Market Lab Report - Premarket Pulse 12/14/15
Major averages took it on the chin Friday on higher volume. The S&P 500 and NASDAQ Composite both broke below major support levels as the S&P dove below its 200-day moving average and the NASDAQ its 50-day moving average. Oil and other commodities continued their downtrends due to lack of demand in the face of a looming global recession combined with oversupply as OPEC voted to maintain current production levels. High-yield "junk" bonds also had a nasty day as one major high-yield fund moved to liquidate while simultaneously blocking investors from redeeming their stakes in the fund. Thus the markets are suffering crisis situations on several different levels. Such days as that seen Friday have preceded eventual major sell offs in the US stock market that often materialize within a few months or less.
The Federal Reserve concludes its meeting this Wednesday. The market assumes it will raise rates, but with the recent weakness in the markets and ongoing weakness in the global economy, the Fed may have no choice but to hold off on any rate hikes.
Updates on the Models
VIX Volatility Model based on long term tests shows substantial profits overall. That said, all strategies go through periods of drawdowns. Such periods fortunately have not lasted longer than typically a few months. The model's current drawdown started in early September, shortly after the model was shared on the website. Here's an update we provided on October 23: http://www.virtueofselfishinvesting.com/reports/view/important-update-on-vix-volatility-model-vvm
Based on back tests going back many years, I expect this difficult period to come to an end sooner than later. That said, the past cannot always predict the future, so patience during prolonged periods of difficulty is warranted.
VIX Volatility Model remains in cash for now as the markets have been very noisy. While constructive volatility can yield steep gains such as in 2011 or more recently earlier this year, it is best to wait out the brief periods where the model does not have the odds on its side. The model needs to see advantage before issuing a buy or sell signal. While US markets this year have been unusually trendless, much of it has been surprisingly profitable with respect to the model's performance tests.
While the model remains in beta for now, the last three signals occurred after the fail safes were implemented. Total loss was just -2.8%. It is constructive that members can see how the model performs under one of the most challenging environments.
So despite the noisy markets, and despite the three signals being losers, the total loss came to just -2.8% as expected based on backtests. Meanwhile, the model has had healthy gains prior to August of this year in backtests after the fail-safes were worked into the strategy. While this year has been one of the most challenging for market timing and hedge funds of all stripes, such periods always come to an end. When it comes to the markets, the only thing that doesn't change is change.
MDM is longer term so to avoid getting whipsawed repeatedly, especially in a year such as this one, it stays on its signals longer than normal. Do look at its overall long term track record vs the Nasdaq and S&P 500 to gain a clearer picture on the models strengths and weaknesses. When it comes to catching intermediate to longer term trends, the model will get whipsawed like it has this year. Also, in the last couple of years, the markets have become far more manipulated by central banks thus shallow floors form even when all signs point to a much worse correction. Likewise, normal sustained uptrends have also been nearly non-existent. Sharp moves in either direction often come without warning off lows or off highs which explains why this year has been one of the most challenging in decades.
Thus our greater focus on individual stocks and, more recently, the VIX Volatility Model given its performance up through August of this year with the implemented fail-safes. Note, the reports emailed out on the VIX model prior to the last three signals did not contain the implemented fail-safes as we have discussed in a prior VIX model update.
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