IN REVIEW | April 2010 ROE Capital Management Performance & Drawdown Analysis
After a 39.78% run up for our Monticello program and a 33.20% run up for our Jefferson program, we turned in our first negative month in over a year, losing -4.98% and -4.74% respectively. April began as did March, anemic volume and volatility coloring a market coasting higher. As in March, our programs found few opportunities in the first few weeks of the month. When the S&P began forming a top above 1200, both of our programs were caught long on news of the SEC lawsuit against Goldman Sachs and fears of the looming sovereign debt contagion. Two trades impacted by these news events delivered most of the loss incurred in April. As mothballed volatility roused erratically to our new market environment, we shook out a few trades to close the month on our lows.
We have entered a drawdown and, as such, it is important to take stock of our performance and examine the risks posed by our investment vehicles. Our programs have experienced a run-up of 39.78% (Monticello) and 33.20% (Jefferson) in the last 12 months, with no more than a 4% intra-month drawdown during that time (and no closed month drawdown at all). That performance placed us in the top 10 of all CTAs trading all asset classes worldwide for the last 12 months as ranked by risk and in the top 5% as ranked by return. Given our April drawdown, we are still in the top 3% by risk and in the top 5% by return of all CTAs reporting to Barclays in the last 12 months. Amongst our peer CTAs in the stock index sector, we were the number 1 and 3 program ranked by risk and number 7 and 8 program ranked by return prior to April. At the time of this writing, we still rank as the 7th and 8th program by return, slipping to the 2nd and 4th Stock Index CTA program ranked by risk. By any valid comparison of which we can conceive, our programs are competing near the top of the industry.
We realize that this is cold comfort for accounts which began trading in March and April, and thereby did not participate in the previous year long run-up. The loss this month, while regrettable (as all losses are), is entirely within expectations for our algorithms. It is our opinion that a drawdown of 10% can be expected annually in each program and a 15% drawdown can be expected every 18 to 36 months. These drawdowns are simply part of the trading game; we have to accept and limit risk in order to deliver return. Obviously if we knew when these losses were due, we would step out of the way. Unfortunately, our crystal ball only gives us probabilities of market action, not specific dates and times.
The market environment of late is one which has few historical equivalents. While the VIX and other volatility indicators have certainly traded at these levels many times in the past decade, what is different is the price action which has produced these levels. Since the February 5th low in the E-mini S&P (and corresponding VIX peak) through April 15th, the e-mini S&P closed down -0.5% or more only twice. In that period, the e-mini S&P has closed lower in only 10 of 46 trading sessions, with an average of those lower closes at a meek -0.47%.
However, despite lack of a sell of sellers, the e-mini S&P gained more than 1% in only 5 of those sessions. That’s a market floating higher ever so gently, with little or no pullback. We can speculate that this resulted from macro conditions favoring capital flow to US equities (unprecedented dovish monetary policy, low bond yields and sovereign debt fears, China’s policy of diversifying US dollar currency holdings into US corporate assets, etc.). Whatever the reason for the market’s price action, it results in fewer trading opportunities for our systems.
When markets coast higher, our algorithms tend to spend more time out of the market. The reason is simple: there is only one way to trade (buy) and those gains—made over the course of months—can be lost in a few minutes when news breaks the markets. Our algorithms are contrarian in nature, seeking momentum exhaustion, and there has been virtually no exhaustion of this bull market since February, save the last week or so. As a result, our programs traded in few sessions.
When trading opportunities are scant for our programs, it increases the odds that we will post negative returns. We have to be precise in the few sessions in which we trade to earn yield; if we are wrong once or twice, the market environment does not provide an opportunity to pare the losses. In the sessions we traded in April, we experienced a few losses which were large relative to the range, and happened upon few opportunities to trade out of them.
The good news for our programs is that the market environment is changing. Ranges are expanding and so too should our trading prospec
IN FOCUS | May 2010 Market Outlook
As we opined in last month’s outlook, the S&P could not find much ground above 1210, though it did work higher from the March close. April was a small gain in the S&P, cut short by some panic selling. Earnings, momentum and monetary policy argue for higher prices, but the ever present sovereign debt crisis is planting fresh uncertainty in equity markets. It is beginning to look like Germany may favor orderly default for weak EU constituents over bailouts. Greece is just the first of the little “piggy’s” to come to market (Portugal, Italy, Ireland and Spain lie in wait). Combine that with China cooling its red hot economy and the vol is back. Equities do tend to “get it last,” so May will be a key month. Will the European debt crisis be enough to force the market to new lows on the year? Perhaps the better question is if two of the top four economic zones in the world (China and the EU) are ending their inflationary policies, can US equities go much higher?
The S&P needs a breakout above 1220 with good volume to keep the bulls around. Recent sell-offs have seen rising volume, while rallies have been on low volume. The market will likely decline into the employment report and then rally, keeping an eye on the action in the Euro currency. If the Euro currency begins a panic decline, expect a panic decline in US equities. Investors will (and should) fear that the already soft recovery is being weakened by sovereign debt burdens. May will likely see a range from 1135 to 1190. A close below 1135 portends a very rough summer for US equities, as deflation becomes the name of the game.
As the market begins to digest its near term prospects and risks, we anticipate a return to a market environment more favorable to our algorithms. Rising uncertainty in the markets will give rise to many trading opportunities. As we find more trading opportunities, I am confident that we will return to profitability. However, please be aware the current drawdown may deepen—perhaps 3 or more times as much as it stands today. As we noted above, clients should expect annual 10% drawdowns and 15% drawdowns in 18 to 36 month periods. We cannot predict the depth and timing of our drawdown. However, we are confident that we will pull out of it.
John L. Roe
President, ROE Capital Management
PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.An investment with ROE Capital Management is speculative, involves a high degree of risk and is designed only for sophisticated investors who are able to bear the loss of more than their entire investment. Read and examine the disclosure document before seeking ROE Capital Management’s services.