Episode 132

Mastering Market Moves with Bruce Kaufman

Articles From: Interactive Brokers
Website: Interactive Brokers


Managing Partner

BDKMarketGroup Investment Management

Join Bruce Kaufman, Managing Partner of BDKMarketGroup Investment Management, as he shares expert insights on market timing and strategies with Jose Torres, Interactive Brokers’ Senior Economist. From early beginnings to navigating today’s volatile markets, Kaufman’s wisdom provides essential guidance for investors.

Summary – IBKR Podcasts Ep. 132

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Jose Torres 

Hello everyone and welcome to Interactive Brokers IBKR podcasts. I am Jose Torres, your senior economist. I’m with Bruce Kaufman, managing partner of BDK Market Group Investment Management. Hi, Bruce. How are you doing? 

Bruce Kaufman 

I’m doing terrific Jose, thank you so much for having me here. 

Jose Torres 

Absolutely! It’s a pleasure. So, a lot of things are going on in the markets these days. Market timing is becoming an important skill nowadays, especially with markets moving around in a volatile way. Tell us about your background, and how you got started. 

Bruce Kaufman 

Well, it’s going to be longer than this time allocated to the podcast, but I started when I was 10. I was fortunate I had an older brother who was a math wizard, and he was 16 years old. I was 10 years old at the time, he came to visit. This is in the 1960s. OK, so probably well before most of you all were born. He brought the Wall Street Journal, and I’m telling you when I looked at the paper and stock tables an electric pulse went through my body. The next month, I opened an account at Paine Webber, which of course for your younger people it’s now UBS, and that’s how it began. My brother really helped me get interested in technical analysis. So specifically, I started with point and figure charting in the 1960s. I used to chart 100 stocks every night, of course right off the newspaper realized this is well before the Internet, well before calculators. That’s how I got started.  

As time went on, one thing led to another as new technical breakthroughs were discovered. What always interested me is “what happened, what were the economic indicators saying, what were technical indicators saying as technical indicators became invented?” At market pivot points and it was always fascinating to me. It’s really been a lifelong study. What has happened over the last 15-20 years is that I have gotten particularly good, and I continue to try to improve my craft, but I’ve gotten particularly good at market timing. Few people can do this, and I’m not going to say I get it right every single day, but I get it mostly right. What I try to do in my firm, I manage money for high-net-worth individuals and institutions, is to avoid major drawdowns. We participate on the upside and avoid any kind of “trapdoor” type of situations where just too exposed on the long side when the market falls apart. We participate via short sales and or just being defensive in general. 

Jose Torres 

Great! So, speaking of the market falling apart and the possible possibilities for volatility, last year was a remarkably strong year. We had a volatility uptick in March during the bank failures of SVB, Signature, First Republic, Etc. Overall, it was a great year. It was a positive year. So far this year in January, we have seen narrowing breadth tech stocks have really led the way. What’s your outlook for this year? 

Bruce Kaufman 

Well first, I don’t necessarily look at it from one year to the next because the year before last was an awful year for those who were long. So, if you look at it, the S&P on an equal weighted basis. For the audience, the S&P is calculated via a market capitalization which throws much more weight to the largest stocks. What has happened is that about 6-9 stocks have really been the main beneficiaries of Fed largess. If you’re on the SPY, you’re not really diversified you, you’re owning 6-9 stocks mostly you think you’re diversified. Until you realize you’re not. So, I also like looking at the market on an equal weighted basis and this is the same with NASDAQ, which is also calculated the same way. As the S&P and on an equal weighted basis, at least through a couple of days ago, the market was down 5% from its all-time high. So, it doesn’t mean it can’t hit it on an equal weighted basis, but the IWM which smaller and midsized companies would have to catch up, so, we will see if that happens.  

The way I look at markets is three ways. I start with the indexes. Why do I do that? It’s because most stocks move with the indexes, the indexes are going up. Then the majority of stocks go up, if the indexes are going down, the majority of stocks are going down. If the if the indexes are in what I call misalignment. Then you have a choppy whipsaw kind of situation. So, what I do, and I have developed a technique to be able to determine accurately where we are and that’s how I start my day. Every morning, I look at the data; my opinion does not matter. What I read, which is essentially somebody else’s opinion, or they’re trying to manipulate me. Who knows? It doesn’t matter, what matters is what the market is saying. If the market is saying we are in misalignment, which we are currently, then we’re in a chop situation. Let me just take a step back.  

I look at 5 indexes the S&P 500, NASDAQ 100, NASDAQ composite, Russel, and the Dow. To be aligned, all those indexes must have gone through a tactical gauntlet. That shows me that it is moving in one direction or another. Now how do I determine the technical gauntlet? 

I am an expert in Demark analysis and for the audience that is not that familiar with that Tom Demark, who I happen to think is one of the brightest people, certainly in technical analysis, he received a lifetime achievement award. I think last year. Has developed a methodology which really fits and has fit. On how I look at markets, which is you have a momentum phase, and you have an exhaustion phase. What I look for are those turning points. Now, I don’t just use Demark, I use other technical tools that I’ve become expert in over the years. Looking at this every morning, which I then published in a market letter. I tell my clients exactly what I think is going to happen in the market and what the outlook is. I then invest accordingly. 

Jose Torres 

Interesting. What are some other indicators you use? I know some popular ones are relative strength index, oscillators, the Bollinger bands moving averages. What are some of your favorites? 

Bruce Kaufman 

One of my favorites, usually the ones that are most popular, are the ones that are my least favorite. What I do like is I look at sentiment because sentiment reflects emotion. Humans are emotional beings. They get excited when stocks are going up and they get really depressed when stocks are going down. It’s amazing where you could have, say, at the start of the week, the market could be slammed. However, by the end of the week, the market is going up and it is as if the beginning of the week never even happened. That is how quickly investors change. I don’t try to get caught up in any of that emotion.  

One of the tools I look at is bullish percentage sentiment. I use several moving averages to tell me when that is turning. One thing that look at what we have now in late January is negative divergences between the sentiment indicator and what the SPX has been doing. So, it doesn’t mean that the sentiment indicator, which is quite elevated, cannot turn back up. I mean, anything can happen in markets. But the probabilities are that at some point the SPX will react to the fact that there is a negative divergence. What it needs is some sort of catalyst, it could be an economic report or something that people just do not expect. 

Jose Torres 

Yeah. This week we have PMI’s tomorrow, Wednesday the 24th. Then on the 25th we have the fourth quarter GDP report on the 26th. We have the core PCE inflation report and then we have a big meeting next week with Chair Powell of the feds expecting to pause. But investors are really going to be looking for clues on when the first-rate cut is going to occur. I think at the Fed. They have been increasingly cautious, realizing that at the December 13th, meeting when Chair Powell talked about rate cuts and the possibility for the near future, how the market started to price in a lot more rate cuts for 2024, what do you think? Do you think he will walk back some of that? Do you think he will have more of a dovish or more of a hawkish tilt? I tend to be more on the hawkish, tilting side because I think last time, he was too dovish. He is going to revert to the other side here. It would be interesting to hear your thoughts. 

Bruce Kaufman 

My thoughts are atypical. My thoughts are I do not care. What matters to me is how the market interprets whatever he does. Because the market is made up of millions upon millions of investors. They are all reacting to a variety of different stimuli. So, trying to isolate as if that one stimuli is the stimuli. To me, it is certainly something I cannot do, and I don’t even bother trying. What I find for myself and for my clients, what is far more important? Is to identify how the market in aggregate is reacting to whatever these policy decisions are, or whatever the news happens to be. A moderate amount of volatility should be considered. Often in any of these timing methodologies, there’s really a question of “where do you set your parameters so that you don’t get whipsawed out of the position?” Now, to get esoteric here in Demark, there’s a concept called the reference close. That can change daily. There’s an upper reference close level, and a lower reference close level. This can change daily based on the volatility of the instrument you’re looking at. To that I have added some of my own technical rules which I have found have worked extremely well. As a result, to answer your question again, it does not matter to me, we will see how the market reacts and then a position accordingly. 

Jose Torres 

Let me ask you in another way, what do you think about rates at the short end and at the long end, of course, the short end has a lot to do with Fed policy. At the long end, some things I read your commentaries; I love them. Some of the things that you talk about. Sometimes or the record number of deficits, debt, and issuance from the Treasury, which you affect the long end. I am curious to know your outlook on rates. 

Bruce Kaufman 

Well, let me answer that in a slightly different way. I will not say it does not matter because it does matter. What I am focused on is the current inversion. 10 out of 10 times over the last 75 years, I look at what is the relationship between the 10-year yield and the 2-year yield. I take the 10-year yield and I divide it by the two-year yield. For the last two to three weeks, it has been somewhere between .93 and .95, with obviously 1.0 being the equal line and anything over 1.0 is a normal sloping yield curve. What is key is before the 10-year and 2-year relationship matters. What I have always looked at is the relationship from the yield quotient perspective of the 10-year and the 3-month. So, for the 10-year and 2-year to be focused on what must happen, you need at least one month. Conversion between the three-month Treasury bill and the 10-year Treasury bond. That was satisfied during the first week of December in 2022. On average, over the last 75 years, every time that has occurred within 18 months, there has been a recession. If you go back and look at history and you look at the media at the time, every time nobody was predicting a recession. It was always a soft landing if things slowed down. Since 1945, there has been one soft landing that was in the mid 90s. Now it is possible we could have a soft landing again, but the odds are not suggestive of that. When the 10 year and the two year reverts, normalizes, and it accelerates. Every time that has occurred, 10 out of 10 times, there has been a significant impact on equity prices to the downside. Is it possible that this time is different? Yes, anything is possible. Do I think it is likely? No!  

That signal has not occurred yet. So, I am not focused on it in terms of positioning. What I have found is that when the 10-year yield is divided by the two-year yield accelerates over a specific proprietary, it triggers the adverse equity reaction. As an example, we had the conditions satisfied in May of 2019. If you look at Treasury tables, you will see that for about a month. There was an inversion between the 3-month and the 10-year. In February of 2020, we had an acceleration of the 10-year and the 2-year. In May of 2019 when we first had that inversion of the 10-year and 3-month, nobody was thinking about COVID. My point is, it’s often something unexpected that causes it. Because if it is obvious, it’s already factored into the market. I have no idea what specifically may cause it. We’ll see at the time, but as of right now, there is no signal, so I’m not focused on it, but it it’s certainly something that I am very aware of.  

If we were to use the 18 months. If it hits on average and we could look at this summer, but it doesn’t have to be 18 months it could be longer than that. As we know, mathematically, the definition of an average is it an average. It doesn’t necessarily mean it’s happening on a specific day; it could take another year. It happens in 2025, so we will see. When the numbers say it’s happening, it’s happening. Until then, it’s just a potentiality. 

Jose Torres 

Here in 2024, we’ve had economic forecasters talk about recession, no landing soft landing, hard landing. So, against that backdrop is the reversion to normalcy on the yield curve led by the short end this time around or is it led by a long end?  

Bruce Kaufman 

Historically, it’s been the former, meaning the 2-year starts heading South in a major way. It is certainly possible that the other could happen where the 10-year rises dramatically. That would mathematically cause the same effect. Usually, the 2-year is dropping because the Fed is panicking. That had had a recession or some adverse economic impact to the economy has occurred, and they are rapidly dropping the Fed funds rate. As we know, they don’t control what the two year is doing. However, the maturities that are closer in typically two years and less most affected by what the Fed does with respect to the Fed funds. I would expect it’s going to be that, but the fed could surprise me. It could go the other way, I guess. 

Jose Torres 

In October we had the, the 10-year at 5% and that was a big driver of the equity sell off down to $4,100. Now today we’re here at $4,850 on the S&P 500. Yields are softer than they were back then. Another important consideration are the valuations. I know you’re a technical expert, but at what point do valuations start to hamper further upside? Last few years I’ve sort of thought of valuations in the context of 20x earnings being too much and 15x earnings being too little for the overall S&P. I wonder what your thoughts are. 

Bruce Kaufman 

I think the market is overvalued, but as we discussed earlier markets can remain overvalued for a long time. They can also remain undervalued for a long time. At some point it will change. When I get a technical signal that says it’s going to change. That’s when it will change. We have seen so many short sellers, I presume getting run over the last year by, predicting, if the markets over the valued. The market is between 20 to 25% overvalued. I think perhaps when we get that yield curve reversion and acceleration, the market drops 20 to 25% somewhere along those lines. We’ll have to wait. Could the market continue to go higher? Sure. As of right now it remains in what’s called misalignment. It’s very, very choppy, so there is no real direction outside of what I would say, the continuing momentum from the November move. It’s drifting, melting upward now and should add from a technical standpoint the E Mini’s and the SPX and the SPY. They’re all trading above. Their upper limit of the Bollinger bands, and Keltner channels. It’s called scalloping. If it continues to stay above that. At some point at a minimum, it typically will react and come back to its 20 day moving average.  

There are also lots of Demark exhaustion signs. An exhaustion signal typically means that within the next 12 sessions you look for a reaction going in the opposite way. However, it doesn’t necessarily mean that it will happen. It is possible for exhaustion signals to do what’s known as recycling. Meaning that there’s still more upside momentum left in the market. The fact that there is lots of exhaustion right now is certainly something that I’m very aware of and looking at. 

Jose Torres 

Great! Shifting a little bit. We just launched another podcast series called Cents of Security, and that’s to inform younger folks and folks that don’t know much about finance about some of the basics and I against that backdrop, I’d like to ask you, what advice can you give younger people who want to learn how to invest? 

Bruce Kaufman 

So, one of the great tragedies of this country, globally, but certainly in the US is you can go kindergarten through college and graduate without knowing how to balance your checkbook. My advice would be to buy books about economics, read investment books, and just start. You do not want to be naive about something that will impact you throughout your life. There is not one book that matters, I have read all the famous investment books throughout my life and that is how I picked up a tremendous amount of knowledge. On top of the foundational background, which was the major in economics and finance. Just having an ECON degree and a finance degree is terrific. However, applying that knowledge to making money in markets is a whole different thing. What I would stress is to know yourself. Everybody is a little bit different when it comes to your personal psychology. 

Some people can gamble, and they can sleep at night like a baby, and that’s fine. Then there are people on the other end of the spectrum. Figure out where you are on the spectrum. And invest accordingly. You never want to wake up at 3:00 in the morning, worried about an investment that you made. That means you have too much of it, whatever it is. You must know yourself then, what I would suggest is to read several different investment books with respect to how different traders or investors do it. Find a process the keyword here is process that works for you and stick to that process. There is no Holy Grail in investing. Even the great investors lose money at times. It’s all about having a mathematical edge.  

Within whatever process you have selected and if it really is nothing more than wash, rinse, repeat. That’s all I do. Wash, rinse, repeat. I stick to my process; it works for me. It doesn’t work for different types of investors because we’re all different and that’s fine. I would never knock another type of investment process. We see this often if you turn on the media; somebody goes on TV and they’re talking their book, and they’re telling people why they are so much smarter than everybody else. I would never do that, there is room for all of us here. Finance and the investment area is such an enormous ocean. Just find your subset within that ocean where you can be profitable and specialize in it. I know guys, all they do is trade in E-mini futures. They don’t do anything else. They have one chart or a few charts, one or two computers. That’s all they do. They’re trying to do 50 things at once, and they’re experts at it. Never invest emotionally, that is a great way to eventually blow up. Listen to the Interactive. Brokers, podcasts and listen to them and find other, smart people. You’re not going to learn a lifetime of knowledge in a week. It takes time, but you must start. It takes time, but you must start. The first day of the rest of your life. Start today! 

Jose Torres 

Great Bruce, thanks for that! Finally, where can people go to find out more information about BDK Market Group Investment Management, and how can they sign up for your daily weekly commentaries? 

Bruce Kaufman 

Well, you can e-mail me at [email protected]

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