Weekly newsletter of Danny Merkel - Issue #86
Market Review:
Okay, so the market managed to bounce sharply this week but, once again, it’s not enough to move the needle.
From a Trend Following perspective, the S&P 500 has been a hot mess for the entire year. Every rally has faded. Every dip has been bought.
The end result is that the market is at the exact same level today as it was 14 months ago. Because trend followers thrive off of big moves - either up or down - this is not great news.
So the best thing you can do in a choppy, sideways trading range is to simply avoid trading it. With a trend following approach, the more often you trade within a trading range, the more money you will lose, so the winner is the trader who trades the least often.
In last week’s issue, I introduced a very easy, yet robust rule of thumb that can help you avoid unfavourable markets. By simply asking yourself has price made a new 52-week-high this month, you can segment the S&P 500 into bullish and bearish zones:
SPY with 52-week-high channel (blue zone)
From this perspective, we can see that price has only made a single solitary 52-week-high for all of the year 2022 (dashed vertical line). From that point, all subsequent months could then be classified as bearish.
If you’re a Stockcharts.com user, you can implement this neat rule of thumb as follows. Note that there are 253 trading days in a year, which is why the blue zone translates to a 52-week-high zone:
Now, if you’re a growth stock trader, you may want to consider an index that more closely tracks the stocks you are actually trading, and my ETF of choice is the iShares Russell 2000 growth fund.
Using the same rule of thumb, notice that the last time growth stocks made a new 52-week-high was on February 16th 2021 (dashed vertical line).
From that point, one could have asked if price had made a new high, and the answer - for the last 19 months - has always been no:
I didn’t feel like writing the word “No” 19 times in the chart above, but you get the idea.
By acknowledging that growth stocks have been - and currently still are - in a bear market, they are a few options available.
The first is to deny the bear market exists and continue to go at it pedal to the metal, trading frequently with large positions. This option has been very popular amongst the growth stock community, and has the advantage of providing the trader with a lot of action and excitement. The disadvantage, however, is that it also leads to drawdowns of over 80%.
The second option is to completely stop trading in a bear market. The advantage with this approach is that you preserve almost all of the gains made during the previous bull market. But the disadvantage is that almost nobody has the patience of doing nothing for 19 months.
The third approach - the one that I use - is to acknowledge the bear market exists, but only continue trading infrequently and at a reduced position size.
A great way to trade infrequently in a bear market is to focus only on stocks making new all-time-highs. Everyday, I run a stock scan that identifies all stocks making new ATHs and a common theme running for months is that there are almost none.
Every now and then, though, there is a stock - such as ENPH - that is able to buck the trend and find its way onto my scan. From there, my system allows me to buy it, but at a reduced position size. To be clear, for this entire bear market, I’ve been buying stocks at a position size that is 75% less than normal.
In summary, this approach allows for some action, but reduces it by focusing on only the most resilient stocks making new highs. And drawdowns are greatly reduced due to the extra small position sizes used.
Interesting ETFs:
If you’re like me and you’re trading infrequently and trading small, chances are that you have a bunch of idle cash sitting in your brokerage account.
Because I have a lot of idle cash and because my brokerage doesn’t pay any interest on the cash, this presents a problem, especially in the high inflation environment we’re in now.
In this section, I’ll discuss a variety of options to put this cash to work to earn some nice passive income.
The chart below highlights 6 low-risk ETFs that generate monthly income:
Starting from the top (in purple) we have PSA.TO, which is an ETF that I personally am using right now to park Canadian Dollars.
The fund deposits its assets under management inside Canadian bank accounts which pay interest and the deposits are insured by the Canadian Government.
The fund is so conservative that one could argue that it’s the only ETF in existence that is guaranteed not to lose money.
Now with interest rates on the march higher, the yield on this guaranteed investment is becoming more attractive. For example, a $1 million investment will currently pump out a monthly dividend payment of $2,566.
I realize that if you’re reading this, you probably don’t have a bunch of Canadian Dollars lying around to invest but, interestingly, this same ETF provider does also offer the same guaranteed return option for US Dollars.
Trading under the symbol PSU/U.TO, this ETF, although currently quite illiquid, is paying out $2,284 per month on an investment of $1 million.
Moving on to something more liquid, let’s have a look at another option: BIL.
In the chart above, BIL (shown in red) was dead money for almost 2 years as interest rates were jammed near zero. However, starting this year (dashed vertical line) interest rates have been on the move and with it, BIL has been resurrected from the dead and is on the move again.
You can love or hate the Federal Reserve, but one thing they’re good at is creating trends. Once a fund like BIL starts going, it tends to keep on going:
BIL - monthly chart (2015 - present)
Notice that back in 2017, once BIL started moving, it kept going, forming around 35 white monthly candles in a row.
My hypothesis is that BIL is beginning a new cycle higher and will continue to print new monthly bars higher every month.
At present, BIL produces a monthly yield of $1,514 for every million dollars invested. Granted, that’s not a fantastic percentage, but it’s still substantially better than the $0.00 that I would otherwise earn on my idle cash.
Other ETFs worth considering are TFLO (green), USFR (orange) and SGOV (white).
Current Holdings:
Here are my holdings going into next week: