily indicative of future results).
(Disclaimer: Sugar uses the October contract, Soybeans the November contract.)
Long/Short Ag Trader CTA = Barclayhedge Ag Traders Index

Chart of the Week: The Futures Markets’ Sideways Bell Curve

Drilling down to the day-to-day gains & losses can be dangerous for your wallet and psyche when analyzing trend followers, but when we checked out today’s futures market performance on Finviz we noticed something unique… a sideways bell curve.

Day Performance(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: Finviz

While most people grew up excited to hear that their teacher/professor was going to grade the test (you didn’t study for) on a bell curve (the highest grade in the class becomes the 100%, and each grade is adjusted from there), this sideways bell curve means something a little different.

You see, when the futures markets work in tandem to average a gain of over 1% or average losses over -1%,  it’s referred to as a Risk On/Risk Off day. (See our most recent 2014 Scoreboard here). But this might be a perfect example of a day showing an average return of 0%, meaning, each market is zigging, while the others are zagging.

What does this mean for trend followers as well as other managed futures strategies? Well, nothing really. Trend followers love to see charts like this, but one day isn’t enough for managers to capitalize off of their trends. They want to see days like this repeat themselves for months, and hopefully even years. The wheat market is continuing its down trend over from May into June, now down 16 of the last 19 days, but managers want to see a trend like that continue for months to come, with no reversion.

Managed futures don’t just need markets moving on their own – they need them moving on their own in a consistent direction.

For example, the curve isn’t so even if you look at the YTD performance, with 22 of the 40 markets only showing a positive or negative 5% performance YTD {Disclaimer: Past performance is not necessarily indicative of future results}.

YTD performance(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: Finviz

About that Volatility = Complacency Claim…

Here’s how the usual reporting on low volatility goes…

There’s Low Volatility because the VIX is low, and the VIX being low reflects investors paying less for future downside protection, and paying less for downside protection means investors are less concerned (or aware) of the possibility of downside… so low volatility means these investors are becoming more “complacent”.  What exactly does complacent mean, we looked it up, via dictionary.com:

“pleased, especially with oneself or one’s merits, advantages, situation, etc., often without
awareness of some potential danger or defect; self-satisfied.”

It’s kind of like a person foregoing hurricane insurance because there hasn’t been one in a while. Their recent good fortune of no hurricanes blowing their house down has made them complacent about the possibility of future hurricanes.

The structure of the VIX leads to this low volatility = complacency argument. The Chicago Board Options Exchange’s Market Volatility Index, or the VIX, measures the implied volatility of S&P 500 index, representing investors’ expectations of volatility in the benchmark equities index over the next 30 days.  Higher VIX values indicate anticipation of higher stock market volatility while lower VIX values indicate the expectation for lower stock market volatility. With stock markets tending to ‘take the stairs up, and the elevator down’ as the old saying goes, higher volatility is associated with lower prices most of the time. So, if investors think equities are going lower, they think it will be accompanied by increased volatility, and therefore will be willing to price the VIX higher.

So….we’ll concede that a Low Vix can represent a certain amount of complacency and lack of awareness of possible downside (or upside spikes for that matter) among investors in equities.

But does it follow that low volatility in say, Bonds, means that bond investors are becoming more complacent. While this is mostly semantics and likely only of interest to the most nerdy among you, does it follow that low volatility in Bonds as measured by tight ranges means there is complacency in that market?  We sort of think no. You see, volatility in nearly everywhere but the VIX is measured not by the prices of options to extrapolate the expected volatility over the next 30 days – but instead by the observed volatility over the most recent period, be it 30 days or 100 or the past year.

And that’s the rub… when we say that there’s low volatility in a market like bonds or the Euro Currency because the ranges have contracted, and that means there’s complacency (like we did in our “Complacency Everywhere” piece last week), we’re missing that the tighter ranges are what happened, versus the VIX reading being a measure of what investors believe will happen.  Now, of course, investors being humans – they often project what just happened onto what they think will happen, so there is a high correlation between the observed volatility and expected volatility.

But you can see intuitively that these aren’t the same thing. The observed volatility being low simply means investors were not faced with any market moving information or outside forces over the observed period. It doesn’t necessarily mean those investors are becoming complacent, i.e. – pricing in low volatility expectations moving forward. Luckily, the CBOE came out with some VIX-index like products a while back which allow us to test out this observed versus implied phenomenon. You can see from the charts that while observed volatility is at multi-year lows, the expected volatility is actually at multi-month highs.

Bonds:

Observed volatility = the tightest 10 Yr Treasury Yield 3 month range in 35 years

Expected Volatity = CBOE/CBOT 10-year U.S. Treasury Note Volatility Index - VXTYN (below)

Bonds Vix(Disclaimer: Past performance is not necessarily indicative of future results)

Euro Currency:

Observed volatility = the tightest consecutive monthly ranges in the Euro since inception

Expected Volatility = CBOE EuroCurrency ETP Volatility Index - EVZ (below)

Eurocurrency Vix(Disclaimer: Past performance is not necessarily indicative of future results)

So next time someone (like us) tells you investors are complacent because there’s low volatility – double check their inputs. Are they saying low volatility using the expected volatility of that market looking forward, or the observed volatility looking backwards?  We couldn’t agree more that tighter ranges and a low VIX portend a more volatile climate coming up (not a lower one), but the slight problem in the low volatility = complacency argument didn’t sit so well with us over the weekend… we feel better now for having gotten it off our chest.

About that 2014 Commodity Breakout…

Amidst all of the talk of the death of volatility, the inexplicable bond rally (rates lower), and broken record of new all time highs in US stock markets – we’ll excuse you if you didn’t notice some rather bizarre behavior in farmed commodity markets in May. The poster child was Wheat, which had a trend reversal on May 6th, and didn’t look back, losing on 14 of the next 16 days to post a negative -13.0% return in May.

New Picture(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: Finviz

But it wasn’t just Wheat  – similar patterns were seen in Corn, Soybean Oil, Rice, Coffee, and Cotton:

New Picture (1)(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: Finviz

What’s going on? Did these grain markets follow the “Sell in May” saying?  Was it the S&P hitting new all time highs? Was it an easing of tensions in the Ukraine (in Wheat’s case)? Was it the price distortion of many Ag commodities like M6 Capital suggested in their newsletter? Maybe. We’re not exactly sure. But one thing’s for certain, the sharp run higher seen earlier this year has reversed course, with Ag heavy commodity indices such as the CRB Index showing the recent weakness.

CCI Reuters Commodity Index(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: Stock Charts

A longer perspective can also be of some help here, where looking back 5 years we can see the 2014 moves higher in Coffee and Wheat were reversals of years long down trends. Perhaps these were just short coverings and dead cat bounces instead of the start of a new uptrend?  Perhaps this is a normal consolidation period before moving higher again.  Only time will tell at this point, but one thing’s for certain – the months long pattern of higher daily and weekly highs and lows, which broke the years long pattern of lower highs and lower lows, is now itself being broken.

Coffee
Wheat(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: Finviz