Author: Michael Arold

Covestor model: Technical Swing

In September, the S&P 500 traded sideways in a range between approximately 1120 and 1220. My strategy to focus on “mean-reversion trades” as discussed in my last month’s review worked out well - for the month, my Covestor model portfolio gained 10.72% while the S&P lost 7.18%.


The strategy was simple: I aimed to go short at the top of the trading range, selling equities of weak sectors, such as the Market Vectors coal ETF (KOL) or stock of investment bank Goldman Sachs (GS). At the bottom of the range, I went long strong sectors, predominantly technology stocks, such as Apple (AAPL) or Amazon (AMZN). Holding periods were extremely short in September because the markets went from overbought to oversold and vice versa in just a few days.

Trading in such a highly volatile environment requires being fast and nimble. As predicted, driving themes were Europe, Fed policy and the fear of a weakening global economy. 



Going into October, investors’ focus is likely to shift: Q3 earnings season is coming up and Alcoa - traditionally the first major company to report - will do so on October 11.

I believe that Q3 earnings have the potential to push equity markets out of their trading ranges of the last months. However, I cannot predict the direction of the breakout. In fact, I don’t have to. My job as a trader is to listen to the markets and then trade accordingly. Being biased can be dangerous. 



My feeling is that earnings will disappoint. Granted, analysts have been lowering estimates in recent weeks, according to Bespoke.com, but analysts have the historical tendency to not lower estimates aggressive enough, according to a McKinsey study. This point was also highlighted by Barry Ritholtz on his blog recently.



Another theme, which could gain traction in the next weeks, is China. Similar to earnings, the topic is not on the front page of public media yet, which means there is more downside risk for stocks. The story is a potential “hard landing” of the country’s economy. Bank of America recently presented the scenario at a conference.

It is interesting that price action of key China related assets (e.g. various commodities, especially copper; the China ETFs FXI, TAO, HAO) has been very weak in September. Since markets are a discounting mechanism, are they predicting the “hard landing” in China? 



Bottom line: it could be a rough October for stocks. So far, I feel that neither the earnings discussion nor the China theme have found their way into mainstream media yet, which is concerning. Investors’ attention is still focused too much on Greece.

Though I sound negative, I’m trying to stay unbiased in my trading.