#23 Signal 2 Noise

In today’s issue:

• Big Central Banking week

• Nvidia gets smoked

• Should I be long, short, or flat the SP500?

S2N Updates

I hope you all had a good weekend. Thanks for the comments; it is much appreciated. I will continue to experiment with subtle and sometimes not-so-subtle changes based on the feedback received.

Performance Review

To learn a bit more about the Z-Score, which I use for the colour signals, read this blog post.

Chart Gallery

Economic News Today

New Signals

In the coming weeks, I will be focusing on bringing this section to life with one in-depth signal analysis each day.

S2N Insights

Big Central Banking Week

At 22:30 UTC on March 18, the Japan Central Bank will be releasing its policy statement. Many are expecting the first rate hike since 2007. Who would have thought that Japan is experiencing a bout of inflation? We will also be hearing from the Australian RBA at a similar time to Japan, with the US Fed also reporting later in the week, which should prove interesting based on last week’s higher inflation readings.

NVIDIA gets smoked

I have been carrying on a lot about the parabolic rise of Nvidia’s share price. You can imagine my shock when I read about another company started at the same time as Nvidia and also run by its founder since inception, which has smoked Nvidia’s cumulative return since it was listed. In case you wondered, Super Micro Computers Inc. makes servers.

They were both incorporated in the same year, but Nvidia was listed as a public company a few years earlier than Super Micro. The last 1-year return for Nvidia was 244%, but Super Micro has risen 999% in 1 year. Super Micro also has a higher cumulative return if you take the start from Super Micro’s listing. The cumulative return I share above is from Nvidia’s listing date which is longer.

Should I be long, short, or flat the SP500?

I have been wanting to go short the SP500 with all that I am worth (sadly, that is not such a lot), as US equity markets feel so overvalued. However, I want to make an impartial decision based on research, not my intuition. Some of you might have seen Ray Dalio, the former head of Bridgewater, the world’s largest hedge fund, say about 10 days ago that we are NOT in a bubble. Ray has been bearish, much like me, for most of this century. He was notorious in Bridgewater circles for being a horrible market timer. Wouldn’t it be sweet if the market collapsed now that he has flipped? I say that because anyone who has read the book The Fund will know that Ray is a monster.

Ok, the first thing I do when making a decision on the SP500 is look at where it stands on a valuation basis. My preferred valuation metric is the Shiller 10-year PE ratio. I will refer you to this post to understand a little more about this metric.

What I have done is a very long-term backtest going back to 1870, where I go long the market when the PE ratio is below 2 standard deviations from its upper mean. The only part of the research that works with information not available during the backtest is the mean. I have decided to use this hindsight bias because I think 150 years of history are a very good reflection of most market cycles and conditions. I will almost never include hindsight in a backtest, but I think in this case it makes sense to me.

This simple strategy has outperformed a buy-and-hold using the Sharpe Ratio for risk-adjusted returns. The Shiller PE strategy produces a 0.24 S.R. versus a 0.07 S.R. for buy and hold. What is important is that there is a current Sell signal to go flat. This model does not go short.

I don’t think it is a good strategy to rely solely on this really long-term valuation model as your only decision input. In fact, I am a believer in multi-factorial models, but I still believe in keeping it simple.

One of the classic long-term trend models is the Golden Cross, where you go long the market when the 50-day moving average crosses above the 200-day moving average. When the 50-day moving average crosses below the 200-day moving average, you sell any open position. This backtest is setup not to go short; the main reason is that stock markets trend up over time for a multitude of reasons, with inflation being a significant one. The data goes back to 1928 for the Golden Cross strategy. Here, its Sharpe Ratio (SR) is 0.58 compared to buy and hold at 0.41 so it seems to be a robust outperforming strategy. It is still suggesting that we remain long the SP 500. That places us in a quandary as we have 2 opposing signals.

Over the coming weeks, months, and years, we will explore more models and come up with a multi-factorial approach that incorporates different factors depending on the investor’s or trader’s time horizon.

For the sake of this newsletter, I am going to take off half of my SP500 exposure. This is not investment advice; it is my approach based on what I have said above and my personal circumstances.

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