November 27 Insights: RISK-OFF market this week

By: Jeffrey Cohen, Investment Advisor Representative
US Advanced Computing Infrastructure, Inc.
November 27, 2022
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We ran our model last week, but kept a low profile on investments. We focused on family and did not make a single trade (our personal portfolio remains intact and our hedged managed accounts are 100% cash).

What we found today:

The expected return from 'risk' of the US Equity market is 4.8% over the next 12 months, including dividends. This compares to a risk-free rate of return of 4.2%. This is not a very large return as compared to the returns of 2021.

These conditions require larger portfolios (at least 20 to 35 stocks held equally) to provide significant alpha over buying the SPY, QQQ or IWM and holding. It may not provide a significant advantage over a simple portfolio of SPY and SHY, and maybe 1 or 2 more stocks, which we are finding to be simple to manage and reasonably good results from our model. We have those portfolios identified.

In short, this is why we are suggesting the market is RISK-OFF this week. A savvy investor looking to balance risk and return to find an edge has to work much harder, hold significantly more stocks, and take less risk.



CQNS Down Run:
The 809 stocks that passed data validation for our CQNS Down run (stocks to potentially avoid) have an all stock variance of 8.0 x 10-4, and this compares unfavorably to the S&P 500 Index ETF (SPY) variance of 2.3 x 10-4. Liquid stocks of unprofitable, US-listed companies (this group) have 3.5x the variance of the S&P 500 index ETF.

There are many biotechnology firms at the 'top' of our CQNS Down stock list, at least half of the top 50. The others are downtrodden names, MEME stocks, and a few fresh new faces that we have not seen in the list, and are potentials for shorting, or at least avoiding. They have variance that outweighs their market-following direction, or BETA.

The #1 stock to avoid is ALLK, and that stock can be put together with many other individual CQNS down stocks to provide a terrible risk-return trade-off portfolio of two stocks. These would be heavily biotech, but we see a few non-biotech MEME-like names to match up with ALLK.

This run is interesting for having 30 stocks with a BETA of 2.50 or higher, and the highest BETA found is AFRM. These stocks will move with the markets, and are unprofitable, so likely 3.5x more risky than the market. Fasten your seat belts.

There are three negative BETA stocks. These stock are moving in the opposite direction as the SPY.
BRK.B Berkshire Hathaway Inc. -0.12
SPRY ARS Pharmaceuticals Inc -0.04
VERU Veru Inc -0.86

CQNS Up Run:

The risk of this portfolio of 1,710 profitable stocks is 2.6 x 10-4, which compares favorably to the SPY with a variance of 2.3 x 10-4. The risk of holding a large, diversified portfolio is 1.13x the SPY, which is insignificant.

We see a few anecdotal things in the data, as follows:

1. The 50 stocks with the smallest volume on Friday compared to last year have very small volumes, all at or below 14.1% of last year's volume. However, the 50 stocks with the largest volume traded at or above 81.7% of last year's volume. Four stocks traded above 205% of last year's average volume.

2. There are stocks that have gone up in price, and stocks that have gone down, also at relatively extremely level (down 3/4 or up 2x as compared to the average over the past year). So, there is movement in prices.
 
3. There are high and low BETA stocks, at the extreme ends of the spectrum (0.1 or below, and 2.5 and above). So, there are stocks that are moving at extreme levels of correlation (or even leverage) to the market, while others are largely independent of market moves.

4.  The best 15 CQNS UP portfolios found are all within one tick of each other, and vary from 18 to 23 stocks.  To retain 37% of the edge, you can hold a 7 stock portfolio that includes QQQ, SPY, SHY, and four individual common stocks.

There are negative BETA stocks that were identified. These are not included in our run, and we present them to you for informational purposes.

CPK     Chesapeake Utilities Corp                               -0.646
SQQQ    ProShares UltraPro Short QQQ -3x Shares                 -3.800
TZA     Direxion Daily Small Cap Bear 3X Shares                 -3.259
UUP     Invesco DB US Dollar Index Bullish Fund                 -0.185
UVXY    ProShares Ultra VIX Short-Term Futures ETF 2x Shares    -3.604
VIXY    ProShares VIX Short-Term Futures ETF                    -2.443

Our previous managed accounts had around 12 stocks, so these are larger portfolios. Again, we call this a risk-off portfolio as we are further spreading out investments to gain the best edge we can, and that edge tends to be smaller along with the return from market risk.

There is one more thing...

We run our model now against two baselines. One is the SPY and the alternative is the QQQ. We do this to get a 2nd look or alternative view of the best portfolios. The answers are always different, and we do learn a great deal.

What we learned today is that you can hold three stocks (ETFs actually) evenly, and hold 82% of the benefit of a fully-sized 34 stock portfolio. There are a few additional portfolios of four stocks that close to 80% of the alpha, and are surrounded by portfolios of ~100 stocks. This is important information if you want to beat the performance of the QQQ. The same results are not available to beat the SPY (our base case run is harder to beat this easily).

Good luck to all.
​Jeff