The ETF Experience – Phil Bak joins David Kotok for conversation during Inside ETFs (Radio-Podcast)

The ETF Experience – Phil Bak joins David Kotok for conversation during Inside ETFs (Radio-Podcast)

Cumberland's David Kotok on Bloomberg Radio
Show notes:
Phil Bak sits down with the legendary David Kotok for an outdoor conversation during Inside ETFs about David’s career, investment principles, Cumberland Advisors and the state of the economy. Conversation highlights:

  • Launching Cumberland just before the oil shock and energy crisis of the 1970’s
  • How David utilizes behavioral finance, quantitative modeling, economics, history and philosophy in his practice
  • The case for equal weight equities
  • The compounding value of writing market commentary and research
  • Reflections on a storied career, and the current state of the market
  • Camp Kotok

Listen via the embedded player below or at this link:
https://exponentialetfsexceptionalpodcast.libsyn.com/david-kotok-cumberland-advisors-ep72


If you’ve enjoyed this exchange, please feel free to explore other interviews and conversations at the Cumberland Advisors website or YouTube channel.
Website: https://www.cumber.com/tag/radio-podcasts/
YouTube: https://www.youtube.com/CumberlandAdvisors


NOTE: Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.


If you like podcasts, check out this one from 2015 featuring David Kotok talking about his background and Camp Kotok with Barry Ritholtz. They also talk about the history of Cumberland Advisors since its founding, and delve into fundamental principles of investing and valuation.


Links here
https://itunes.apple.com/us/podcast/masters-in-business/id730188152?mt=2

And here
http://www.bloomberg.com/podcasts/masters-in-business/




Cumberland Advisors Market Commentary – Turkey & Trump

Here is an updated report from Al Jazeera on the Turkey ceasefire and related developments. While it reflects network leanings, they are much different from the CNN-Fox distortions, and more facts may often be gleaned.

Market Commentary - Cumberland Advisors - Turkey & Trump
https://www.aljazeera.com/news/2019/10/turkey-military-operation-syria-latest-updates-191017051518215.html

Next we have the presidential tweeter’s self-proclaimed brilliance, hard on the heels of Pence and Pompeo’s trip to Ankara to meet with President Erdogan. He tweeted this at 2:17 PM on Thursday:

“This is a great day for civilization. I am proud of the United States for sticking by me in following a necessary, but somewhat unconventional, path. People have been trying to make this ‘Deal’ for many years. Millions of lives will be saved. Congratulations to ALL!” (https://twitter.com/realDonaldTrump/status/1184895160871571456)

President Trump also remarked that the Kurds “didn’t help us in the Second World War. They didn’t help us in Normandy.” Actually, the Kurds were our allies in both World War I (http://www.kaiserscross.com/304501/407043.html) and World War II (https://www.dailykos.com/stories/2019/10/9/1891413/-The-Kurds-did-help-the-Allies-in-WWII). In both conflicts they fought with distinction in the Iraq Levies, which were troops recruited by the British to fight on the soil of Iraq, Palestine, Cyprus, the Persian Gulf, Albania, Greece, and Italy.

And here’s a personal statement from and report about a 100-year-old Kurd who fought with the allies in WWII: https://www.rudaw.net/english/kurdistan/13102019. Ahman Mustafa Delzar responded to the ill-informed tweet: “Trump was not born then – that is why he does not know that the Kurds participated in the war.” He explained, “The Levies were mainly Assyrians and Kurds and a smaller number of Arabs. I was the 8,000th Kurd who joined the Levies during the Second World War.”

The bottom line is well-summarized by this Washington Post article: “Trump’s retreat in Syria turns into a mess” (https://www.washingtonpost.com/world/2019/10/14/trumps-retreat-syria-turns-into-mess/).

The following Atlantic piece by Joseph Votel and Elizabeth Dent provides additional trenchant detail on the negative effects of Trump’s decision to withdraw: “The Danger of Abandoning Our Partners,” https://www.theatlantic.com/politics/archive/2019/10/danger-abandoning-our-partners/599632/. (General Votel is currently a nonresident Senior Fellow on National Security with the Middle East Institute (MEI). As commander of CENTCOM, General Joseph Votel oversaw U.S. military operations across the Middle East, including the campaign against the Islamic State in Iraq and Syria, from March 2016 to March 2019. Elizabeth Dent is likewise a non-resident fellow at MEI, focused on counterterrorism, and worked in various capacities at the State Department for the US Global Coalition to Defeat ISIS from 2014 to 2019.) The authors conclude that Trump’s Syria policy reversal “threatens to undo five years’ worth of fighting against ISIS and will severely damage American credibility and reliability in any future fights where we need strong allies.”

Nevertheless, the president declared on Saturday, Oct. 19 that “We’ve had tremendous success I think over the last couple of days,” adding, “We’ve taken control of the oil in the Middle East” – a claim that observers had difficulty in connecting with the situation in Syria.

Dear readers, there is no rational way to seek an investor path through the bewildering twists and turns of present American foreign policy, if policy it be. It changes continually; and its disruptiveness, accompanied by constant, corrosive hyperbole, makes macro-dependent investing a high-risk adventure.

Here’s our position. We don’t own the Turkey ETF. We see the entire Middle East as a risky place. Think about it. Saudi gets attacked, and drones disable 5% of global oil production. Then nothing happens. Next, two missiles hit an Iranian tanker. Still nothing happens. Now, hundreds of ISIS fighters have escaped, and the lives of hundreds of thousands of Syrian Kurds are at risk. What will happen next?

US policy seems to be lurching toward isolationism in fits and starts, in deadly counterpoint to domestic political turmoil. Remember, Senators McConnell and Graham have both strongly repudiated Trump, as did over two thirds of House Republicans when they joined all the Democrats in an anti-Trump vote on Wednesday, Oct. 16.

On Oct. 14 McConnell said, in part, “For years, the United States and our Syrian Kurdish partners have fought heroically to corner ISIS and destroy its physical caliphate. Abandoning this fight now and withdrawing U.S. forces from Syria would re-create the very conditions that we have worked hard to destroy and invite the resurgence of ISIS. And such a withdrawal would also create a broader power vacuum in Syria that will be exploited by Iran and Russia, a catastrophic outcome for the United States’ strategic interests.” (https://www.courier-journal.com/story/news/politics/2019/10/14/mitch-mcconnell-issues-second-major-statement-syria-crisis/3977983002/). McConnell followed that statement with further remarks on Oct. 16. They can be viewed here: https://www.courier-journal.com/story/news/politics/2019/10/14/mitch-mcconnell-issues-second-major-statement-syria-crisis/3977983002/.

Senator Graham expressed his views in a series of tweets on Oct. 16 tweets, at https://twitter.com/LindseyGrahamSC. He minced no words: “The worst thing any Commander in Chief can do is to give land back to the enemy that was taken through blood and sacrifice. I fear those are the consequences of the actions being taken right now.”

We remain overweight domestic US oil production, exploration, and natural gas. We remain fully invested in our domestic US ETF strategy and in our quantitative strategies (three of them).

Now a personal note.

My family members served in one branch of the military or another for several generations and during multiple wars. I personally attended a special NATO multi-country officers’ course in the 1960s. The British were the hosts. My task partner happened to be a Dutch colonel. I met and worked with WWII veterans in uniform and worked with others who served in their countries’ underground networks, fighting the Nazis.

Alliances matter. Long-term, tested alliances matter a lot.

Experienced leaders know that trustworthy allies are hard to develop and easy to lose. You don’t throw them under the bus. And you certainly don’t brazenly recite insults based on a false understanding of history, offending your friends and emboldening your enemies.

David Kotok, US Army. In memory: Leslie Kotok, US Navy. In memory: Sam Serata, US Air Force. In memory: Oscar Hacker, US Army. I’ll stop there. There are several more.

David R. Kotok
Chairman and Chief Investment Officer
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Leveraged ETFs

Our quantitative strategy at Cumberland Advisors is a trading model that combines fundamental indicators and quantitative analysis into a binary output – either fully invested or all in cash. The strategy trades the S&P 500 in two versions: unleveraged and leveraged. Specifically, the leveraged portfolio uses a leveraged ETF as our vehicle to track 3X the market movement. As many may wonder whether one should use a leveraged ETF, we would like to express our opinions on leveraged ETFs today.

Market Commentary - Cumberland Advisors - Leveraged ETFs

First, what is a leveraged ETF? It is simply an ETF using derivatives and debt to track and amplify the return of an index. However, a leveraged ETF does not expose investors to traditional margin risk; rather, investors just pay the ETF cost. A leveraged ETF resets each day and targets to track an index’s daily movement. A leveraged ETF is usually considered a trading tool. It is typically held for less than a week at most, and oftentimes just daily. Investors are generally told not to buy and hold this type of security due to “time decay,” a term that is often misused when applied to leveraged ETFs. Time decay is a term used to describe the loss of value of an option as time approaches the expiration date. However, leveraged ETFs are not subject to option expirations. What “time decay” really refers to, in connection with leveraged ETFs, is the compounding effect. For example, if the market went up 10% on day 1 and went down 10% on day 2, one would lose 1% at the end of day 2; with 3X leverage, one would go up 30% on day 1 and down 30% on day 2, being left with a 9% loss at the end:

1 – (1+0.1) x (1-0.1) = 0.01     (1)
1 – (1+0.3) x (1-0.3) = 0.09     (2)

Time has nothing to do with the math above. It is compounding that magnifies the leveraged number. In other words, anything that increased 30% and then decreased 30% would have the same outcome regardless of leverage. Imagine that equation (2) represented a scenario where the market went up 30% on day 1 and down 30% on day 2 – one would be left with 9% loss without any leverage or so-called “time decay” effect. Another example: If the market dropped 1% a day for 10 consecutive days, one would suffer a 9.56% loss, while the loss would be 26.26% with 3X leverage:

1 – (1-0.01)10 ≈ 0.0956     (3)
1 – (1-0.03)10 ≈ 0.2626     (4)

Again, the math demonstrates that time is not the reason for the significant difference; compounded return is the master behind the scene. To understand the power of compounding, let’s take a look at a famous motivational poster that some people have as their desktop – if you improve just 1% a day, you will be much better in a year:

Chart 1. 1% a day difference
Now that we have clarified the mathematical misconception, let’s dig into the more important question: Should one buy and hold leveraged ETFs? The chart below compares the 3X leveraged ETF SPXL against the benchmark S&P 500.

Chart 2. S&P 500 vs. SPXL, 11/5/2008–11/9/2018. Data source: Bloomberg

Clearly, the 3X ETF has substantially outperformed the S&P 500 since its inception on November 5, 2008. However, not every investor would have had the stomach for the volatility that was experienced along the way. Leverage can be a powerful tool to take advantage of a bull market if used properly, but one must possess extensive risk management skills. At Cumberland Advisors, we prioritize risk control by keeping our focus on risk-adjusted returns.

If you are interested in obtaining information about our quantitative strategy, please email me.

Leo Chen, Ph.D.
Portfolio Manager & Quantitative Strategist
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.




Causality

On day 1 our econometrics professor warned us to be careful with correlation: A strong correlation doesn’t necessarily mean causality. This is the case with the VIX. It’s closely related to the S&P 500 with a negative correlation, but the relationship may not be causal. I will never forget the example our professor gave us: The number of people who have drowned by falling into a swimming pool, it turns out, is highly correlated with the number of movies Nicolas Cage has filmed. Unlike school vending machines that can be causally linked to childhood obesity, Nicolas Cage didn’t need a scientific study to prove his innocence.

However, investors sometimes mistakenly assume causality between seemingly related events. If a rise in VIX is accompanied by some down days in the stock market, did the VIX cause stocks to fall? To answer this question, we need to know how the VIX is calculated. The VIX uses factors from the options market, one of which is the observed forward index price calculated by out-of-money options in the short term. But this correlation calls for caution about endogeneity: The VIX is derived from traders’ perceptions about the future, but actual futures prices also affect traders’ perceptions. How can we be sure that the VIX causes stock price to change? If anything, VIX is more likely the effect than the cause in this relationship. Analogously, the more firemen are sent to a fire (effect), the bigger the fire is (cause). From the perspective of future perceptions, VIX appears more likely to correspond to the firemen who respond to the fire in numbers according to its size than to the fire itself.

What is causation as opposed to correlation, then?  Here’s an example of causation: Consuming alcohol can cause a hangover the next morning. Unfortunately, causality is not as easy to identify in finance as it is in the case of having too much to drink. Oftentimes, what appears to be causation turns out to be just correlation. But why is causation so important for investors? The reason is simple: If a variable can cause stock prices to change, then it is a predictor. Who wouldn’t like to know tomorrow’s stock prices? If we have causation, we have a way to anticipate what’s coming. Why is it so difficult to identify a causal relationship? It is not because there is a limited supply of crystal balls; instead, the stock market is too complex. The stock market is sensitive to all information pertaining to the future. Therefore, it’s not just one variable but many that affect the stock market. Those variables can be as simple as some new product or quarterly earnings, or more intricate ones such as a tax bill or an interest rate change.

At this point we seem to be mired in a paradox: If there are so many factors that can cause stock prices to change, why is it so difficult to identify one? The answer once again falls upon the complexity of the market. Investors and financial engineers have studied the stock market extensively. Although there have been many models, such as the Fama-French three-factor model, created to attempt to explain stock prices, unfortunately, no model yet invented captures the complex interactions of the stock market. This limitation makes it extremely difficult to test any variable against the so-called benchmark. Currently, one of the most-used ways to mitigate this problem is to test one variable at a time against a bundle of existing factors. Nevertheless, our modern research methodologies still only allow us to conclude with a probability rather than certainty. To complicate matters further, the stock market is dynamic. This challenges any model used to predict the stock market. In other words, a factor may have a causal relationship with the stock market at a certain time but not at all times. The explanation is straightforward. If a factor were known to cause stock prices to change, then investors would use that factor repeatedly. By Goodhart’s Law, that factor would not be rendered ineffective over time.

Finally, the key difference between causation and correlation is simple. Causation means A happens before B, while correlation suggests A and B both happen at the same time. Let’s use the figure below, for instance. By rule of thumb, household income is likely to lead personal expenditures, which may explain why there is a slowdown in income preceding each decrease in expenditures.

Personal Consumption Expenditures and Median Household Income in the United States. Source: St. Louis Fed. 
Leo Chen, Ph.D.
Portfolio Manager & Quantitative Strategist
Email | Bio

Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

Sign up for our FREE Cumberland Market Commentaries

Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.