QuantDesk® Machine Learning Forecast
for the Week of August 1
The US market was mostly flat, breaking a 4-week winning streak. As global markets continue to anticipate accommodative monetary policy, the US Fed is contemplating another rate hike this year. While the US Federal Reserve claimed that near-term risks have diminished and employment continues to improve, the disappointing GDP Q2 figures, reported on Friday, pointed to an economy growing at a measly 1.2% annual rate, well below the expectations of 2.2%. With historically low interest rates in the US and around the world (some are still in negative rate territories), investors seeking yield are left with very few choices, mostly accompanied by a higher risk relative to their comfort zone. Consequently, equity prices continue to move higher, while most reporting companies are beating low earnings expectations. PEG ratios (price/earnings to growth ratio) have been reaching new levels, and without robust growth, most are unsustainable in my opinion.
Oil rates also continue to decline with West Texas Intermediate crude falling from $44.38 to $40.70 per barrel for the week. A decline of -8.3%. The VIX also moved lower, ending the week at $11.87, a 52-week low.
Image 1: USO July 25th to July 29th – Source: Google Finance
Past performance is not indicative of future returns.
Image 2: VIX July 25th to July 29th – Source: Google Finance
Past performance is not indicative of future returns.
Using QuantDesk® Forecaster and Optimizer to Anticipate Market Sentiment
This week, I wanted to showcase Lucena’s QuantDesk Optimizer and Price Forecaster in the context of anticipating the US market’s mood through a sector rotation strategy.
WaveRider is Lucena’s long/short 2X sector rotation strategy. It anticipates individual sector price moves using QuantDesk® Price Forecaster together with QuantDesk® Mean Variance Optimization (MVO). The strategy assumes that there is a clear pattern in the flow of funds between the major US industry sectors relative to their business cycle. In backtesting, the strategy has demonstrated consistent low volatility returns, outperforming the S&P 500 in total return while demonstrating less than half of the S&P’s volatility. The strategy boasts an annualized Sharpe of 1.06 vs. the S&P’s of 0.56.
Image 3: WaveRider 2X sector rotation strategy backtest simulation. 1/1/2004 to 3/31/2016.Backtest represents long/short holdings applying 2X leverage. Backtest assumes slippage of 5 bps per transaction (10bps round trip) and transactions costs as the larger of 6.95 per trade or $0.0035 x number of shares traded.
Past performance is not indicative of future returns.
WaveRider holds 11 highly liquid ETFs representing the nine major US sectors, one short term fixed income, and one REIT. The fund reassesses its positions daily but only changes its allocation when it detects a substantive shift in momentum and risk appetite. Since WaveRider is a long/short strategy, it is able to tilt long and short exposure among its ETFs, effectively forming a hedge to protect against a sudden widespread market drawdown. (See backtest performance above during the financial crisis in 2008, for example.)
In the past three months or so, we have been tracking WaveRider using a forward paper trading simulation. In addition to backtesting, QuantDesk enables its users to track a paper trading performance on a roll forward basis as if they were trading a live portfolio. The performance summary below represents WaveRider’s returns over the last 3 months and as can be seen the returns so far have been consistent with the backtest’s performance.
Image 4: WaveRider 2X sector rotation strategy against the S&P 500, 4/25/2016 to 7/29/2016 paper trading simulation. Performance assumes transactions costs as the larger of 6.95 per trade or $0.0035 x number of shares traded.
Past performance is not indicative of future returns.
Step 1: Create a portfolio consisting of the 9 major US sectors’ Spider ETFs.
Image 5: SPDR sector ETFs in a portfolio with initial cash value of $1M.
Step 2: Set min/max allocation restrictions and optimize the portfolio using QuantDesk® Forecaster. In other words, apply a mean variance optimization based on a projected state of the portfolio (vs. the traditional historical price average).
Image 6: Setting min/max allocation thresholds (between 0 and 20% per each constituent).
Image 7: Optimization settings.
Step 3: Optimize and inspect the results.
Image 8: New allocation recommendations after optimization.
Image 9: Before (blue) and after (orange) optimization main view and the efficient frontier via risk/return scatter chart on the bottom right.
As you can see, the Optimizer suggests splitting its allocations about 50/50 between its long and short holdings. In addition, it recommends overweighting consumer discretionary and industrials while underweighting technology and financials.
Analysis
BlackDog, Lucena’s risk parity portfolio continues to rock! It reached a new all-time-high, gaining 2.14% for the week. Tiebreaker gained 0.13% while both the DOW and the S&P closed lower and flat, respectively. The Dow lost -0.74% while the SPY was down -0.05%.
- DIA lost -0.74% (SPDR Dow ETF).
- SPY lost -0.05% (SPDR SP-500 ETF).
- Tiebreaker model portfolio gained 0.13% and currently stands at a YTD return of 0.18%.
- BlackDog 2X model portfolio gained 2.14%, holding a YTD gain of 13.99% and ahead of the SPY by 6.33%.
The table below delineates a trailing 12-month performance and a YTD comparison between the two model strategies we cover in this newsletter (BlackDog and Tiebreaker), as well as the two ETFs representing the major US indexes (the DOW and the S&P).
Image 10: Last week’s changes, trailing 12 months, and year-to-date gains/losses.
Past performance is no guarantee of future returns.
Model Tiebreaker: Lucena’s Active Long/Short US Equities Strategy:
Tiebreaker: Paper trading model portfolio performance compared to the SPY and Vanguard Market Neutral Fund from 9/1/2014 to 7/29//2016.
Past performance is no guarantee of future returns.
Model BlackDog 2X, Lucena’s Tactical Asset Allocation Strategy:
BlackDog 2X: Paper trading model portfolio performance compared to the SPY and Vanguard Balanced Index Fund from 4/1/2014 to 7/29/2016.
Past performance is no guarantee of future returns.
Appendix
For those of you unfamiliar with BlackDog and Tiebreaker, here is a brief overview: BlackDog and Tiebreaker are two out of an assortment of model strategies that we offer our clients. Our team of quants is constantly on the hunt for innovative investment ideas. Lucena’s model portfolios are a byproduct of some of our best research, packaged into consumable model-portfolios. The performance stats and charts presented here are a reflection of paper traded portfolios on our platform, QuantDesk®. Actual performance of our clients’ portfolios may vary as it is subject to slippage and the manager’s discretionary implementation. We will be happy to facilitate an introduction with one of our clients for those of you interested in reviewing live brokerage accounts that track our model portfolios.
Tiebreaker:
Tiebreaker is an actively managed long/short equity strategy. It invests in equities from the S&P 500 and Russell 1000 and is rebalanced weekly using Lucena’s Forecaster, Optimizer and Hedger. Tiebreaker splits its cash evenly between its core and hedge holdings, and its hedge positions consist of long and short equities. Tiebreaker has been able to avoid major market drawdowns while still taking full advantage of subsequent run-ups. Tiebreaker is able to adjust its long/short exposure based on idiosyncratic volatility and risk. Lucena’s Hedge Finder is primarily responsible for driving this long/short exposure tilt.
Tiebreaker Live Interactive Brokers Portfolio Performance
Live performance reports are taken from an interactive brokers account which attempts to follow Tiebreaker’s model closely with the following potential differences:
- Transactions Fees - Performance is net of transactions fees.
- Management Fees - Performance is net of management fees.
- Manager’s discretion – Manager can use own discretion as to final trade executions. For example, employing VWAP (volume weighted average price) and/or manually monitoring exit during stop loss and target gain.
- Hard to borrow and restricted stocks - Hard to borrow, and restricted stocks may be substituted with highly correlated alternatives.
- Dividends, interest or any other credits are reinvested.
- Slippage - Depending liquidity, large block purchases could impact certain stock prices unfavorably.
Tiebreaker Model Portfolio Performance Calculation Methodology
Tiebreaker’s model portfolio’s performance is a paper trading simulation and it assumes opening account balance of $1,000,000 cash. Tiebreaker started to paper trade on April 28, 2014 as a cash neutral and Bata neutral strategy. However, it was substantially modified to its current dynamic mode on 9/1/2014. Trade execution and return figures assume positions are opened at the 11:00AM EST price quoted by the primary exchange on which the security is traded and unless a stop is triggered, the positions are closed at the 4:00PM EST price quoted by the primary exchange on which the security is traded. In the case of a stop loss, a trailing 5% stop loss is imposed and is measured from the intra-week high (in the case of longs) and low (in the case of shorts). If the stop loss was triggered, an exit from the position 5% below, in the case of longs, and 5% above, in the case of shorts. Tiebreaker assesses the price at which the position is exited with the following modification: prior to March 1st, 2016, at times but not at all times, if, in consultation with a client executing the strategy, it is found that the client received a less favorable price in closing out a position when a stop loss is triggered, the less favorable price is used in determining the exit price. Since March 1st, 2016, all trades are conducted automatically with no modifications based on the guidelines outlined herein. No manual modifications have been made to the gain stop prices. In instances where a position gaps through the trigger price, the initial open gapped trading price is utilized. Transaction costs are calculated as the larger of 6.95 per trade or $0.0035 * number of shares trades.
BlackDog:
BlackDog is a paper trading simulation of a tactical asset allocation strategy that utilizes highly liquid ETFs of large cap and fixed income instruments. The portfolio is adjusted approximately once per month based on Lucena’s Optimizer in conjunction with Lucena’s macroeconomic ensemble voting model. Due to BlackDog’s low volatility (half the market in backtesting) we leveraged it 2X. By exposing twice its original cash assets, we take full advantage of its potential returns while maintaining market-relative low volatility and risk. As evidenced by the chart below, BlackDog 2X is substantially ahead of its benchmark (S&P 500).
In the past year, we covered QuantDesk’s Forecaster, Back-tester, Optimizer, Hedger and our Event Study. In future briefings, we will keep you up-to-date on how our live portfolios are executing. We will also showcase new technologies and capabilities that we intend to deploy and make available through our premium strategies and QuantDesk® our flagship cloud-based software.
My hope is that those of you who will be following us closely will gain a good understanding of Machine Learning techniques in statistical forecasting and will gain expertise in our suite of offerings and services.
Specifically:
- Forecaster - Pattern recognition price prediction
- Optimizer - Portfolio allocation based on risk profile
- Hedger - Hedge positions to reduce volatility and maximize risk adjusted return
- Event Analyzer - Identify predictable behavior following a meaningful event
- Back Tester - Assess an investment strategy through a historical test drive before risking capital
Your comments and questions are important to us and help to drive the content of this weekly briefing. I encourage you to continue to send us your feedback, your portfolios for analysis, or any questions you wish for us to showcase in future briefings.
Send your emails to: [email protected] and we will do our best to address each email received.
Please remember: This sample portfolio and the content delivered in this newsletter are for educational purposes only and NOT as the basis for one’s investment strategy. Beyond discounting market impact and not counting transaction costs, there are additional factors that can impact success. Hence, additional professional due diligence and investors’ insights should be considered prior to risking capital.
For those of you who are interested in the spreadsheet with all historical forecasts and results, please email me directly and I will gladly send you the data.
If you have any questions or comments on the above, feel free to contact me: [email protected]
Have a great week!
Lucena Research brings elite technology to hedge funds, investment professionals and wealth advisors. Our Artificial Intelligence decision support technology enables investment professionals to find market opportunities and to reduce risk in their portfolio.
We employ Machine Learning technology to help our customers exploit market opportunities with precision and scientifically validate their investment strategies before risking capital.
Disclaimer Pertaining to Content Delivered & Investment Advice
This information has been prepared by Lucena Research Inc. and is intended for informational purposes only. This information should not be construed as investment, legal and/or tax advice. Additionally, this content is not intended as an offer to sell or a solicitation of any investment product or service.
Please note: Lucena is a technology company and not a certified investment advisor. Do not take the opinions expressed explicitly or implicitly in this communication as investment advice. The opinions expressed are of the author and are based on statistical forecasting based on historical data analysis. Past performance does not guarantee future success. In addition, the assumptions and the historical data based on which an opinion is made could be faulty. All results and analyses expressed are hypothetical and are NOT guaranteed. All Trading involves substantial risk. Leverage Trading has large potential reward but also large potential risk. Never trade with money you cannot afford to lose. If you are neither a registered nor a certified investment professional this information is not intended for you. Please consult a registered or a certified investment advisor before risking any capital.