MLR - UPDATE ON TVIX/UVXY MODEL and "I find 2012 incredibly frustrating and highly unusual and unprecedented. Why is the market moving higher while the RS line of the IBD 85-85 index moving lower?"

Published : October 24 2012 at 7:27 ET

The TVIX/UVXY model continues to show great promise as a new short-term and intermediate-term strategy since the modifications were put in place starting with its signal on September 5, 2012. The TVIX/UVXY is capable of capturing gains during trendless periods as well as trending periods and is essentially a sub-variant of the Market Direction Model (scroll down to the TVIX/UVXY table).



Q: I find 2012 incredibly frustrating and highly unusual and unprecedented. I often check the RS line of the IBD 85-85 index to see how leading stocks are trading against the broad indexes. The RS line of the 85-85 index has been lagging the major indices all year, failing to hit new highs earlier in the year even though the NASDAQ Composite hit new highs in February. Then since May 2012, the IBD 85-85- index has been directionless while the major averages continue to trend higher. 

It is not out of the ordinary to see the 85-85 index underperform during a bear market, but not often do you see it underperform in a year when the market goes up (it underperformed in 2009 off of the lows).

Any thoughts on the underperformance of the IBD 85-85 index?


A: IBD 85-85 index tracks stocks that are strong fundamental and technical performers. The index's underperformance against a market that has moved higher up until recently is another reason why 2012 is probably the most challenging year on record. Quantitative easing continues to manipulate the market reluctantly higher. Meanwhile, the trend following wizards continued to be collectively down for 2012 with several wizards showing double digit percentage underperformance, even though the major market averages are up double digits percentages. Even the great Dunn Capital is down -17.78% and JWH & Co is down -21.13%. Both were interviewed extensively in Michael Covel's book Trend Followers. What we are seeing is almost unprecedented, with the only other year this occured being 2011, as 2011 was trendless, volatile, and news-driven creating a series of gap ups and gap downs in a market that could rarely find direction.

Incidentally, by the end of March 2012, the trend following wizards were collectively down 2012 despite the market being in an uptrend with the NASDAQ Composite up +19.7% and S&P 500 up +13.1%. The uptrend, however, was illusory as it was mostly driven by Apple (AAPL) and a scant handful of other names such as (PCLN) during the first quarter of 2012.

As we wrote in an August 10, 2012 note from our website, “2012 is reminiscent of the second and third quarters of 1999 when the model had its largest drawdown in its history. During the second and third quarters of 1999, the NASDAQ Composite was the most volatile and directionless in its near 30-year history giving the Market Direction Model its worst drawdown at that point at -15.7%. Since then, 2012 has traced out an equally unusual situation, especially during the months of May through early August when the market moved just enough to trigger false buy and sell signals, giving the model its worst drawdown at -18.2%. Fortunately, such periods are aberrations and always have come to an end. Even though dark pools and high frequency trading and quantitative easing have been alive and well since 2010, the Market Direction Model outperformed in 2010 and 2011 using NASDAQ Composite as benchmark (multiple by roughly 3x if using 3x ETF TECL):

2011 MDM +11.2% vs NASDAQ Composite -1.8%

2010 MDM +26.0% vs NASDAQ Composite 16.9%

Eventually, the market will catch a sustained trend. This has historically made a big difference in terms of overall performance over time, and this is the premise of the Market Direction Model.

That said, the market direction independent TVIX/UVXY model (and market direction dependent as it can catch longer term trends) can help during future trendless periods when the Market Direction Model may be having false signals.

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