Systematic Relative Strength Blog Now at MarketInsite

May 24, 2017

Eight years and 3,822 posts later, we are shifting venues for our Systematic Relative Strength blog to the Nasdaq MarketInsite – Systematic Relative Strength.  Thank you to everyone who has followed our posts over the years and we look forward to continuing to share research and commentary on the markets and specifically on relative strength investing for many years to come!  We have a couple new posts now up on the new blog: Nasdaq MarketInsite – Systematic Relative Strength.  Thanks again!

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Global Macro: Communicating Tactical To Clients

May 2, 2017

Risk management is an overarching objective of tactical asset allocation strategies.  Whether you are employing our Global Macro strategy (available as an SMA, DWTFX, or DWAT), one of the Tactical Tilt Models, or another application of DALI, becoming great at communicating the merits of these strategies is an important part of your business.  Two images that I have found useful in this effort are shown below and I share them here with the idea that you also may wish to incorporate them into your communications with your clients.

The first image is taken from John Lewis’ white paper Tactical Asset Allocation Using Relative Strength.  In this white paper, John ran a portfolio test on a broad range of ETFs from a variety of asset classes: U.S. Equities (long and inverse), International Equities (long and inverse), Currencies, Commodities, Real Estate, and Fixed Income.  In the white paper, the portfolio test showed the results of implementing a disciplined relative strength strategy of ranking a universe of ETFs by relative strength and making buy and sell decisions based on relative strength rank.  This trend following approach to asset allocation had results that were very compelling (detailed in the white paper).  One chart from the white paper that I like to use when presenting tactical asset allocation is shown below.  The green line is the trailing 12 month beta of the tactical asset allocation model vs. the S&P 500 and the black line is the trailing 12 month beta of a 60/40 (60% S&P 500/40% Barclays Aggregate Bond Index) vs. the S&P 500.  Visually, it is very easy to see that the green line fluctuates within a much broader range than does the black line, illustrating the more dynamic nature of a tactical asset allocation strategy driven by relative strength.  In markets where equities are in favor, the portfolio will be tilted towards equities and will tend to be more volatile.  In markets where equities are doing poorly, it is likely that the portfolio will be tilted towards more defensive asset classes.

Ultimately, I believe that this is what clients are looking for form a tactical asset allocation strategy.  They want to dial up the risk in good markets and they want the ability to dial down the risk in bad markets.  I believe that relative strength is ideally suited for this task.

trailing 12 month beta

Source: Tactical Asset Allocation Using Relative Strength, John Lewis

This example is presented for illustrative purposes only, and does not represent a past or present recommendation.  Performance of the switching strategy is the result of back-testing.  Back-tested performance results have certain limitations.  Such results do not represent the impact of material economic and market factors might have on an investment advisor’s decision-making process if the advisor were actually managing client money.  Back-testing performance also differs from actual performance because it is achieved through retroactive application of a model investment methodology designed with the benefit of hindsight. The performance numbers above are pure price returns, not inclusive of dividends, fees, or all transaction costs.  Investors cannot invest directly in an Index, like the S&P 500 Index (SPX), and index performance numbers do not include fees.  Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.

Another chart that I often use in presentations on tactical asset allocation strategies is the chart below.  I came across this image on Twitter a couple years ago and immediately knew I would be making good use of it.  If you happen to lose some clients with terms like beta, standard deviation, drawdowns, etc, chances are good that you’ll be able to help them understand the concept with the following chart.  It would be nice if investing were similar to the “Your plan” portion of the image below.  Under that scenario, it is a smooth upward trajectory to your financial goals.  Clients often look at the long-term annualized return of a strategy and mistakenly think that they will be granted that return each and every year.  “Reality” doesn’t quite work that way.  There are bull markets, bear markets, periods of high volatility, periods of low volatility, geopolitical risks, market shocks and all kinds of other things that are part of investing.  The goal of tactical asset allocation is to help smooth out the ride for a client.  Will a tactical asset allocation strategy be able to completely smooth out the ride?  Clearly not.  No strategy can do that.  However, if tactical asset allocation is able to seek to mitigate some of the downside risk and also be able to adapt and participate in good markets then it will have achieved its goal of providing risk management to a client.

plan_reality

Source: Twitter @ThinkingIP

Of course, telling the story is part of what is required.  Delivering results is the other part of it.  As shown below, the Arrow DWA Tactical Fund (DWTFX) has outperformed 91% of its peers in the Morningstar Tacical Allocation category over the past 5 years, which I believe speaks to the efficacy of relative strength investing over time.

dwtfx

Source: Morningstar, 4/27/17

If you have questions about accessing tactical asset allocation strategies for your clients, please contact Andy Hyer at andyh@dorseymm.com or 626-535-0630.

Each investor should carefully consider the investment objectives, risks and expenses of any Exchange-Traded Fund (“ETF”) prior to investing. Before investing in an ETF investors should obtain and carefully read the relevant prospectus and documents the issuer has filed with the SEC. ETFs may result in the layering of fees as ETFs impose their own advisory and other fees. To obtain more complete information about the product the documents are publicly available for free via EDGAR on the SEC website (http://www.sec.gov)  There are risks inherent in international investments, which may make such investments unsuitable for certain clients. These include, for example, economic, political, currency exchange, rate fluctuations, and limited availability of information on international securities.  Past performance does not guarantee future results. In all securities trading, there is a potential for loss as well as profit. It should not be assumed that recommendations made in the future will be profitable or will equal the performance as shown. Investors should have long-term financial objectives when working with Dorsey, Wright & Associates.

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Jim O’Shaughnessy on Active Management

April 23, 2017

If you want to succeed with active management, I would suggest this is a must watch.

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Stat of the Week

April 21, 2017

From Hendrick Bessembinder’s recent white paper.

While the overall stock market outperforms Treasury bills, most individual common stocks do not. Of the nearly 26,000 common stocks that have appeared on CRSP since 1926, less than half generated a positive holding period return, and only 42% have a holding period return higher than the one-month Treasury bill over the same time interval. The positive performance of the overall market is attributable to large returns generated by relatively few stocks. When stated in terms of lifetime dollar wealth creation, one third of one percent of common stocks account for half of the overall stock market gains, and less than four percent of 28 common stocks account for all of the stock market gains. The other ninety six percent of stocks collectively matched Treasury-Bill returns over their lifetimes.

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Market Insights

April 21, 2017

The stock market continued its climb upward during the first three months of the year.  The S&P 500 Total Return index finished with a gain of 6%, and the bull market celebrated its 8th birthday!  The Dow Jones Industrial Average (DJIA) closed at a record high for 12 days in a row during February.  This was a milestone that has been seen very infrequently in the history of the DJIA.  We are constantly hearing opinions and reasons why the bull market’s end is near, but the market has been able to shrug these off for years.

The biggest event during the first quarter was the transition of power from Obama to Trump.  Investors are hopeful that tax reform might be on the way.  There was also initial hope that the repeal and replace of Obamacare would be a huge plus for US stocks.  However, the failure to do anything meaningful with healthcare was a stark reminder to everyone that politicians love to say things and then get nothing done.  This is just the world we live in now, and we don’t see that changing any time soon.  The one thing we do know about politics is it is very dangerous to mix your political views with your investment strategy!  We had conversations with many people who were convinced the world was ending because of one of Obama’s policies or another.  We are hearing the same thing about Trump now (although from different people).  The market did extremely well under Obama and his policies.  Only time will tell if it will for Trump or not.  Keeping your politics out of investing will help you see things much more objectively.

There has also been a lot of talk during the beginning of the year about low volatility levels.  We certainly don’t disagree with that from a broad market point of view.  However, we have noticed more volatility under the surface of the broad market and in high momentum strategies in particular.  There were several days during the quarter that the highest momentum stocks dramatically underperformed the broad market.  We tend to see that happen from time to time, but seemed out of character this quarter considering momentum held up very well relative to the broad market.  We think this speaks to the underlying sentiment of investors who still seem very skittish even after an eight year bull market run.  This is actually a good thing from a longer term perspective.  Once investors turn euphoric it has historically been the precursor to a major top.  That doesn’t seem to be the case right now at all.  Investors are still waiting for the proverbial next shoe to drop.  Climbing the wall of worry has always been necessary in bull markets, and it appears that wall doesn’t show signs of crumbling soon.

The one big area that didn’t do well to start the year were oil and energy prices.  Just one year ago it was a totally different story.  A year ago, we saw a huge laggard bounce from the energy sector that had been beaten down in 2015.  That laggard rally was difficult for momentum strategies because oil had performed so poorly the twelve months prior.  The S&P Goldman Sachs Commodity Index (GSCI), which is dominated by energy prices, was down more than 5% for the quarter.  This caused shifts in a lot of our models and we reduced exposure to energy in a lot of our portfolios.

Despite the commodity weakness, Emerging markets did particularly well to start the year.  Developed markets also outperformed US markets.  Our domestic markets have been performing much better than international markets over the past few years.  We might be in the initial stages of that changing.  The price earnings ratios of emerging and developed markets indexes are well below those of the S&P 500.  We are also seeing international equities demonstrating good relative performance and moving up our asset allocation rankings.  That combination of good momentum with relatively attractive valuations is something to keep an eye on for the remainder of the year.

We are off to a good start to the year.  FactSet is predicting first quarter earnings to grow at a decent pace, and there are a number of other positive factors that support higher prices in the coming months.  If you have any questions about any of our strategies please don’t hesitate to contact us at any time.

This information is from sources believed to be reliable, but no guarantee is made to its accuracy.  This should not be considered a solicitation to buy or sell any security.  Unless otherwise stated, performance numbers are not inclusive of dividends or fees.  Investors cannot invest directly in an Index.  Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.

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Relative Strength Spread

April 18, 2017

The chart below is the spread between the relative strength leaders and relative strength laggards (top quartile of stocks in our ranks divided by the bottom quartile of stocks in our ranks; universe of U.S. mid and large cap stocks).  When the chart is rising, relative strength leaders are performing better than relative strength laggards.    As of 4/17/17:

spread

The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.

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And The 2016 ETF.com Awards Winners Are …

April 12, 2017

The fourth annual ETF.com Awards was held last Thursday night in New York City  to honor products, people and companies that made a difference in the ETF industry in 2016.  Dorsey Wright and PowerShares were honored to receive the award for Best New Asset Allocation ETF with the PowerShares DWA Tactical Multi-Asset Income Portfolio (DWIN).

From Yahoo! Finance:

PowerShares has an entire line of ETFs that incorporate the Dorsey Wright relative strength model into various segments of the stock market. But in 2016, for the first time, it applied the model to an asset allocation ETF. The “fund of exchange-traded funds” usually holds five ETFs chosen based on yield and price momentum. Those ETFs can be from any asset class, including equities, bonds, REITs, preferred stocks and more. Since its inception in March 2016, DWIN has garnered a strong following, and already has $117 million in assets. It’s a modestly priced fund with an expense ratio of 0.69%, which is in line with other Dorsey Wright ETFs.

We wanted to check in with John Lewis, Senior Portfolio Manager at Dorsey Wright, for his reaction and some additional insights into this strategy.

Q: Can you provide some background on what led to the development of this strategy?

A: PowerShares has a very diverse lineup of funds with good yields.  They were looking for a solution that would allow investors to leverage their lineup while getting away from the issue that has plagued many multi asset income funds.  What you normally see with these types of funds are static sleeves or allocations to certain income producing areas of the markets such as high yield bonds, MLP’s, or REIT’s.  As we have seen over the years, there are times when these asset classes are in favor and times when they aren’t.  Our discussions with PowerShares centered around the premise that we could use DWA tools to time entry and exit into these high income producing asset classes.  The result was something that was very different than what we had done with PowerShares before.  We came up with a multi factor approach that we felt would be extremely robust over time, and, as it turns out, got the attention of many industry watchers as well.

Q: The need for income is ever-present in this industry.  In what ways do you think this strategy addresses investor’s income needs?

A: DWIN remains invested in the highest income producing areas provided they are performing well.  So in risk-on type markets it can throw off a lot of interest income.  But we don’t chase yield for yield’s sake.  Someone once said, “More money has been lost chasing yield than at the end of a gun.”  We think this statement is very true!  There are times when certain high yielding areas have very poor performance so we shift into safer holdings during those times.  So the investor’s income from the product will be variable over time.  We think that approach will be beneficial over time because protecting capital is as (or more) important as generating the income.

Q: Risk management seems to be a key objective with this strategy.  Can you walk us through how DWIN seeks to manage risk?

A:  We run a matrix with everything in our universe.  To qualify for the portfolio each month holdings need to be in the top half of our matrix ranks.  From the top half of the ranks we select the five securities with the highest current yields.  When markets are performing well we wind up with a lot of high yielding securities.  When markets get into trouble these high yielding securities usually fall quickly down the ranks and high quality securities tend to move to the top of the ranks.  These high quality securities are usually US Government Bonds that perform well as investors seek safety.  In these times, we may hold large positions in US Treasuries.  These types of securities generally have much lower yields than other things in our universe.  So during times of stress, we may have a much lower yield in the portfolio because it is positioned for safety rather than appreciation.

Q: What is the potential problem with income strategies that seek for the highest possible yield with few if any other considerations?

A: Reaching for yield can be very dangerous.  High yield investments have always been very enticing for investors because everyone wants more income!  But they have high yields for a reason.  There is risk in them.  You are receiving a high current yield to compensate you for the added risk you are taking.  That is great when things are going well.  But when the economy turns, for example, high yield bonds can come under pressure because many companies have problems making their debt payments.  Another example is what happens to MLP’s when energy prices fall.  While an investor is still receiving a high current yield, a lot of the total return is lost as the prices of those assets go down.  So we think it is prudent to look at the bigger picture with high yielding investments rather than just the current yield an investor will (is supposed) to receive.

Q: What asset classes are included in the investment universe for DWIN?

A:  It is a very diverse group of assets.  We use PowerShares ETF’s to get our exposures so it is very efficient for us to move the money around to different areas as momentum shifts.  We can invest in all sorts of fixed income including US Treasuries, High Yield Bonds, Global Bonds, Munis, and more niche areas like Build America Bonds.  We can also move in to equity income areas (both domestic and international) if that is where the strength is.  There are also a few areas like MLP’s and REIT’s that are more narrowly focused but very high yielding that we include in our universe.

Q: How is the strategy currently allocated?  What parts of the investment universe have been gaining strength in recent months?

A: We are allocated in MLP’s and REIT’s, which are a big driver of yield for us right now.  We also own Short Term Global High Yield bonds and Emerging Markets debt.  Finally, we have a position in Preferred Stocks that has performed well in the model.

Q: Do you have any suggestions for how DWIN could fit in a client’s asset allocation?

A:  We think DWIN can be used in many ways and by a number of different types of investors.  The obvious choice is for clients looking for current income that also want some sort of risk management built in to the strategy.  But this strategy can also be considered for a more aggressive portion of a fixed income allocation.  As interest rates rise, investors are looking for alternative ways to allocate to high yielding and fixed income instruments.  DWIN uses a momentum overlay to shift to areas that may perform better than traditional fixed income in a rising rate environment.  If it turns out traditional fixed income performs well, then DWIN has the ability to allocate there too.  That flexibility comes at a price.  We can’t guarantee any sort of minimum yield over time.  However, we think the ability to adapt to changing markets is more important over time than remaining in asset classes that aren’t performing well.

Neither the information within this article, nor any opinion expressed shall constitute an offer to sell or a solicitation or an offer to buy any securities, commodities or exchange traded products.  This email does not purport to be complete description of the securities or commodities, markets or developments to which reference is made. DWA provides strategies, models, or indexes for the investment products discussed above and receives licensing fees from the products’ sponsors. The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Relative Strength is a measure of price momentum based on historical price activity.  Relative Strength is not predictive and there is no assurance that forecasts based on relative strength can be relied upon.

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Shifts in Sector Leadership

April 6, 2017

Trend followers love environments with stable leadership, but the reality is that markets don’t always comply.  As shown below, those sectors that had the best performance in 2016 (Energy, Telecom, Financials) tended to have the worst performance in Q1 2017 while the sectors that tended to have the worst 2016 (Healthcare, Consumer Staples, Consumer Discretionary) tended to have the best performance in Q1 2017.  However, there has been some stability in leadership.  Technology, for example, performed well both last year and in the first quarter of this year.

sector 03.31.17

Source: Twitter @Econompic.  As of 3/31/2017.  Returns are inclusive of dividends, but do not include fees or transaction costs.

Dorsey Wright’s relative strength work is designed to pick up intermediate to longer-term relative strength trends and it is designed to allow us to adapt and change as leadership changes in the market.  In the table below, we show the sector exposure in our Systematic Relative Strength Aggressive Portfolio.  This is a separately managed account strategy that we have been managing since 3/31/2005.  The strategy starts with an investment universe of about 900 U.S. mid and large cap stocks and then ends up with a portfolio of 20-25 stocks.  The nature of the strategy is to seek to overweight strong sectors and to underweight weak sectors.  A relative strength score is assigned to each stock in the investment universe and that score determines when we buy and sell a stock out of the portfolio.  Buys are made from stocks that are in the top decile of our ranks and then stay in the portfolio as long as they remain in the top quartile of our ranks.  Trades are done on a weekly basis if needed.

SRS Aggressive_Sector

Source: Dorsey Wright

As shown above, Technology exposure in our Systematic Relative Strength Aggressive Portfolio has been relatively high over the last number of months.  However, other sectors have had some pretty significant shifts as we have seen some changes in relative strength.  Healthcare and Basic Materials are two sectors where our exposure has increased in recent months (exposure to Consumer Cyclicals has also slightly increased).  Those sectors shaded in gray have seen drops in exposure since the beginning of the year.

Sometimes sector strength can be short-lived; other times sector strength (or weakness) can persist for years at a time.  Outside of Technology, we have seen quite a few shifts in sector strength in recent months.  The great thing about relative strength is that it allows us to be adaptive and to shift exposure as needed.

To learn more about our Systematic Relative Strength Portfolios, please e-mail andyh@dorseymm.com or call 626-535-0630.

Neither the information within this article, nor any opinion expressed shall constitute an offer to sell or a solicitation or an offer to buy any securities.  This email does not purport to be complete description of the securities or commodities, markets or developments to which reference is made. The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Relative Strength is a measure of price momentum based on historical price activity.  Relative Strength is not predictive and there is no assurance that forecasts based on relative strength can be relied upon.

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Helping Clients Get Comfortable with ADRs

April 3, 2017

As we noted in one of our recent articles, over the last 20 years, publicly listed companies worldwide have grown significantly in number, while the number of publicly listed companies here in the U.S. has contracted.  Navigating global investment opportunities is a key way that financial advisors can add value for their clients.  The benefit of incorporating ADRs into the mix is that these securities are listed on U.S. exchanges, really making investing in them no more difficult than accessing any other securities that trade on our exchanges.

To get a flavor of some of the investment opportunities in this space, consider the following table which lists the top ten performing ADRs year to date from the investment universe that we use for our Systematic Relative Strength International portfolio (includes around 500 small, mid, and large cap ADRs from Emerging and Developed International markets).

adr_top 10

Source: Dorsey Wright. As of 3/28/2017.  Returns are price only, not inclusive of dividends or transaction costs.  Dorsey Wright currently owns LFL.  A full list of buys and sells in our Systematic RS portfolio over the past 12 months is available upon request.

Part of the reason that clients can be hesitant to invest in foreign securities is simply lack of familiarity—the well-documented home country bias.  See below for a brief description of the businesses of each of the companies listed above (Source: Yahoo! Finance).  This is in no a way recommendation of any of the above-listed stocks, but I do think it serves the purpose of helping pull back the curtain on some of the opportunities that exist when investors look to foreign companies.  Online gaming, flight transportation, semiconductors, plastics, communication equipment, travel agencies, natural gas and more.  We may use relative strength to identify what we believe to be good investment opportunities, but our clients may very well want to get a sense for the businesses before they are willing to allocation a portion of their money to these opportunities.

Gravity Co., Ltd (GRVY)

Gravity Co., Ltd. develops and publishes online games in South Korea, Japan, the United States, Canada, Taiwan, Hong Kong, Macau, China, and internationally. It offers online games; mobile games and applications; and other games and game-related products and services, including character-based merchandise and animation.

GOL Linhas Ãreas Inteligentes S.A. (GOL)

Gol Linhas Aéreas Inteligentes S.A. provides regular and non-regular flight transportation services for passengers, cargoes, and mailbags in Brazil and internationally.

ASM International NV (ASMIY)

ASM International NV, together with its subsidiaries, engages in the research, development, manufacture, marketing, and servicing of equipment and materials used to produce semiconductor devices. The company operates through two segments, Front-end and Back-end. The Front-end segment manufactures and sells equipment used in wafer processing, encompassing the fabrication steps in which silicon wafers are layered with semiconductor devices in Europe, the United States, Japan, and Southeast Asia.

Fuwei Films (Holdings) Co., Ltd. (FFHL)

Fuwei Films (Holdings) Co., Ltd., together with its subsidiaries, develops, manufactures, and distributes plastic films using the biaxially-oriented stretch technique in the People’s Republic of China. Its products include printing base films used in printing and lamination; stamping foil base films and transfer base films used for the packaging of luxury items, such as cigarettes and alcohol; metallized films or aluminum plating base films used for vacuum aluminum plating for flexible plastic lamination; high-gloss films used for aesthetically enhanced packaging purposes; and heat-sealable films used for construction, printing, and making heat sealable bags.

Sharp Corporation (SHCAY)

Sharp Corporation manufactures and sells electronic communication equipment, electronic equipment, electronic application equipment, and electronic components in Japan, The Americas, Europe, China, and internationally.

LATAM Airlines Group S.A. (LFL)

Latam Airlines Group S.A., together with its subsidiaries, provides passenger and cargo air transportation services in South America, North/Central America, Europe, Africa, Asia, and Oceania.

MakeMyTrip Limited (MMYT)

MakeMyTrip Limited, an online travel company, provides travel products and solutions in India and internationally. It operates through two segments, Air Ticketing, and Hotels and Packages.

Intelsat S.A. (I)

Intelsat S.A., through its subsidiaries, provides satellite communications services worldwide. The company offers a range of communications services to media companies, fixed and wireless telecommunications operators, data networking service providers for enterprise and mobile applications in the air and on the seas, multinational corporations, and ISPs; and commercial satellite communication services to the U.S. government and other military organizations and their contractors.

Himax Technologies, Inc. (HIMX)

Himax Technologies, Inc., a fabless semiconductor company, provides display imaging processing technologies to consumer electronics worldwide.

Transportadora de Gas Del Sur S.A.

Transportadora de Gas del Sur S.A. provides natural gas transportation and distribution services in Argentina.

Never before has it been easier for investors to invest in the strongest trends wherever they might be found in the world. Relative strength offers an ideal framework for allocating among those trends. Markets are global and your portfolio should be too.

Two resources for your consideration:

  • Use the query tool on the Dorsey Wright site to evaluate the list of ADRs that we follow (record count is 720 before you narrow it down by any further criteria, such as technical attribute).

query

  • Consider using our Systematic Relative Strength International Portfolio.  This portfolio has a 10+ year track record that we are very proud of.  We evaluate a broad investment universe of ADRs and own 30-40 ADRs in the portfolio.  Buy and sell decisions are determined by relative strength rank.  E-mail andyh@dorseymm.com to receive the fact sheet and see the list of firms where this strategy is available.

Dorsey, Wright & Associates, LLC, a Nasdaq Company, is a registered investment advisory firm.  Neither the information within this presentation, nor any opinion expressed shall constitute an offer to sell or a solicitation or an offer to buy any securities, commodities or exchange traded products. This article does not purport to be complete description of the securities or commodities, markets or developments to which reference is made.  The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value. There are risks inherent in international investments, which may make such investments unsuitable for certain clients. These include, for example, economic, political, currency exchange, rate fluctuations, and limited availability of information on international securities.

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High RS Diffusion Index

March 28, 2017

The chart below measures the percentage of high relative strength stocks (top quartile of our ranks) that are trading above their 50-day moving average (universe of mid and large cap stocks.)  As of 3/27/17.

diffusion 03.28.17

The 10-day moving average of this indicator is 69% and the one-day reading has pulled back to 57%.

The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Investors cannot invest directly in an index.  Indexes have no fees.  Past performance is no guarantee of future returns.  Potential for profits is accompanied by possibility of loss.

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Think Global to Avoid Shrinking U.S. Stock Market

March 27, 2017

Ben Carlson, quoting research from Dimson, Marsh and Staunton in their Global Investment Returns Yearbook 2017, has some fascinating stats on worldwide publicly listed companies today versus just 20 years ago.

According to CRSP data, there were more than 9,100 U.S.-listed public companies in 1997. Today, that number is down to slightly more than 5,700. The Wilshire 5000, an index used as a proxy for all U.S. securities with readily available pricing data, holds just over 3,600 stocks as of the start of this year, down from more than 7,500 in 1998. So the number of stocks that trade on the exchanges has basically been cut in half over the past 20 years or so. There are a number of reasons for this change — increased regulations to go public, fewer IPOs, lax anti-trust laws, venture-backed companies staying private longer and a winner-takes-all marketplace in many industries.

Investors are worried that the shrinkage in the number of U.S. companies means that wealth and the markets themselves are becoming more concentrated in fewer and fewer hands. Fewer investment options could make it harder for investors to find adequate investment opportunities. For those investors who share these worries my advice would be to look abroad for more investment opportunities. While U.S.-listed companies have seen their ranks diminish since the 1990s, there are now more public companies than ever worldwide.

According to Dimensional Fund Advisors, the number of companies listed on global stock market exchanges has increased from about 23,000 in 1995 to 33,000 by the end of last year. So while the number of companies in the U.S. has shrunk the number of companies worldwide has exploded.

These are very important trends that have a variety of meaningful implications for investors.  As it relates to international equity exposure, more choices can be a good thing if investors have a logical framework to analyze this broad universe of securities.  We are partial to using relative strength to evaluate any given universe of securities, but perhaps the rationale for doing so is even greater for international equities.  It is one thing for a fundamental analyst to become an expert in U.S.-listed securities.  There is a common currency, one government, one set of regulations, and so on, but when it comes to international equities, an investor is dealing with much, much greater complexity of fundamentals.  However, for a relative strength-driven strategy, it always comes back to price, which makes international investing no more complicated than investing here in the U.S. from a portfolio construction perspective.

John Lewis, our Senior Portfolio Manager, did an interview with HedgeWeek recently in which he delved into more of the reasons why we think there are so many opportunities when it comes to international equities.  That interview focused on why we think ADRs are a great way for US investors to get this exposure.

This trend of more and more securities being listed abroad and fewer here in the U.S. is something that should be a topic of conversation with your clients.  Being able to provide them with some strong options for international equities is another important way that you can help them navigate growing global investment opportunities.

The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  There are risks inherent in international investments, which may make such investments unsuitable for certain clients. These include, for example, economic, political, currency exchange, rate fluctuations, and limited availability of information on international securities.

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Tom Dorsey and John Lewis on AdvisorShares AlphaCall

March 21, 2017

Click here for a replay of their recent conversation on our International strategy, available as AADR and as an SMA.

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Relative Strength Spread

March 21, 2017

The chart below is the spread between the relative strength leaders and relative strength laggards (top quartile of stocks in our ranks divided by the bottom quartile of stocks in our ranks; universe of U.S. mid and large cap stocks).  When the chart is rising, relative strength leaders are performing better than relative strength laggards.    As of 3/20/17:

rs spread

The RS Spread has declined for most of the past 12 months as the RS laggards have performed better than the RS leaders, but that dynamic appears to be changing.  The RS Spread has now moved above its 50 day moving average, a potentially positive development for relative strength strategies.

The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.

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Process over Short-Term Outcome

March 20, 2017

Jim O’Shaughnessey, author of What Works on Wall Street, recently wrote about 7 traits that he believes are required for active investors to win in the long run.  I fully agree with all 7, but I found #2 on his list to be particularly compelling:

2. Successful Active Investors Value Process over Outcome.

“If you can’t describe what you are doing as a process, you don’t know what you’re doing.”

~W. Edwards Deming
The vast majority of investors make investment choices based upon the past performance of a manager or investment strategy. So much so that SEC Rule 156 requires all money managers to include the disclosure that “past performance is not indicative of future results.” It’s ubiquitous–and routinely ignored by both managers and their clients. In keeping with human nature, we just can’t help ourselves when confronted with great or lousy recent performance. “What’s his/her track record?” is probably investors’ most frequently asked question when considering a fund or investment strategy. And, as mentioned above, the vast majority of investors are most concerned with how an investment did over the last one- or three-year period.

Yet successful active investors go further and ask “what’s his or her process in making investment decisions?”  Outcomes are important, but it’s much more important to study and understand the underlying process that led to the outcome, be it good or bad. If you only focus on outcomes, you have no idea if the process that generated it is superior or inferior. This leads to performance chasing and relying far too much on recent outcomes to be of any practical use.  Indeed, shorter-term performance can be positively misleading.

Look at a simple and intuitive strategy of buying the 50 stocks with the best annual sales gains. Consider this not in the abstract, but in the context of what had happened in the previous five years:

Year                            Annual Return            S&P 500 return

Year one                      7.90%                          16.48%

Year two                     32.20%                        12.45%

Year three                   -5.95%                         -10.06%

Year four                     107.37%                     23.98%

Year five                     20.37%                        11.06%

Five-year

Average Annual

Return                         27.34%                        10.16%

$10,000 invested in the strategy grew to $33,482, dwarfing the same investment in the S&P 500, which grew to $16,220. The three-year return (which is the metric that almost all investors look at when deciding if they want to invest or not) was even more compelling, with the strategy returning an average annual return of 32.90% compared to just 7.39% for the S&P 500.

Also consider that these returns would not appear in a vacuum—if it was a mutual fund it would probably have a five star Morningstar rating, it would likely be featured in business news stories quite favorably and the long-term “proof” of the last five years would say that this intuitive strategy made a great deal of sense and therefore attract a lot of investors.

Here’s the catch—the returns are for the period from 1964 through 1968, when, much like the late 1990s, speculative stocks soared. Investors without access to the historical results for this investment strategy would not have the perspective that the long term outlook reveals, and thus might have been tempted to invest in this strategy right before it went on to crash and burn. As the data from What Works on Wall Street make plain, over the very long term, this is a horrible strategy that returns less than U.S. T-bills over the long-term.

Had an investor had access to long-term returns, he or she would have seen that buying stocks based just on their annual growth of sales was a horrible way to invest—the strategy returned just 3.88 percent per year between 1964 and 2009! $10,000 invested in the 50 stocks from All Stocks with the best annual sales growth grew to just $57,631 at the end of 2009, whereas the same $10,000 invested in U.S. T-Bills compounded at 5.57 percent per year, turning $10,0000 into $120,778. In contrast, if the investor had simply put the money in an index like the S&P 500, the $10,000 would have earned 9.46 percent per year, with the $10,000 growing to $639,144! What the investor would have missed during the phase of exciting performance for this strategy is that valuation matters, and it matters a lot. What investors missed was that these types of stocks usually are very expensive, and very expensive stocks rarely make good on the promise of their sky-high valuations.

Thus, when evaluating an underlying process, it’s important to decide if it makes sense. The best way to do that is to look at how the process has fared over long periods of time. This allows you to better estimate whether the short-term results are due to luck or skill. We like to look at strategies rolling base rates—this creates a “movie” as opposed to a “snapshot” of how strategies perform in a variety of market environments.

This is a philosophy you’ve repeatedly heard from us as well.  Short-term outcomes are important, but process ultimately determines long-term results.  Among the ways that this can be illustrated is by looking as some of our white papers on relative strength investing.  John Lewis’ white paper, Point and Figure Relative Strength Signals detailed the long-term investment results of a relative strength process that took 1,000 U.S. stocks and categorized them into one of four portfolios based on their PnF relative strength signal (BX-buy signal and in a column of X’s; BO–buy signal and in a column of O’s; SX—sell signal and in a column of X’s; or SO—sell signal and in a column of O’s).  Portfolios were equal-weighted and rebalanced on a monthly basis.  Performance of these four portfolios from 12/31/1989 to 12/31/2015 is shown below.  As detailed in the paper, following a disciplined process of investing in stocks with the highest momentum (BX portfolio) generated significant outperformance over this test period.

base rates

Click here for disclosures

Long-term success with active management comes from doing sufficient due diligence to either design a robust investment process yourself (or to employ one designed by someone else) and then to execute, execute, execute.  If the process is sound, long-term outcomes should take care of themselves.

The performance above is based on total return, inclusive of dividends, but does not include transaction costs.  Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.  The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Some performance information presented is the result of back-tested performance.  Back-tested performance is hypothetical and is provided for informational purposes to illustrate the effects of the strategy during a specific period. The hypothetical returns have been developed and tested by DWA, but have not been verified by any third party and are unaudited. Back-testing performance differs from actual performance because it is achieved through retroactive application of a model investment methodology designed with the benefit of hindsight. Model performance data (both backtested and live) does not represent the impact of material economic and market factors might have on an investment advisor’s decision making process if the advisor were actually managing client money.  Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.

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False Sense of Security with Passive?

March 14, 2017

Peter Chiappinelli in Advisor Perspectives sheds some interesting light on the active versus passive debate as it relates to fixed income exposure.  See below for a few excerpts of his recent article.

The trends are clear. 2016 was the year in which the investment community warmly embraced passive portfolios. Our worry, however, is that investors are feeling a false sense of security, particularly with passive bond portfolios–namely those funds and Exchange Traded Funds (ETFs) linked to a common benchmark, the Bloomberg Barclays U.S. Aggregate Bond Index (the Agg). There is nothing passive about this index, and we would argue it is aggressively taking on more risk at the worst possible time. There are three main reasons for our concern: the simple math of bond duration; the changing composition of the index; and the very logical financing behavior of corporate borrowers.

Bond math and duration

Without doing a rehash of intricate bond math, duration is an important calculation of bond risk. Though it has many variants, at its root duration measures the sensitivity of a bond’s price to a shift in yields. For example, a bond (or a bond portfolio) with a duration of 5 years means that for every 1% shift upwards in yields, there is a 5% drop in the price of the bond. Duration is measured in years because it is a function of the timing and magnitude of a bond’s cash flows (coupons and principal repayment): the more distant the cash flows, the higher the sensitivity (i.e., higher risk) to a change in interest rates, all else held equal. The cleanest example of this is the 30-year zero-coupon bond, which pays a single massive cash flow 30 years down the road, and therefore this bond has a duration of exactly 30 years. There are no coupon payments along the way that would dampen its sensitivity to a change in yields. Generally speaking, the smaller the coupon, the higher the duration (and vice versa); the longer the maturity, the higher the duration (and vice versa). That’s just how the math of bond risk works.

Unfortunately for investors in passive bond portfolios or ETFs tied to the Agg, bond math is making this “safer” bond portfolio much riskier than it was even a few years ago. It is now much more sensitive to a possible rise in bond yields (as we saw in November) due simply to a lower “cushion” of coupons. As shown in the chart below, coupons have dropped dramatically since the Financial Crisis of 2008 and the introduction of Quantitative Easing by the Federal Reserve (Fed). For many years leading up to 2008, the Agg happily paid its investors a healthy coupon of over 5%, but today it is a measly 3%, a number that is among some of the lowest ever recorded. This is problem number one.

coupons

Changing composition of the Agg

Problem number two is that the Agg has dramatically changed its stripes since the Financial Crisis. Eight years ago, the largest bond sector was securitized loans (e.g., asset-backed securities, mortgage-backed securities), and most of these types of securities have shorter maturities and duration. Today, longer-dated Treasuries are now the dominant sector of the Agg, while securitized bonds have dropped off significantly. This, again, has shifted both the maturity and duration of the Agg upward.

Click here for the rest of Chiappinelli’s article, but following paragraph is a nice conclusion to his analysis:

The bond math of lower coupons, the changing composition of the Agg, and the issuance of longer-maturity bonds by corporate America all conspired to increase risk, at possibly the worst time. By any reasonable fiduciary standard, this was a time to be reducing duration, yet the Agg, and the passive bond portfolios and ETFs tied to it, has seen a 62% increase in duration over the past 8 years. There is nothing passive about the Agg–it has actually become more aggressive! Be careful.

Contrary to popular belief, passive does not necessarily mean static.  The composition of the Aggregate Bond Index has changed dramatically over time and this has important implications for its investors.  Part of the reason that we introduced our Tactical Fixed Income portfolio (available as a separately managed account) in 2013 is that we thought that we were likely  entering a period of time where active could be increasingly important in the fixed income space.  See below for the FAQ on this strategy:

Why is there a need for Tactical Fixed Income?

Bond buyers face a dilemma. Yields are very, very low. If interest rates stay low this low, bondholders are facing minimal returns, all the while having those returns eaten away by inflation. If interest rates rise, bondholders are facing potentially significant capital losses. Both outcomes, obviously, are problematic. This situation demands a tactical solution that can manage through either outcome.

At Dorsey Wright, we have taken our time-tested relative strength tools and have applied them in a unique way to the fixed income markets. This solution is now available as a separately managed account. We think it will be welcome news for bond holders and prospective bond buyers who are grappling with the current bond market dilemma. Equally important, we think it will be a robust solution in the future across a broad range of possible interest rate environments.

What is the investment universe for the Tactical Fixed Income strategy?

The Tactical Fixed Income strategy can invest in short-term and long-term U.S. Treasurys, inflation-protected bonds, corporate, convertible, high yield, and international bonds. This is a broad universe of fixed income types that have varying yields and volatility characteristics.

How is the risk managed in the Tactical Fixed Income portfolio?

The Tactical Fixed Income model structures the portfolio in a way that balances risk and reward. Certain types of fixed income behave better in “risk-on” environments, while other fixed income categories are more defensive. Our model is built to ensure that the portfolio remains diversified. It’s very important to understand that this is designed as core fixed income exposure. We’re trying to generate good fixed income returns, without creating equity-like volatility.

Our model compares the relative strength of all of the ETFs in the investment universe. Those fixed income sectors exhibiting the strongest trends will be represented in the portfolio.

How does the strategy handle a rising rate environment?

Although the general trend of interest rates has been down over the past three decades, there have been periods where rates have generally risen. The period of mid-2003 to mid-2007 was generally a period of rising interest rates, while the period of mid-2007 to late 2016 was generally been a period of declining interest rates. Sectors like long term government bonds tend to perform much better in a declining interest rate environment while sectors like convertible bonds tend to perform much better during rising rate environments.

Our Tactical Fixed Income strategy is designed to be adaptive and seeks to add value in both environments.

Will the strategy invest in inverse bond ETFs?

We do not use inverse bond ETFs in the portfolio due to the cost of carrying the short positions, which includes the management fees of the ETFs as well as paying out the interest payments while you own these funds. However, a rising rate environment typically is accompanied by a strong economy. We do have ample ability to have exposure to sectors of the fixed income market, like high yield, international, and convertible bonds, that may perform well during these environments.

How has the strategy performed since it was introduced in March 2013?

We have been pleased with the performance of this strategy.  As shown below, it has outperformed the Barclays Aggregate Bond Total Return Index since inception:

TFI performance

As of 2/28/17

To receive the fact sheet for this portfolio please e-mail andyh@dorseymm.com or call 626-535-0630.

Net performance shown is total return net of management fees for all Dorsey, Wright & Associates accounts, managed for each complete quarter for each objective. The advisory fees are described in Part II of the adviser’s Form ADV. All returns since inception of actual Accounts are compared against the Barclays Aggregate Bond Index. A list of all holdings over the past 12 months is available upon request. The performance information is based on data supplied by the Manager or from statistical services, reports, or other sources which the Manager believes are reliable. There are risks inherent in international investments, which may make such investments unsuitable for certain clients. These include, for example, economic, political, currency exchange, rate fluctuations, and limited availability of information on international securities. Past performance does not guarantee future results. In all securities trading, there is a potential for loss as well as profit. It should not be assumed that recommendations made in the future will be profitable or will equal the performance as shown. Investors should have long-term financial objectives when working with Dorsey, Wright & Associates.

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International Climbs the Ranks

March 6, 2017

While the bull market in U.S. equities is capturing plenty of headlines, perhaps less well understood is the strength taking place in International equities. Dorsey Wright’s main asset allocation tool, Dynamic Asset Level Investing (DALI), ranks six asset classes based on their relative strength. As shown below, U.S. equities remain firmly in first place, but International equities currently finds itself in the number two spot.

The whole point of a tool like DALI is to be able to identify asset classes that are in favor as well as asset classes that are out of favor so an investor’s portfolio can be positioned to capitalize on those trends.

dali

Source: Dorsey Wright, 3/2/17

The chart below shows the historical rank of International equities in DALI. As shown below, it wasn’t all that long ago that International equities was ranked dead last. Over the last year, this asset class has made a powerful move higher.

int'l_dali

Source: Dorsey Wright, 3/2/17, based on monthly tally ranks

Chances are good that your clients have a healthy allocation to U.S. equities, but are they currently light on exposure to International equities? If so, we have a suggestion for how you go about getting that exposure for your clients.

On March 31, 2006 we launched our Systematic Relative Strength International Portfolio that was designed to start with an investment universe of ADRs from developed and emerging markets, small, mid, and large cap stocks and then to evaluate that universe based on our relative strength model. Our model seeks to overweight strong sectors and to underweight weak sectors. It also makes its buy and sell decisions by relative strength rank. Stocks are bought from the top quartile of our ranks and they are sold when they fall out of the top half of our ranks. It is a disciplined trend following approach to international equity exposure. The results have been something that we have been very proud of. See below for details:

intl 1

intl 2

As of 2/28/17.

This portfolio is available on a large and growing number of SMA and UMA platforms. To receive the fact sheet for this portfolio, please call 626-535-0630 or e-mail andyh@dorseymm.com.

The performance represented in this brochure is based on monthly performance of the Systematic Relative Strength International Model. Net performance shown is total return net of management fees, commissions, and expenses for all Dorsey, Wright & Associates managed accounts, managed for each complete quarter for each objective, regardless of levels of fixed income and cash in each account. The advisory fees are described in Part 2A of the adviser’s Form ADV. The starting values on 3/31/2006 are assigned an arbitrary value of 100 and statement portfolios are revalued on a trade date basis on the last day of each quarter. All returns since inception of actual Accounts are compared against the NASDAQ Global ex US Index. The NASDAQ Global ex US Index Total Return Index is a stock market index that is designed to measure the equity market performance of global markets outside of the United States and is maintained by Nasdaq. A list of all holdings over the past 12 months is available upon request. The performance information is based on data supplied by the Manager or from statistical services, reports, or other sources which the Manager believes are reliable. There are risks inherent in international investments, which may make such investments unsuitable for certain clients. These include, for example, economic, political, currency exchange, rate fluctuations, and limited availability of information on international securities. Past performance does not guarantee future results. In all securities trading, there is a potential for loss as well as profit. It should not be assumed that recommendations made in the future will be profitable or will equal the performance as shown. Investors should have long-term financial objectives when working with Dorsey, Wright & Associates.

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Relative Strength Spread

March 2, 2017

The chart below is the spread between the relative strength leaders and relative strength laggards (top quartile of stocks in our ranks divided by the bottom quartile of stocks in our ranks; universe of U.S. mid and large cap stocks).  When the chart is rising, relative strength leaders are performing better than relative strength laggards.    As of 3/1/2017:

spread

The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.

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Ever-Increasing Efficiency

March 1, 2017

For those of you who have been in this business for a decade or longer, how much more efficient is your business today than it was when you began?  I suspect that the answer to that question is “much more efficient.”  Why?  Because those advisors who failed to innovate and streamline their business are likely already on to a different career.  We are all aware of just how much competition there is in this industry and have seen the general trend in lower fees and increased automation.  Yet, in my humble opinion, there is still no better place to be.  In fact, for the advisor who is on the right side of these trends, who continues to find ways to operate more efficiently, and continues to increase their value proposition to their clients, the future is as bright as ever.

While recently reading Martin Ford’s book Rise Of The Robots, I came across the following passage which speaks to the pace of innovation and ever-increasing efficiency in our economy.

In 1988, workers in the US business sector put in a total of 194 billion hours of labor.  A decade and a half later, in 2013, the value of the goods and services produced by American businesses had grown by about $3.5 trillion after adjusting for inflation—a 42 percent increase in output.  The total amount of human labor required to accomplish that was…194 billion hours.  Shawn Sprague, the BLS economist who prepared the report, noted that “this means that there was ultimately no growth at all in the number of hours worked over this 15-year period, despite the fact that the US population gained over 40 million people during that time, and despite the fact that there were thousands of new businesses established during that time.”  (Shawn Sprague, “What Can Labor Productivity Tell Us About the U.S. Economy?,” US Bureau of Labor Statistics, Beyond the Numbers 3, no. 12 (May 2014)

Kind of amazing, isn’t it?  42% more output with the same amount of human labor.  As you look at your business today, what parts need to become more efficient?  Marketing, reporting, compliance, investment management, customer service, client onboarding?  Perhaps, a little of all of the above?  While we don’t profess to be all things to all people here at Dorsey Wright, we can make a major impact on your investment management process.

Let me suggest 3 ways that Dorsey Wright can help your business become more efficient.  This is by no means an exhaustive list, but it does include some which I believe to have the most potential to take your business to the next level.

  1. Become an expert in implementing one or more of the following tools across your client portfolios: Team Builder (to employ a process for defining your investment inventory and then building a diversified allocation while selecting best of class funds), Portfolios (to track your current holdings and to receive alerts when any of those holdings fall below an acceptable technical attribute of fund score), Tactical Tilt (to enable tactical shifts within strategic boundaries), Models (to put to work pre-built sector rotation, fixed income rotation, or country rotation models),  Matrix Plus (to facilitate the automation of buy and sell decisions based on relative strength rank within a customized investment universe).  Each of the above tools are scalable, giving you the opportunity to provide world class investment management in a time-efficient manner.
  2. Leverage the expertise of Dorsey Wright’s Systematic Relative Strength Portfolios.  Perhaps, part of becoming more efficient for your business is to outsource some of the investment management to a 3rd party money manager–especially to one whose investment process is one that you believe in.  Click here to see a list of SMA/UMA platforms where these portfolios are currently available.  E-mail andyh@dorseymm.com to receive the brochure.
  3. Leverage the expertise of Dorsey Wright through the use of ETFs or mutual funds which DWA is involved in managing.  Click here for the list of options.  These products give you turn-key access to relative strength strategies, driven by Dorsey Wright’s global technical research.

I suspect that that success as a financial advisor in the future will require the capability to continually streamline your investment management process in a way that is clearly differentiated from the competition.  Dorsey Wright research tools and managed products can be instrumental and foundational in that effort.

The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.

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Q&A With John Lewis, CMT

February 27, 2017

As we approach the 12-year anniversary of the launch of our family of Systematic Relative Strength Portfolios, we check in with Senior Portfolio Manager, John Lewis, CMT for an update.

Q: How much of your own personal net worth have you invested in the Systematic Relative Strength Portfolios?

A:  The majority of my personal net worth is invested in the same strategies we run for our clients.  I do have some other investments where DWA investment strategies are not available, such as my 401k, but for the most part we believe in eating our own cooking.

Q: What do you think is the single biggest benefit to a person who commits money to one of our Systematic Relative Strength Portfolios?

A: The discipline in which the strategies are implemented is a huge part of what makes the SRS series so special.  Day in and day out we are using the same models to harness the power of the momentum factor.  The momentum factor isn’t always in favor, but the process is designed to just cut through the noise and keep tilting the portfolio that way so when momentum is in favor we are there to capture it.  These also tend to be concentrated portfolios so the disciplined sell process we use is very important.  We take high conviction positions and if you don’t manage those properly the entire portfolio can quickly get away from you.

Q: What are you most proud of as you look back at the past 12 years of running these portfolios?

A: The performance of the strategies has been very solid over a time period that hasn’t always been the best for the momentum factor.  But more importantly, we are very proud of the fact that the original design of the strategies has been robust enough to handle a number of wildly different markets we have had over the last 12 years.  We shy away from constant tweaking of our models.  That is something we feel is actually detrimental to performance because you are constantly fighting the last battle.  Doing so much research up front has given us tremendous confidence in the strategies going forward, and being able to stick with them through all types of conditions has been one of the big reasons for their success over the years.

Q: The Aggressive portfolio has come on very strong in the last couple of years.  What do you think is going on with that strategy?

A: The aggressive strategy is designed to be a more aggressive application of the momentum factor.  We are taking the highest rated stocks in our rankings and kicking them out quickly if the fail to perform.  When the momentum factor is performing well, the aggressive strategy tends to outperform the other strategies.  We have had a good environment for the quick rotation over the last year or so.  That isn’t always the case.  Also, since the aggressive strategy is very concentrated (20-25 positions) stock picking can play a larger role than in some of our index based strategies.  We have had some very good performance out of a few of our holdings over the last year, and that has really been a key driver of performance.

Q: Why does the Core portfolio tend to have a little lower volatility and a little lower turnover than some of our other portfolios?

A: The Core strategy is also a concentrated strategy (20-25 names), but we don’t kick stocks out as fast as they fall in our ranks.  This allows the portfolio to be more diversified over time, and it also allows for positions to recover in choppy markets where they might get sold our of the Aggressive strategy.  When the momentum factor isn’t in favor the Core strategy tends to perform better than the Aggressive strategy.  That is what we say over a 3 to 5 year period that ended about a year or so ago.   The market (in terms of momentum stocks) was rather choppy, and the Core strategy was able to weather that better than a strategy like Aggressive that rotates more rapidly.

Q: The Growth portfolio has a unique capacity to raise cash in certain types of markets.  Describe what can cause that portfolio to raise cash?

A: The Growth strategy will raise cash in bear markets.  We have a market filter that moves the portfolio from a fully invested mode to a sell and don’t replace mode.  We don’t automatically sell positions when the market filter turns negative.  There are a lot of times when the market filter has a negative reading and out holdings continue to perform just fine.  In that case we won’t sell anything.  If we do need to sell something we wait until it breaks trend or drops to our sell level.  So the cash tends to build slowly as the market drops.  It is designed to be like an insurance policy.  We would rather not use the insurance, but it is comforting for investors in the Growth strategy to know it is there.  We use the same market filter to get back in to the market.  If we raise cash and the market reverses we just go through our disciplined buy process and bring the portfolio back to a fully invested stance.  This actually happens more often than the portfolio getting to very high cash levels.  In strongly trending up markets raising cash tends to hurt performance, but it works very well to protect capital in bear markets.

Q: While the rules of these models might not change over the years, the investment universe can.  How has the investment universe for the Global Macro portfolio changed over time?

A: The Global Macro strategy is a little different because it invests exclusively in ETF’s that represent different asset classes.  It is a tactical asset allocation strategy that can go anywhere we can efficiently find exposure.  We have a predefined investment universe that covers everything from domestic equities, to fixed income, to commodities, to international investments.  There are all ranked unemotionally by our momentum ranking process and we are constantly driving the strategy to where the strength is.  Over the years, the ETF landscape has expanded a great deal.  As new products come to market they are evaluated and if there is a hole in our current lineup we will consider adding new ETF’s to broaden our opportunity set.  In a go anywhere strategy like Global Macro, the more varied exposures we can add to the universe the better.

Q: The International portfolios has been among the best performing strategies in this family of accounts.  From a portfolio construction perspective, how do you think our approach differs from the competition?

A: The SRS International strategy has a few unique features.  First, it is comprised entirely of ADR’s and foreign equities listed on US exchanges.  That means we can get exposure to foreign equities without having to buy the shares on local exchanges, do currency conversions, etc…  It makes it an ideal way to get international exposure through a retail SMA.  We also don’t have minimums or maximums on our developed versus emerging markets exposure.  This has served us well over the last ten years as different markets have come in and out of favor.  Our job is to buy the best momentum securities from the ADR universe so we don’t constrain ourselves to countries or regions.  Wherever the strength is is where the portfolio will be overweighted.  Since the process is very disciplined we are very comfortable that when markets change our models will pick that up and we can change the portfolio accordingly.

Q: A passive approach to fixed income has worked pretty well for the last 35 years, arguably until recent years.  Why do you think there will be a need for Tactical Fixed Income in the years to come?

A: Tactical Fixed Income is one of our newer strategies, and it has also performed very well since inception.  Our process is very much a risk on, risk off approach to fixed income markets.  If rates begin to rise significantly we are able to rapidly rotate into defensive positions and preserve gains made during better times.  Since we use ETF’s in this strategy it is very easy for us to move quickly between different areas of the bond market.  We believe having an allocation to a tactical fixed income strategy will be a great way to diversify your bond holdings in a different interest rate environment.

Nothing contained herein should be construed as an offer to sell or the solicitation of an offer to buy any se­curity. This report does not attempt to examine all the facts and circumstances which may be relevant to any company, industry or security mentioned herein. We are not soliciting any action based on this document. It is for the general information of clients of Dorsey, Wright & Associates, LLC (“Dorsey, Wright & Associates”). This document does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. Before acting on any analysis, advice or recommendation in this document, clients should consider whether the security or strategy in question is suitable for their particular circumstances and, if neces­sary, seek professional advice.  The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Relative Strength is a measure of price momentum based on historical price activity.  Relative Strength is not predictive and there is no assurance that forecasts based on relative strength can be relied upon.

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Weekly RS Recap

February 27, 2017

The table below shows the performance of a universe of mid and large cap U.S. equities, broken down by relative strength decile and quartile and then compared to the universe return.  Those at the top of the ranks are those stocks which have the best intermediate-term relative strength.  Relative strength strategies buy securities that have strong intermediate-term relative strength and hold them as long as they remain strong.

Last week’s performance (2/20/17 – 2/24/17) is as follows:

ranks

Good week for the RS laggards last week.

This example is presented for illustrative purposes only and does not represent a past or present recommendation.  The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  The performance above is based on pure price returns, not inclusive of dividends, fees, or other expenses.  Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.

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Relative Strength Spread

February 23, 2017

The chart below is the spread between the relative strength leaders and relative strength laggards (top quartile of stocks in our ranks divided by the bottom quartile of stocks in our ranks; universe of U.S. mid and large cap stocks).  When the chart is rising, relative strength leaders are performing better than relative strength laggards.    As of 2/22/17:

spread

The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.

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Politics and Investing

February 21, 2017

Last week Bloomberg reported that Americans recently broke the American Psychological Association’s anxiety meter for a record level of stress.  You read that right.  No, this is not from late 2008.  This is from January 2017.

“The results of the January 2017 poll show a statistically significant increase in stress for the first time since the survey was first conducted in 2007,” the APA said on Wednesday in a report on the survey of 1,019 adults living in the U.S., conducted from Jan. 5 to Jan. 19 by Harris Poll.

Americans’ stress levels in January were worse than in August, in the middle of the angriest, most personal campaign in recent memory, when some believed the anxiety would abate after the election. At 57 percent, more than half of respondents said the current political climate was a very or somewhat significant source of stress. Stressors for everyone, including Republicans, were the fast pace of unfolding events and especially the uncertainty of the current political climate, said Vaile Wright, director of research and special projects at the APA.

What is it that has everyone so worked up?  Politics.  How many of your clients invest their politics?  When the resident of the Oval office is of their same political party, do they tend to be more bullish and when the opposite is true, do they tend to be more bearish?

When I read that article I couldn’t help but think back to something that The Motley Fool wrote last year as it relates to the problem of conflating politics and investing:

Economics is a close cousin of politics, which is dangerous because politics is a close cousin of emotional decisions detached from reality.

Not only do most of us have emotional opinions about who should/shouldn’t run the country, but we unfailingly overestimate how much influence presidents have over the economy and stock market. When presidents do impact the economy, good luck guessing how markets will respond. Lots of smart people predicted that Barack Obama’s spending plans meant surging interest rates and a collapsing dollar.

Growing the economy means getting everyone to win, whereas politics by definition means getting the opposing party to lose. Rationality melts when you set up this kind of my-team-versus-yours dilemma. Psychologist Geoffrey Cohen showed that Democratic voters supported Republican proposals when they were attributed to fellow Democrats more than they supported Democratic proposals attributed to Republicans, and vice versa. Imagine the same part of your brain analyzing investments. It’s a disaster.

I like politics, and I love investing. But I run from anything conflating the two.

Thus, the power of an emotionless method of investing.  The chart just reflects what is, not what we fear might be.  And what does that chart—using the S&P 500 as a proxy for the market—look like right now?

spx

As of 2/16/17

Well it doesn’t look bearish…  Invest accordingly.

Investors cannot invest directly in an index. Indexes have no fees. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.

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Weekly RS Recap

February 21, 2017

The table below shows the performance of a universe of mid and large cap U.S. equities, broken down by relative strength decile and quartile and then compared to the universe return.  Those at the top of the ranks are those stocks which have the best intermediate-term relative strength.  Relative strength strategies buy securities that have strong intermediate-term relative strength and hold them as long as they remain strong.

Last week’s performance (2/13/17 – 2/17/17) is as follows:

ranks

This example is presented for illustrative purposes only and does not represent a past or present recommendation.  The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  The performance above is based on pure price returns, not inclusive of dividends, fees, or other expenses.  Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.

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Sector Performance

February 16, 2017

The table below shows performance of US sectors over the trailing 12, 6, and 1 month(s).  Performance updated through 2/15/2017.

sector

The performance above is based on pure price returns, not inclusive of dividends, fees, or other expenses.  Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.  Source: iShares

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High RS Diffusion Index

February 15, 2017

The chart below measures the percentage of high relative strength stocks (top quartile of our ranks) that are trading above their 50-day moving average (universe of mid and large cap stocks.)  As of 2/14/17.

diffusion 02.15.17

The 10-day moving average of this indicator is 69% and the one-day reading is 81%.

The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Investors cannot invest directly in an index.  Indexes have no fees.  Past performance is no guarantee of future returns.  Potential for profits is accompanied by possibility of loss.

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