QuantDesk® Machine Learning Forecast
for the Week of September 5
The August jobs report indicated approximately 151K new jobs added during the month of August. Although lower than the expected 180K, it is still in line with a healthy average job growth of 175K for the last 6 months. Markets responded positively, since the Fed will likely not be pressed to raise rates as early as September. With muted US inflation, imminent further accommodative policy in Europe and Asia, and the pending US election, the Fed will likely not be in any hurry to inject additional volatility by raising rates in a market chugging along just fine.
The VIX dropped approximately 12.25% from a week ago, underscoring August as one of the lowest US market trading ranges since 1928. Expectations are that the VIX will likely continue to exhibit historically low levels until the next earnings season, which will coincide with the November elections.
Image 1: VIX August 29th to September 2nd – Source: Google Finance
Past performance is not indicative of future returns.
On the oil front, the supply glut continues to pressure Brent and WTI crude even in the face of an unplanned September OPEC meeting to curtail record production in order to stabilize crude prices.
WTI Crude dropped from 47.65 to 44.44 for the week.
Image 2: USO Aug 22nd to August 26th – Source: Google Finance
Past performance is not indicative of future returns.
Searching for Shorts
A prominent portfolio manager at a large hedge fund once told me; “If you can come up with a method to reliably identify short opportunities, you will likely own Wall Street.”. Indeed shorting, or betting against a stock, could be very profitable but nevertheless a risky business. For one thing, shorting a stock presents an asymmetric risk with hypothetical unlimited losses. When buying a stock (or going long a stock) at $10 per share for example, the most you could lose is $10 or 100% of your initial investment. Shorting a stock is technically selling a stock you don’t own for a current price with the obligation to buy it back at whatever the market price is at a later time. If you were to short a stock priced at $10 today and the price of the stock moves higher to $200 per share, you will be obligated to pay $200 for each $10 investment. Losses equal to $190 per share, 19 times (or 1900%) of your initial investment. Practically, however, your broker will not allow you to accumulate such losses and will force you to liquidate your short position in order to maintain certain margin requirements. A short squeeze is normally a situation by which large short interest in a stock is forced to close (liquidate) at market price. This type of rush to closing large short positions inherently creates excess buying pressure on a stock, forcing it to move even higher against the short holders.
On the other hand, experienced traders need ways to hedge their portfolios against market corrections or unexpected moves and betting against a stock whether through short selling or options could be very effective. In addition, since short moves are inherently larger and quicker than long stock price appreciations, they present compelling opportunities for quick profits for those able to endure such high risk and volatility in their investment. Evident in the NY Times bestseller “The Big Short: Inside the Doomsday Machine” by Michael Lewis, there are hedge funds enjoying great profits by effectively identifying shorting opportunities.
Why is it so hard to find short selling opportunities?
Betting against a company is unpopular primarily because it is counter intuitive but more so because it can be perceived unpatriotic, as if you’re betting against the American economy. The reality is that companies are not normally eager to advertise difficulties and setbacks. They are, however, quick to promote their success. In most short opportunities, a company’s bad performance is either already baked into its stock price or would come as a complete surprise with a dramatic and quick price correction to follow. Bottom line, short opportunities are hard to foresee and even harder to react timely.
This week, I wanted to show you how Lucena’s technology can help you beat the odds in identifying short investment opportunities with quantitative analysis science on your side.
Let’s start with a simple common belief that a stock priced below its 200 day moving average is a sign of weakness and is an indication of a grim near future. Using QuantDesk Event Analyzer, we can easily confirm or refute such a common hypothesis.
Let’s roll back time and see if historically the theory above holds. We will conduct two event scans in 2010:
- Assess the one-month price action of all the stocks in the S&P 500 when their price was above their 200-day moving average.
- Assess the one-month price action of all the stocks in the S&P 500 when their price was below their 200-day moving average.
Image 3: Assessing frequency and price action for stocks in the S&P with prices above their 200 day moving average.
Image 4: Assessment result: 93,580 events during 2010. Average price move 21 days later 0.54% above the S&P 500.
Image 5: Assessing frequency and price action for stocks in the S&P with prices below their 200 day moving average.
Image 6: Assessment result: 32,416 events during 2010. Average price move 21 days later 0.90% above the S&P 500.
The table below summarizes our findings:
As can be seen, there are approximately three times more up than down moves, but the average market- relative change 21 trading days later (about 1 calendar month) is inconclusive. Both tests yielded a higher 21-day price action. We are looking for situations in which the stock price dropped.
Next, let’s further qualify our stock universe by looking at stocks with unfavorable fundamentals. How about high PE ratio relative to their peers? We are adding to the scan to include two qualifying attributes:
- price action for stocks below their 200-day moving average.
- Above average PE ratio.
Image 7: Assessing frequency and price action for stocks in the S&P with prices below their 200 day moving average and with above the median P&E ratio.
Image 8: Assessment result: 11,072 events during 2010. Average price move 21 days later 1.02% above the S&P 500. This is surprisingly even higher than our previous scan.
After refuting two common market beliefs, let’s get put some science to work.
QuantDesk is capable of recommending additional screening conditions (also called factors) that should better classify a downward price action. We have applied a unique classification technology that recommends which additional screening conditions from our 450 or so should be added to our scan to indicate a down price move.
See below how it’s done.
Image 9: Assessment result: 32,416 events during 2010. Average price move 21 days later 0.90% above the S&P 500.
Image 10: With the new recommended SMA 100-day momentum change, we now have more favorable results: 4,164 events during 2010. Average price move is -0.47% 21 days later below the S&P 500. We finally have a high concentration in a lower price action following a well-defined condition.
After refuting two common market beliefs, let’s get put some science to work.
QuantDesk is capable of recommending additional screening conditions (also called factors) that should better classify a downward price action. We have applied a unique classification technology that recommends which additional screening conditions from our 450 or so should be added to our scan to indicate a down price move.
See below how it’s done.
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 11: 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 9/2/2016.
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 9/2/2016.
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.