High RS Diffusion Index

November 26, 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 11/25/14.

diffusion 11.26.14 High RS Diffusion Index

The 10-day moving average of this indicator is 94% and the one-day reading is 95%.

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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When in Doubt, Do Nothing

November 25, 2014

Phil Jackson’s 11 Mindful Leadership Principles are worth studying.  I am always happy to learn from someone who has achieved greatness and 11 NBA titles would certainly qualify!  Number 10 has particular relevance to investors, especially investors who are employing relative strength:

10. When in Doubt, Do Nothing. ”Basketball is an action sport, and most people involved in it are high-energy individuals who love to do something—anything—to solve problems. However, there are occasions when the best solution is to do absolutely nothing….I subscribe to the philosophy of the late Satchel Paige, who said, ‘Sometimes I sits and thinks, and sometimes I just sits.’

In the realm of investing, there is a natural tendency to believe that increasing the frequency of trading will lead to better results.  Testing shows that not to be the case.  Consider the following excerpts from Point and Figure Relative Strength Box Sizes by John Lewis.

Point and figure charts use box sizes to control the volatility of the chart.  A large box size filters out more short term movements than a smaller box size.  As a result, a chart with a small box size can have many more columns than the same chart with a larger box size.  The goal is to find a box size that is small enough to pick up the intermediate term trend, but large enough to filter out the short term trading gyrations that lead to whipsaws…  …So what box size should you use?  The data in Table 1 summarizes a strategy that buys stocks with strong relative strength characteristics… …The universe is comprised of the top 1,000 U.S. stocks by market capitalization.  We include companies that have been delisted for any reason.  Each month a point and figure relative strength is calculated.  As we demonstrated in our previous study, those stocks having the best momentum characteristics (on a point and figure “buy” signal and in a column of “x’s”) performed the best over time.  For the original study we used a 6.5% box size for equities versus a broad market benchmark, which is the default box size for equities on the Dorsey, Wright research database.  We now extend that study by calculating point and figure relative strength charts for each stock using box sizes ranging from 1.5% all the way up to 10.5% at 1.0% intervals.  Each month the average equal weighted return for the group of stocks on point and figure buy signals and in a column of x’s is calculated.  All of the stocks are held for one month and then the group is reconstituted and reweighted.

The data in Table 1 helps us determine what the equivalent of an intermediate term horizon is in terms of point and figure boxes sizes.  Much like the time-based methods, the returns suffer when the box size is too small or too large.  In the case of the former, the system picks up too much of the short term trading noise.In the case of the latter, too much has to happen in order for the point and figure chart to register a change.  The sweet spot is in the 6.5% to 7.5% box size reange.  Using a 6.5% box size means that a security has to underperform the broad market by 19.5% in order to change columns and be shifted out of the group that qualifies as having the best relative strength.

Table 11 When in Doubt, Do Nothing

My emphasis added.  In other words, using a smaller box size certainly leads to more trades (which can make investors feel better about themselves), but better investment performance has come from slowing the signals down in order to avoid “trading the noise.”

Yes, investing is an action sport, just like basketball.  Phil Jackson was notorious for not calling time out in the final minutes of a game and the results were favorable.  Similarly, when employing a relative strength strategy it can be advantageous to stay the course, only making changes when the longer-term relative signals suggest that change is warranted.

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

HT: Michael Covel

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Quote of the Week

November 25, 2014

Via Alpha Architect:

Any third-rate engineer or researcher can increase complexity; but it takes a certain flair of real insight to make things simple again. –E.F. Shumacher

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Relative Strength Spread

November 25, 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 11/24/14:

spread 11.25.14 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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Weekly RS Recap

November 24, 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 (11/17/14 – 11/21/14) is as follows:

ranks 11.24.14 Weekly RS Recap

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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U.S. vs. International Equities

November 24, 2014

Michael Batnick presents some interesting data on U.S. vs. International stock market performance since 1969:

Diversifying your equity holdings across multiple continents has been a substantial drag on returns over the last few years. At this point, It’s easy to ask ourselves, “why even bother with international stocks?” The U.S. hasn’t just been instrumental in the global equity rebound, it’s playing lead guitar, drums and doing vocals all at the same time.

But before we go all in on U.S. stocks, history has proven that we should be very careful to extrapolate recent performance out into the future. I was very surprised to learn that when looking at three-year rolling periods, U.S. stocks outperform just 53% of the time. Even more interesting, when U.S. stocks do outperform, they do so by an average of 7.7%; when international stocks outperform, they do so by an average 0f 10%!

The U.S. goes on long streaks of both leading and lagging the rest of the world. The chart below shows long periods of time where U.S. stocks outperform (gray) as well as long stretches of time that U.S. stocks fall behind (without gray).

tumblr inline nfelnnhnLq1sba62w U.S. vs. International Equities

It seems as if we’ve been hearing that U.S. stocks are “the best house in a bad neighborhood” for years now. November will be the 60th straight month of out-performance, which is the second longest stretch going back to 1972. The longest streak was from 1996 to 2002, a 70 month period of U.S. domination.

How might we know when U.S. outperformance has run its course for this cycle?

RS U.S. vs. International Equities

(click to enlarge)

An investor can get themselves into a lot of trouble by trying to forecast when the switch in relative strength between U.S. and International markets will take place.  One approach is simply to strategically weight the two in an asset allocation and completely remove any element of tactical shifts.  That approach has its strength and its weaknesses.  The strength is that you ensure that you won’t get whipsawed on any trades and you enforce diversification.  The weakness of that approach is that, as shown in both charts above, these streaks of outperformance have historically lasted for many years at a time.  With streaks that long there is an opportunity to generate superior performance by making tactical shifts between the two.  Finally, the benefit of relying on relative strength to know when to make such tactical shifts is that it removes the need to forecast (guess) when to make the change.  With a trend following approach, you will never be in at the very beginning of the trend and you will never be out at the very top, but you will be in a position to capitalize on the bulk of the trend.

This example is presented for illustrative purposes only and does not represent a past recommendation.  Prior to the inception date of EFA, performance data is calculated using extrapolated underlying index data.  The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.

HT: Abnormal Returns

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FV Crosses $1 Billion

November 24, 2014

From ETF Trends:

Over 160 exchange traded products have debuted this year and as is always the case with new ETFs, some of this year’s new funds have flailed while others have been successful right away.

As of mid-October just over 10% of the new ETFs that had come to market to that point in 2014 had topped $75 million in assets under management. The First Trust Dorsey Wright Focus 5 ETF (Nasdaq GM:FV), which debuted in early March, long ago left $75 million in AUM in the dust.

In fact, FV is now a $1 billion fund, easily making it one of this year’s most successful new ETFs. This is how rapidly FV has grown: The ETF debuted in early March and by September, it had $500 million in AUM. By September 24, that number had swelled to $530 million. When we highlighted some of this year’s most successful new ETFs in mid-October, FV had $570 million in AUM. [Another Good Year for New ETFs]

Translation: FV has added $430 million, or about 43% of its current AUM total, in just five weeks. Doresy Wright’s indices that focus on relative strength and other technical factors serve as the benchmarks for scores of sector and specialized ETFs, many of which have delivered impressive out-performance of more plain vanilla competing products. FV has gained a rapid following because advisors were already familiar with the methodology backing the ETF prior to the fund’s launch.

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.  Nothing contained herein should be construed as an offer to sell or the solicitation of an offer to buy any security.  The article does not attempt to examine all the facts and circumstances which may be relevant to any product 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 situation, or needs of individual clients.  Before action on any analysis, advice or recommendation in this document, clients should consider whether the security or strategy in question is suitable for the particular circumstances and, if necessary, seek professional advice.

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The Implications of Manager Tenure

November 20, 2014

Nick Kirrage of Pieria recently wrote about portfolio manager tenure—a key data point for many advisors when selecting a fund.  This data happened to be for the UK, but I suspect that the data would be similar for the U.S.

When it comes to evaluating funds, just how important a consideration is fund manager tenure – that is to say, the length of time somebody has been at the helm of a particular portfolio? It is a question that crops up with a fair degree of frequency – including at a recent investment conference organised by Citywire and at which we were speaking.

An electronic voting system enabled the audience of UK-based financial advisers to express their thoughts on the matter and the overriding view turned out to be that, yes, fund manager tenure was a very important consideration. It also emerged that the audience members themselves had averaged around two decades of experience as financial advisers so how did fund managers do by comparison?

Not great, would be the short answer while the slightly longer one can be seen in the chart below. It plots, courtesy of data Citywire holds on its universe of 17,000-odd funds, the experience levels of fund managers – from the 91.1% who can boast a whole 12 months in charge of a portfolio to the 1.1% able to match the 20 years or so averaged by that audience of advisers.

starter for tenure chart The Implications of Manager Tenure

It is striking how steep the drop-off rate becomes over time, with under a fifth of fund managers surviving to celebrate their tenth anniversary. This has to play on some managers’ minds and may help to explain the index-hugging and consensus views so often seen in investment. Unfortunately, doing what is right by your investors is not always consistent with doing what might keep you in your job.

It is often said that “financial products are sold, not bought.”  In other words, very few individual investors wake up one morning and say to themselves, “Today, I am going to buy a global tactical asset allocation strategy.”  They may wake up knowing that they would like to see their money grow and risk management is very important to them, but in terms of selecting a product to help them achieve that objective they usually don’t have any idea of how to go about selecting a particular strategy.  Of course, that is why there are financial advisors.  However, what the above data on manager tenure reveals is that the rationale that was used by an advisor and an individual client to select a given investment fund in the first place may only hold true for a very short period of time.  Most portfolio managers have a given approach to managing a particular strategy.  For example, if the portfolio manger considers himself to be a “value manager,” what are the chances that there will be consistency in investment strategy for the fund when/if that portfolio manager decides to take a different job?  Even if the manager stays with the fund for a long period of time, what are the chances that the same investment process employed today will be the same process employed in five years?  Surely another function of a good financial advisor is to stay on top of the strategies being used for their clients and to make changes in managers when they deem necessary.  However, the reality is that the manager/investment strategy employed at a given fund may be constantly changing.  I don’t think most investors have much awareness of that fact.

These are among the very reasons that at Dorsey Wright we place such emphasis on process, consistency, and on building and executing rules-based models.  If someone were to ask me how the investment process for our Systematic RS International portfolio has changed since it was launched in April of 2006, the answer would be that nothing has changed.  Same for PDP, PIE, and PIZ and other investment strategies that we manage.  In full disclosure, very occasionally we will uncover something in our testing that we believe will result in meaningful improvement in the strategy and we reserve the right to make such a change.   Additionally, the line-up of guided ETF models (available at www.dorseywright.com) offer advisors a repeatable process for managing a client’s money.

Every advisor in this business is in competition for assets.  Educating clients and prospects about the systematic nature of the Dorsey Wright investment methodology can go a long ways towards helping you set yourselves apart from the competition.  Of course, we are not the only investment manager that employs a systematic investment process (think about the array of Smart Beta strategies).  But the larger point should be clear, consistency is a not a commodity in ample supply and yet it just may be among the most important considerations for any strategy.

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.  Nothing contained herein should be construed as an offer to sell or the solicitation of an offer to buy any security.  The article does not attempt to examine all the facts and circumstances which may be relevant to any product 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 situation, or needs of individual clients.  Before action on any analysis, advice or recommendation in this document, clients should consider whether the security or strategy in question is suitable for the particular circumstances and, if necessary, seek professional advice.

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High RS Diffusion Index

November 19, 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 11/18/2014.

diffusion 11.19.14 High RS Diffusion Index

The 10-day moving average of this indicator is 91% and the one-day reading is 95%.

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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Weekly RS Recap

November 17, 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 (11/10/14 – 11/14/14) is as follows:

ranks1 Weekly RS Recap

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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Sector Performance

November 14, 2014

The chart below shows performance of US sectors over the trailing 12, 6, and 1 month(s).  Performance updated through 11/13/14.

sector 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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Commodities Corner: Live Cattle vs. Cotton – A Tale of Two Tapes

November 14, 2014

At Dorsey Wright Money Management, we view dispersion among asset classes and sectors as an opportunity to gain exposure to the strongest performing markets while minimizing exposure to the weakest.  Throughout most of the year this has allowed us to maintain our highest exposure towards US equities, while keeping exposure toward under performing asset classes such as commodities to a minimum.  However, this isn’t to say there haven’t been some underlying pockets of relative strength within commodities asset class that have created opportunities.  In a blog post from a few weeks back, we noted the relative strength of the grains markets (corn, soybeans, and wheat) appeared to be strengthening.   This has continued to hold true with all three of them now trading at multi-month highs.

In this piece we will take a look at the traditional point & figure charts for both Live Cattle & Cotton.   Although not the most commonly discussed commodities, they both provide for very solid examples of how using relative strength can provide market participants with great advantages from both an offensive and defensive perspective.  We will also discuss the RS point & figure charts for each respective market in order to better display the dispersion in performance relative to their peers.

Point & Figure Chart:  Live Cattle (LC/Z4 – Dec ’14)

We can see below just how large of base the live cattle market has been forming.   The sharp move higher yesterday was able to punch through the key overhead supply level which had been located at $170.00.     From a trading perspective, it could also be viewed that a large number of sellers (or shorts) who had previously shown up at $170.00 are now holding positions which are “under-water.”    Often times this will propel the market sharply higher as race to exit losing positions creates demand (short covering).  The triple top break out pattern which was confirmed with the move above $170.00 has a measured move price objective of $180.50 and would only be negated on a move below $164.50.

live cattle trip 300x191 Commodities Corner:  Live Cattle vs. Cotton   A Tale of Two Tapes

Point & Figure Chart:  Cotton (CT/ – Continuous Contract)

On the flip side, we can see right away on the below chart that the cotton market has been displaying a very different picture in terms of supply & demand then that of live cattle.   The sharp move lower yesterday was able to punch through a key demand level located at $0.60.    This double bottom break pattern has a measured move price objective of $0.51, and would only be negated on a move above $0.67.  In terms of a trading perspective,  those previous buyers at the $0.60 level are now holding losing positions (under-water) which may spark a rush to the exits and another sharp leg down as those same market participants look to minimize losses.

cotton cont1 300x204 Commodities Corner:  Live Cattle vs. Cotton   A Tale of Two Tapes

Let’s move on to the relative strength Point & Figure charts to see if we can get a better visible picture of how each of the above commodities performance has been this year relative to their peers.   Given the patterns and targets we mapped out above, we should already have a pretty good idea of what the relative strength charts should look like.

Relative Strength P&F:  Live Cattle vs. Continuous Commodities Index (LC/ vs. UV/Y)

The relative strength chart below displays the continuous live cattle contract vs. a basket of commodities.   This is a great visual aide in showing us just how strongly the cattle market has performed relative to the rest of the commodities universe.

live cattle cont 278x300 Commodities Corner:  Live Cattle vs. Cotton   A Tale of Two Tapes

Relative Strength P&F:  Cotton vs. Continuous Commodities Index (CT/ vs. UV/Y)

A quick glance at the RS chart below and we can clearly see the under performance cotton is displaying compared to the majority of its peers.  The RS chart is now currently sitting near a double bottom level which if broken may be a sign cotton prices are set to further weaken relative to the rest of the commodities universe.

cotton con 300x250 Commodities Corner:  Live Cattle vs. Cotton   A Tale of Two Tapes

Conclusion:

In the above blog post we have identified how using traditional point and figure charts can allow market participants to identify potential trading ideas, and more importantly help aide in establishing proper risk management.   Furthermore, we displayed how following a relative strength based approach can keep investors allocated towards stronger performing markets and away from those that are under performing.   Although commodities in general continue to under perform the equity markets, the dispersion among the sector (as evidenced by live cattle & cotton) is just another example of using a relative strength based approach can be very beneficial in helping identify opportunities within asset classes.

***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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So a Family Member Asks For Some Advice

November 13, 2014

Recently, a family member of one of our portfolio managers asked for some investment advice.  This person had a sum of money and they wanted some guidance on what they should buy.  Keep in mind that this is a slightly different question than we typically receive.  This family member was looking for a complete asset allocation, whereas most of the work that we do here involves building strategies that are used as pieces of the overall portfolio.  For example, we most frequently interact with financial advisors who are making decisions about how our strategies might fit into the overall allocation that they are building for their clients.

When faced with a question like this a couple things become apparent.  First, the ETF has changed (for a good way) asset allocation.  Liquidity, low costs, transparency, potential tax efficiency, access to Smart Beta…all these things have been dramatically improved by the expansion of the ETF universe over the past decade.  Second, the fact that strategies are wrapped in ETFs minimizes the need for trading and allocation changes.  We’ve come a long way from the days when ETFs just gave you cheap access to cap-weighted indexes.  Now, global tactical asset allocation strategies can be easily accessed in an ETF structure.  There is no need to trade in and out of a strategy like that because those changes are taking place on an index level.

So, here is the allocation that John provided for this family member:

asset allocation So a Family Member Asks For Some Advice

  • 25% in low cost exposure to U.S. Treasurys
  • 25% in a Global Tactical Asset Allocation strategy that uses relative strength to dynamically allocate among U.S. equities, International Equities, Inverse Equities, Currencies, Commodities, Fixed Income, and Real Estate
  • 12% to U.S. mid and large cap momentum stocks
  • 12% to U.S. large cap value stocks
  • 6% to U.S. large cap low volatility stocks
  • 5% to U.S. cap-weighted small cap stocks
  • 5% to U.S. small cap momentum stocks
  • 10% to a relative strength-based International rotation strategy

Check in and rebalance every couple years and I think this is an allocation that can successfuly take an investor through the next several decades.  Are there alternative allocations that also make sense?  Of course.  That is where the art comes in.  However, with this allocation I see a diversified portfolio built on principles that have stood the test of time: Diversification between U.S. equities, International equities, and Fixed Income.  The ability to have meaningful exposure to alternatives such as Commodities, Real Estate, Currencies, and Inverse equities when they are in favor.  And mixing the Smart Beta strategies of Momentum, Value, and Low Volatility.

With better tools advisors can build better allocations, and we believe that the allocation above employs some of the very best and blends them together in a way that we believe will be very effective over time.

Dorsey Wright is the index provider for PDP, DWAS, and IFV.  Dorsey Wright is the signal provider for DWAT.  Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.  An investor should consult with a financial advisor and read the prospectuses before considering any of the above strategies.  This example is presented for illustrative purposes only and does not represent a past recommendation.  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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Fund Flows

November 13, 2014

Mutual fund flow estimates are derived from data collected by The Investment Company Institute covering more than 95 percent of industry assets and are adjusted to represent industry totals.

ici 11.13.14 Fund Flows

This data is presented for illustrative purposes only and does not represent a past recommendation.

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Monitoring The Gold Market: Overhead Supply at $1180 In Focus

November 12, 2014

The gold market has been garnering a lot of attention lately, with prices touching multi-year lows near the $1130 level last week.  Volatility really picked up last Friday, with the gold market rallying $50 after the release of the Non-Farm Payroll figures.  Sharp moves like what was seen this past Friday can often have emotional effects on traders and force them out of their game plan.   This is one of the main reasons that at Dorsey Wright Money Management we view a systematic based approach as a major advantage in forming a consistent process-driven approach to investing.

In the below blog post we will discuss a recent bearish pattern which was completed on the traditional point in figure chart of gold.   Furthermore, we will take at particular price levels which if violated may be a sign the tide is starting to turn in favor of the bulls in the short term.

Point & Figure Chart:  Gold Futures (Continuous Contract)

We previously noted that in recent weeks volatility in the gold market has picked up with large price swings in both directions being displayed on numerous occasions.   One of the main advantages of using traditional point & figure chart analysis is that it aides in blocking out the so called market “noise”.    In other words, buy and sell signals are produced less often due to the way the traditional point & figure charts are constructed.   Remember, the key idea here is that we are attempting to spot areas of supply & demand which can help us form objective opinions on the near term direction of the market.   More importantly, we can also define levels that tell us where our opinion may be wrong, which therefore allows for proper risk management!  Let’s take a look at the recent developments to get a better idea of what’s been taking shape on the supply & demand front for gold.

gold futs 300x178 Monitoring The Gold Market: Overhead Supply at $1180 In Focus

The first major technical development to point out was the spread triple bottom break which was confirmed with the move below $1180.    This had previously been a level where demand had overwhelmed supply on two previous occasions.   However, on the most recent test the gold bears proved successful and the spread triple bottom was confirmed which has a measured move target of $1050.

Interesting to note the $50 reversal which occurred last Friday did reverse the chart back into a column of X’s.   However, thus far the counter-trend rally has stalled out just below the $1180 level.  Remember, this is the same area where our initial sell signal was given when supply overwhelmed demand and confirmed the spread triple bottom break.  Another way to think about this in terms of the trading aspect would be that any of those market participants holding long futures positions from the previous demand level of $1180 are currently under water and could use this as a break-even point on existing positions, thus creating supply.  Even if the gold bulls are able to force prices back above $1180, the spread triple bottom sell signal itself wouldn’t be negated until a move above $1260 was achieved.

This blog post serves as reference as to just how useful traditional point & figure charts can be in blocking out the “noise” as well as defining price levels to help develop proper risk management techniques.   At Dorsey Wright, we use traditional point & figure charts in order to help us spot where pockets of relative strength among asset classes may be changing, not necessarily as buy and sell signals.  Following our systematic based approach to relative strength investing has kept our exposure to markets like gold very minimal throughout much of the year.

***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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High RS Diffusion Index

November 12, 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 11/11/14.

diffusion index 11.12.14 High RS Diffusion Index

The 10-day moving average of this indicator is 86% and the one-day reading is 92%.  Quite the rally from the Oct. 16 lows (single day reading of 12%).

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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Building Better Beta

November 11, 2014

Ari Polychronopoulos, CFA of Research Affiliates just released an excellent new white paper on the potential benefits of combining different Smart Beta strategies.  Specifically, he looked at combining Fundamentals Weighting, Low Volatility, and Momentum.

PERFORMANCE AND CORRELATIONS

The three smart beta strategies under consideration produce results with very different characteristics. Table 1 compares the performance, volatility, tracking error, Sharpe ratio, and information ratio of the simulated strategies over the 47-year period from 1967 through 2013.  All three outperformed a cap-weighted benchmark, the S&P 500 Index, by approximately 2% to 3% per annum over the measurement period. As one would expect, low volatility has the lowest standard deviation of returns, and momentum has the highest. Because the percentage reduction in volatility is much greater than the percentage decline in return, low volatility yields the highest Sharpe ratio; but it also has the lowest information ratio due to its high tracking error vis-à-vis the cap-weighted index. The fundamentally weighted strategy most resembles the cap-weighted index in that its volatility is closest to the overall market and it has the lowest tracking error.

Table 1 Building Better Beta

My emphasis added.  All three strategies outperformed the S&P 500 over this time by healthy margins.  But, an equally-important part of his research shows the correlation of returns in excess of S&P 500 returns.

correlations Building Better Beta

What is this telling us?  It is reflecting the fact that these three factors, which independently outperformed the S&P 500 over time, outperform at different times.  The result: meaningful diversification!

Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.  This example is presented for illustrative purposes only and does not represent a past recommendation.  The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  See www.powershares.com for a prospectus.

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The Virtues of Trend Following: Emerging Markets Edition

November 11, 2014

A key reason that the markets can be so frustrating to investors is that many of the relationships that investors believe should hold true, in fact, do not.  Take the relationship between GDP growth and stock market performance.  Many assume that investing in stock markets from economies with high economic growth rates should lead to favorable investment results.  As Institutional Investor explains, that has just not been the case:

Many investors in emerging markets believe that identifying the fastest-growing economies is the key to finding higher returns.  But while this approach has been effective in fixed-income investing, our research shows that it’s fairly useless for guiding country selection in developing-market equities.

Imagine that it’s the early 1990s and your crystal ball has identified an emerging-markets nation whose economy is on the cusp of growing more than 20-fold over the next two decades.  You’d probably think you had found the investment winner of a lifetime.  But you’d be wrong.  That country was China.  Despite compound annual gross domestic product (GDP) growth of 15 percent since 1992, Chinese stocks fell by an annualized 2 percent through December 31, 2013 (see chart below).

GDP The Virtues of Trend Following: Emerging Markets Edition

Now, what if the same crystal ball also — correctly — predicted that Mexico was headed for low-single-digit GDP growth over that same 20-year period?  You’d likely look for better investment opportunities elsewhere.  And you’d be wrong again.  Mexican stocks have delivered annualized gains of more than 18 percent since 1992, placing them among the period’s best performers, despite 2.4 percent annual GDP growth.

For comparison, the following table shows the country holdings, weight in the index, and GDP growth of the PowerShares DWA Emerging Markets Momentum ETF (PIE).  Clearly, we are not weighting the index by GDP growth:

pie1 The Virtues of Trend Following: Emerging Markets Edition

Rather, this index is constructed by using Point & Figure relative strength analysis on a universe of approximately 1,000 emerging markets stocks.  From that universe, we select the 100 stocks with the most favorable relative strength characteristics.  Again, price is the only input to the rankings.

I often use the following quote, written by one of our analysts, to explain our, admittedly, much more pragmatic approach to investing:

The market cares about what it wants, when it wants, and for this reason we find that listening to the market and following its trends is a better approach than trying to adapt an economic premise to a market prayer.

Perhaps some take our “single-factor” approach to investing as overly simplistic, but to us, price encompasses all relevant information for an investor.  And the results have been compelling.  For example, the three ETFs for which Dorsey Wright is the index provider and have been out for the past 5 years (PDP, PIZ, and PIE), all are the top strategies in their respective categories over the past 5 years.

Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.  This example is presented for illustrative purposes only and does not represent a past recommendation.  All holdings for the past 12 months are available upon request.  The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  See www.powershares.com for a prospectus.

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Relative Strength Spread

November 11, 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 11/10/14:

spread 11.11.14 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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Quote of the Week

November 10, 2014

Ben Carlson (A Wealth of Common Sense):

It’s difficult for intelligent people, especially in the world of finance, to admit that less is more and simple can be a far more effective framework than complex for the majority of investors. Some view this as an admission of ignorance. In fact, I view it as the ultimate sign of intelligence.

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Weekly RS Recap

November 10, 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 (11/3/14 – 11/7/14) is as follows:

ranks Weekly RS Recap

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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Tweet of the Day

November 6, 2014

moyo Tweet of the Day

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Last Time GOP Took Senate With Sitting Democrat in White House

November 5, 2014

Tuesday was election day and now we know the results—the GOP has taken the Senate.  The last time there was a Democrat in the White House and the Republicans were in control of Congress it was followed by quite a run in the stock market.  From Business Insider:

cotd midterm election Last Time GOP Took Senate With Sitting Democrat in White House

This example is presented for illustrative purposes only and does not represent a past recommendation.  Past performance is not indicative of future results.

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High RS Diffusion Index

November 5, 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 11/4/14.

diffusion 11.05.14 High RS Diffusion Index

What a recovery from the single-day low of 12% on 10/16/14!  The 10-day moving average of this indicator is now 72% and the one-day reading is 85%.

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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PowerShares DWA Momentum ETFs: Top Strategies Over Last 5 Years

November 4, 2014

Three Dorsey Wright ETFs have now been in existence for over 5 years.  So, how have they done?

PDP (PowerShares DWA Momentum ETF), PIZ (PowerShares DWA Developed Markets Momentum ETF), and PIE (PowerShares DWA Emerging Markets Momentum ETF) are all the top performing strategies in their Morningstar category over the past 5 years.  PDP and PIZ are also the top performing strategy in their category over the last 3 years, and PIE is in the top quintile.

pdp PowerShares DWA Momentum ETFs: Top Strategies Over Last 5 Years

piz PowerShares DWA Momentum ETFs: Top Strategies Over Last 5 Years

pie PowerShares DWA Momentum ETFs: Top Strategies Over Last 5 Years

Source: Morningstar, a/o 11/4/14

Part of the reason that it is so encouraging to see these types of results is because it confirms the thesis that Point and Figure can be effectively employed to generate alpha over time.  Before we first partnered with PowerShares on these ETFs, there was extensive testing completed that gave us reason to be very optimistic about the types of returns that we might be able to achieve.  But that was just testing (as important as testing is).  These are live results and show how we stack up against a universe of our peers and against our benchmarks.  There have been periods of outperformance and periods of underperfomance, just like there are likely to be in the future, but the process is clearly demonstrating its value.

This year, we have published much of our very best research that provides valuable insights into our investment process.  These white papers can be found by clicking here, here, and here.  The concluding paragraph from one of these white papers summarizes our findings:

Momentum is an investment factor that has worked very well for over a century.  The momentum factor has been through bull markets, bear markets, and sideways markets and still continues to deliver oupterformance versus broad market benchmarks.  Plotting a ratio of a security versus a benchmark on a point and figure chart is one way to objectively classify securities in to groups based on their intermediate and long-term relative strength characteristics.

The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Dorsey Wright is the index provider for the suite of PowerShares DWA Momentum ETFs.  Past performance is not indicative of future results.

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