Market Outlook: Welcome to the Victor Niederhoffer Puppet Show

by: Stephen Castellano

Recent market action seems to continue to follow the summer of 2007 play book. If we are correct about this, we could see another day or two of declines followed by a sharp rise before we start spiraling down again in the fall. To see what we mean, take a look at this table, or just read our May 6 article in its entirety. Our guess is that May 20, 2010 is going to be a replay of August 14, 2007 or August 17, 2007 -- we give those scenarios a 75%/25% respective chance of occurring later today.

It seems ridiculous, even to ourselves, that we can even suggest looking at a table of daily returns from two years ago, and proclaim like some Velcro-turbaned, occult palm reader that there is some kind of probability of history repeating itself today. But maybe not. Maybe that's all that this market has turned into.

We seem to recall that Victor Niederhoffer, or one of his friends, built a software program in the 1980s that looked for thousands of historical market patterns and bet according to them. If our currency hedge fund friends are doing this by the micro-second in currencies, then you can be sure there are some old-school billionaires still playing with versions of their old FORTRAN software and betting the same way in the equity markets. In times of uncertainty, people gravitate to what they know. The last two to three years are burned into everyone's minds. The situation may be different, but there seems to be an ongoing similarity in daily return data between now and the summer of 2007. So why shouldn't the puppet show continue to repeat itself?

In any case, now that we are hedged again with a short bias, we don't really care what happens. Any sharp rise in the markets should be mitigated a bit, and meanwhile we stay poised to benefit from any continued trending downturn. If we do experience a sharp rise, we will be giving back some gains we have made relative to the index. In other words, we have positioned ourselves to either be more right, or less right -- which is more or less what marketing oneself working on Wall Street is all about.

Separately, Wednesday, May 19, 2010 was another great day for quantitative hedge funds as our model long ideas declined less than the market and model short ideas declined more. From what we have seen, our model portfolios tend to generally track the direction of real hedge funds. The only thing that is missing is an intra day technical indicator -- though we have played with those. Our take is that intra-day technical indicators tend to limit upside as much as downside. However, in this ugly market, it might be a good idea to start pulling those intra-day indicators off the shelf again. Or better yet, just stay in any cash raised at the open on May 6.

Ascendere Long/Short Strategy Daily Update
'High-quality' stock positions in the unleveraged long model portfolio were closed at the open on May 7 and reopened at the open on May 18. However, we have continued to track the basket's daily performance for the month.

High-quality' stocks in an unleveraged model long portfolio declined -0.44%, and 'low-quality' stocks in the unleveraged short portfolio declined -0.95% for the day ended May 19, 2010. This compares to a decline of -0.51% in the S&P 500.

For the MTD, 'high-quality' stocks in an unleveraged long portfolio would have been down -5.65%, ahead of the S&P 500 (ex dividends) at -6.04%.

'Low-quality' stocks in the unlevered short portfolio are down even more for the MTD at -7.89%.

As a result, an accompanying unmodified Market Neutral Model Portfolio increased 0.51% today and is now up 2.24% MTD.

Moderate Long/Short Portfolio
Given the now 80% long/120% short weighting in the Moderate Long/Short Model Portfolio, it appreciated 0.79% overall for the day. The Moderate Portfolio is now up 0.97% MTD versus -6.04% for the S&P 500, excluding dividends - "alpha" of more than 7%.

Aggressive Long/Short Portfolio
Given the 50% long/150% short weighting in the Aggressive Long/Short Model Portfolio, it appreciated 1.21% overall for the day. The Aggressive portfolio performance is now down -0.31% MTD versus -6.04% for the S&P 500, excluding dividends.

'High-Quality' Long Stocks Performance
The best daily performers in a 'high-quality' model long portfolio included Family Dollar Stores Inc. (FDO) up 3.20%, ITT Educational Services Inc. (ESI) up 2.54%, and Canadian Imperial Bank of Commerce (CM) up 1.91%.

The worst daily performers in a 'high-quality' model portfolio included Kinross Gold Corporation (KGC) down -4.67%, Seagate Technology (STX) down -2.56%, and SanDisk Corp. (SNDK) down -2.48%.

'Low-Quality' Short Stocks Performance
The best daily performers in the 'low-quality' short portfolio included Randgold Resources Ltd. (GOLD) down -3.80%, AngloGold Ashanti Ltd. (AU) down -2.74%, and Petrohawk Energy Corp. (HK) down -2.65%.

The worst daily performers in the 'low-quality' short portfolio included Sony Corporation (SNE) up 4.31%, Huntsman Corp. (HUN) up 4.15%, and PerkinElmer Inc. (PKI) up 1.45%.

Our Long/Short indicator is solidly in the net short position. Despite a signal that suggests we remain completely unhedged to the short side, we covered our positions in a model portfolio yesterday morning, May 18.

About the Model Portfolio
The Ascendere Long/Short Model Portfolio Strategies are "tactical tilt" portfolios that buy the highest quality stocks and sell the lowest quality stocks while maintaining a net long or net short position at all times. They are composed about 100 stocks and rebalanced monthly.

Investors focusing on daily performance could find monitoring our model portfolio useful as a proxy for what is working in the market in general as viewed through the lens of "high-quality" versus "low-quality" stocks.

In addition, daily readers can be apprised to changes in our proprietary long/short indicator, which has been successful at capturing general trends in the market.

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Disclosure: none

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