Unconstrained Fixed Income

October 17, 2014

“Why do we own bonds?” Investor in 2013

“Why don’t we own more bonds?” Same investors, now

The sharp equity market declines in recent weeks have once again confirmed that fixed income remains the ballast and primary diversifier of a portfolio.  Investors should expect that when other asset classes are experiencing losses, fixed income investments will remain resilient and mitigate a portfolio’s overall decline.  For most investors, fixed income will always remain a meaningful piece of the overall portfolio.  As part of that fixed income allocation, unconstrained fixed income strategies are growing in demand.  From the September/October 2014 IMCA Journal:

Morningstar’s nontraditional bond fund category, which contains the majority of funds classified as unconstrained, grew from $20 billion in total assets in January 2010 to $119 billion in total assets as of November 2013.

At Dorsey Wright, we believe that this category of unconstrained bond strategies will continue to become more important to investors in the years ahead.  In March of 2013, we introduced our “Tactical Fixed Income” separately managed account and we have been very happy with the results since inception.  Performance and holdings are shown below:

11 Unconstrained Fixed Income

21 Unconstrained Fixed Income

For more information about this strategy, pleas see the FAQ’s below:

Why is there a need for Tactical Fixed Income?

Bond buyers face a dilemma.  Yields are very, very low (and have recently been going even lower).  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 present has 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.

What is the turnover of the Tactical Fixed Income strategy?

Adapting to different fixed income environments is the nature of the Tactical Fixed Income strategy.  We built the strategy to be robust across the spectrum of bond market environments.  The model typically has about twenty swaps a year.  Our model selects approximately six ETFs to be held in the portfolio and each position remains in the portfolio only as long as it retains strong relative strength.  We have a disciplined relative strength process in place to replace any positions that weaken beyond an acceptable level.

To receive the fact sheet for this portfolio please e-mail andy@dorseywright.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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High RS Diffusion Index

October 16, 2014

The chart below measures the percentage of high relative strength stocks that are trading above their 50-day moving average (universe of mid and large cap stocks.)  As of 10/15/14.

diffusion 10.16.14 High RS Diffusion Index

The 10-day moving average of this indicator is 30% and the one-day reading is 14%—more oversold than at any time in the past three years.  Dips in this index have often provided good opportunities to add to relative strength strategies.

This example is presented for illustrative purposes only and does not represent a past recommendation.  The performance above is based on pure price returns, not inclusive of dividends or all transaction costs.   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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Podcast: Oversold Markets

October 14, 2014

Podcast: Oversold Markets 

Andy Hyer and Chris Moyer

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Commodities Corner: Coffee Futures Approaching Key Area of Supply

October 14, 2014

In some of our recent posts regarding commodities we’ve noted the large declines the majority of this asset class has seen in recent months.   Some of the hardest hit sectors have been the energies, grains, and precious metals just to name a few.   However, in further examining this universe it’s important to note there have been certain commodities showing pockets of strength when compared to the rest of asset class in general.   We noted this in a previous post regarding live cattle, which recently made a new all time high.   We will continue with our theme of identifying commodities which have been outperforming their peers.    One primary reason for doing so is reaffirm that having access to a number of investment products during times of increased market volatility can allow investors to remain tactical and continue to find strong performing markets.  At Dorsey Wright Money Management, we have a number of products that allow investors to gain access to alternative asset classes such as commodities and currencies should their relative strength ranking be high enough to become part of the portfolio.

Coffee Futures (Dec ’14):  Point & Figure

The below point & figure chart of the Dec 14 Coffee futures contract is displaying some interesting technical developments.   Let’s take a closer look to see what the current supply & demand of the coffee market is telling us.   Currently, coffee futures are approaching a previous area of supply located at 224 which thus far has helped form a double top.  In order for the double top break out pattern to be confirmed, price would need to advance through the 228 level.    A development such as this may be a sign the relative strength ranking of the coffee market may be poised to increase further when compared to those of other commodities.

KCZ4 300x216 Commodities Corner: Coffee Futures Approaching Key Area of Supply

RS Chart (Coffee Futures Dec ‘14 vs. DWA Continous Commodity Index)

Note below we have inserted the RS chart of Coffee futures vs. the DWA Continuous Commodities Index.   This is a great visual tool in confirming our above statement that coffee futures have been outperforming the majority of other commodities in recent months.  Exposure to a highly RS ranked commodity such as coffee has proved beneficial when compared to others such as crude oil or silver.

kc rs chart 300x267 Commodities Corner: Coffee Futures Approaching Key Area of Supply

Conclusion:

Although not the most commonly discussed asset class when it comes to investing,  commodities can offer opportunities and diversification away from traditional asset classes s when market volatility begins to increase.   As we have shown above, coffee futures are a great example of a market building a rather large base and possibly on the verge of a substantial move higher.   This could help lead to an even higher RS ranking for coffee futures when compared to its other commodity peers.

***The relative strength strategy is not a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  The information found on Dorsey, Wright & Associates’ Web Pages has been prepared without regard to any particular investor’s investment objectives, financial situation, and needs. Accordingly, investors should not act on any recommendation (express or implied) or information in this report without obtaining specific advice from their financial advisors and should not rely on information herein as the primary basis for their investment decisions. Information contained herein is based on data obtained from recognized statistical services, issuer reports or communications, or other sources, believed to be reliable. However, such information has not been verified by Dorsey, Wright and Associates, LLC (DWA) or the information provider and DWA and the information providers make no representations or warranties or take any responsibility as to the accuracy or completeness of any recommendation or information contained herein.

Neither the information nor any opinion expressed shall constitute an offer to sell or a solicitation or an offer to buy any securities or commodities mentioned herein. This report or chart does not purport to be a complete description of the securities or commodities, market or developments to which reference is made. There may be instances when fundamental, technical, and quantitative opinions may not be in concert.

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.  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).     

A list of all holdings for the past 12 months is available upon request.

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Weekly RS Recap

October 13, 2014

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 (10/6/14 – 10/10/14) is as follows:

ranks 10.13.14 Weekly RS Recap

A week to forget…

This example is presented for illustrative purposes only and does not represent a past recommendation.  The performance above is based on pure price returns, not inclusive of dividends or all transaction costs.  Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss. 

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Analyzing the VIX Index: Volatility On The Rise

October 10, 2014

One of the best parts about using point and figure charts to analyze the markets is that it allows us to apply the concept of supply and demand to just about anything.   Whether it be the stock price for AAPL, the price of Coffee futures, or even the strength of the US Dollar.   In taking our analysis a step further, we wanted to discuss some recent developments on the VIX.   This is a measure of expected 30 day stock market volatility and is calculated by the Chicago Board Options Exchange.   As we stated in our post about TLT yesterday, during times of heightened volatility markets are often approaching key levels of supply and demand.   This can be seen across various asset classes whether it be equities, commodities, or fixed income.

CBOE Volatility Index :  (Point & Figure)

vix 300x156 Analyzing the VIX Index: Volatility On The Rise

The point and figure chart of the VIX displays a massive base which had been forming for an extended period of time.   In other words, supply and demand for volatility had been in a state of equilibrium for the most part during this time frame.  This scenario changed on Wednesday when the VIX Index traded through 18 and confirmed a spread triple top break out.  The overhead supply which had been containing the VIX Index below 18.00 during the period of consolidation finally gave way.  The measured move target for this break out is 28.50.

Conclusion:

A brief technical update on the VIX index displays volatility may continue to rise in the near term.   The overhead supply which had been keeping the VIX in check was broken to the upside earlier this week.  Having a consistent game plan toward risk management throughout turbulent market environments is vital in order to help limit losses.  At Dorsey Wright Money Management, we achieve this by following our systematic relative strength based investing models which allow us to eliminate the human emotion during periods of heightened volatility.

***The relative strength strategy is not a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  The information found on Dorsey, Wright & Associates’ Web Pages has been prepared without regard to any particular investor’s investment objectives, financial situation, and needs. Accordingly, investors should not act on any recommendation (express or implied) or information in this report without obtaining specific advice from their financial advisors and should not rely on information herein as the primary basis for their investment decisions. Information contained herein is based on data obtained from recognized statistical services, issuer reports or communications, or other sources, believed to be reliable. However, such information has not been verified by Dorsey, Wright and Associates, LLC (DWA) or the information provider and DWA and the information providers make no representations or warranties or take any responsibility as to the accuracy or completeness of any recommendation or information contained herein.

Neither the information nor any opinion expressed shall constitute an offer to sell or a solicitation or an offer to buy any securities or commodities mentioned herein. This report or chart does not purport to be a complete description of the securities or commodities, market or developments to which reference is made. There may be instances when fundamental, technical, and quantitative opinions may not be in concert.

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.  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).     

A list of all holdings for the past 12 months is available upon request.

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Sector Performance

October 10, 2014

The chart below shows performance of US sectors over the trailing 12, 6, and 1 month(s).  Performance updated through 10/9/14.

sector 10.10.14 Sector Performance

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

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Momentum in a Rising Dollar Environment

October 10, 2014

Nick Kalivas, Senior Equity Product Strategist of PowerShares, has a nice write-up in ETF Trends about how Momentum has historically fared in a rising dollar environments:

Although predicting major foreign exchange (FX) trends is never easy, the potential for a major dollar bull market suggests FX could influence investment planning in the coming months. In this light, we examined how various equity risk factors have performed in a strong dollar environment, and found that the momentum factor historically outperformed.

The dollar rally and backdrop

The US Dollar Index (DXY) has risen over 8% from its May low driven by relatively strong US economic growth and favorable interest rate advantage.1 Dollar strength is well discussed in the market and the long dollar trade could be getting crowded in the short term, but fundamental factors are supportive to a sustained dollar uptrend. The Federal Reserve is ending QE3, while the European Central Bank and Bank of Japan (BOJ) continue with aggressive monetary stimulus. In fact, the BOJ was willing to buy T-bills at a negative rate in September. At the same time, global Purchasing Managers Index (PMI) data highlights the outperformance of the US economy. Recent manufacturing PMI numbers showed the US at 57.5 compared to 52.8 for Japan and 50.3 for the eurozone.2

Investment implications

As a review, there are four factors or equity risk premiums that were popularized by academics Eugene Fama, Kenneth French and Mark Carhart. These can be examined using the Kenneth French Data Library:3

  1. Market Return (Mkt – RF): Excess return of the market over the risk-free rate using all NYSE, AMEX and NASDAQ stocks, and the one-month T-bill.
  2. Momentum (MOM): Average return of two high prior return portfolios minus the average return of two low prior return portfolios.
  3. Small Minus Big (SMB): Average return of three small portfolios minus the average return of three big portfolios.
  4. High Minus Low (HML): Average return on two value portfolios minus the average return on two growth portfolios.

The US terminated the gold standard in August 1971 and allowed the dollar to be a fiat currency. A study was performed to examine factor returns during strong dollar periods. The table below highlights factor returns during periods of material dollar strength. Dollar gains based on DXY were measured from monthly trough to peak (the return was not annualized). Factor returns were annualized with values calculated from the corresponding troughs and peaks of DXY. The dollar rallied over 10% in each time periods measured. Results include:

KALIVAS BLOG 1010 chart1 e1412805787922 Momentum in a Rising Dollar Environment

  • Momentum was the strongest-performing factor with a median annualized gain of 12.61%. Momentum rose in each occurrence.  After a double take, momentum was even able to perform well during the financial crisis in 2008 when the dollar was strong. This suggests that investors may have been quick to pare lagging names from their portfolios during the crisis.
  • Value outperformed growth in five of seven strong-dollar periods, or 71.4% of the time with a median return of 7.29%. Value performed poorly during the financial crisis as investors sold to raise cash.  It should be noted that the Russell 1000 Value Index outperformed the Russell 1000 Growth Index between 1995 and 2002, displaying some of the difference between academic factors and market indices.1
  • Small-cap outperformed large-cap in six of seven periods, or 85.7% of the time with a median return of 4.48%. Large caps are more currency-exposed than small caps, which have tended to have a greater domestic influence. Outsized returns in 2013 coupled with the potential for mean reversion and a weak trend in earnings estimates are current headwinds to small-cap sector performance.
  • The market risk premium was positive in five of seven periods, or 71.4% with a median return of 7.06%. Returns were poor in the ‘73/’74 and ‘08/’09 period. Both periods were consistent with the market pricing recession. Oil prices surged and stagflation was present in ‘73/’74, while the collapse of the housing and mortgage markets damaged market returns in ‘08/’09.

Ideas for gaining exposure

Those focused on factor performance in a strong dollar environment can talk to their advisors about PowerShares’ suite of momentum ETFs based on Dorsey, Wright & Associates relative strength methodology. Click here for more information.

Dorsey Wright is the index provider for the suite of Momentum ETFs at PowerShares.  A Momentum strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.

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Monitoring The Bond Market: Lower Yields On The Horizon?

October 9, 2014

Market volatility has come back to the forefront in recent weeks, with equity indices around the globe experiencing broad swings in both directions.   Often times during periods of heightened market volatility, it’s interesting to take a look at the US Treasury market to see if there are any noteworthy technical developments taking shape.   The global bond market is massive in size, and developments within in it can often have an outside influence on other asset classes when it comes to asset allocation and money flows.  At Dorsey Wright Money Management, investors can gain exposure to the fixed income market in a number of ways.  Both the Tactical Fixed Income & Balanced strategies are available through seperately managed accounts.   More information on these products can be found here:

TLT updated 300x227 Monitoring The Bond Market:  Lower Yields On The Horizon?

iShares Barclays 20+ Year Treasury Bond ETF (TLT):  (Point & Figure)

We wanted to take another look at the point and figure chart of TLT in order to get a better idea of the current supply & demand situation for US Treasuries.  Previously, we noted the TLT was coming into a major uptrend support line near 113.00.   This uptrend line represents an area where buyers (demand) have previously overwhelmed sellers (supply).  On the most recent test, the bond bulls once again showed up in force as the  level held firm and the TLT has since produced a significant rally.   In fact, yesterday’s move above 119.00 produced a double top break out pattern which has measured move price target of 133.00.    At Dorsey Wright Money Management, we don’t use these developments as an actual buy signal (we use our RS matrices to determine those), but we do believe it’s a development worth noting.   Time will tell if the TLT achieves its measured move target of 133.00, but given the double top break out it is surely something to keep an eye on and may signal a period of even lower interest rates lies ahead.

Dorsey Wright currently has positions in TLT

***The relative strength strategy is not a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  The information found on Dorsey, Wright & Associates’ Web Pages has been prepared without regard to any particular investor’s investment objectives, financial situation, and needs. Accordingly, investors should not act on any recommendation (express or implied) or information in this report without obtaining specific advice from their financial advisors and should not rely on information herein as the primary basis for their investment decisions. Information contained herein is based on data obtained from recognized statistical services, issuer reports or communications, or other sources, believed to be reliable. However, such information has not been verified by Dorsey, Wright and Associates, LLC (DWA) or the information provider and DWA and the information providers make no representations or warranties or take any responsibility as to the accuracy or completeness of any recommendation or information contained herein.

Neither the information nor any opinion expressed shall constitute an offer to sell or a solicitation or an offer to buy any securities or commodities mentioned herein. This report or chart does not purport to be a complete description of the securities or commodities, market or developments to which reference is made. There may be instances when fundamental, technical, and quantitative opinions may not be in concert.

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.  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).     

A list of all holdings for the past 12 months is available upon request.

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Technology Momentum: Another Major Test for Tech?

October 8, 2014

In keeping with our recent theme of monitoring noteworthy technical developments throughout the different Dorsey Wright Money Management Investment Products, we would like to point a a few things we noticed on the PowerShares DWA Technology Momentum Portfolio (PTF).  This underlying index is composed of at least 30 common stocks of companies in the technology sector with powerful relative strength characteristics.

We are just using this traditional point and figure analysis as a simple way of monitoring supply & demand, not necessarily to make an actual buy or sell recommendation which are instead done using our RS matrix models.  The key point not to overlook is that often times technical developments on traditional point & figure charts are noteworthy and can help give us an idea of where pockets of relative strength may begin to increase or decrease.

PowerShares DWA Technology Momentum Portfolio (PTF):  (Point & Figure)

As we can see on the point and figure chart of PTF, there was a double bottom pattern break on 10/2 which was confirmed with the move below 33.50.   In other words, this previous level of demand failed to hold as sellers (supply) overwhelemed buyers (demand).  This pattern has a potential measured move price objective of 30.00.  Furthermore, we can also note the long term uptrend line on which has been intact for an extended period of time. Looking back we can see the number of occasions this line has held as firm support.  Let’s think about that for a second and apply it to our concept of supply and demand.    Ultimately, this is the concept we believe is what moves stock prices.  In other words, this uptrend line has been an area where buyers have stepped in and provided the market with a firm bid to overwhelm the sellers (or supply of stock) in the past.  The longer a trend line has been intact and the more times it has held typically means it’s more important to monitor.

PTF 300x226 Technology Momentum:  Another Major Test for Tech?

Dorsey Wright is the index provider for PTF

Conclusion:

This research article gives us a brief overview regarding the current point and figure technical set up of the PowerShares DWA Technology Momentum Portfolio ETF.   As we’ve pointed out above, PTF is currently sitting just above an uptrend line which has been an area of demand on previous occasions.   It will be interesting to see if this level can once again prove itself as it has in the past.   Price levels such as this which have been tested and held firm on numerous occasions can sometimes lead to heightened levels of volatility should they be breached.

***The relative strength strategy is not a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  The information found on Dorsey, Wright & Associates’ Web Pages has been prepared without regard to any particular investor’s investment objectives, financial situation, and needs. Accordingly, investors should not act on any recommendation (express or implied) or information in this report without obtaining specific advice from their financial advisors and should not rely on information herein as the primary basis for their investment decisions. Information contained herein is based on data obtained from recognized statistical services, issuer reports or communications, or other sources, believed to be reliable. However, such information has not been verified by Dorsey, Wright and Associates, LLC (DWA) or the information provider and DWA and the information providers make no representations or warranties or take any responsibility as to the accuracy or completeness of any recommendation or information contained herein.

Neither the information nor any opinion expressed shall constitute an offer to sell or a solicitation or an offer to buy any securities or commodities mentioned herein. This report or chart does not purport to be a complete description of the securities or commodities, market or developments to which reference is made. There may be instances when fundamental, technical, and quantitative opinions may not be in concert.

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.  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).     

A list of all holdings for the past 12 months is available upon request.

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Sector Rotation With Point and Figure Matrices

October 8, 2014

Investors have used momentum or relative strength to implement sector rotation strategies for many years.  Our latest whitepaper (which can be found here) takes a look at some sector rotation strategies using a momentum factor that isn’t commonly used.

Most of the research you will see on using momentum for sector rotation uses a time-based price window to calculate the momentum factor.  That means you would take the trailing 6 months price return, for example, and rank the sectors in your universe from best to worst.  All of the research shows that these types of strategies work over an intermediate term time horizon, which is often around 3-12 months.

Another way to determine relative strength or momentum is to use Point and Figure charts.  Point and figure charts remove time from the equation and only look at price movement versus a market benchmark or another security in the universe.  It is a very different way to calculate momentum, but also does an effective job at capturing the strong sectors.  It also speaks to the robust nature of the momentum factor.  There are many different ways to calculate what is “strong,” and as long as you are capturing intermediate price movements all of the different calculation methods work over time.

In the paper we look at two different sector rotation strategies.  One strategy uses broad macro sectors and would be similar to an investor that is using 10 ETF’s to rotate among broad sectors of the U.S. market.  The growth in the ETF market over the past several years has allowed investors to get much more granular when picking sectors.  Investors have the option to pick Biotech, Pharmaceuticals, or Healthcare Providers instead of just a broad Healthcare ETF.  There are also different weighting and factor tilts that allow investors to get even more granular than broad, cap weighted ETF’s.  We also ran a strategy that looks at getting more granular in sector selection.

Point and figure matrices are very effective in determining rankings for a sector rotation strategy.  It is also very advantageous to get more granular in your security selection when running a sector rotation strategy.  The details can be found in the whitepaper.

WhitePaper zps2f9a4650 Sector Rotation With Point and Figure Matrices

Sector Rotation With Point and Figure Matrices

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September Arrow DWA Funds Review

October 8, 2014

9/30/14

The Arrow DWA Balanced Fund (DWAFX)

At the end of September, the fund had approximately 41% in U.S. equities, 27% in Fixed Income, 21% in International equities, and 11% in Alternatives.

We did have one trade in September—sold Belgium and bought China in our International sleeve.  The broad equity markets pulled back in September, with International equities pulling back more than U.S.  However, our Healthcare position held up well, as did our fixed income holdings.  Much of our fixed income exposure is fairly short duration and that helped us this month.  One of the trends that has been unfolding in recent months is the improvement in Emerging markets compared to Developed International markets.  However, it was the Emerging markets that pulled back the most in September.  Real Estate is another area that has generally been strong this year, but pulled back sharply for the month.

DWAFX fell 3.12% in September, and is down 0.89% YTD through 9/30/14.

We believe that a real strength of this strategy is its balance between remaining diversified, while also adapting to market leadership.  When an asset class is weak its exposure will tend to be towards the lower end of the exposure constraints, and when an asset class is strong its exposure in the fund will trend toward the upper end of its exposure constraints.  Relative strength provides an effective means of determining the appropriate weights of the strategy.

dwafx September Arrow DWA Funds Review

The Arrow DWA Tactical Fund (DWTFX / DWAT)

At the end of September, the fund had approximately 90% in U.S. equities and 8% in Real Estate.

There were no changes in the holdings in September.  Our sector exposure generally helped us in September as Healthcare and Technology held up better than the market.  However, our Real Estate and Mid Cap U.S. equity exposure pulled back sharply for the month.  We remain invested in those asset classes (U.S. equities and Real Estate) that have the best relative strength.  While U.S. equities have been the most highly ranked asset class in our investment universe for years now, the specific styles and sectors that are leading have seen quite a few changes this year.  Periods with above average turnover, like we have seen the last six months or so, are often followed by periods of below average turnover and environments that are more favorable for the strategy.

DWTFX lost 2.35% in September, but is up 0.78% YTD through 9/30/14.

This strategy is a go-anywhere strategy with very few constraints in terms of exposure to different asset classes.  The strategy can invest in domestic equities, international equities, inverse equities, currencies, commodities, real estate, and fixed income.  Market history clearly shows that asset classes go through secular bull and bear markets and we believe this strategy is ideally designed to capitalize on those trends.  Additionally, we believe that this strategy can provide important risk diversification for a client’s overall portfolio.

dwtfx September Arrow DWA Funds Review

A list of all holdings for the trailing 12 months is available upon request.  Past performance is no guarantee of future returns.  These relative strength strategies are NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  See www.arrowfunds.com for a prospectus.

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High RS Diffusion Index

October 8, 2014

The chart below measures the percentage of high relative strength stocks that are trading above their 50-day moving average (universe of mid and large cap stocks.)  As of 10/7/14.

diffusion 10.08.14 High RS Diffusion Index

The 10-day moving average of this indicator is 46% and the one-day reading is 31%.  Dips in this index have often provided a good opportunity to add money to relative strength strategies.

This example is presented for illustrative purposes only and does not represent a past recommendation.  The performance above is based on pure price returns, not inclusive of dividends or all transaction costs.   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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WSJ Highlights DWA

October 7, 2014

Nice write-up on Dorsey Wright & Associates in the Wall Street Journal today.

Thirty-five years after Mr. Dorsey started sketching out buy and sell signals with paper and pen, his firm, Dorsey Wright & Associates, is the engine behind 16 exchange-traded funds and oversees $5.1 billion in assets. That is up from $1.6 billion less than three years ago.

TD WSJ Highlights DWA

The article also highlights our largest ETF (PDP):

The largest ETF managed by Mr. Dorsey, the $1.3 billion PowerShares DWA Momentum Portfolio, has seen its price rise 62% since inception on March 1, 2007, while the S&P 500 index has risen 40% during that time. Including dividends, the Momentum ETF is ahead of the S&P by three percentage points. So far this year, the ETF’s price has risen 6.4%, compared with a 6.3% rise in the S&P 500. It has outperformed 92% of ETFs in its Morningstar category.

PDP WSJ Highlights DWA

A relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value.  Dorsey Wright & Associates is the index provider for PDP.  See www.powershares.com for more information.

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SMA Performance Update

October 3, 2014

Performance for our family of Systematic Relative Strength portfolios, updated through Q3, is shown below.  Three of our our portfolios outperformed their benchmarks for the quarter: International, Global Macro, and Tactical Fixed Income.

perf SMA Performance Update

To receive the brochure for these portfolios, please e-mail andy@dorseywright.com or call 626-535-0630.  Click here to see the list of platforms where these separately managed accounts are currently available.

Total account performance shown is total return net of management fees 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.  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.  Past performance should not be considered indicative of future results. 

The S&P 500 is a stock market index based on the market capitalizations of 500 leading companies publicly traded in the U.S. stock market, as defined by Standard & Poor’s.  The Barclays Aggregate Bond Index is a broad base index, maintained by Barclays Capital, and is used to represent investment grade bonds being traded in the United States.  The 60/40 benchmark is 60% S&P 500 Total Return Index and 40% Barclays Aggregate Bond Index.  The MSCI EAFE Total Return Index is a stock market index that is designed to measure the equity market performance of developed markets outside of the United States and Canada and is maintained by MSCI Barra.  The Dow Jones Moderate Portfolio Index is a global asset allocation benchmark.  60% of the benchmark is represented equally with nine Dow Jones equity indexes.  40% of the benchmark is represented with five Barclays Capital fixed income indexes.

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. 

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Small Cap Stocks: Keeping It Simple with Supply & Demand

October 3, 2014

It’s no secret to most that small cap stocks have been the under-performing market cap sector of US equities in 2014.  In fact, the IWM (iShares Russell Small Cap ETF)  is down 5.69% over the last 9 months,  which compares to the SPY which is up 6.70%.  Obviously this a very large difference, particularly given the fact both ETF’s are representing different baskets of the US stocks!

At Dorsey Wright Money Management we tend to try and keep things as simple as possible when analyzing the markets.   Our systematic approach to relative strength based investing is done by analyzing all of the markets across the globe and looking to gain exposure to the ones with the strongest rankings.   Obviously this strategy has been helpful in minimizing exposure to the small caps sector in recent months in many of our models.   However, there will be a time at some point where money will funnel back into the small caps.  Our trend following approach is typically not associated with trying to “find the bottom” of the market, but more so geared to gain exposure later in the move and catch the “bulk “of the trend instead of the top and/or bottom.

In this blog post we take a look at current technical set ups on the traditional point & figure charts of both the iShares Russell Small Cap ETF (IWM) and PowerShares DWA SmallCap Momentum Portfolio (DWAS).

 iShares Russell 2000 Index Fund:  (Point & Figure)

In analyzing the global markets, we view each point and figure chart as a simple concept of supply & demand.   Regardless of the many  reasons people believe markets move, supply & demand are ultimately what determine asset prices around globe.  Let’s take a quick look at the traditional point & figure chart of the IWM to see what the supply & demand factors are saying regarding the current levels of small cap stocks.

Just recently (10/1), a double bottom pattern break was confirmed which has a measured move price target of 98.00.    However, in taking a closer glance at the chart below we can also see prices are resting on a triple bottom support level which would only be broken should a move  down through 106.00 occur.  Let’s think about that in terms of supply & demand.   On the two previous attempts to break this level the market found support as willing buyers decided to step back in and overwhelm the sellers.  It will be interesting to see if these same buyers once again come back in and help give the market a firm bid as they did previously!  A move below the 106.00 level may be a sign supply is overwhelming demand this time and the small cap bulls are in retreat mode.  The potential measured move price target should the triple bottom break be confirmed is 94.00.

IWM pnf 300x260 Small Cap Stocks:  Keeping It Simple with Supply & Demand

 

PowerShares DWA Small Cap ETF (DWAS):  (Point & Figure)

Let’s take our analysis a step further and see if the PowerShares DWA Small Cap Momentum Portfolio (DWAS) has a similar technical structure at the moment.   Again, as we stated above, we are just using traditional point and figure charts to determine if there are any areas where we might expect the small cap sector to find some under-lying demand.   These areas of demand aren’t necessarily buy signals (we use our relative strength matrix for those decisions), but they may help us spot when pockets of relative strength start to develop within the small cap sector.

The  DWAS is also approaching an area where demand has shown up in the past.  A quadruple bottom pattern is setting up should price re-test the 34.50 level in the near future.  This level has held 3 times in the past and would only confirmed with a move through the 34.00 level.

dwas 300x267 Small Cap Stocks:  Keeping It Simple with Supply & Demand

 

Dorsey Wright is the index provider for DWAS

Conclusion:

This note serves as a brief update regarding the current technical structure of the small cap sector within US Equities.   In a sector that has trailed most of its peers throughout 2014, we can see that both the IWM and DWAS products are near levels where demand overwhelmed supply in recent attempts.   As we stated above, at Dorsey Wright Money Management we don’t necessarily view these levels as buy signals, but they give us a general idea of where RS rankings for such a beaten down sector may begin to improve.

***The relative strength strategy is not a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  The information found on Dorsey, Wright & Associates’ Web Pages has been prepared without regard to any particular investor’s investment objectives, financial situation, and needs. Accordingly, investors should not act on any recommendation (express or implied) or information in this report without obtaining specific advice from their financial advisors and should not rely on information herein as the primary basis for their investment decisions. Information contained herein is based on data obtained from recognized statistical services, issuer reports or communications, or other sources, believed to be reliable. However, such information has not been verified by Dorsey, Wright and Associates, LLC (DWA) or the information provider and DWA and the information providers make no representations or warranties or take any responsibility as to the accuracy or completeness of any recommendation or information contained herein.

Neither the information nor any opinion expressed shall constitute an offer to sell or a solicitation or an offer to buy any securities or commodities mentioned herein. This report or chart does not purport to be a complete description of the securities or commodities, market or developments to which reference is made. There may be instances when fundamental, technical, and quantitative opinions may not be in concert.

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.  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).     

A list of all holdings for the past 12 months is available upon request.

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Arrow DWA Tactical ETF (DWAT) Podcast

October 1, 2014

Arrow DWA Tactical ETF (DWAT) Podcast

Tom Dorsey, Tammy DeRosier, and John Lewis

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Q4 2014 PowerShares DWA Momentum ETFs

October 1, 2014

The PowerShares DWA Momentum Indexes are reconstituted on a quarterly basis.  These indexes are designed to evaluate their respective investment universes and build an index of stocks with superior relative strength characteristics.   This quarter’s allocations are shown below.

PDP: PowerShares DWA Momentum ETF

pdp2 Q4 2014 PowerShares DWA Momentum ETFs

DWAS: PowerShares DWA Small Cap Momentum ETF

dwas2 Q4 2014 PowerShares DWA Momentum ETFs

DWAQ: PowerShares DWA NASDAQ Momentum ETF

dwaq2 Q4 2014 PowerShares DWA Momentum ETFs

PIZ: PowerShares DWA Developed Markets Momentum ETF

piz2 Q4 2014 PowerShares DWA Momentum ETFs

PIE: PowerShares DWA Emerging Markets Momentum ETF

pie2 Q4 2014 PowerShares DWA Momentum ETFs

Source: Dorsey Wright, MSCI, Standard & Poor’s, and NASDAQ, Allocations subject to change

We also apply this momentum-indexing methodology on a sector level:

sector1 Q4 2014 PowerShares DWA Momentum ETFs

See www.powershares.com for more information.  

The Dorsey Wright SmallCap Momentum Index is calculated by Dow Jones, the marketing name and a licensed trademark of CME Group Index Services LLC (“CME Indexes”). “Dow Jones Indexes” is a service mark of Dow Jones Trademark Holdings LLC (“Dow Jones”).  Products based on the Dorsey Wright SmallCap Momentum IndexSM, are not sponsored, endorsed, sold or promoted by CME Indexes, Dow Jones and their respective affiliates make no representation regarding the advisability of investing in such product(s).   A list of all holding for the trailing 12 months is available upon request.  This example is presented for illustrative purposes only and does not represent a past recommendation.  Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss. 

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High RS Diffusion Index

October 1, 2014

The chart below measures the percentage of high relative strength stocks that are trading above their 50-day moving average (universe of mid and large cap stocks.)  As of 9/30/14.

diffusion 10.01.14 High RS Diffusion Index

The 10-day moving average of this indicator is 62% and the one-day reading is 48%.  Dips in this index have often provided good opportunities to add money to relative strength strategies.

This example is presented for illustrative purposes only and does not represent a past recommendation.  The performance above is based on pure price returns, not inclusive of dividends or all transaction costs.   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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Income, Income, Income

October 1, 2014

What is top of mind for investors today (and most days)?  Income, Income, Income.  Among the tools and investment products that DWA provides to address this demand is the First Trust DWA Relative Strength Dividend Portfolio.  This unit investment trust invests in stocks selected by DWA using our proprietary investment process and is designed to be held over the fixed 15-month term of the trust.

Portfolio Selection Process

Through the selection process, DWA seeks to identify those companies that we believe will meet the dividend objective of the portfolio. DWA begins with the companies listed in the S&P 900 Index. All of the securities in the universe are scored on several measures of relative strength. The next step in the process is to determine the portfolio’s sector exposure. The sector weightings are determined by a combination of current market weights, the relative strength ranking and those with the highest dividend yield of the securities within each sector. The goal is to acheive a portfolio of high relative strength securities with an overall sector weighting close to current market weights. The final step is to select the top 50 companies for the portfolio based on relative strength and dividend yield. The stocks are equally-weighted within the portfolio.

ft dividend Income, Income, Income

Current holdings of the most recent series–Series 15–which was initially offered on 9/17/14 are shown below:

series 15 Income, Income, Income

Holdings as of 10/1/14

To receive the fact sheet, see www.ftportfolios.com.

An investment in this unmanaged unit investment trust should be made with an understanding of the risks involved with owning common stocks, such as an economic recession and the possible deterioration of either the financial condition of the issuers of the equity securities or the general condition of the stock market. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss. A relative strength strategy is NOT a guaranteee. There may be times where all investments and strategies are unfavorable and depreciate in value.

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Power 4 Model Holdings

October 1, 2014

Current holdings of the DWA PowerShares Sector 4 Model are shown below:

power 42 Power 4 Model Holdings

Click here for model details.

The information contained herein has been prepared without regard to any particular investor’s investment objectives, financial situation, and needs.  Accordingly, investors should not act on any recommendation (express or implied) or information in this material without obtaining specific advice from their financial advisors and should not rely on information herein as the primary basis for their investment decisions. Any statements nonfactual in nature constitute only current opinions, which are subject to change without notice. Neither the information 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 document does not purport to be complete description of the securities or commodities, markets or developments to which reference is made. 

The PowerShares DWA Sector Portfolios are calculated by NYSE Euronext or its affiliates (NYSE Euronext). The PowerShares DWA Sector Momentum ETFs, which are based on Dorsey Wright indexes, are not issued, endorsed, sold, or promoted by NYSE Euronext, and NYSE Euronext makes no representation regarding the advisability of investing in such product.

NYSE EURONEXT MAKES NO EXPRESS OR IMPLIED WARRANTIES, AND HEREBY EXPRESSLY DISCLAIMS ALL WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE WITH RESPECT TO THE DORSEY WRIGHT INDEXES OR ANY DATA INCLUDED THEREIN. IN NO EVENT SHALL NYSE EURONEXT HAVE ANY LIABILITY FOR ANY SPECIAL, PUNITIVE, INDIRECT, OR CONSEQUENTIAL DAMAGES (INCLUDING LOST PROFITS), EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES.

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Introducing the Arrow DWA Tactical ETF

September 30, 2014

With each passing year, global financial markets offer more and more choices to investors. More choice can be good, if investors have a logical framework to analyze this broad universe of securities. The Arrow DWA Tactical ETF (DWAT), which is expected to begin trading on October 1, 2014, provides a logical framework for analyzing a broad universe of investment categories and investing in those asset classes that are in favor. This fund is designed to make available a strategy that many of you use within your business already, but within a structure that was not previously available.

This new Tactical ETF can invest in the following macro asset classes:

  • U.S. Equities
  • International Equities
  • Inverse Equities
  • Currencies
  • Commodities
  • Real Estate
  • Fixed Income

Why We Believe This ETF is Timely

While we believe this ETF is built on an investment process that will stand the test of time, we also believe it is particularly timely for investor’s needs now. After the last decade, this generation of investors has a much greater appreciation for how much variability there can be in returns of different asset classes that commonly make up a diversified portfolio. Today’s investors first ask a prospective advisor about their plan for risk management. Only if that is answered satisfactorily will they move on to other questions. Yes, they want to earn good returns, but they want to do it in a way that gives them a process for dealing with bear markets. One of the realities for a typical investor preparing for retirement is that they do not have an unlimited time for their investments to work out. Take, for example, a 55 year old client with $1.5 million in investable assets. Whether this investor earns a return of 4%, 8%, or 12% on their portfolio over the next several decades is going to dramatically change their standard of living.

See: DWA Tactical Asset Class Study Whitepaper

How DWAT Manages Risk

All asset classes go through secular bull and bear markets. For example, Commodities as measured by the Goldman Sachs Commodity Index (GSCI) had an annualized return of 21% in the 1970s, but just over 3% in the 1990’s; U.S. equities as measured by the S&P 500 had an annualized return of 18% in the 1990s, but -1% in the 2000s. Bonds have also had wide fluctuations in returns from one decade to the next. Flexibility in an asset allocation strategy is key to keeping clients invested in the markets and working towards achieving their financial goals.

This ETF holds approximately 10 ETFs that demonstrate favorable relative strength characteristics. We do not approach the asset allocation from a strategic standpoint. Instead, we implement a tactical approach. Our tactical overlay is designed to own the areas of the market exhibiting the greatest relative performance and avoid or use inverse funds for the weakest areas. You can expect the weightings to change over time! When, for example, domestic equities are performing poorly, our tactical process will avoid or use inverse funds in these areas or favor an area with better relative performance, like fixed income. We make changes to the investment mix as markets and leadership change. The portfolio is designed to be quite responsive to emerging strength.

The investment strategy is 100% systematic. We have designed our processes to remove the portfolio managers’ emotions and biases, which are detrimental to superior long-term performance. Our investment process can be summarized in the diagram below. First, we categorize a broad investment universe into asset class baskets so that we can identify which asset classes we want to own.

Then, we rank all the individual ETFs in our universe. That ranking determines what we buy and when we will sell a current holding. Holdings will only remain in the ETF as long as they remain sufficiently highly ranked in our model. In short, we let the winners run and we cut the losers out so that they can be replaced with stronger options.

Just How Flexible is the Strategy?

Exposure to the different asset classes can vary within the following bands:

12 Introducing the Arrow DWA Tactical ETF

Exposure may have minor fluctuations outside those bands based on market appreciation.

Currently, DWAT is heavily weighted towards US Equity, followed by Real Estate. Roughly, 91% of the fund is allocated to US Equity at this time with exposure to US sectors as well as size and style themes. The three largest holdings are currently US Sectors; Healthcare (XLV), Materials (XLB), and Technology (XLK). Outside of US Equity, Real Estate has a 8.5% position in the fund at this time, through the SPDR DJ Wilshire REIT (RWR).

2 Introducing the Arrow DWA Tactical ETF

3 Introducing the Arrow DWA Tactical ETF

Legacy of This Strategy:

While being able to access this strategy in an ETF wrapper is new, the strategy itself is not. High demand for this strategy is what has driven us to the point where we have made it available in a number of different investment vehicles. This strategy can now be employed in the following:

  • Mutual Fund: Since August 2009, this strategy has been the underlying model used to manage The Arrow DWA Tactical Fund (DWTFX)
  • Separately Managed Account: Under the name of Global Macro, this strategy is available on over 20 different platforms
  • Unified Managed Account: Also under the name of Global Macro, this strategy is available on the Wells Fargo Masters and DMA platforms
  • Exchange Traded Fund: Now, investors can easily access the Arrow DWA Tactical strategy in an ETF (DWAT).

Experience has demonstrated that this strategy resonates with investors. Investors want flexibility, risk management, and diversification. They want to make money, but they want to do it in a prudent way. This strategy is designed to be that solution.

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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Live Cattle: Monitoring Recent Technical Developments

September 30, 2014

In monitoring the commodities universe, much has been made in recent weeks about the sharp declines seen across the board in the hard assets sector.   The price of grains (corn, soybeans, wheat) and precious metals (gold, silver, platinum) have seen some of the largest declines.   Regardless of the reason (most are chalking it up to a sharply higher US Dollar Strength), holding onto these assets over the course of the past month has been quite painful.

However, in looking at the commodities complex in more detail there have been some pockets of out-performance.   Our relative strength-based approach to investing allows us to sort through the various asset classes around the globe and then break each one down by sector to gain exposure to the strongest trending markets.   Our discussion today will be a brief technical update on the Live Cattle market.  For those of you who are not avid followers of these markets, the price of live cattle has surged to record highs this year.  This has also had an influence on the price of beef at grocery stores so it might be affecting your pocketbook more then you realize!

Point & Figure Chart:  Live Cattle (LC/)

The traditional point and figure chart of the continuous live cattle contract achieved a double top break out on Friday (9/26).  Note we chose the continuous chart instead of the front month Oct 14 contract in order to display more price historical price data.  The measured move target for double top break out pattern is $174.50.  Of course, as with any pattern nothing is guaranteed and time will tell whether or not the target is achieved.  However, in a sector that has been largely beaten up over the past month, owning Live Cattle proved to be much more beneficial then most other commodities.

2014 09 30 12 34 18 279x300 Live Cattle:  Monitoring Recent Technical Developments

Live Cattle RS Chart (vs UV/Y –Continuous Commodities Index)

In taking our analysis a step further, we have also posted a relative strength chart below which compares live cattle to the continuous commodities index.  The chart paints a very clear picture of the out-performance live cattle has had compared to other areas such as energy, grains, and precious metals.

lc RS chart 278x300 Live Cattle:  Monitoring Recent Technical Developments

Conclusion:

This brief update on the live cattle market was just to point out that although commodities in general have had a rough go of it lately, there have been pockets of strength such as the live cattle market.   An investor’s ability to be tactical and gain exposure to markets other than just the traditional asset classes of stocks and bonds can be very beneficial.  Furthermore, gaining access to these markets has never been easier as product development continues to evolve.

***The relative strength strategy is not a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  The information found on Dorsey, Wright & Associates’ Web Pages has been prepared without regard to any particular investor’s investment objectives, financial situation, and needs. Accordingly, investors should not act on any recommendation (express or implied) or information in this report without obtaining specific advice from their financial advisors and should not rely on information herein as the primary basis for their investment decisions. Information contained herein is based on data obtained from recognized statistical services, issuer reports or communications, or other sources, believed to be reliable. However, such information has not been verified by Dorsey, Wright and Associates, LLC (DWA) or the information provider and DWA and the information providers make no representations or warranties or take any responsibility as to the accuracy or completeness of any recommendation or information contained herein.

Neither the information nor any opinion expressed shall constitute an offer to sell or a solicitation or an offer to buy any securities or commodities mentioned herein. This report or chart does not purport to be a complete description of the securities or commodities, market or developments to which reference is made. There may be instances when fundamental, technical, and quantitative opinions may not be in concert.

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.  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).     

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Relative Strength Spread

September 30, 2014

The chart below is the spread between the relative strength leaders and relative strength laggards (universe of mid and large cap stocks).  When the chart is rising, relative strength leaders are performing better than relative strength laggards.    As of 9/29/14:

spread 09.30.14 Relative Strength Spread

This example is presented for illustrative purposes only and does not represent a past recommendation.  The performance above is based on pure price returns, not inclusive of dividends or all transaction costs.   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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Do You Feel Lucky?

September 29, 2014

Part of what seems to motivate investors is a desire to make money in the context of working towards their financial goals.  However, part of the motivation for many investors is the accolades that come when they get a call right.  Think about all the bragging rights when you call a stock out as overvalued!  ”Yea, I shorted XYZ stock all the way down.  The numbers just didn’t make sense to me.”  If you can pull that off a couple times, CNBC will be booking you ASAP.  However, does it really make sense to try to short “overvalued” stocks—either from a financial perspective or from an accolades perspective?

Alon Bochman, CFA, of the CFA Institute has some data that should make you think twice.

Valuation shorts have a bad reputation on Wall Street. You may be right in the long run, but you may not be able to hold the position long enough to get there. As David Einhorn puts it, “We have repeatedly noted that it is dangerous to short stocks that have disconnected from traditional valuation methods. After all, twice a silly price is not twice as silly; it’s still just silly.

Valuation shorts are a dicey proposition on intellectual grounds, too. John Hempton, who is the chief investment officer at Bronte Capital and publishes one of my favorite investment blogs, puts it this way: “In a valuation short we are working on the same information as everyone else has. This makes me uncomfortable. There is an arrogance in suggesting we can analyze the information better than anyone else. We find it harder to answer the question of what we see when others don’t and hence harder to justify the position at all.”

I was curious whether valuation shorts work as a whole, and have recently had occasion to test this question using a new research service called Activist Shorts Research. They have compiled data on more than 400 campaigns by noted short-sellers from 2002 to the present. The returns look like this:

alon1 500x445 Do You Feel Lucky?

The mean price change (not including dividends), indicated by the blue line, was −14.2% over an entire “campaign,” which can be arbitrarily long. Additionally, 65% of campaigns were “successful” in the sense that the price of the target stock dropped since the campaign was announced. In 4% of campaigns, the price dropped 99% or more. These figures sound quite good, but it is important to note the sample is biased because the service does not cover all short-sellers, only the “best” and “most public” ones. These two groups likely overlap but not completely.

Despite the biases of the overall sample, the question I was most interested in was whether valuation shorts work better than fraud shorts. For each campaign in the dataset, we have a “Primary Allegation” which is the reason the short-seller used to publicly justify the short call. The reasons provided are many and varied, but I have grouped them into the two buckets we are interested in. The results are stark:

Primary Allegation Fraud Valuation Total
Mean Return −30% 3% −14%
Campaigns 229 219 448

Short campaigns that allege a stock is overvalued are wrong as a group: the target stock rises 3% over the life of the campaign, on average. Shorts that allege fraud are much more effective: the target stock drops 30% on average. We can see this result in some more detail by comparing return distributions:

My emphasis added.  On average, shorting stocks based on valuation hasn’t worked out so well.  You might win, but the odds aren’t in your favor.  Kind of like Vegas.

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