Perspective: Turbulant Markets & Index Tracking Matters
May 24, 2021
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Many Worrisome Market Dips – But Still Heading Higher
The market continues to trudge higher in spite of being regularly perturbed from seemingly every direction, including: inflationary news from multiple sectors, a ransomware attack that shut down oil pipelines in the southeast, more new administrative policy announcements, the threat of a 40% tax on all capital gains, the serious attacks between Israel and Hamas, political scandals in New York and California, companies that cannot find workers willing to return... and many more. Of course, we must not forget the seasonal pressure from the “Sell in May and Go Away” crowd. Still, the market continues higher. A few $Trillion of stimulus does seem to be doing its job.
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The Divergence Between Growth and Value ContinuesAs illustrated in the chart (right), a significant divergence began between growth and value equities (MDYG: SPDR Midcap Growth, and MDYV: SPDR Midcap Value) in late February signaling the start of a major rotation from “lockdown” to “re-opening.” This may be thought of as the former champions leading the charge have given way to companies that became undervalued during the pandemic. The massive vaccination programs along with the precipitous fall in cases and deaths changes everything. But labor shortages, energy production cuts, lumber price increases, and many other factors will affect how this all plays out.
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Why Catching a New Wave Takes Time
Some subscribers have asked why ARKK was not sold at the end of February by the strategies that held it, and why some strategies continued to hold ARKK into May. The chart (right) for the Nasdaq 100 ETF, QQQ, illustrates why it generally takes more time than expected to reliably identify new trend leaders. If you exited QQQ at the end of February or March you would have missed it’s all-time market high in mid-April after having sold low. It is the job of our Progressive Tuning algorithm to automatically determine what trend time frame produces the best returns. Often it takes three to six months to optimally avoid knee-jerk whipsaw losses. Whenever there is a sea change, there is inherently a lag before a new trend leader is identified and confirmed.
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Sharp Drops Often Snap Back
The reason why professionals on CNBC often recommend that we “buy the dips” is because it is most often profitable, albeit counterintuitive. The table (right), produced by Delta Investment Management, shows that 84% of the time declines are in the range of 5% to 20% and recover within two months. Once one of these declines have happened, it is more likely that you will be whipsawed than protected if you try to exit the dip after it has formed. Knee-jerk exits are always to be avoided. The character of long-term bear markets is to roll over more slowly and provide additional confirmation indications that StormGuard-Armor uses to exit the market in a prudent and timely manner.
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Index Execution Delay Performance Effects
Following the last trading day of the month, SectorSurfer, AlphaDroid, and Merlyn.AI Strategies determine which of their candidate funds have become trend leaders. The published hypothetical Index performance shown on SectorSurfer, AlphaDroid, and MAIindexes (for Merlyn.AI) presumes execution of trades is completed at the close of the subsequent market day. However, individuals, financial advisors, and fund managers often are unable to trade at that exact moment and will experience slightly different trade pricing. To help understand the effects of trading at different times, the chart (right) illustrates the hypothetical differences in long-term performance for trading the Index with +1, +2, and +3 days of extra delay. The story told by this chart is that the differences for each trade are driven by random luck and over many trades average out to become relatively unimportant. In fact, in this instance, one additional day of execution delay performed slightly better than trading to match the published Index.
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Index Execution Delay Accumulated Differences
In the chart (right), it is easier to see the effects of each trade difference. The percentage difference from the Index return is shown for the Index with +1, +2, and +3 days of extra delay. When the market has volatile days during the first few days of the month, differences can be a few percent in either direction for a single trade. The area circled in red illustrates the accumulated difference so far in 2021. The future should be expected to behave similarly. The best thing we can do is to understand that over time these short term anomalies are random noise that will average out over the course of many trades and should be ignored.
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Surf Long and Prosper,
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S&P 500 Index - 6 Months
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Divergence:
Growth vs Value Last 6 Months
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Nasdaq 100 Index - 6 Months
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Sharp Drops Often Snap Back
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Index Execution Delay
Long Term Performance Effects
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Index Execution Delay
Cumulative Tracking Error
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