I am sorry for the late post today. My youngest child was speaking at his school this morning and as much as I try to encourage my kids’ schools to put assemblies at the end of the day, I don’t think all the parents work trading hours and for some reason, actually prefer early morning events.
As this is the week that spring finally arrives in Toronto and people start taking off their winter tires, I thought it would be a good time to talk about rotation.
The first two months of 2014 had a very 1999 feel to them. At the end of February I even wrote about how the trading resembled the end of the 90s I wish I had been more bold in my positioning as this post was fairly near the top in these speculative momentum stocks.
Starting in March the froth came out of these stocks, and then with the FOMC meeting in the middle of the month, the selling intensified going into the end of the first quarter.
Let’s go through some charts to see what I mean. Here is the poster child for this rally – Facebook:
Facebook Year to Date</a> </div>
Facebook went from $55 at the beginning of the year straight up to $72 by the end of February. Doesn’t sound like much except when you realize that this 31% move added $34 billion of market cap. However, the dip in mid March knocked off almost the entire two month gain in two weeks.
Netflix was a very similar situation except that it basically did knock off the entire gain:
NFLX – YTD</a> </div>
And lest you think it is only technology stocks, let’s look at the most hyped of the bunch – the Biotechs:
XBI – Biotech ETF – YTD</a> </div>
That move from $130 to $174 for an index is breathtaking and certainly harkens back to 1999.
The damage to these high flying momentum stocks was huge. Many hedge funds were stuffed to the gills with these names (of course) and March ended up being an especially cruel month. According to Goldman, the week ending March 27th was the worst 5 day return of hedge fund returns versus the S&P 500 since 2001!
This is yet another great example of why you don’t want to be in trades that are popular with hedge funds. When things turn they all have the same position on and there is no one to sell it to. Therefore the declines end up being way worse than they should be.
Now here is where we get to the meat of my argument. The damage done in these names was absolutely huge. There are now boatloads of highflying traders and portfolio managers that are long and offside in the most crazy names. These names will be for sale for some time to come.
Will they rally? Yes. Will the rally fail? Yes.
Instead of trading these names and hoping for a return to the highs, you will be much better off going and figuring out the new stock leaders.
Think about it for a second. The S&P is hitting new highs this morning, yet FB is still 13 handles from the highs. The biotechs are not only miles from the highs, but they are actually hitting new lows! These stocks are no longer leading. Stop trading them from the long side!
Have a look at the massive rotation that occurred in March. This is a great chart from Bespoke that outlines the moves within the groups:
Which brings me to an actionable trade. I believe these former high flying stocks are going to struggle for some time to come. Therefore as they rally, I am going to sell naked calls in these names. I am going to pick away and be selective, but I think that these names are going to get quiet (which will send vol down) or they are going to continue their decent. Either way, the market is (as usual) too excited for the recent past to simply continue. It won’t. The damage was too great in these names. Trade accordingly.
Currency Wars Redux
Late last year I came across this great post in the blog Sober Look that highlighted a strategy of buying the stock indexes of countries whose currencies had been depreciating, while shorting the stock indexes of those countries whose currency had been appreciating. The original study was the work of a Morgan Stanley analyst.
Although we couldn’t replicate the study perfectly, we recreated it using only countries where we could transact easily (it wouldn’t do us much good if the strategy told us to buy a country where we didn’t have a hope in hell of execution without getting our face ripped off). We settled on using the following countries: UK, Japan, Hong Kong, Australia, Taiwan, Korea, India, Singapore, Mexico, Brazil, South Africa, Russia and Canada.
Using only these countries, we managed to achieve a very similar looking total return chart.
When we did this study in late 2013, the total return was hitting new highs.
And in keeping with the notion that the Market Gods always love to make you look like the biggest fool possible, at the very moment I wrote my blog piece about this strategy, it topped. I couldn’t have picked a worse time to highlight this strategy.
Now although I did indeed start trading this strategy in December of 2013, I am embarrassed to admit, I gave up on the strategy relatively quickly. Call it boredom, attribute it to the fact that other trades interested me more, or simply call it lucky, but I fell down and stopped trading it after one month.
I am not proud of this fact because it shows a certain lack of organizational skills. It also shows a definite deficit of discipline.
But either way, now that it has gone four months in a row with losing trades, I am ready to climb back aboard the trade. (I don’t need a lecture about how after 19 heads in a row, the odds are still 50/50 on the 20th also coming up heads… actually the trader in me, says that if you get 19 heads in a row, you should bet heads again because the coin is probably not weighted correctly.)
This time, I am going to trade it smaller, and not think about it until the end of the month comes and it is time to rebalance.
I still firmly believe in the strategy, and will do a better job at staying on top of it.
This month’s BUY countries are Canada and Russia while the SELL countries are Brazil and Australia. Interestingly enough, they are all commodity countries. You probably wouldn’t have guessed that both the strongest and weakest currencies over the last 4 months have all been from the same general type of country.
I will update the total return graph and the new countries at the start of the next month with the tag “Currency Wars” in the post. No falling down this time…