By Jeffrey Cohen, Investment Advisor Representative
US Advanced Computing Infrastructure, Inc.
Today is options expiration day. The markets should be volatile today as positions are closed out and options (and the underlying asset) prices are moved around to maximize trading profits.
We also expect the market to digest many changes from yesterday's action:
- Bank of Japan gave up the JGB yield cap of 0.25%, which boosted the YEN, which has now come back to its previous highs of 134.50
- US equities opened lower yesterday (gap down) and traded in a range, ending down ~4%. This is a significant drop.
- US Federal Reserve raised interest rates by 0.75%, and short-term yields rose
- High number of new lows in both Agency and Corporate fixed income, and US equities. New lows dominate the decliners (about 40% of all stocks or bonds that declined broke through new lows). On the opposite side, ~4% of advancers broke through new high levels.
However, this morning US equity futures are up around 1%, and all looks calm. Foreign exchange markets look normal, crypto seems to be setting into its new, lower range. BTC/USD ~$21,000. This confuses us, we expected more action this morning.
We spoke in support of rational stock market pricing today. We went back to the $CLF or Cleveland Cliffs discussion from twitter yesterday. The price of the stock is down ~50% recently, and we support the company's mission of domestic iron ore and steel production. The stock is down because the futures on their primary inputs are up, and the futures on their 'best, highest price' output is down. Also, we should expect higher energy and labor costs to tighten their margins further. This stock is dropping because public information suggests their profit margins may evaporate.
We saw one key indicator this morning flash RED.
Short-term interest rates are rising. This has an immediate impact on our quantitative model, the Chicago Quantum Net Score. It lowers the expected return to risk assets, which lowers the benefit of risk, which then increases the benefit of reducing variance. If you hold risk for expected return and that return falls, then you should hold less risk. There is a lower risk-return trade-off. (there, we finally said it).
So, our model picked more stocks to hold (spreading out investments) to get a smaller edge on the S&P 500 Index ($SPY is the ETF we use).
As a reminder, the overall indices are much lower than they were a year ago.
Year through: 2022-06-16
QQQ: 271.39 339.38
IWM: 163.90 227.43
SPY: 366.65 416.62
Riskfree rate = 1.50%
Actual SPY return = -12.00%
Use floor S&P500 rate = 5.00%
Actual IWM return = -27.94%
Use floor Russell 2000 rate = 5.00%
Actual QQQ return = -20.03%
Use floor NASDAQ 100 rate = 5.00%
Market return = 3.50%
CQNS negative net income stocks variance:
Expected Return = 5.64%
CQNS positive net income & positive cash flow from operations stocks variance:
Expected Return = 4.31%
$SPY S&P 500 Index ETF variance:
Expected Return = 4.5464%
In other words, by picking money losing companies to invest in, your expected return for risk increases by 1.33% and you take on ~3x the price variance. That risk/return trade-off is getting less attractive in a negative return, increasing risk-free rate environment.
The risk/reward trade-off by holding the $SPY is better than for any individual stock in our run.
You still can find an edge by holding (10,16) stock portfolios, evenly weighted. That edge is 2.3x10-4, which is less than half the edge we were finding a week ago.
This market is getting unpredictable.
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