Eta Carinae, a global equity focused program, was down -6.70% (net) in October. A major trend reversal had the program struggling to gain its footing with Japanese and (some though not all) US trading hardest hit. All three geographic regions (Asia- Pacific (APAC), Europe (EU) and North America (NA)) finished in the red this month. The program’s break out systems had mixed results, as some managed the conditions ably while others struggled. The same could be said, surprisingly given the reversals, of the long-term trend following systems. The mean reversion models were tripped up all around. In the second half of the month, a new component was added to the program: Volatility. A new volatility market and model were introduced and will likely maintain a presence in the hopes of providing greater overall stability to the return stream.
To recap: September’s “rattling of the cage” was but a prelude to the equity turbulence which followed. October opened seemingly looking like all was back on track in US equities, but this was just the calm before the storm. A fantastic unemployment number (showing drops to levels unseen since 1969) shifted concerns to rising interest rates. The culmination of a 5-day slide occurred on the 10th when the Dow dropped 800 plus points. This was just about the time quarterly earnings reports were starting to be released, and investors were in no mood to ignore any possible harbinger of bad tidings ahead. Also contributing to the overall malaise were poor economic reports released in China, which impacted Japanese equities. Meanwhile in Europe, the European Commission continued to wrestle publicly and privately with the Italian government’s still unresolved budget agenda.
Asia-Pacific (APAC): -4.95% (gross)
Eta Carinae came into the month long much of Asia, including Japan where equities had shot straight up in September (see SGX Nikkei 225 chart below). As positively as this positioning had contributed to Eta Carinae’s overall robust finish last month, it delivered a devastating blow and then some to the program this month. The same could be said for Japanese stocks as the indices (again, refer to SIMEX Nikkei 225 chart below) incurred a “whopper” of a reversal, relinquishing all of September’s gains and dropping further still until finding support just above February’s lows. Factors contributing to the brutal month were certainly America’s sell-off coupled with contagion fears from the slowing of China’s economic engine. Perhaps, too, some investors may have questioned the Bank of Japan’s (BOJ) unwavering commitment to quantitative easing, so much so that the BOJ felt its stance needed to be defended publicly. To that end, a MarketWatch article (“Japan’s Nikkei leads heavy losses in Asia stocks as global woes mount” published October 25th) noted:
…While concerns are growing that the Bank of Japan’s prolonged easing may be causing financial overheating, BOJ Deputy Gov. Masazumi Wakatabe says it’s still debatable whether the central bank should tighten monetary policy as a preemptive measure against rises in asset prices. “Although we should not ignore asset price fluctuations completely, taking a strong measure to burst the bubble could push the economy into a serious recession,” he said in a speech at a Japanese university, looking back at Japan’s financial crisis in the 1990s.
As for the poor Chinese third quarter gross domestic product report, excerpts from a Wall Street Journal (WSJ) article (“Chinese Stocks Surge After Xi’s Economic Czar Leads Calls for Confidence” by Shen Hong published Oct 19, 2018) cited the unusual efforts by Chinese officials to maintain calm. The report noted the withering interest in the Chinese stock market by the average retail investor.
Chinese stocks rallied, despite disappointing economic data, after a rare joint effort by top officials to soothe investors. …Stocks rallied after Vice Premier Liu He, President Xi Jingping’s economic czar, called for confidence in China’s economic outlook… The barrage of reassuring messages came as data showed China’s third-quarter gross domestic product was up 6.5% from a year earlier, off from the second quarter’s 6.7% pace, and the weakest since the global financial crisis. …The decline has been a slow grind, exacerbated by rising trade tensions and domestic economic concerns-fundamentally different from 2015’s abrupt rout. …For sure, pessimism is rife among China’s 90 million retail stock investors. However, there is little panic, nor the public outrage or frustration that has previously triggered quick official responses to restore financial and social stability. …And many retail investors have simply given up: Daily trading volume tumbled to 239 billion yuan Thursday…
Europe (EU): -0.28% (gross)
EU trading was the best of the worst but still down. Positive results were garnered via short positioning in the German Dax and Spanish Ibex indices but were outflanked by French (long throughout October) and Amsterdam Exchange (mixed positioning) trading. Although this sector contributed the least to the problems last month, there was a question as to when the sideways to slumping EU markets will emerge from their respective ruts. In a brief but interesting article posted October 22nd in the WSJ (“Eurozone Squabbles are a Problem for Stocks, Not Bonds” by Jon Sindreau), the author commented on the issue while observing the European Commission’s displeasure with Italy’s proposed budget:
News of the eurozone’s demise is exaggerated, but that may not offer much comfort to stock investors. …Yet when it comes to eurozone stocks, which are more tightly linked to economic prospects, the latest political spat should give investors pause. …The eurozone’s problem has always been about economic growth, not deficits. Between the year 2000 and now, the total amount of Italian government debt has actually expanded at a much slower pace than its peers, thanks to smaller deficits. Italian figures only look worrisome as a percentage of output because the country’s economic performance since joining the euro has been so dismal. …Right now, European officials seem ready to let slide – as they have many times in the past – over-optimistic deficit projections in the budget of the new Spanish government. Yet in Italy, their instinct is to come down hard on a populist government they dislike… Global investors have long applied a discount to European equities. As long as eurozone policymakers seem more intent on delivering discipline than prosperity, that looks unlikely to change.
North America NA: -1.35% (gross)
The bulk of the losses for this sector was due to S&P 500 index trading. Eta Carinae began the month flat. With a rally in the first few days, it built up a long position, only to see it wiped out when sentiment turned starting on the 5th of October. Positioning was quickly stopped out but then rebuilt just in time to be long on the 10th. Such was the way the month proceeded, with some long positioning remaining through the 24th where again another round of bearish sentiment hit US markets. To a much lesser degree, trading in the Russell 2000 (small cap) futures contract incurred setbacks as well. However, the “in-between,” short positioning entered into on the second day of trading in the E-mini S&P MidCap 400 and held throughout, was a buffer against some of the downside.
With US unemployment at decades-long lows, the US economy seemingly humming along and corporate earnings that were not exactly horrific, why was the timing ripe for a market sell-off? For those of us with a superstitious bent, there’s the déjà vu “beware the ides of late September and October” historical sort of vibe that seems to blow this time of year, based on the timing of some of the more notable market implosions of the past. A more cerebral response came courtesy of a Morgan Stanley (MS) market recap white paper distributed to its clients on October 24, which theorized that market volatility was impacted by several events. Referring to the quarterly corporate reporting season, MS explained that companies with disappointing earnings were punished for missing expectations far more than companies were rewarded for exceeding analysts’ projections. The paper went on to add that a disappointing home sales report, the Saudi government’s alleged involvement in a murder conducted in its Turkish embassy, and Italian budget discussions all helped to sway bearish sentiment.
At mid-month, a new market, the Chicago Futures Exchange VIX (volatility index), was added to the portfolio. While trading in the VIX contract was not able to fully neutralize the losses, it did generate a positive return stream as it caught the upward trend in volatility (see CFE VIX chart below) that began around mid-month.
A new volatility model also was added to the model basket. The volatility model completed the month essentially breaking even.