The investment strategy of the funds that is triumphing this year

Trend following has been one of hedge funds' best-performing stock investment strategies this year. He SG Trend Index has risen 29,6%, while the S&P 500 index has fallen 19%. These trend-following investors have achieved these returns by focusing on price signals, looking for momentum, and keeping in mind the old adage of not going against the Federal Reserve. Let's see how this stock investment strategy is made up...

What is the trend following strategy?​

Trend following aims to take advantage of long, medium or short-term trends in financial markets. It is not about predicting these trends, but about taking advantage of them when they occur. That is, identify the main operations and changes that have impulses and generate benefits from them. The trend following strategy works by buying high and selling higher, or selling short and exiting short at an even lower level. We can implement a trend following strategy using the moving averages 100 and 200 period markets you follow. Essentially taking advantage of them to define our entry and exit points, the key will be to follow the price of the asset and let the profits run. For example, let's see how it would have worked in recent years if we invested in the Nasdaq xnumx. When the 100-period moving average (yellow line) and the 200-period moving average (pink line) crossed in May 2019, our trend-following strategy would tell us to buy, specifically technology stocks. We estimate the closing of the operation for April 6 of this year, when the 100-period moving average line crossed the 200-period moving average. At that moment, our strategy would indicate a change of positions, from buying to selling. 

How has the Federal Reserve influenced all this?​

This year, the Federal Reserve has driven trends in almost all markets. This includes the weakening of investment in stocks, the growth of the returns of the bonos and the strengthening of American dollar. Since the global financial crisis of 2008-09, a rule in the markets was "don't fight the Fed." Central banks, including the Fed, had lowered interest rates to near zero and authorized massive bond purchasing programs. In this way they generally offered a position that encouraged investment in stocks, making the economy work again. There are two key factors of these events:

Runaway inflation

But lately, inflation has reached levels not seen in more than 40 years, and the Federal Reserve has been forced to change its stance, abandoning its previous permissive stance on the economy. Its objective is to return inflation, which reached a maximum of 9,1% in June, to the 2% target, even if this is detrimental to the economy. Last week, rates were raised again by 0,75 percentage points by the Federal Reserve, with others to follow.

Interest rate increases

There is now a strong alternative to investing in stocks, six-month Treasuries are returning almost 4%. This is because the rates paid on cash deposits rise in line with the rate hikes planned by the Federal Reserve. Last week, the billionaire hedge fund manager Ray Dalio He said that with interest rates of 4,5%, stock investment prices could fall by 20%…

On the other hand, Goldman Sachs published a report in which it estimated that, if the tightening of the Fed causes a recession in the US, the S&P 500 could fall a further 27%. Although inflation is the Fed's main concern and is on the rise, the saying "not fighting the Fed" now suggests a very different tactic; Stay away from the stock and bond investment markets.

Is there any investment opportunity in stocks?

As interest rates and fears of recession rise, we've probably already thought about replenishing our investment portfolio with stocks in the most defensive sectors of the market, such as healthcare or utilities. After all, they are likely to be more insulated from an economic downturn. Of course, a recession in the US could cause most stock investment sectors to decline. We may consider allocating part of our stock investment portfolio to trend following strategies. These will allow us to invest in the current direction of the market and not suffer setbacks. But rather than trying to predict what the Fed will do next, it's probably much better to use simple trend following strategies with moving averages. Right now, there are a few ETFs we can follow…

List of the best ETFs forward

• ProShares Short 20+ Year Treasury (TBF): It offers us a return opposite to the daily return of the index ICE US Treasury 20+ Year Bonds. Expectations of higher interest rates may push this ETF higher. 

• Simply Interest Rate Hedge ETF (PFIX): It is more volatile and risky, but it provides us with a hedge against sharp increases in long-term interest rates.

• ProShares Short S&P 500 ETF (SH): It offers us the opposite profitability of the S&P 500. That is, when the S&P 500 does not give good results, this one does. 

• ProShares Short QQQ (PSQ): This ETF offers us an opposite return to the Nasdaq-100. The two anti-indices ETFs could be expected to generate good returns if fears of a US recession rise.

• WisdomTree Long USD Short GBP (GBUS): It's a ETC (Exchange Traded Certificate) that tracks long positions in the US dollar against the pound sterling. The current situation in the UK remains unconvincing, suggesting to us that the US dollar will continue to gain ground against the pound. Even if expectations of further interest rate hikes in the United States fall, their increasing pace will continue.