If you're an investor with hard earned money at stake, you need to know the current market state such as the trend, momentum, and volatility.
Even if we make our decisions systematically applying a rules-based method, it's useful to monitor the overall market state.
At Shell Capital Management, we apply directional trend systems for trend following markets, among other systems such as countertrend and pattern recognition.
Our core investment strategy is trend following, not because we're biased toward identifying trends to capitalize on until they change, but instead because markets are generally trending directionally most of the time.
Everything we do revolves around asymmetry, so for us, it's all about asymmetric risk/reward for asymmetric investment returns.
Asymmetric investment returns create return streams whereby the capital gains are larger than the drawdowns over a full market cycle.
To create asymmetric investment returns, we necessarily need to find and capitalize on individual positions with asymmetric risk/reward payoffs.
So, in all we do, our focus is on asymmetry.
It so happens, trend following is one of the most idealized examples of asymmetric returns that captures the trends we want, and avoids those trends we don't.
With that said, let's look at the overall trend of the U.S. stock market.
Below is a chart of the S&P 500 using data from Barchart.
The short term trend is up, and we can say that because the recent action is higher lows and higher highs, and the SPX is above its own 25, 50, and 200 day average as seen in marker 1. Marker 2 shows its less than 1% above the 25 day average, marker 3 shows SPX is 2.5% above its 50 day, and 4 show it's 3.5% above the longer term 200 day average. Despite the weakness the last wee, the trend is up.
Next we observe the relative strength index at marker 5, which is at the half way point, so it's never overbought nor oversold. If there is enough buying demand next week, this mid field marker will serve as support.
If selling pressure takes over, the SPX could easily decline 4-5% before it reaches a statistically oversold level.
Marker 6 shows the average true range over the last 15 days as a percentage, which normalizes the data and makes it comparable to other markets. At 1.5%, it implies a realized volatility, or range of how far price spreads out, of 1.5%. So, if the stock index gains or declines 1.5% I consider it within the normal noise of the market. If it trends outside that range, it's a volatility expansion, and we could see more of it in that direction.
For trend following, we monitor the market state to understand the direction of the trend and its volatility.
A market state can be volatile and trending (up or down), volatile and non-trending, which would show the swings of a choppy market, or it could be quiet and trending, or quiet and non-trending. All of which is relative to its own recent past.
I consider the U.S. stock market to be trending up, and quiet (non-volatile) relative to its last year. As you can see in marker 6 of the chart, it's at the low range.
However, if we zoom out and look at the last two years, we see prior to 2022, the range was less than 1%, so by and large, realized volatility is about 50% higher now that it was before the bear market.
The S&P 500 Equal Weight gives us another observation of the index, except the 500 stocks are equally weighted instead of cap weighted, which puts more emphasis on the largest companies.
Here we see the equal weight index has recovered more than the cap weight. Both of these indexes were down over 20% at the October 2022 low, but the smaller and mid size stocks have helped drive the equally weighted stock index higher since then. The equal weight is now only 8% below its January 2022 high, as the same index weighted based on capitalization is still down about 15% from its all time high.
The bottom line is the U.S. equity market is in a short term uptrend as it's trying to recover from the bear market, and until it prints a close below the 50 and 200 day averages or breaks below the 3,770 low it printed December 28th, I'll continued to call it an uptrend.
Since the stock market is trending up and relatively non-volatile, we've maintained our exposure to stocks until it changes. Our entry and exit algorithms are different from those in the charts and include momentum, but by and large they are in synch.
A retracement of gains in an uptrend is normal price action. A pullback that relieves excessive optimism but doesn’t damage bullish long-term momentum and trend can set the stage for a continuation of an uptrend.
There's no shortage of potential catalysts that could cause selling pressure to increase to the point it dominates and takes over, but for now, the bulls are in control, so we are long and strong.
If the trend changes, so shall we.
I hope this example of our data-driven evidence based observation helps!
Mike Shell is the founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as investment advice to buy or sell any security. This information does not suggest in any way that any graph, chart, or formula offered can solely guide an investor as to which securities to buy or sell, or when to buy or sell them. Securities reflected are not intended to represent any client holdings or recommendations made by the firm. In the event any past specific recommendations are referred to inadvertently, a list of all recommendations made by the company within at least the prior one-year period may be furnished upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities on the list. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is not advice and is subject to change without notice. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect the position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.