Weekly newsletter of Danny Merkel - Issue #98
Market Review:
With November over, let’s start with a monthly chart of the DJIA to get a big picture perspective.
For the month, the DJIA printed another white candle with a gain of 5.94%. That follows October’s strong white candle, which leads me to another observation: white candles tend to lead to more white candles.
Although academics believe that markets are random, experienced traders know that markets tend to trend.
This means that after a strong month, the next month isn’t a 50/50 coin toss - the odds slightly favour further strength.
DJIA monthly chart (2013 - present)
The strength in the DJIA is undeniable and, in fact, this has been the strongest 2-month-rally for the index since 1938.
But as I mentioned previously - and what should be obvious if you’re an experienced trader - is that the DJIA is not the market; it consists of only 30 holdings and that’s only about 0.3% of stocks globally.
Therefore, to get a more realistic picture of the stock market, it’s important to look at a broader index.
Containing 3,693 stocks, the Vanguard Extended Market ETF holds every liquid stock in America, except for the companies that comprise the S&P 500 and so it offers a unique picture of the market that is not dominated by just a few large names.
And so when we go beyond the 30 stocks that comprise the DJIA, the picture suddenly looks less impressive. The typical stock in America hasn’t exceeded its August high and remains entrenched in a long-term downtrend:
Vanguard Extended Market ETF (VXF) with long-term trend
So if the DJIA is looking pretty good, while everything else is still in a bear market, what should you do?
In my opinion, the correct Trend Following approach would be to buy the DJIA if it meets your criteria. My criteria is to buy ETFs making new 52-week-highs, so it is conceivable that I’ll be buying DIA in the near future.
On the other hand, the wrong approach would be to see the strength in the Dow and use that as a kind of market barometer to start buying all stocks.
In other words, it makes no sense to start buying companies in downtrends such as ZM, PYPL or TSLA just because you see “the market” going up everyday.
Moving on, another major theme for the month of November was the massive reversals in almost every asset class.
For example, the US Dollar lost 5.29% against the Euro for the month. This means that for non-American investors, an ETF like SPY barely rose for the month in terms of Euros.
The chart below shows that the S&P 500 has been in a trading range for the entire year when denominated in Euros:
S&P 500 denominated in Euros - weekly (2018 - present)
Basically, when the stock market was falling, the US Dollar was rising, so that combination cushioned the blow. But now the opposite is happening. Yes, the market is rising, but that rise is being neutralized by a falling USD.
One idea I had recently is that the reason there was never any panic selling or spike in the VIX is because the average global investor never experienced much pain this year.
In any case, the sharp reversal in the USD this month was a huge hit to most Trend Following firms. As an example, Bill Dunn’s main strategy was down 8.25% for the month:
Similarly, the Trend Following ETF I discussed previously - DBMF - lost 8.84% for the month, its largest monthly decline on record.
At the time I discussed DBMF, it was making new all-time-highs, so it was completely reasonable for me to be a buyer, given the information available at the time.
However, even the best looking charts have the potential to unravel quickly, which is why it’s essential to have a pre-determined exit plan. The exit strategy that I use for my own trading is to sell once the 20 day moving average has been broken.
In the case of DBMF, the last exit occurred on October 27th. From there, the ETF never regained its footing and failed to make a new high, thus it failed to generate any further buy signals.
And so by following pre-determined, systematic rules the strategy was able to sidestep all of November’s losses.
In my opinion, the chart above looks “wrecked” with a nasty gap down and non-stop weakness day after day.
Even though I’m out of the trade, I’m still monitoring DBMF’s holdings each day to try to understand how the strategy works.
To better make sense of what the fund is doing, I’ve added a column “Equivalent ETF” to make each position easier to visualize.
Not every holding has a corresponding ETF, but otherwise you can see that the fund is getting blasted from all angles.
Most recent holdings of DBMF
Shorting the Euro? Not working.
Short the S&P 500? Not working.
Short Gold? - Not working.
Short bonds? - Definitely not working.
In summary, DBMF was a reasonable buy at the time, but it didn’t work out, and so I simply took the trade off the table.
Because the position was small, I ended up losing just 0.2% of my account account capital on the trade (red rectangle) and so I’m easily able to go onto the next trade.
Recent transaction history of my trading system
In the context of the last 20 recent trades, DBMF doesn’t really stand out. Think next 1,000 trades.
Interesting ETFs:
If you’re like me and you scan for new 52-week-highs each day, you may have come across something intriguingly called the “Leatherback Long/Short Alternative Yield ETF”.
Trading under the symbol LBAY, this fund is making new all-time-highs while almost no other equity ETF is, which got me thinking in terms of why.
From a purely Trend Following point of view, there’s no need to determine why or how something is going up - just take the trade and don’t over think it.
Nonetheless, to make things interesting, I delved a little deeper and found that the ETF is holding the following stocks:
Top 10 holdings of LBAY
The fund is invested in some decent names, such as Exxon Mobil, but there are dozens of ETFs that have similar holdings, yet they are not at new highs, so there’s something else going on here. What is it?