Sleep well traders in North America. It looks like good news in Ukraine and the strong potential for a very small CPI reading on Tuesday (due to energy price weakness) will influence valuations into this week.  The equity market rally (bear-market rally) looks to continue for another day.

We have our model set to a ever-so-slightly more optimistic position of 7.25% expected return and 3% riskfree rate. It caused us to cover some of our shorts (our hedge of the $SPY) on Friday morning and buy higher-BETA stocks.

We stand by our slightly more optimistic settings for today's market. The Futures and Asian Markets look to validate this decision. Let's see where the week goes. Good luck to all.

Well, the US equity markets are up slightly and stronger today. This is welcome news for us personally, as our personal holdings are down > 50%.

The supporting financial assets are as follows:

• VIX, down
• Bond yields, down
• Energy, down (not good for energy stocks, but good for consumers and producers)
• Copper, down (lower inflation and lower industrial demand)
• Silver, up (risk on and positive on industrial demand)
• US Dollar is up against all major currencies (including the Chinese Yuan). This is likely due to our narrowing trade deficit, higher interest rates, and general malaise in global markets (flight to quality of the US).

Yesterday, we saw corporate fixed income have the worst New Low / New High market breadth we have seen in ages. 100 new lows for every 1 new high (see pix below) and data here from FINRA. From the same site, we see the US Treasury Yield Curve (riskfree yields across maturities) is higher and very flat. All money now costs around 3% to 3.5%, regardless of duration or maturity date. This is expensive for short-term money, which could be what is driving the market lower. Expensive short-term money makes speculation and trading more costly, and therefore selling short could be even more attractive (sell first, then buy later).

Some of these movements could be due to the global energy shock as the world realizes that clean energy may not be plentiful enough, and that Coal, Oil and Sweat may be required for the foreseeable future. Sacrifices in demand must be made if we are to live with less energy, or we need innovation to leverage higher energy alternatives (like nuclear fusion, fission, and space-based. In fact, I am getting up now and turning off our AC (true).

We are reflecting today on the sector rotation underway in the US equities market for the past year. Energy stocks have risen while consumer / communication stocks have fallen. It may be time for that rotation to reverse itself. Take a look at relative performance at Finviz here. 

Our model suggested a move into more commonly held stocks, and more of them. It takes 25 stocks, evenly held, and hedged against the SPY, to create an edge (or alpha) that can be captured regardless of market movements higher or lower. This is because variances are up, risk-free rates of return are up, and market expectations of new risk capital returns are lower.

In terms of sectors, retail looks strong. Coal is weak. Retail Banks are doing ok (mixed but higher), and the rest of the industry sectors are mixed. Not to say 50%/50% up and down, but almost every sector is mixed. 

A few learnings as we papertrade our model in a repeatable, scalable fund concept.

1. We did not buy and sell at the open, or in pre-market. We waited 17 or 19 minutes into the trading day. Paper trading only. We made a few dollars because stocks fell early, but we also lost on stocks we were exiting.  We hold the same 5 core stocks and the SPY hedges for a 2nd day (no transaction costs or trading), but we were supposed to buy 2 stocks and sell 2 stocks.  By the time we pulled the trigger, the market moved. In today's market, that movement was material to our results for the day.

Objective: how to rebalance effectively, and how to avoid the 'market open' in rebalancing on a down day.

​2. Our core 5-stock holdings are down significantly today. They are down from 4x to 12x the percentage drop of the SPY. When the market is rising, these stocks rise faster than the SPY. However, when the market falls they fall faster. With a time horizon of minutes (watching the tape), this seems catastrophic. With a time horizon of days or weeks, this evens out and is what we expect to see. The BEAR market leg lower is not kind to high-BETA stocks, even those that work well together. 

3.  We set our model to assume positive expected returns to risk assets. If we were to reduce our expectation for profits in the stock market, or increase our expectation of the risk free rate of return, it changes the stocks that we pick. It is hard to know how to calibrate the expectations of investors. This is an area to focus on.  For example, if we assume that September is a bad month, and investors have lowered expectations of earnings for 'fresh' money in the markets, then the model would pick less risky stocks. This allows the 'edge' to work better and more slowly than for high velocity stocks. Think Berkshire Hathaway B-class shares vs. Bitcoin financier.

We will work through these issues and have a fund concept that is workable. It requires a consistent management process, labor available in the evenings and mornings every day the market is open, and commitment to learn and evolve the process. Thanks for taking the journey with us.  If you are interested in learning more, please reach out via our 'contact' page.

Regards,
Jeffrey Cohen, President, US Advanced Computing Infrastructure, Inc.