From the September 2013 issue of Investment Advisor • Subscribe!

Are Trends Trending?

Trend watching might become more valuable in the coming months

The trend is your friend” is one of those sayings that endures because it has been proven right so often. When markets are going up, chances are better than even that they’ll keep going up—until, of course, they don’t. Pinpointing the change in direction is certainly a challenge. But what if there are no trends at all?

For one category of managers, “trend followers” of managed futures, trendless markets present an even bigger challenge than trying to spot reversals. Choppy prices and directionless markets are to trend followers what placid seas are to surfers. Because trend followers profit from identifying and capitalizing on the likelihood that the price of oil (or many other sectors like gold, currencies or stock market indexes) will continue in the same direction for a while, trends have indeed become their friend. Without sustained market moves—either up or down—trend followers just paddle around, waiting to catch a wave.

We pay close attention to trend followers (and a subset of managed futures managers called specialized managers, as well) at Altegris. Mostly this is because we believe that a portfolio that includes managed futures—both trend followers and specialized managers—offers the potential to deliver returns when traditional assets are performing poorly. Because of managed futures’ historical record for zigging when long-only stock and bond portfolios are zagging, there has been an understandable demand for them as core long-term diversifiers.

But as it turned out, “trendless” and “directionless” accurately described the markets for trend followers in 2009, 2011 and 2012.  In fact, those years have the distinction of posting three of the four lowest trend-strength readings for a calendar year in history. That observation comes from an interesting measurement developed by Rho Asset Management, an investment management firm in Zug, Switzerland that specializes in managed futures.

The Rho Trend Barometer measures the strength of a market trend and, as Rho puts it, “reveals whether you should ride the tiger or stand aside.” You can read more about it at Rho’s website, Rhoam.ch, but the gist is the higher the mercury moves—in this case a value of more than 43.3%—the more the markets are trending. If the mercury reads a value that is less 43.3%, it’s a sign that market trends are weakening.

Not surprisingly, then, four of the five calendar years that the Rho Trend Barometer registered a value of less than 43.3% turned out to be losing years for managed futures. In 2009, for instance, the Trend Barometer dipped to 34.7%, a year when managed futures returned a negative 7.98%. By contrast, in 2008 the Rho Trend Barometer registered 52.1%, and managed futures returned an average 15.47%.

So, what’s ahead? After a long stretch of meandering, are market trends strengthening or weakening? To borrow Twitter’s terminology, are trends “trending”? Historically, exceptionally trendless markets like the ones in recent years have been short-lived. However, some other factors associated with managed futures’ poor showing in recent years may also become less of a factor.

Specifically, if the era of low interest rates, diminished or compressed volatility and risk-on/risk-off investing is over, managed futures could benefit. If the Federal Reserve Bank does taper quantitative easing this year, as it has hinted it might do, a sustained period of more conservative, risk-off investing could ensue. Again, all trend followers want is to catch a wave. We think there is a good possibility that trends will strengthen in the months ahead.

Past is not prologue, as we like to remind investors. But historically, managed futures’ underperformance has been infrequent and relatively lower in comparison to traditional long-only asset classes.  They have a track record of generating profits through a wide array of market cycles over the long haul. In 19 of the last 23 years ended December 2012, managed futures have turned in positive results. And that’s not a trend. That’s a fact.

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