December the 29th was the last trading day of the year, with 2023 now behind, let's review what was achieved, lessons learned and what the future might look like.
2023 Portfolio Performance:
The portfolio closed the year with a gross profit of 12.20%; 2.52% for the month of December. January and February were two painful months. We experienced a drawdown of about 8%. Reflecting on the pain always leads to progress. It took quite a lot of work to understand what works and what does not work, the underlying mechanism moving the different asset classes,... Adjustments were made and from March onward the portfolio started to perform better. I was particularly proud of the months of September and October. The portfolio showed its ability to mitigate the downside risk. During these months the US equity market went down, the portfolio managed to deliver alpha. How was that achieved? Wait for the next section!
2022 and the beginning of 2023 were two very painful moments that made me question my ability to generate alpha during difficult times. Since I was a young kid, I have always been solution oriented. If it does not work, I'll figure out a way to make it work. It will take time and effort but I'll manage. This experience was no different. For the sake of brevity, I'll focus on the findings. If you are curious how I got there, feel free to follow up with an email.
I came across to two main realizations that defined the way I think when it comes to allocate capital to different asset classes:
The VIX futures term structure offers this statistical hedge. Statistical hedge meant being right many more times than being wrong. Nothing to do with having a crystal ball. Since February / March 2023, the portfolio transitioned from being positioned mostly in US equities to predominantly trade and invest long & short volatility products. Fundamentally, this is a trend following strategy. Despite there are some volatility regimes in which being a contrarian has its advantage; October 2023 was a noteworthy example.
If on one hand statistical hedges can be found when trading equities on the other hand market participant behavioral dynamics make it less robust as compared to trading the VIX term structure. I do not rule out the idea that in the future some of the strategies that were developed might come back. For the time being, I use these signals as entry and exit points when trading derivatives and in particular bull and bear options vertical spreads. Even if the underlying asset moves against your trading signal, option trading can still be profitable as long as volatility is on your side. As a result, option trading has become an integral part of the portfolio.
Any cash available left in the portfolio is invested directly or through ETFs in T-Bills. Historically they have lower yields than T-Bonds and T-Notes but from a return risk adjusted perspective, they offer better returns with insignificant drawdowns.
When it comes to equities pullback. If they are fear induced, the VIX term structure is a good predictor. Typically the portfolio opens long volatility positions. When it comes to slow bleeding pull backs, these are sneakier to see coming. The VIX term structure is not a good predictor. In these types of instances, I look at what I call the beta indicator. It measures the relative movement between growth and value stocks. When a threshold level is reached, typically a pullback starts. I typically try to take advantage of these situations through vertical spreads.
In a nutshell, this is how Numericon Alpha has been positioned since 23Q2 and how it is entering 2024.
What to expect in 2024?
Let's start by having a look at some of the past predictions made by some major US banks. 2021: "The increase in Fed Fund Rate increase will break something in the economy and then the Fed will be forced to cut rates". 2022: "By the end of 2023, the S&P500 will close below 4,000". Did it happen? Not really. This is because the future is hard if not impossible to predict. If equities were a mechanical system, the 2021 and 2022 predictions could have come to fruition (my S&P500 model is aligned with the analysts estimates) but there are many more dynamics that make an accurate prediction nearly impossible. I close this paragraph on a somewhat hilarious note: many analysts are predicting the S&P500 reaching 5,000 points by the end of 2024. Given their track record, we might know what to expect.
There are few things worth noting:
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