The Challenges of a Whipsaw Market

It's important to periodically examine the performance of Best Ideas to a) ensure that that results are consistent with expectations and b) identify ways to improve. Its difficult to interpret results and compare them to expectations without examining the context first. That's the focus of this post.

I explore the performance of the S&P 500 from March 2019 onward. Best Ideas Competitive Edge was launched on 1/3/2019. Best Ideas Market Timing launched on 11/4/2019.

The S&P 500 has bounced back and forth for most of the period since March. This is commonly known as a Whipsaw market.

It can be very difficult to know how to position a portfolio during a whipsaw market. Just as you think you've figured out what happening, things change. You start to re-position, but the changes don't last long before quickly reversing. I'm quite pleased with the performance of the two Best Ideas investment strategies since inception. They've done well considering the behaviour of US stocks since March.

The chart above is in three sections. They are (from top to bottom):

  1. S&P 500 Daily return (high, low and close bars) since the inception of Best Ideas Competitive Edge (1/3/2019). The chart also shows the 50-day (blue) and 200-day (red) moving averages

  2. Total return (including dividends) of the S&P 500

  3. Change in the AUD USD exchange rate.

The total return of the S&P 500 index is 9.0% (in USD) since inception (1/3/2019). This hasn't been smooth sailing. There have been seven short periods where the S&P 500 has swung between positive and negative returns (shown in green on the chart):

  • +6.2%

  • -6.7%

  • +10.6%

  • -6.0%

  • +6.3%

  • -4.0%

  • -3.9%

We see a similar pattern if we compare US stocks to US Treasuries.

This is the relative performance (shown as a ratio) of US 10-year Treasury futures to the S&P 500 (in USD). When the blue line is positive, bonds are beating stocks and vice versa. The lead has shifted seven times since March:

  • Bonds

  • Stocks

  • Bonds

  • Stocks

  • Bonds

  • Stocks

  • Bonds???

There has also been a lot of churn under the surface. The chart below shows the relative performance of the Russell 3000 Growth Index vs the Russell 3000 Value Index.

When the blue line is positive, value is beating growth and vice versa. Growth has been in the ascendancy, except for early-September when value went on a two-week tear. We've written more about this style rotation HERE. Value has since given back some of it's gains. We'll have to wait and see how this unfolds.

Low-volatility stocks (represented by the S&P 500 Low Volatility Index) have out-performed the S&P 500, although the lead has changes several times.

Small caps (Russell 2000 Index) have continued to under-perform relative to the S&P 500 since March. Small caps did rebound in September, along with value vs growth. Is the performance of small caps vs large caps starting to bottom out? Once again, time will tell.

What about volatility? We monitor volatility regimes by comparing the 10-day moving average of the VIX (blue) versus the 60-day moving average (red).

Using the 10-day moving average helps to smooth out the daily noise. Volatility is high (low) when the 10-day average is above (below) the 60-day average. Once again we've experienced several alternating episodes of high and low volatility since March. Its also worth noting that the 60-day moving average is rising and the 10-day moving average is making higher lows. In other words, volatility is increasing.

Sentiment has shifted rapidly since March.

Here's the National Association of Active Investment Managers (NAAIM) survey. The survey asks approximately 200 fund managers to report on their current allocation to equities. The solid blue line shows the 100-day moving average and the dotted blue lines are set one standard deviation either side of this average. Fund manager sentiment is bullish (bearish) when the current allocation to equities is one standard deviation above (below) the moving average.

Once again, a familiar pattern emerges:

  • Over-optimism in April

  • Pessimism in June, Pessimism in July

  • Pessimism in August and early-September

  • Neutral in late-September

  • Pessimism in October

Its also interesting to compare the current period since March to recent history.

Here we have another S&P 500 chart (same format as before), except the period shown is calendar year 2018.

As you can see in the bottom panel, there was a bit of choppiness early in the year. This is similar to the period we've been through since March. But it was followed by a relatively steady +14.4% (in USD) rally from April trough to the end of September. This was followed by a bear market between from early October trough to year-end.

There were two periods, lasting for several consecutive months, where there was a sustained trend (up then down). In other words, investors could have positioned their portfolios either aggressively or defensively and been rewarded for this decision (assuming they got the timing right).

We see a similar pattern looking at volatility during 2018. High volatility early in the year, followed by a nice long stretch of low volatility where the VIX didn't break 20 for months, followed by panic-level volatility at the end of the year.

The contrast between the environment since the inception of Best Ideas Competitive Edge and calendar year 2017 is even more extreme. The S&P 500 went up for the entire year!

Volatility was eerily low. Look at the scale on the right of the chart below. The VIX stayed well below 20 all year, spending a lot of time as low as 10. In contrast, it's been above 20 three times since March.

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