What has Moved Australian Equities from the March 2009 Low? by Andrew McCauley
As most practitioners know, in various periods, certain indicators have more influence on price than others. I find it helpful to see what has recently moved our market. The correlations for each variable below have been calculated using daily percentage change data from the S&P ASX 200 low in March 2009 to the present (approx. 200 days).
WTI Oil 37%
Gold New York 15%
S&P 500 55%
US 10 Year Bond Yield 16%
AUDUSD 14%
AUDGBP 7%
Aust. 3 Year Bond Yield 43%
It is interesting to note that of these coincidental indicators Oil has more influence than I would have thought. Also the relationship between Australian Equities & the $A/US appears to have been overplayed.
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Does any Juice remain in the Fruit of the Santa Claus Rally? by Andrew McCauley
An article on Bloomberg highlights a study that suggests “the Santa Rally is not just a figment of the imagination.” The study records the seasonally positive bias of December from 1992 onwards. The research predicts that the benchmark stock index may finish the year as high as 4,800 if the market follows the historical trend of rallying in December.
Let’s put this December bias to the test.
The table below indicates that the traditionally strong upward seasonal bias in December is more recently a figment of the markets’ imagination. It also highlights the ever changing nature of financial markets & that of complex systems.
As you can readily observe most of the total sample return came in the first interval. Figures like those described in the article tend to help the public lose their account overplus while adding to the upkeep of the noise promotion business. Don’t get me started on the Afternoon Illusionist.
December may yet eke out a gain. I very much doubt it has anything to do with December seasonality. The juice in this fruit has been drunk by the anomaly traders of Last Christmas.
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Melbourne Cup Day may Change the Dyer Mood, by Andrew McCauley
For the most part the Melbourne Cup should be viewed as an economically neutral financial market event. However this event produces mean returns that differ from all other daily changes in a statistically significant manner.
Over the past 10 years the S&P ASX 200 Futures Index has displayed an inordinate positive 1 day bias on Melbourne Cup Day. Running a Bootstrap Permutation (Sampling with Replacement) on all non Melbourne Cup daily returns (1992 to 2009), to produce 10,000 random samples of 10 daily changes, offers evidence that the observed mean is higher than approximately 9,500 random samples.
The returns for the physical index are also impressive. However these returns, albeit, statistically significant at above the 10% level fail on the economic front due to transaction cost hurdles.
It could be intuitively argued that a positive social mood is the major influence on these returns. Not unlike the better than average returns that occur for stocks at Christmas & New Year. Another factor may be the reduced levels of liquidity that accompany Melbourne Cup Day. As always this should be tested.
As an aside, post a Bart Cummings’ Melbourne Cup victory, the All Ordinaries Index has produced an average gain of 1.79% to year end. Better than drift. Oops, I forgot to mention the behaviour of this particular distribution. Perhaps I can join the Afternoon Illusionists.
Be part of the positive social mood & help the markets. Have a great Melbourne Cup day.
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Australian Banks Produce 2nd Best Quarterly Advance on Record – What Happens Next? by Andrew McCauley
Today marks the end of a very strong Quarter for Australian Shares. The All Ordinaries Index is up in the order of 20% for the Quarter with Banks advancing over 30% for the same period.
The table below highlights how the Banking Sector has performed post Quarterly Increases of 25% plus.
As is readily observable the outcome in the next Quarter is consistent with random. However from an absolute deviation perspective the data does provide edge.
The absolute deviation (close to close) in the next Quarter is almost 4 times that of all other Quarterly Absolute Change post an advance of 25% plus. The data is significant & suggests a annualised volatility level of approximately 35%.
Given that major Bank volatility is trading around 30% implied in December, & without assigning any value to a range based volatility estimate, it does appear that Bank implied volatility is trading at a discount of anywhere between 15% to 25% from its practical level.
The data does not provide any directional edge. However, being anything but index weight over the next Quarter is probably a quick way to the poor house.
The edge is in the absolute deviation trade. December volatility at or below the 30% implied level using the appropriate hedge should provide a low risk & profitable trade that will provide enough money to buy your kids the G.I. Joe with the kung-fu grip for Christmas.
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Insightful Interview with Michael J. Mauboussin (Chief Investment Strategist at Legg Mason Capital Management)
A great site that I regularly visit & is worth checking out is Broken Symmetry. Today they highlighted an interview with Michael J. Mauboussin from the Simoleon Sense site.
The interview features a discussion on a multidisciplinary approach to finance & investing. The dialogue on “attribute” driven models is interesting & illustrates a weakness in this approach due to lack of context.
In Australia investors probably overplay the value of attribute driven models. For the most part these models fail to account for context & the high cross correlation between the inputs. For example low PE & high Yield are very similar inputs.
I once asked a highly rated Quant Analyst (Sell Side) why he didn’t reduce the number of inputs due to this correlation problem. The answer was unequivocal, 20 inputs sell & 5 don’t. This is marketing not analysis.
In the Veritas library we have Michael’s book More Than You Know. I highly recommend it. As an aside Simoleon is a slang term for dollar.
The article is well worth reading.
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Afternoon Delight – (Index Futures) Open to Close Data in Flight, by Andrew McCauley
As at Friday’s close the S&P ASX 200 Index Futures (SPI) has closed higher than its opening price level on 5 consecutive occasions. Today could mark the 6th observation.
A streak like this is very rare and has only happened on 3 other occasions (excluding overlap) since the market peaked in November 2007. I note that 5 days post this condition the SPI was always lower.
The Afternoon Delight trade could be a sign of day trader overconfidence or just another meaningless pattern observation. Funnily enough the Starland Vocal Band’s second album was aptly titled Rear View Mirror.
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Geelong Win is Bearish for Stocks & Other Illusions, by Andrew McCauley
The 1980 Nobel Prize recipient for Literature, Czelaw Milosz, once remarked that “Men will clutch at illusions when they have nothing else to hold to.” This rings true in financial market analysis & sadly more often than not these illusionists are highly paid & respected market authorities.
Spurious correlations are rife in the financial business & provide wonderful sound bites for clients & media alike. So in sticking with this generally accepted analytical practice I offer another illusion to behold.
As we now know Geelong won the AFL premiership on the weekend. Since 1950, post a Geelong premiership victory, the All Ordinaries Index on average has produced negative returns over the next 12 months. In fact Geelong is the only club that has a negative return profile post victory.
If St. Kilda had of won I would have been more bullish than Jamie Bravo. Given the Geelong victory, it now appears certain that the market is in for a pullback.
I’m reminded of the thoughts of Gerd de Ley that “A barrel full of certainties won’t roll very far.” Gerd has a point. However, the ability to highlight these uncertain certainties, has some significant account balance advantages.
Sell Stocks after Geelong victory, increase Pirates & decrease Global Warming, increase Lemon Imports from Mexico & decrease US Highway Fatalities. It’s all in the numbers no matter how spurious.
Why do I find it hard to write the next line?
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The Afternoon Illusionists, by Andrew McCauley
For the most part financial forecasting is a wonderful mixture of imagination, myth, occult, bullish & bearish dogma. Very little attention is paid to evidence. Why let the truth get in the way of a good story. Hans Christian Andersen would prosper in this business.
With this in mind a comment in today’s AFR (Market Wrap Section) caught my attention. A sales trader (whatever that is) from a major investment bank suggested that the “Dow has risen in seven of the last eight trading sessions & if this winning streak could be extended to 9 out of 10 positive sessions, it would be a very powerful buy signal.” After last night’s gain the scoreboard stands at 8 out of 9 positive sessions.
Another positive night & we have our powerful buy signal. Sounds like I should get on board. A powerful buy signal must have a significant advantage over market drift. I can barely hold myself back.
Running the numbers on this powerful buy signal indicator on the S&P 500 from 1950 to 2009 leaves me a little disappointed. This indicator over a 20 day time frame provides an average return of 0.57% versus drift of 0.64% for all other rolling 20 day periods. Powerful I think not. However, perhaps if I adjust for overlap the results may improve to a statistically significant average return.
Disappointed again. Adjusting for overlap does improve the figures. The bias is also positive. However, this indicator does not stand up to a basic significance test. The variance in return profile is too large for this indicator to be considered reliable over the selected sample period. The returns are consistent with random.
Perhaps all the afternoon illusionists could consider some basic statistical & or categorical tests (eg. how the indicator works in various cycles) to offer a more robust sound bite to the media.
John Jobber Comments
My favourite illusionist was the late great Tommy Cooper (’just like that’) whose trickery was ALWAYS clumsy, visible and hilarious. This particular Bottle and Glass Trick that the market is playing has made my shorts go “Just Like That” …
The Shopkeeper Adds
In today’s SMH (page 6 – Business Day – 21/09/09) a research analyst stated the following;
“A prudent strategy is to react to a top. I know it sounds simple, but price is the one thing you can believe in this market & in any market for that. It will tell you when it’s time to sell. At the moment, it’s telling us it’s going higher. Stay long until proven wrong.”
This analyst should package up his claims into a product & the money will find him. Good luck.
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This Rally has Reached its Historical Limit (Australian Index Returns Post Major Lows), by Andrew McCauley
Over the last 50 years the Australian Equity Market has produced 7 major observable bottoms with March 2009 being the most recent addition to the list.
Since the March 09 low the All Ordinaries Index has rallied just over 47% in 132 trading days. The return profile post a major low indicates that the rally has reached its historical limits in term of percentage gain over a given time frame.
Given that the maximum gain over the 150, 200 & 250 day intervals are 48.60%, 44.89% & 51.2% respectively, it would appear that any upside from these levels is limited over the next 3 to 6 months.
Moving from cash into equities after a 45% plus rally seems imprudent. Just like moving into cash when The Grim Mood Is Evident. Investors who have been lucky enough to participate in this rally, should probably write just out of the money calls on the index.
As always this ain’t certainty its probability. However, I think theta is becoming my friend again.
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Thoroughly Modern Melanie, by Andrew McCauley
An article by Matthew Futterman & Carl Bialik from the WSJ Online suggests that professional tennis is way behind other professional sports in the use of digital-video analysis & statistics. However, it does appear that Melanie Oudin with the help of her coach Brian de Villiers is embracing the potential edge that this type of analysis can provide.
Some interesting comments in the article overlap with financial market analysis.
If you provide too much information, it’s almost like providing no information. Tennis statistician Leo Levin of IDS Sports
I like technology to a certain point but sometimes you can overanalyze and become paralyzed by all that stuff. Jose Higueras, director of coaching for the USTA’s Elite Player Development program
It’s like a puzzle. Larry Stefanki Professional Tennis Coach
Big broker reports & little information. Too much information & can’t make a decision. The right amount of information & the puzzle changes.
Melanie Oudin is paying approximately $17 to win the US Open. Probably worth a small wager.
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James Hardie (JHX), Alice Cooper & Volatility Persistence, by Andrew McCauley
In 1981, Alice Copper penned a song titled Vicious Rumours, from the album Special Forces. The song displays a unique insight into volatility persistence as evidenced by the following lyric.
I’ve been denied, debriefed, detuned
Sometimes I howl right at the moon
My family treats me gradually
They know my volatility
Over the past couple of weeks I guess most JHX & market observers have felt a little like old mate Alice. “Denied”, did not buy enough before the recent explosive rally. “Debriefed”, called into the room of mirrors by your boss and or customers for continually being on the wrong side of the moves. “Detuned”, I actually don’t think this is a word but I’ll forgive Alice on that one.
However, Alice does display a certain persistence in behaviour, & thankfully his family treat him gradually.
JHX also has a certain persistence in behaviour post large intra month moves. I note that the intra month volatility (Monthly Range divided by Monthly Open) for JHX in August was 50%. This deviation is the largest in our sample back to 1995 (approx. 14 years).
I observe that gyrations of this magnitude are rare indeed with intra month volatility only exceeding 25% on 14 occasions (sample = 172 months). It does appear that intra month fluctuations of this expanse have historically provided no directional clues but have provided deviational clues. This is a regular signature of market structure in that price movement can be dependent yet uncorrelated.
Speaking mathematically, markets can exhibit dependence without correlation. The key to this paradox lies in the distinction between the size & the direction of price changes. Suppose that the direction is uncorrelated with the past: The fact that prices fell yesterday does not make them more likely to fall today. It remains possible for absolute changes to be dependent: A 10 percent fall yesterday may well increase the odds of another 10 percent move today – but provide no advance way of telling whether it will be up or down. If so, the correlation vanishes, in spite of the strong dependence. Large price changes tend to be followed by more large changes, positive or negative. Small changes tend to be followed by more small changes. Volatility clusters.
The performance of James Hardie after large intra month volatility is evidence of this market phenomena. The table below provides a visual summary.
As you can readily observe the intra month volatility is significantly persistent post a range based volatility measure of 25%. Under this conditional setup volatility is almost double that of all other non conditional observations. The same effect is also observed when calculating the absolute monthly close to close change. The 13% level post our condition equates to annualised volatility of 45%.
Given that JHX September 2009 at the money options are trading at just above the 50% mark in terms of implied volatility, it does appear that the market is pricing volatility just above the absolute close to close volatility mark & gives little credit to range based volatility measures. This seems way too cheap based on the very real threat of volatility clustering.
Combining the conditional intra month & absolute monthly close to close volatility equates to a practical volatility level in the order of 70%. On this measure JHX September volatility is underpriced by 25%.
Buying JHX September volatility at or below the 55% implied level using the appropriate hedge, may not provide any directional window, however it should provide a low risk & profitable trade that may stop you howling at the moon.
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Do Returns to August Predict the Back End of the Calendar Year? by Andrew McCauley
So far this calendar year the All Ordinaries Index is up over 20%. I’m fairly confident that over the next few days a couple of our local noiseletter writers will suggest that a gain of this magnitude has some predictive prowess with regard to the back end of the calendar year.
In fact whenever the All Ordinaries Index gained between 20% & 30% in the first 8 months of the year the market was always higher 4 months later with an average gain of just over 10%. Never mind the bollocks, the data is very persuasive, until you analyse the full data set.
As you can readily observe the relationship between the front 8 months of the year with the back 4 months is close to random. After running a simple regression study I observed a slightly positive linear relationship albeit insignificant which is described by the equation;
Y = 0.0865x + 0.0088.
Substituting the current calendar year to August return of 23%, for x, forecasts a year end close that is approximately 3% higher than where we sit today.
Don’t get fooled by half the data. It is clear that the relationship between the front end & back end of the year is nebulous. Perhaps if the Pistols had of minded the bollocks, old mate Malcolm would have taken less.
John Jobber offers some Insight
Never mind the Priests was how Richard Branson tells the story of the court action that enabled the word Bollocks to be used; as defended by John Mortimer of Rumpole fame.
The Shopkeeper Responds
Are these Priests present in our market? If so who are they?
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The Changing Turn of the Month Effect, by Andrew McCauley
I note that for the past 10 months the S&P ASX 200 has displayed a significant positive bias in the last 2 trading days of the month. Interestingly in the preceding 12 months this bias was negative. More change than Tears for Fears. The Turn of the Month Effect may provide insights into broader institutional money flow.
Perhaps the recent end of month strength indicates that money flowing into the market is currently more aggressive at finding a home than that of money looking for rental accommodation. Over the past 10 months the market is up approximately 15% versus a decline of -30% plus in the period prior.
I suggest that when the turn of the month effect starts to display a negative tendency, our market will be losing support from the current institutional overplus.
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September Many a Cloudy Day (Paired Combination Analysis), by Andrew McCauley
Earth Wind & Fire had a disco hit in 1978 with the song September. I’m fairly sure that these blokes were not thinking about the stock market when singing “September, Never a Cloudy Day”. More likely they were thinking about running amuck in Studio 54.
It is well documented that September is a negative month for Australian Equities. The average September return for the All Ordinaries Index is -0.56% (sample 1936 – 2008, n=73), t stat -2.31, standard deviation 4.79%, win rate 47%, max 9.18% & min -17.73%. This compares poorly to the average drift of 0.68% for all other non September monthly intervals. The data is statistically significant at North of the 1 in 40 level.
When looking at seasonal effects it is prudent to review a more recent sample. The last 10 observations are in line with the total sample for an average decline of -1.28% versus non September monthly drift of 0.60%.
Besides seasonal factors another reason to suspect a September pullback could be the distance (time) between certain paired combinations.
A pair of trading months (or days & weeks) can be broken up into 4 categories, Up Up, Up Down, Down Up & Down Down. Intuitively I would have expected that all paired categories would produce the same number of observations (given that I adjusted the data for market drift). Unexpectedly, the number of Up Up & Down Down combinations was greater than might be anticipated by randomness. The table below provides a summary of results.
Using the data as a practical tool reveals that on average the category of Up Down occurs approximately 21% of the time (drift adjusted). The average time to this paired combination is in the order of 5 months.
Given that it has been 11 months since market recorded an Up Down combination (ironically last September) & armed with the knowledge that these combinations occur at a rate of 1 in 5 months, it is arguable that a Up Down pair is overdue. For the most part, due to the flaw of the averages, seasonality is hit & miss. However, a more defensive stance for the short term speculator is probably warranted. Short dated at the money puts may provide insurance if September plays out its below average game.
I expect more cloud cover than Earth Wind & Fire suggest.
John Jobber Responds
I like to watch a similar pattern / structure, being the number of up and down months in the rolling 12 month period. Intuitively I look for a down month if 8 of last 12 months are up, then stronger bearishness if 9 etc. The pattern that broke the bank at Monte Carlo was probably the bull run from 2003 to 2007.
This is an old Japanese rice trading indicator, and applies to dailies, weeklies quarterlies etc. Currently the rice is cooked and ready to cool.
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From Black Swans to Dragon-Kings, by Andrew McCauley
Proponents of the “Black Swan Theory” suggest that events of large impact are part of a population that can be described by a power law distribution. Therefore these events cannot be predicted because we cannot distinguish them from their smaller siblings. The large impact event comes as a surprise outside the realm of normal expectation.
A recent paper titled, Dragon-Kings, Black Swans & the Prediction of Crises, by Didier Sornette of the Swiss Federal Institute of Technology, in Zurich, challenges this common wisdom. Sornette asks whether power laws are really the whole story & suggests that in a significant number of complex systems, extreme events are even more exaggerated than predicted by the extrapolation of the power law distributions in their tail.
Sornette observes a number of data sets (including financial market time series) showing power laws with outliers that he says are the result of positive feedback mechanisms that make them stand out from the other related data. He has coined the term Dragon-King to describe this outlier event.
A series of graphs illustrate that these Dragon-Kings are unaccounted for by power law distributions. What is of interest from a practical point of view is that Sornette believes that these Dragon-Kings are identifiable in real time. This means they have predictive power. In terms of financial markets Sornette looks for qualifying signatures that identify a potential end to financial bubbles. Basically these signatures are statistical properties of time series price returns that are significantly different from the rest of the population. This process provides clues in a diagnostic sense that highlights the maturation of a system towards crisis.
Recently we highlighted one of these Dragon-King predictions with regard to the Chinese market. I note that the Chinese market has fallen by just over -15% in the last 2 weeks. Perhaps these observable precursory financial bubble fingerprints deserve more attention & study. I will endeavour to apply this Dragon-King technique to some Australian stock market data.
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The Grim Mood is Less Evident – Rally of 1974 vs 2009 – What Happens Next, by Andrew McCauley
I note that since Our Favourite Shop posted, The Grim Mood is Evident, the market has rallied over 40% in just over 110 trading days. In that article I suggested the following;
Our evidence suggests that a 40% rally in the S&P ASX 200 from these levels (3,150) over the next 12 months is plausible. That would still leave the index approximately 35% below its all time high.
Well as you know the rest is history.
The question that most speculators are now asking is what will occur next. The relationship between 1974 & 2009, in terms of broad index measures, has been a regular theme of this site. It is interesting to note that at approximately 110 trading days, the rally from the low in 1974, was just over 40%. Move forward to 2009 & we are virtually at the same level of performance. Neil Finn was wrong.
If we continue to mirror the rally of 1974, which I suspect we will, then further index gains should be anticipated over the next 6 months. However, short & sharp pullbacks will be the order of the day.
At approximately day 110 in 1974 the All Ordinaries Index suffered a fall in the order of -7.5% in 20 trading days. I believe a pullback of this size is very likely over the coming month (300 odd point decline). In 1974 this pullback was followed by a rally of 5.61% in 10 days.
The extract below is from an article in the Time Magazine Archive titled, Spring Outlook: A Few Signs of Sunshine, Monday, March 24, 1975.
For more than 14 bumpy months, the U.S. economy has been headed in one dismal direction: down. Now, slight to moderate improvements in several indicators lead many economists and businessmen to say that while the economy is still skidding, it is declining at a slower rate. The belief is widespread, though not unanimous, that it will probably hit bottom in three or four months. Summed up Donald C. Miller, executive vice president of Continental Illinois Bank: “Over the past ten days or so, we seem to be picking up better feelings, some end to the steady drumbeat of bad news.”
This article was published at approximately day 120 of the rally from the 1974 low. Sounds familiar. Sentiment for the most part is the same now. Time to lighten some stock holdings.
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BHP Displays Good Form Post Result, by Andrew McCauley
The market reaction to BHP’s full year earnings’ release is somewhat muted. As at posting the stock is down just over a quarter of a percent. I note that BHP has a tendency to perform significantly well 5 trading days post its half & full year result.
Reducing the sample to the past 12 result periods, increases the 5 day return to 3.41% without any negative 5 day returns. A better winning streak than the Dragons from 1956 to 1966.
These numbers do not include the day of the result & for the purpose of this study would not include today as the result came out after market close yesterday.
Evidence suggests a move above $38.75 over the next 5 days.
The Shopkeeper Also Notes
The last 2 results provided a negative outcome on the day of release. The last Full Year result (August o8), BHP lost just over -4% on release day. Over the next 5 days BHP gained 10.14%. The last Half Year result (February 09), BHP lost -0.03%. Over the next 5 days BHP gained 8.73%.
It does appear that the initial price response is not always accurate at predicting direction over the next week.
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Are the Pilot Fish Telling us Something? by Andrew McCauley
Robert Patterson in his book, First Steps to Zoology (1849), suggested that “the pilot fish is supposed by the ancients to have pointed out to navigators their desired course, and borne them company during their voyage.”
Perhaps financial markets have various forms of pilot fish that lead investors into safe harbour.
I observe that so far in this reporting period, 3 companies that comprise the 50 Leaders Index, have reported financial results. Of these 3 companies (AXA, NWS, TAH) not one is trading at a 5 or 10 day high. Are these companies the pilot fish for the reporting season?
If so perhaps the market has priced in a better than expected reporting season already. Most analysts’ believe that results are going to be reasonably strong. However, reasonably strong results do not always equate to upward moves in stock prices. It’s all about what is & what is not expected.
I’m reminded of the non silent majority that were suggesting to equity investors in January this year to wait until the 2nd half of the year when the numbers would show signs of improvement. I wonder what pilot fish they were using. For the most part the victims have only missed 15% for the calendar year (double the average yearly drift) & twice that from the lows.
The pilot fish also has a working relationship with all manner of sharks. Sounds familiar.
Abe Bowfinger (Northern Beaches’ Spear Fisherman) Responds
Pilot Fish are hitchhikers on the vast ocean highways. They may seem to lead, but actually follow.
The Shopkeeper Responds
That being the case perhaps the BHP & CBA results due out next Wednesday (August 12, 2009) are the Sharks amongst the Pilot Fish.
John Jobber offers some advice
Don’t follow the pilot fish for it will lead you to a sharky doom, & avoid the tuna too, for it will never know that the blood in the water is its own.
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Will August become the 6th Up Month in a Row? by Andrew McCauley
The end of July 2009 will mark the 28th occasion (non overlapping, since 1936) that the All Ordinaries Index (XAO) recorded 5 consecutive monthly increases. Intuitively, I would have expected a reversal effect (negative recency, gambler’s fallacy) post this event.
The data indicates a continuation (hot hand behavior) of the positive streak. The table below highlights the frequency of continuation is 17 from 27. The mean difference is not statistically significant versus all other non conditional monthly returns.
The data is evidence of a consistent market theme, that the market has a tendency to provide an outcome that is contrary to what was, or might have been, expected. Perhaps a positive August is that contrary outcome.
The data also adds weight to The Bureau Effect, in that streak continuation is more likely to spurn reversal, the longer the streak continues. In fact the inflection point for reversal would be post 10 consecutive monthly increases where the frequency of next month reversal is 5 from 6.
I also observe that when the 5 consecutive up months produced returns north of 20%, as is the case now, the next month was always up for an average gain of 2.43%.
It does appear that this market has a sustained dose of Yazz.
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Not All 10 Day Positive Streaks Are Created Equal, by Andrew McCauley
I observe that the distance from all time high has some influence on the return profile of the All Ordinaries Index post 10 consecutive up days. The data is adjusted for overlap.
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