Technically Speaking, July 2023

President’s Letter from Rob Palladino, CMT

Greetings. I would like to introduce myself as the newly elected President of the CMT Association to you, our dues-paying members globally. I am honored to succeed the 34 Past Presidents who have brought forward the Association over the past six decades. Without their leadership and the outstanding work of our Staff and long line of volunteers, we would not have achieved the international success that has made us the gold standard of technical analysis and quantitative finance. 

As for my background, I have been a member of the CMT Association since 2013 and have served on the Board of Directors since 2018. After graduating from Middlebury College (VT) in 2009 during the heart of the GFC, I went to work at State Street Bank in Hong Kong as a foreign exchange trader. I have stuck to foreign exchange ever since, continuing the craft at State Street Bank in Boston, as a macro trader at Deutsche Bank in New York, and currently as a FX trader at JPM Chase in New York. Markets are a passion (obsession?) of mine, and I have met many of the best minds in this business at our Annual Symposium and local Chapter events. To say I have gotten more out of the Association than it has gotten out of me is an understatement: there are so many excellent members out there to meet, you just need to put yourself out there!

Throughout my years as a CMT member, I have volunteered on the Admissions and Governance Committees, and have also served as the Secretary and Vice President of the Board. I believe my experience as part of the Executive Committee of the Board during the Covid pandemic and my role in organizing and leading the Board’s Annual Long Range Planning meeting over the last two years will assist me to guide the Association over the coming years. We have a tremendous group of dedicated Board members, and our Executive Committee of John Kolovos (VP), Karen Benefiel (Treasurer), and Kelly Corbiere (Secretary) look forward to serving and listening to you. 

I plan to write a monthly column in this publication going forward which will serve as my primary communication tool with our growing membership. The general format will be to share the Board’s vision for the organization, any governance/rules changes that will affect you as members, industry commentary, and CMT event announcements. 

Here are a few summary goals as President upon which I intend to achieve and will elaborate on in upcoming Technically Speaking segments:

1. Continue the foundation of sound governance of the Association
2. Improve upon the high quality CMT Program and digitize future learning
3. Create professional currency in the CMT Charter 
4. Expand the academic reach and acceptance of technical analysis at the university level

Lastly, I will finish by applauding the fine work of Kaizad Marolia, our staff member in India, who has created our inaugural Faculty Focus Newsletter to highlight our rapidly growing Academic Partner Program (APP). If you have not received the newsletter, please contact any of the staff to be added to the distribution list. We would ask that each CMT member scan through their contact lists at their alma mater, local university, and/or any faculty contacts so that the Staff can add their e-mail to the distribution list in the future. Exciting times! 

Key Takeaways:

• Most major averages are coming into the second half with some impressive returns. History suggests the momentum could continue.
• Since 1950, the S&P 500 has followed up a positive first half with an average second half gain of 6.0%. Furthermore, when first half gains were 10% or higher, the index posted average gains of 7.7% in the second half, with 82% of occurrences producing positive results.
• Despite the bullish inclinations from a positive first half, bull markets are not linear, and pullbacks or even a correction should be expected in the second half. The average maximum drawdown for the S&P 500 during any calendar year dating back to 1950 has been -13.8%, well below this year’s current maximum drawdown of only -7.8%.
• Given the performance gap between the Russell 1000 Growth and Value indexes this year, many investors are asking if and when value will start catching up to growth. Since 1979, when growth outperformed value in the first half, it historically outperformed again in the second half. However, when the growth-value spread exceeded 5%, as it is now, value modestly outperformed growth in the second half.

Climbing the Wall of Worry

To say stocks have had an impressive first half is an understatement. The S&P 500 shrugged off rising recession alarms, elevated inflation, global monetary policy tightening, including 75 basis points of additional rate hikes from the Federal Reserve (Fed), and the collapse of three major U.S. regional banks. As shown in the chart below, most major U.S. indices climbed the wall of worry and are wrapping up the first half with some impressive gains.

View enlarged chart

The NASDAQ Composite Index is leading the way, with a first half advance of 29.9% as of June 28, marking its third-best first half since its inception in 1971. Large caps and growth have been major drivers of first half performance, evidenced by the 26.3% gain on the Russell 1000 Growth Index, a 24.1% delta over the Russell 1000 Value Index. The S&P 500 has added 14.0%, nearly matching its first half 2021 gain of 14.4% (for reference, the index advanced 10.9% during the second half of 2021).

Given the vast disparity in performance between the Russell 1000 Growth and Value indexes this year, many investors are asking if and when value will start catching up to growth. Since 1979, whenever growth outperformed value in the first half, it historically outperformed again in the second half. However, when the growth-value spread exceeded 5% in the first half, as it is now, value modestly outperformed growth in the second half.

View enlarged chart

Well Begun is Half-Done

As the proverb goes, “Well begun is half done,” and the market’s bullish first half momentum could spill over into the second half—at least that’s what history suggests. Since 1950, the S&P 500 has followed up a positive first half with an average second half gain of 6.0%. Furthermore, when first half gains were 10% or higher, the index posted average gains of 7.7% in the second half, with 82% of occurrences producing positive results.

View enlarged chart

As we pointed out in our latest Weekly Market Commentary, bull markets are not linear. Pullbacks and even a potential correction should be expected in the second half. This is not a bold call but a reflection of history. Since 1950, the average maximum drawdown for the S&P 500 during a calendar year has been -13.8%, well below this year’s current maximum drawdown of only -7.8%.

Positive first half S&P 500 returns have historically led to shallower second half drawdowns. As shown below, the average second half maximum drawdown after a positive first half is -9.0%, as opposed to an average drawdown of -13.1% when the first half was negative.

View enlarged chart

Summary

Stocks are off to an impressive start this year, and history suggests the bullish momentum could continue into the second half. However, expect some bumps along the way as the market faces headwinds from additional global monetary policy tightening, including the prospect of further rate hikes from the Fed, stubbornly high inflation, interest rate volatility, and elevated recession risk. The good news is that 1) drawdowns in the second half tend to be shallower after a positive first half, and 2) a pullback in stocks could provide investors who missed the first half rally a buying opportunity into this new bull market.

I keep hearing the market’s on life support, but June has been another really terrific month that’s rewarded investors yet again for buying stocks.

I hope everyone’s done well.

With June in the books, I’m continuing to keep a close eye on many of the possible rotations (and possible rebound levels) developing out there, whilst I know many would like me to cover Tech again, I don’t see the point in going over old ground.

Today, I’m just going to get into some areas of the market I currently find interesting, so let’s just get into it.

June – Month to Date

Something I tend to notice much more than most, is when the market decides to move out of 1 area and into another.

From the 10 ETF’s above, do you also notice less growth and more value?

When 1 area goes down, another area tends to go up, I don’t make up the rules, that’s just how investor behaviour (price) works.

S&P500 Value ETF (IVE)

The S&P500 Value ETF, which as you can see has a fair amount of technology exposure, is on the cusp of breaking out to new all time highs, and this is information I want to pay attention to.

ARK Fintech Innovation ETF (ARKF)

Or how about Auntie Cathie and her Fintech ETF?

She’s taken a lot of flak over the last couple of years, but with the out-performance in growth over value this year, there’s probably a comeback story in there somewhere.

A break out on both an absolute and a relative basis, what’s not to like?

Social Media (SOCL)

We’re seeing charts like this setting up absolutely everywhere just now.

If Social Media is above $39 and breaking out on a relative basis, again, what’s not to like?

Bitcoin

Let me be clear about my thoughts on Bitcoin and crypto in general.

I don’t buy it and I don’t like it and I couldn’t care less if Blackrock are getting involved.

I much prefer sleeping soundly at night.

That said, I do of course have many professional clients and members who want my thoughts on Bitcoin, and this is the chart I’m working with just now.

Maybe that $31k-32k level offers something?

In Conclusion

I keep hearing it’s just 5 stocks driving the market performance this year, and if you’re hearing it too, you should pay close attention to who you’re listening to.

These folks continue to be downright lazy and just aren’t putting in the hard yards.

It takes a special kind of economic analyst to tell everyone else they’re wrong, and to continually push out confirmation biased narratives when stocks have offered the returns of a lifetime this year.

Thankfully I like to pay attention to price, because it’s the only data that matters.

If the market crashes / corrects tomorrow, next week, next month or next year, it’s not a problem, that’s why we manage risk around here.

In the world of trading, where fortunes can be made and lost, the importance of employing a sound strategy cannot be overstated. Traders are constantly seeking effective methods to increase their profitability and minimize losses. One such strategy that has gained attention is the Paroli system of betting, which originates from the world of gambling but can be adapted for trading purposes. In this article, we will explore the Paroli system and its potential application in trading, using a real-life example to highlight its benefits and considerations.

The Paroli system is a positive progression betting strategy that focuses on maximizing wins while minimizing potential losses. Traditionally, it has been used in games like roulette or blackjack, where players increase their wagers after each win. However, the same concept can be applied to trading, helping traders to capitalize on winning streaks while limiting potential losses during losing streaks.

Applying the Paroli System in Trading

Let’s consider a hypothetical scenario where a trader implements the Paroli System in their trading strategy.

Step 1: Define the initial bet size

The trader sets their initial bet size at $100 for each trade.

Step 2: Win trade

The trader successfully executes a trade and earns a profit of $200. According to the Paroli System, they increase their bet size for the next trade.

Step 3: Increase the bet size

Following the win, the trader decides to increase their bet size to $200 for the next trade.

Step 4: Win trade again

The trader’s trade is successful once more, resulting in a profit of $400. The Paroli System dictates that they should further increase their bet size.

Step 5: Increase the bet size again

Building upon their previous wins, the trader raises their bet size to $400 for the subsequent trade.

Step 6: Lose trade

Unfortunately, the trader experiences a loss on this trade. As per the Paroli System, they should revert back to their original bet size for the next trade.

Step 7: Reset to the initial bet size

Following the loss, the trader resets their bet size back to $100.

The Paroli system offers several advantages when applied to trading:

1. Capital Protection: By resetting to the base unit after a loss, the Paroli system helps limit potential losses during a downturn, preserving trading capital for future opportunities.
2. Amplified Profits: During winning streaks, the Paroli system allows traders to compound their gains by reinvesting profits into subsequent trades, potentially magnifying their returns.
3. Psychological Advantage: The positive progression nature of the Paroli system can instill confidence in traders, as successful trades reinforce a sense of accomplishment and momentum.

However, it is essential to recognize the limitations and risks associated with the Paroli system:

1. Market Volatility: The Paroli system assumes that winning and losing streaks will occur, but it cannot predict or control market conditions. Traders must remain mindful of market volatility and adjust their risk management accordingly.
2. Risk of Overconfidence: While the Paroli system can be psychologically advantageous, it is crucial to avoid becoming overconfident or abandoning sound trading principles. Diligent analysis and risk assessment are still essential components of successful trading.

The Paroli System offers traders a structured approach to betting that can be applied to trading with careful consideration. By capitalizing on winning streaks and limiting losses during losing streaks, the Paroli System provides a framework for managing risk and maximizing profits. However, traders should remember that no strategy guarantees success, and market conditions should always be evaluated before implementing any approach.

We interrupt this raging bull market to update you on some historic positioning in the bond market that is sure to impact your portfolio, whether you like it or not.

Even if you don’t trade bonds, this is really really important.

You see, I know it’s easy to sit back and chill out with the S&P500 making new 52-week highs, the Dow Jones Industrial Average and Dow Transportation Average making new 52-week highs and, of course, the Nasdaq100 making new 52-week highs after posting its best first half to a year EVER.

Market breadth continues to expand and sector rotation is frustrating the hell out of anyone trying to short this market.

The thing is, what even changed?

What happened that stocks have absolutely been ripping higher since last year?

Positioning.

It’s not the economy that drives stocks. It certainly isn’t fundamentals.

It’s positioning.

Or mispositioning in the case of many hedge funds and other investors coming into the year.

They were the most short they were at any point during the last bear market.

Folks, 2023 is what a short squeeze looks like.

And I don’t feel bad for any of them. In fact, we all thank them.

Short sellers are important.

Remember, short sellers are promising to be future buyers. Shareholders are only promising to be future sellers.

Don’t forget that.

And the fact that short sellers got their faces ripped off all year, was fuel to send stocks higher at a historically fast rate.

So again, thank you angry permabears! Drinks on me!

We have a similar setup now in bonds.

Large Speculators have on their most aggressive bet in the history of the bond market. They’re more short than ever.

Here is a chart of the US 10-year Note showing Large Speculators, basically hedge funds and other large buy side institutions, with their largest short positions ever.

When Large Speculators are at consensus, it consistently pays to take the other side of their bets. Take 2018 for example. At that time, the Large Specs had on their largest short bets in the bond market ever.

And bonds went on a historic run. I remember it well. Interest collapsed to new all-time lows.

Now here we are. Large Spec are betting more aggressively than ever that the 40 year bull market in bonds is over, and a rising rate regime is here and here to stay.

Are you betting that bonds are about to collapse? Immediately after they just collapsed?

We just saw the largest rate of change in rising interest rates ever. And NOW they want to bet on rising rates?

No thanks.

We’re taking the other side and looking to buy bonds and/or positioning ourselves in assets that benefit from lower rates.

One sector that is standing out as bonds are starting to get going is Bank stocks.

I was promised a banking crisis, but all I got was one of the strongest bull markets in history.

Here’s what the S&P Bank Index looks like as it breaks out to new 4-month highs:

;7

How do you say, Not a top?

We started buying bank stocks last month and so far they’re working.

They seem to like these falling rates.

Does this trend continue?

Or are you betting along with the dumb money that bonds are about to fall apart, again, right after they already fell apart?