The perfect Market!

It is the tape, not macro!

I watched a show about macro today. The discussion was that the signal trumps everything!

The thing is macro was extremely unreliable 2021 until to today.

Absolutely nothing fit.

We had a reflation in the first and the second quarter 2021. Guess what, high beta trash got killed (have a look at ARKK!).

That should not happen in a reflation / goldilocks regime!

Same thing now. Officially we are in a deflation regime. Guess what, energy is up, bonds are down. Not deflation behavior. The only thing I can see in the market is an inflation tape!

Believe me, I can go on and on and on.

So, my question is: if the price momentum, volatility behavior and (my take) the factor momentum trumps everything, why the hell do I need macro in the first place?

I am updating my model here! The tape will be 100% of my trading from now on!

First, what works on wall street for a sub 1 Million account.

The most important thing, if you are trading ETFs you do something wrong, because ETFs can not capture the best factors for a small account, namely Size (small) and low liquidity.

Second:

• Size —> the lower the market cap, the higher the total return

• Liquidity—> the lower the dollar traded every day, the higher the return

• Momentum —> back tested to the 1600s, for bigger portfolios this is the biggest factor out there

• Positive EPS Revisions —> same thing, back tested to death, the results are very positive

• Quality —> tricky one, it rhymes, but I have it in there because its psychologically important for me to know that I own stuff that has good quality and it is doing well in tough times (not so much in really good times in the market, but even then, it does not tank it just drags on performance a bit in very good times)

• Value —> but very importantly combine it with momentum, otherwise you get into value traps

From my (and academic papers that go back to the 1600s!) back-tests I know:

The above factors (let’s call it enhanced micro-small cap value momentum) work in almost every regime, but one regime and that is a deep deflation (GDP and Inflation rate of change down!).

So, the only thing I need to do is, to be hedged if things turn sour (= volatility trending).

How to see that?

Well lets first define the perfect market, something we saw in November 2020 - Feb 2021:

• Small cap value momentum higher highs, higher lows with relative strength to the market in drawdowns (yes, the case now!)

• High Beta Big Caps higher highs, higher lows with relative strength to the market in drawdowns (not the case now!)

• High Beta with no earnings with higher highs, higher lows with relative strength to the market in drawdowns (not the case now!)

• Runner (the factor is called residual volatility!) stocks that come out of a flat base are very strong and 50% break out several times, e.g. hold their gains (not the case now!)

• TLT weak (yep, the case right now, which is bullish for value stocks!)

• VIX downtrend (not the case now!)

• ECRI uptrend (not the case now!)

• Crowding (right now high beta, high residual volatility, high liquidity is crowded) —> e.g., do not be in overcrowded factors because overcrowding means that future performance of that factor is terrible.

If all above is green, we have the strongest market possible.

Right now, last men, last women standing is small cap value momentum (because inflation was still trending and with war in Europe that should go on for at least 6-12 Weeks) and weak bonds.

Let’s look at some signals:

When high beta trash is overcrowded and in the abyss (look at ARKK) then we can not be in a perfect market (the following is a shorting system on high beta trash and QQQ long) —>

And if big cap high beta is doing bad, we can not be in a great market —>

Well, if that is the case the question is to raise cash or to to stay in the market and just hedge.

That decision is simple. If you have a modell with real alpha it should show positive performance even when it is hedged 100%!

So, that seem to be the case (see above).

My framework got really, really simple.

Be 100% long if:

—> Small cap value momentum is strong

—> at least big cap high beta is as strong as the market (better showing relative strenght in drawdowns!)

—> even better: smaller cap high beta stuff is strong

Get protected as soon as big cap high beta stuff is getting problems (and still make money because the model also works if hedged!).

Have a good weekend!