The Polaris program encountered a significant speed bump in October losing -5.95% (net). Of the four sectors traded (Commodity, Currency, Equity and Interest Rate), unsurprisingly, equity trading was hardest hit, given the significant trend changes which occurred intra-month. Moreover, as Polaris is a trend-based strategy, most of the systems which make up the program incurred setbacks.
Suffice to say that equity volatility was a major theme playing out in October. While some bearish sentiment had made its presence known in September, the month had concluded, and October began with a 5-day up streak and the Dow closing on the 3rd at another all-time high. This only proved to be the calm before the storm despite or perhaps the more appropriate wording might be due to, at least from a US standpoint, some strong economic reports. The monthly unemployment numbers released (as always) on the first Friday of October indicated that unemployment in the US had fallen to its lowest levels since 1969. A Wall Street Journal (WSJ) article (“US Unemployment Rate Falls to Lowest Level Since 1969” by Eric Morath & Harriet Torry) cited:
Unemployment rates below 4% are extremely rare in 70 years of modern recordkeeping. …Federal Reserve officials believe the current period can be sustained. …Unlike the 1960s and, central to their outlook, Fed officials estimate inflation will remain subdued, allowing them to keep short-term interest rates relatively low. …Bond investors have become worried about the interest-rate outlook in recent days. With the economy running so strong they have come to the conclusion that the Fed will keep raising short-term rates to keep it from overheating.
By October 10th, the market had tallied five consecutive down days, and the 5th was quite a doozy – off more than 800 points – fueled in part and further put off by those rising yields. It’s not just the case that the Fed had recently and overtly raised rates in late September, but also that is doing so “covertly,” courtesy of its desire to exit the quantitative easing business. These “behind the scenes” transactions (or the lack thereof) in conjunction with their straightforward once- a- quarter hikes are contributing to accelerating rates. A CNBC article by Patti Domm published on October 12, “There’s another big reason why Trump could blame the Federal Reserve for rising interest rates,” details the Fed’s reduced presence as a buyer in the Treasury market.
Since last year, the Fed has been gradually reducing the purchases it makes to replace Treasury and mortgage securities on its balance sheet as they mature. …In an effort to help the economy and add liquidity to markets, the Fed loaded up on those securities during the financial crisis… It took the Fed another 3 years to start unwinding… Bond market pros say it’s difficult to gauge just what type of impact the Fed has had on rates, but it’s getting more attention since the slowdown in purchases comes at the US government’s borrowing needs are dramatically rising.
This article goes on to summarize the across-the-board approaches being taken by the major economies regarding their respective quantitative easing (QE) policies. Japan’s central bankers are still in QE-mode but are mainly purchasing their own bonds. Europe is striving to unwind QE, but much less aggressively; thus, they’re not a major purchaser either right now. With the Fed aggressively reducing its purchases and the US deficit expanding greatly, the lack of buyers could make for an interesting 4th quarter for the bond markets.
Another theme playing out was in the energy complex where Crude Oil had continued its surge upward, bolstered by both the pending Iranian oil sanctions and upbeat global growth projections. In fact, the WSJ posted an article by Gunjan Banerji on October 8th entitled “Traders Bet on Return of $100 Oil.” Two weeks later, Oil had taken a beating with the explanation being concerns centered around oversupply and global economic growth.
Commodities: -2.32% (gross)
The energy complex was by far the biggest contributor to sector losses and, drilling deeper, trading in Crude Oil and Gasoline markets were hardest hit. Polaris held long positioning across the spectrum. The sudden change of bullish sentiment was helped along by what appeared to be a somewhat unexpected announcement by the Saudi energy minister, via a Russian news agency interview, that his country intended to increase production. A WSJ article (“Oil Drops More Than 4% on Prospect of Higher Saudi Output” by Stephanie Yang and Christopher Alessi dated October 23, 2018) explained it this way:
“That rhetoric draws parallels to OPEC’s strategy that helped crash crude prices lower in late 2014, though today’s market has much more limited spare capacity and lower overall inventories,” said analysts at Schneider Electric.
This news coupled with equities tanking resulted in a 4.2% one-day drop in oil prices on October 23rd and a 12% dip overall for the month. As shown in the charts below, the September rally was completely erased by the drop in October in Crude Oil and though modestly less for Gas Oil, still amounted to quite a reversal.
Currency: +2.03% (gross)
Holding primarily long dollar positioning provided profitable windfalls, helping to counteract some of the damage from energy and equity trading. Only Japanese yen and Mexican peso (the sole short, USD, held in the portfolio until switching at mid-month) detracted from the results. US rates continued to rise due to multiple Fed machinations both in front of and behind the scenes. Combined with a “flight to quality,” the USD continued to show strength relative to other currencies, as is shown in the ICE Dollar Index.
Equities: -6.54% (gross)
In addition to the aforementioned issues, the ongoing trade war saga with China together with disappointing Chinese growth reports had investors spooked. Chinese government officials made supportive announcements to calm the markets which temporarily helped. An October 24 Morgan Stanley (MS) white paper summarized how market volatility is impacted by several events. As this was a corporate quarterly 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 alleged Saudi government’s involvement in a murder conducted in its Turkish embassy, and Italian budget discussions all helped to sway bearish sentiment. Despite the “monthus horribilis,” there are still equity bulls out there. An article published by Byron Wien on the RealClear Markets website on October 26th concluded his upbeat equity outlook this way:
…I believe we are going through a necessary correction prior to the next upleg, which should occur after the mid-term election regardless as to whether the Democrats take control of the House of Representatives or not. Earnings will continue to drive the market and the prospects for earnings growth in the US for 2019 remain strong in spite of what is happening elsewhere in the world.
Although this summary highlights all the volatility this month, in all actuality, volatility indices had a very muted reaction to all these market machinations. An interesting article published on the last day of October in the Wall Street Journal supported Mr. Wien’s bullish assertions as well as Morgan Stanley’s commentary on sell-offs impacting only certain stocks. Entitled “Panic in Stocks? Options Signal No” (by Gunjan Banerji), it affirms:
An unusual dynamic in options markets is signaling that investors aren’t panicking despite October’s stock-market drubbing: Expectations for volatility are greater in individual companies than the broader market. …This earnings season, options investors are pricing in some of the biggest swings from specific stocks since 2015, according to Credit Suisse Group AG. …A few heavyweights like Amazon.com, Microsoft Corp., Apple Inc, and Alphabet Inc. made up the bulk of losses in the S&P 500, according to Wells Fargo Securities. …Meanwhile, moves in the Cboe Volatility Index have been relatively muted compared with the stock fall, analysts say. The measure known as VIX tracks expected swings in the S&P 500 and is known as Wall Street’s fear gauge. Measures of volatility in oil, currencies and US interest rates also remain relatively low – another sign that investors aren’t as fearful as the month’s declines might indicate.
The Polaris Program’s Asian holdings were primarily long in Japan (recall the strong rally Japanese equities experienced in September followed by the huge October drop – see OSE Nikkei 225 Index chart below) and India; short in China and, in Europe, essentially short except for France, Amsterdam and UK equity indices, but by month end the program was short most of Asia and Europe. In the US, the program was long to start and ended the month with mixed positioning. The bearish stance in Chinese equities and in a few European markets (German Dax and Spanish Ibex) did provide some profitable results but were far outflanked by the losses in Japan (which had experienced a very strong bullish run just last month) and US equities trading. The NASDAQ futures positioning was the hardest hit of all, aided by the significant sell-off in the US technology stock complex.
Interest Rates: +0.92 (gross)
Positioning here aligns pretty closely with the extent to which Japan, Europe, and the US are unwinding (or not) their respective central bank QE policies. In Japan, the program began and maintained a bullish stance throughout the month. In Europe, positioning tended to be mixed throughout, and here in the US, it was resolutely short across all timeframes. The best trading results came from the US positioning.
Returning to the CNBC article, Jeff Gundlach, CEO of DoubleLine, was quoted, “Investors are starting to realize just how many bonds are coming at us in the year or two ahead.” His tallying of all the US government debt coupled with the Fed’s quantitative easing exit adds up to “around $2.25 trillion of debt increase.” With a glut of bonds here in the US, prices will have to decrease. Thus, rates should continue to move higher which, in turn, could present some profitable opportunities for trend followers in this sector.