QuantDesk® Machine Learning Forecast
for the Week of October 10
World markets were mostly unchanged while the S&P ended the week lower by approximately 70bps. News headlines were dominated by four main themes this past week. In the US, we had the impending election and a deadly Hurricane Matthew making landfall in the Florida coast line. In the UK, the British Pound dropped in what many describe as a flash-crash scenario, to a 31-year low of $1.14 before rebounding to finish the week at $1.24. The US added 156K new jobs, fewer than expected although not enough to change the view of a year-end Fed’s rate hike.
The VIX ended the week lower at 13.48. Although still historically low, the VIX has been rather volatile intraweek due to uncertainties stemming from a December rate hike and the November US election.
Image 1: VIX October 3rd to October 7th – Source: Google Finance
Past performance is not indicative of future returns.
Oil prices ended higher passing the psychological $50 per barrel barrier, with West Texas Intermediate crude rising to $50.25 per barrel from $47.90 a week ago. Our view is that skepticism over OPEC’s production cut and the persistent increase in alternative oil production around non-OPEC countries will continue to cap crude’s rise in the coming weeks.
Image 2: USO October 3rd to October 7th – Source: Google Finance
Past performance is not indicative of future returns.
Lucena’s one-week price forecast anticipates oil to remain flat with daily volatility not exceeding 2.5%.
Image 3: USO next week’s price forecast. Estimated to stay flat and within 2.43% price volatility.
The Waffle House Index
Background: With the emergence of big data, not a week goes by in which I don’t receive a call from a data provider asking how to make their data accessible through QuantDesk. A data vendor partner once told me that QuantDesk puts “a face” on their data and thus enables both prospects and customers to visualize their predictive power and thus make educated investment decisions. It’s true that, historically, big data was only a luxury of large investment wire houses and hedge funds who possessed the massive infrastructure and in-house expertise needed to make use of such data. Lucena has developed a streamlined approach that integrates and incorporates new data sources with ease and thus makes such data accessible to a wide audience on our decision support platform, QuantDesk®.
Image 4: Lucena’s process of loading and integrating a new data source.
As more data providers surface, it has become abundantly clear that unique data sources have tremendous value to hedge funds seeking to maintain a competitive advantage. Satellite imaging, supply chain dependencies, GPS location, and social media sentiment is a small example of data providers seeking to make their data the “next best thing.” As someone who tries to stay on top of predictive data sources, I once in a while come across a peculiar index derived from an unexpected data source. The Waffle House index is one of them and made the news during the recent category 4 hurricane (Matthew), which hit Caribbean Islands, Haiti and the United States last week.
What is the Waffle House Index?
The Waffle House is a restaurant chain primarily in the southern portion of the United States which prides itself on staying open 24×7, 365 days per year. A common joke in the region states that they don’t need locks on their doors because they are always open. Practically, by law any operating commercial property must have locks on their doors.
From Wikipedia: “The Waffle House Index is an informal metric used by the Federal Emergency Management Agency (FEMA) to determine the effect of a storm and the likely scale of assistance required for disaster recovery. The measure is based on the reputation of the Waffle House restaurant chain for staying open during extreme weather and for reopening quickly, albeit sometimes with a limited menu, after very severe weather events such as tornadoes or hurricanes.”
The Index has three levels, based on the extent of operations and service at the restaurant following a storm:
- Green: the restaurant is serving a full menu, indicating the restaurant has power and damage is limited.
- Yellow: the restaurant is serving a limited menu, indicating there may be no power or only power from a generator or food supplies may be low.
- Red: the restaurant is closed, indicating severe damage.
Investment Opportunities from Natural Disasters?
Besides loss of life, infrastructure destruction, business shutdowns and consequently loss of jobs are by far the most obvious type of damages that comes to mind when we think about natural disasters. However, there are certain business sectors that benefit such as construction, restoration and building material companies. To illustrate how one may find investment opportunities when a devastating hurricane approaches a region, I have extracted Home Depot’s (HD) price chart from last week. As Hurricane Matthew approached US shores prior to October 6th, a day in which the Waffle House Index reached red status, HD’s price rose. Subsequently, on October 7th, HD’s price dropped significantly after the realization that Matthew is destined to leave behind much less damage than originally anticipated.
Image 5: Waffle House Index impacts on Home Depot (HD) price action.
Conversely, insurance companies are exposed to major losses from coverage payouts and premium losses. It would be therefore natural to expect Allstate’s (ALL) price chart to drop when the Waffle House Index reached red status on October 6th, and subsequently reverted back higher when the Waffle House Index turned green.
Image 6: Waffle House index impacts on Allstate Insurance (ALL) price action.
Lucena Visiting London – Presenting on October 13, 2016.
On October 13th, I will be traveling to London and will be presenting in partnership with the local Market Technician’s Association (MTA) chapter our approach to building a winning machine-learning based Foreign Exchange strategy. If you happen to be in the area and would like to attend, you can find more information and register here:
Analysis
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 7: 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 10/7/2016.
Past performance is no guarantee of future returns.
Model BlackDog 2X, Lucena’s Tactical Asset Allocation Strategy:
BlackDog: Paper trading model portfolio performance compared to the SPY and Vanguard Balanced Index Fund from 4/1/2014 to 9/30/2016.
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.