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Current
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Turbo Signal
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Turbo Model Returns (Long & Short Strategy)
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Nasdaq 100
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Russell 2000
(IWM)
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S&P 500
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Classic Signal
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Trade Date
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Classic Model Returns (Long & Short Strategy)
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World
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Nasdaq 100
(QQQ)
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Russell 2000
(IWM)
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S&P 500
(SPY)
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Stocks continued to retreat this week amid fears over the situation in Japan and Libya. The market started lower Monday as investors had plenty of global events to worry about, such as a potential nuclear disaster in Japan, continued violence in Libya and resurfacing worries over the debt situation in several european countries. If the main indexes managed to recoup some of their losses by day's end, the S&P 500 finished the session 0.6% lower. The selling intensified Tuesday as the worsening of the situation at Japan's Fukushima nuclear plant rattled world markets.
Down around 3% shortly after the open, the major averages managed to recover a good chunk of the losses, helped in part by a dovish policy statement from the Federal Reserve: the Central Bank said that the economy is recovering and that the job market is improving. Yet, the S&P 500 lost another 1.1% on the day. With global worries continuing to generate a good dose of anxiety, the market was ready for more losses Wednesday. Indeed, the S&P 500 dropped 1.9% on the day, in effect relinquishing all its gains of the year. Helped by better-than-expected weekly jobless claims data, the index recaptured 1.1% during Thursday's session, as a bounce was in order after the heavy selling of the previous days. News of a possible cease-fire in Libya provided a boost to equities early Friday, but a loss of support from large-cap tech stocks limited the gains, still allowing the S&P 500 to finish the day 0.4% higher.
For the week, the Russell 2000 (IWM), S&P 500 (SPY) and Nasdaq 100 (QQQQ) respectively lost 0.90%, 2.35% and 3.61%. All three ETFs are now located below their 50-day exponential moving average (EMA) but remain above their 200-day EMA.
For its part, our World portfolio bested its U.S. counterparts this week with a loss of only 0.53%. The portfolio consists of the 5 top-ranked world ETFs as of February 25, which marked the beginning of the current 4-week holding period. Please note that since we have an active Classic Model Cash signal, the World approach calls for selling your holdings if you follow the "Long Only" or "Long and Short" strategy. Only if you follow the "Buy and Rebalance" strategy should you remain invested in the top 5 ETFs, as the strategy calls for staying invested at all times. Please go to the Classic Model "Description" page for all the details.
Our current Classic Model Cash signal and Turbo Model Buy signal remain in effect.
More
on leveraged ETFs
We talked at length about leveraged ETFs in the past, but with the
introduction of our new Turbo Model, we thought that
it was opportune to further detail how these investment vehicles work.
First, let us go back to the basics. Here is how the Proshares Ultra
QQQ
brochure describes its behavior: "The investment seeks daily
investment results, before fees and expenses, that correspond to twice
the daily performance of the NASDAQ-100 Index." This was
taken out from ProShares documentation, but all leveraged ETFs work
the same way, they all try to deliver a return on a daily-basis equal
to a multiple of the daily performance of the underlying index. If
you scrutinize the daily performance of the ETF and its corresponding
index, you will notice some minor discrepancies from time to time.
These differences tend to average out over time as the ETF company
is doing a reasonably good job at staying on target. Anyway, we will
leave these minor technicalities on the side and go back to some more
fundamental analysis of these powerful investment vehicles.
The initial perception for most people is that using a double ETF
will simply double the performance of the index, meaning that any
gain (or loss) of the index over a certain period of time will be
doubled when using the ETF. This is a false perception, or at least
a distorded one. As we have seen from its definition, an investment
in a leveraged ETF will evolve according to the daily
compounding effect of that instrument. This is all great when the
market is going your way, but can be troublesome when the opposite
is true. For the ones among us who like to play with numbers here is a short
example (the rest of us can safely jump to the conclusion, a few lines
below):
- Non leveraged case: let's assume that the market
drops 10% on a particular day, a $1000 investment would have shrunk
to $900, and you will need the market to rise 11.1%
the next day to break even ($900 x 1.111 = $1000).
- Double
leveraged case: with the market dropping 10% the first
day, a double leveraged ETF would have lost twice as much, i.e.
20%, meaning that the same $1000 would have plummeted to $800.
Now to recover this loss the ETF will need to move up 25% ($800
x 1.25 = $1000), which can only happen if the underlying index
rises by half as much, or 12.5%.
Comparing the two situations, we see that the market has to move up
by an extra 1.4% in the double leveraged case for
the initial loss to be recovered. This tells us that it is harder
to recoup one's losses with a leveraged instrument than it is with
a non-leveraged one. Of course, when there is a profit, the opposite
is true, but unfortunately to a lesser extent: a 10% gain on the index
(20% gain on the double ETF) can withstand a drop of 9.1% (16.7% for
the double ETF) before losing money, meaning that the 'loss tolerance'
is 0.8% (9.1% - 16.7% / 2) more in favor of the leveraged
instrument in that case (it was 1.4% in favor of
the non-leveraged instrument in the previous case). Of course, daily
variations are typically not that big, but the same mechanics apply
day after day, resulting in a drift for the leveraged instruments
if one hangs on to it for too long. To illustrate this, we can graph
the QQQQ since inception and compare it to a double (and inverse double)
investment of the same QQQQ.
Chart 1: Comparing QQQQ with its Double and Inverse Double
leveraged strategies
Chart 1 clearly shows that holding on to the same
leveraged instrument forever is not what a savy investor would do.
Both strategies, double long and double short, end up far behind the
index in the long run: while the QQQQ is up 14% since inception, a
double long ETF would have lost 64% of its value (98% for the inverse
double!).
Luckily for us, we are not Buy and Hold investors! The Turbo
Model in particular helps us stay on the right side of the
market (Turbo Model trades have a 70% win ratio),
giving us a chance to fully benefit from leveraged instruments. The
best way to illustrate this is to plug a pair of long/short leveraged
ETFs (QLD/QID
in our case) into the performance tool ("Performance
with individual security") that is accessible at the
bottom of the Turbo Model "Results"
page and see how much leverage we would get in that case.
Chart 2: Turbo Model performance with the QLD/QID pair
When measured from January 2007, the leveraged Long and Short
strategy has an annualized return of 114.45%,
almost exactly twice the return of the QQQQ (Long and Short)
which has an annualized return of 57.64%
over the same period. So this tends to prove that in this situation,
we are able to fully take advantage of the leveraging capability of
these ETFs. This is particularly comforting, especially for the ones
among us who can only trade half of their portfolio in an IRA account
in order to obey the 3-day settlement rule (as explained in the Weekly
Update we wrote on February 25, 2011). All this being said,
we want to remind everybody that using
leveraged ETFs involves a certain level of risk, so these powerful
instruments must be used wisely. Not all trades will be positive,
and as explained above, applying leveraged techniques will amplify
the losses, so one has to carefully pick his/her own level of risk
tolerance.
Question:
Where do I see the detailed performance statistics for the Turbo Model?
With the introduction of our Turbo Model, some subscribers
are asking us what is the largest drawdown and/or win ratio for the
Turbo Model system. The answer is there, at your
finger tips. Simply follow these easy steps:.
- Go to the Turbo Model "Results"
page
- Click on the "Statistics"
bullet point at the top of the page
- A window will display a list of information including the
maximum drawdown
Warm wishes and until next week.
The TimingCube
Staff |