As we begin a new year and reflect on 2017’s performance I can’t help but wonder if this will be the year for commodity trend followers. I know I probably sound like a broken record preaching the trend following strategy and encouraging investors to stay the course. Trust me, I know it isn’t easy after a few years of dismal performance. Investors are always quick to say, “trend following is dead” after not reaping any rewards for a few consecutive years, especially when the stock market is making new highs. That is why I believe it’s important to revisit history and the drivers behind trending markets.
Revisiting previous years of performance and market trends brings both good and bad news. The bad news is we have seen roughly three years of less than stellar performance for trend following, allowing us to accumulate some not so pretty tax losses. The good news is historically markets have always begun to trend well after these periods of lackluster performance.
CRB Index – It appears, trend following has the commodity research bureau(CRB) index working in its favor now. The CRB index tracks commodity prices, which must be trending either up or down to capture the performance. Generally, when the CRB index is stuck in a range and prices aren’t moving too much in either direction, trend followers tend to pay the price by getting whipsawed by repeatedly buying into failed trends. The best years in trend following are when the CRB index has moved sharply in one direction. Looking back at 2008 the index went from a peak level of 463 down to a low of 213 over an 8-month period; providing traders, managers and systems excellent opportunity to participate. Again in 2010 we saw the index rise 254 up to the 370 level over 11 months. The 12-month period in between those two trends were stagnant, with the CRB index ranging from 213-254. If you continue to look back over the trends of the index you will see these patterns. More recently in 2014 we had an amazing trend in commodity prices, going from 305 down to 163 which provided a year of performance that all trend followers yearn for.
So why the history lesson on the CRB index? Because over the last two years commodity prices have been at historically low levels. The CRB index bottomed out in Feb 2016 at the 163 level and recently in June of 2017 retested levels around 174. We haven’t seen these levels on the CRB index since 2002. We are growing, expanding, consuming and building more, it only makes sense that commodity prices are positioned to rise. We could get stuck back in a sideways range that we experienced from February 2016 through June 2017, a long 16 months, but the index along with other factors we will visit below indicates we are already breaking out of that range.
Interest rates – Rates have already risen, and the fed has made it known we will continue in this pattern. I believe the largest driving factor to low commodity prices and the lack of trends was due to an extremely low interest rate environment. From 2008 to 2015 we had next to no movement in the fed funds rate. This prevents inflation which keeps commodity prices low. In December 2008 the fed funds rate was .12% in November 2015 the fed funds rate was .12% (not a typo). Look at the chart below for the CRB index over that same period.
Chart provided by marketwatch.com
All signs are pointing to 2018 being a big growth year. The Fed has already indicated they plan on additional rates increases. Consumers are making more money with increased wages, unemployment is lower, and more wage earners are participating in the economy. Corporations and individuals will see more money from lower taxes, which will come back into the economy through spending, consuming, building, and growth. If all the indications are right, we will see commodity prices trending again in 2018.