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 7/13/10.
The 10-day moving average of this indicator is 27% and the one-day reading is 59%. The rally over the last week is bringing this indicator out of deeply oversold levels. Dips in the High RS Diffusion Index have often provided good opportunities to add to relative strength strategies.
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Posted by Andy Hyer
One of the great strengths of a capitalist, entreprenuerial economy is its ability to adapt. Although the politicos in Washington may have no idea how to restart the economy, it might not matter. As long as things are not completely in flux, businesses and consumers will figure out a way to move forward.
From Newsweek comes evidence that conditions for a recovery are being put in place without any help from the government:
This do-it-yourself stimulus has already started. Corporate America’s balance sheet has never looked better, and consumers are paying down debt and bolstering savings. The challenge is a reluctance to spend. To try to jump-start consumption, companies are enacting mini stimulus programs of their own. In years past, teen-oriented retailer American Eagle has given away free T shirts and movie tickets to potential shoppers as part of a back-to-school promotion. This year it’s offering a free smart phone to shoppers who try on a pair of jeans (and sign up for a plan). Chrysler just kicked off a round of promotions that includes zero-interest financing and an offer to cover the first two installment payments. With banks reluctant to lend to small businesses, warehouse giant Sam’s Club has started a program with an approved Small Business Administration lender, Superior Financial Group. Sam’s Club will essentially subsidize a chunk of the loan process to enable its members to borrow up to $25,000—with the hopes they’ll spend the proceeds in the retailer’s wide aisles.
Innovative retailers like American Eagle, Chrysler, and Wal-Mart will figure out ways to improve their sales. Other companies will too. There are always trends because there are always corporate winners and losers-and often a recession strengthens the winners and makes them stand out relative to their competition. An investment policy that makes systematic use of relative strength is well-positioned to be able to separate the winners and the losers.
Leave a Comment » | Markets, Thought Process | Permalink
Posted by Mike Moody
Our latest sentiment survey was open from 7/2/10 to 7/9/10. The response rate was high, clocking in at 151 respondents. Your input is for a good cause! If you believe, as we do, that markets are driven by supply and demand, client behavior is important. We’re not asking what you think of the market—since most of our blog readers are financial advisors, we’re asking instead about the behavior of your clients. Then we’re aggregating responses exclusively for our readership. Your privacy will not be compromised in any way.
After the first 30 or so responses, the established pattern was simply magnified, so we are comfortable about the statistical validity of our sample. Most of the responses were from the U.S., but we also had multiple advisors respond from at least two other countries. Let’s get down to an analysis of the data! Note: You can click on any of the charts to enlarge them.
Question 1. Based on their behavior, are your clients currently more afraid of: a) getting caught in a stock market downdraft, or b) missing a stock market upturn?
Chart 1: Greatest Fear. 94.7% of clients were fearful of a downturn, as negative sentiment surged with the market weakness. The market action of the last two months has pushed investor sentiment to very bearish, pessimistic levels. This is a new high in fear, ahead of last survey’s 85.6% reading and above the previous peak of 92.7% reached on 5/21/2010 . Only 5.3% of clients were concerned about missing an up-move, a drop from last survey’s reading of 14.4%. Overall, we are still seeing a strongly pessimistic outlook in client sentiment.
Chart 2. Greatest Fear Spread. Another way to look at this data is to examine the spread between the two groups. The spread remains significantly skewed towards fear of losing money this round. This survey’s reading was 89%, up from last survey’s 71%. This is also a record fear spread. Chart 2 is constructed by subtracting the percentage of respondents reporting clients fearful of missing an upturn from the clients reported as fearful of a market downdraft.
Question 2. Based on their behavior, how would you rate your clients’ current appetite for risk?
Chart 3: Average Risk Appetite. The average risk appetite for this survey moved in-line with the other stats we’ve gone over thus far. With weakness in the market, client fear has grown and the average risk appetite has continued to shrink. This survey’s average risk appetite was 2.05, down from last period’s reading of 2.29. This is also a new low.
Chart 4: Risk Appetite Bell Curve. This chart uses a bell curve to break out the percentage of respondents at each risk appetite level. Right now the bell curve is biased to the low-risk side, as it has been for the few months. What we see in the bell curve is more evidence that clients are afraid of losing money in the market. Just as in last survey, we have absolutely zero 5’s, which points towards a market dominated by fear.
Chart 5: Risk Appetite Bell Curve by Group. The next three charts use cross-sectional data. This chart plots the reported client risk appetite separately for the fear of downdraft and for the fear of missing upturn groups. We would expect that the fear of downdraft group would have a lower risk appetite than the fear of missing upturn group and that is what we see here.
Again we have a total of zero responses with a risk appetite of 5, indicating pervasive fear in the marketplace. The most aggressive responses from the fear of missing upturn group were only a neutral 3. Only time will tell if these “oversold” emotional conditions will lead to a market rally.
Chart 6: Average Risk Appetite by Group. A plot of the average risk appetite score by group is shown in this chart. The fear of missing downdraft group had an average risk appetite of 2.03, while the fear of missing upturn group had an average risk appetite of 2.50. Theoretically, this is what we would expect to see.
In an earlier survey recap, we highlighted the fact that the missing upturn group seems to have a more volatile risk tolerance – their risk appetite as a group seems to swing more frequently and further than the downdraft group. We see this again, with the missing upturn average dropping 45 basis points from 2.95 to 2.50, versus only a 15 basis point move in the downdraft group, from 2.18 to 2.03.
Chart 7: Risk Appetite Spread. This is a spread chart constructed from the data in Chart 6, where the average risk appetite of the downdraft group is subtracted from the average risk appetite of the missing upturn group. The spread is currently .47, showing modest compression from last survey’s reading of .77.
This round of sentiment survey is still suffering from the effects of the market correction that started in late April. This survey was conducted on 7/2/10, near the lows of the latest downturn; the previous survey was conducted on 6/18/10, which reflected an upward bounce. Although the volatility of the last three months has put a significant damper on client mood, the biggest factor in client sentiment still seems to be what just happened over the last two weeks. As we like to emphasize, it’s important for the advisor to keep the client’s eye on the prize – long term performance. In two weeks, anything can happen in the markets, and as these surveys point out, a client’s emotional tolerance for pain can swing just as easily. It’s your job as an advisor to help the client manage his emotional proclivity to shift his long-term investment objectives based on short-term market action.
No one can predict the future, as we all know, so instead of prognosticating, we will sit back and enjoy the ride. A rigorously tested, systematic investment process provides a great deal of comfort for clients during these types of fearful, highly uncertain market environments. Until next time, good trading and thank you for participating!
Leave a Comment » | Sentiment | Permalink
Posted by Mike Moody
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 7/12/2010:
It is almost hard to believe that this is the same indicator for the entire three year period shown (but it is, we checked…). The RS Spread was very volatile, especially from mid ’08 to early ’09 . It then declined sharply during the laggard rally off the bear market low and it has since laid flat…for almost a year. Relative strength tends to move in and out of favor over time, and I suspect that what we are seeing now will eventually lead to a very favorable environment for relative strength investing.
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Posted by Andy Hyer
Are retail or institutional investors better at getting performance out of their funds? The answer turns out to be neither! After an examination of investor returns versus NAV returns for various share classes, Morningstar comments:
One thing is clear: Across the board, investor returns are lower than total returns. Regardless of sales channel, the data don’t provide evidence that advisors and institutions do an excellent job timing their moves while other channels are rife with fickle investors. In aggregate, they’re all losing money to poor timing.
Thrashing around doesn’t help. Study the various available return factors and then stick with your program. We like relative strength because of its historical performance and great adaptability, but other factors work as well. In particular, deep value mixes nicely with relative strength.
Leave a Comment » | Investor Behavior, Markets | Permalink
Posted by Mike Moody
The more commentary I read from Morningstar, the more sensible I think they are. Yet I suspect many advisors are misusing the tools that Morningstar provides, or certainly not using the tools in a nuanced way as Morningstar recommends.
For example, a recent article discussed a very topical issue: how to determine if your slumping fund or advisor has permanently lost their touch. Clients grapple with this issue all the time and, most frequently, get it wrong. Studies show that both retail and institutional investors tend to terminate advisors after a period of poor performance and to hire advisors after a period of good performance. Most often, this period tends to be temporary and the studies have demonstrated that investors cost themselves an enormous amount of money by doing so.
On the other hand, no client wants to be permanently stuck with a lousy manager. So how can you differentiate?
There are a couple of different conditions in which Morningstar suggests you not act too impetuously.
1. Funds that don’t follow the crowd often have very different performance profiles than the broad market. Their ranking can zig when the market zags. (Our Systematic portfolios tend to visit both the top and bottom deciles with regularity.)
2. Sometimes an anomalous time period can make a fund look worse than it is. Relying on the ranking of a value fund at the end of a growth cycle, or vice versa, would probably be a significant mistake.
In both cases, the fund’s peer ranking can suffer, but as Morningstar points out, the ranking often comes roaring back. The rankings are exceptionally fluid because the returns are often tightly clustered. For example:
…most category rankings are based on a tightly constrained range. In the large-value category, a 10-year annualized gain of 1.6% lands a fund in the group’s worst third, but a 3.1% gain puts it in the top third. Neither is good on an absolute basis. It is easy to see how a good month or two is all it would take to vault a fund from the group’s basement to its penthouse, and vice versa.
I’ve added the emphasis because I don’t think the fluidity in ranking is generally understood by the investing public. If a good month or two can swing your 10-year ranking significantly, it seems to me that it is much more important to understand the manager’s process than it is to worry about the temporary ranking. Rankings can be unstable; process is permanent.
Leave a Comment » | From the MM, Investor Behavior, Markets, Thought Process | Permalink
Posted by Mike Moody
The chart below shows performance of US sectors and capitalizations over the trailing 12, 6, and 1 month(s). Relative strength strategies buy securities that have strong intermediate-term relative strength and hold them as long as they remain strong. Performance updated through 7/8/2010.
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Posted by Andy Hyer
Click the image below to access the second quarter review of our Systematic RS Portfolios.
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Posted by Andy Hyer
The Investment Company Institute is the national association of U.S. investment companies, including mutual funds, closed-end funds, exchange-traded funds (ETFs), and unit investment trusts (UITs). Members of ICI manage total assets of $11.82 trillion and serve nearly 90 million shareholders. Flow estimates are derived from data collected covering more than 95 percent of industry assets and are adjusted to represent industry totals.
Taxable Bonds continued to attract the most net new mutual fund assets for the week ending 6/30/10.
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Posted by Andy Hyer
It turns out that money can buy happiness. Well, maybe not directly-but researchers were surprised when they examined data from a Gallup survey. According to a Wall Street Journal synopsis of the results:
A new analysis of Gallup World Poll data, surveying 136,000 people across 132 nations from 2005 to 2006, suggests that income is much more highly correlated to happiness (or at least a form of it) than previously thought.
Even some experts in behavioral finance were surprised:
What was interesting about the study was how universal the desire for financial success was across the world. “People in Togo and Denmark have the same idea of what a good life is, and a lot of that has to do with money and material prosperity,” Daniel Kahneman, professor emeritus of psychology and public affairs at Princeton University, told the Washington Post. “That was unexpected.”
To me, it’s not so surprising. If you work in the financial services field, you see firsthand how hard people strive to achieve financial success for themselves and their families. When they fail, they are miserable.
Warren Buffett, on the other hand, has a lot to be happy about. He has lifelong buddies (Charlie Munger), new friends (Bill Gates), influence, and financial security. Although he might be less happy if his friends and influence went away, he probably wouldn’t be miserable because he would still have financial security, Cherry Coke, and the t-bones at Gorat’s.
Source: Yahoo! News
Financial security is a much more important financial good than people give it credit for. Like most quantities, it seems to be relative. A retired executive might feel pinched or deprived at a different level of retirement income than a retired janitor, for example. This psychological insight led some clever financial service professional in the hazy past to popularize the “70% of income in retirement” rule of thumb, which is completely relative. There’s probably a paper waiting to be written on the S-curve of satisfaction with relative retirement income levels-above (and below) certain thresholds, satisfaction is probably reliably high (or low). In between, there may be a steep incline, where rising assets equate with rising happiness. At this point in the curve-where most of us are-the impact of good or bad financial advice can be huge.
Perhaps financial advisors can’t do much about the current worldwide financial malaise, but they certainly have the ability to influence and improve their clients’ finances through the encouragement of savings and the pursuit of sensible investment policies.
1 Comment | Just for Fun, Non-partisan op-ed, Retirement/Saving | Permalink
Posted by Mike Moody
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 7/6/10.
The 10-day moving average of this indicator is 22% and the one-day reading is 15%. This indicator has been bouncing around in oversold levels for two months now. Dips in this indicator have often provided good opportunities to add to relative strength strategies.
Leave a Comment » | Markets | Permalink
Posted by Andy Hyer
…of the Efficient Markets Hypothesis. Rather than random walking, sector funds seem to outperform the market when rotated according to a relative strength (momentum) criterion.
After performing a simple study, CXO Advisory concludes:
In summary, simple sector ETF momentum strategies have generally outperformed the broad stock market over the past decade for reasonably low trading frictions.
But wait, there’s more:
Including ETFs representing other asset classes (such as bonds, commodities, equity styles and international stocks) may enhance results.
That is essentially the recipe for our Global Macro separate account and the two Arrow Funds we sub-advise. Our own white paper on asset class rotation found the same thing. Relative strength just tries to go where the returns are. The evidence shows that often those returns persist.
Leave a Comment » | Markets, Relative Strength Research, Tactical Asset Alloc, Thought Process | Permalink
Posted by Mike Moody
Bill Hester, CFA of Hussman Funds recently wrote a very insightful article about the convergence of the global financial market performance that began in the second half of the 1990s and then the growing divergence seen in recent months:
For a brief period during the last decade the developed economies around the world became one. Countries shared similar fiscal policies, interest rate policies, and spending patterns which resulted in uncharacteristically similar economic performances. Investors took their cues from these trends and sent financial market securities converging in price and yield. The range of bond yields tightened, the level of valuations became closely aligned, and trailing stock returns were remarkably similar. As the developed economies continue to recover from the world-wide credit crisis, and now face new pressures of over-levered sovereign balance sheets and the prospects for below-average economic growth, investors should expect financial market performance among countries to continue to diverge.
(Bold is my emphasis)
Included in his article was the graph below which shows the spread between the highest and lowest 6-month returns of the members of Morgan Stanley’s index of developed countries (the spread is smoothed to highlight the medium-term cyclical fluctuations of the series).
Source: Hussman Funds
The large spread around 1990 highlights the weakness in the Nordic countries during this period as their stock markets collapsed as they battled their domestic banking crises. The peak around 2000 coincides with the peak in the world-wide stock market bubble where a few indexes that were over-weighted in telecommunication and technology stocks fueled strong relative outperformance. But even outside of those peaks, the graph shows that during the 1970′s and 1980′s it was typical for there to be large divergences between the best and worst performing countries – 40 to 50 percentage points difference was typical. More recently through 2007 the divergence in stock market returns among developed countries collapsed. There was very little value in making distinctions at the country level when individual country returns were so tightly centered about broad benchmark return levels.
These trends have shifted the last couple of years and the recent spread between relative performances continues to widen. Year to date, Denmark’s benchmark index is up 20 percent, while the Athens Stock Exchange index has dropped 33 percent. Country selection is beginning to matter again.
This divergence is potentially a very favorable development for global relative strength strategies. In any universe of securities there is a dispersion or bell curve of returns with the bulk of the returns huddled around the mean and then a number of extreme positive outliers and a number of extreme negative outliers. The goal of relative strength strategies is to focus the portfolio on the positive outliers and to avoid the extreme negative outliers. The greater the dispersion in returns, the more likely relative strength is to be able to deliver superior performance over a benchmark index fund. If we do indeed see much greater divergence in country returns going forward, relative strength is well-positioned to capitalize.
2 Comments | Tactical Asset Alloc | Permalink
Posted by Andy Hyer
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 7/2/2010:
The relative strength spread continues to mark time at this point, neither rising nor declining. Nobody knows how soon we will again see a rising spread. However, we do know that relative strength tends to move in and out of favor over time. It is quite possible that the transition that we are seeing now could be setting the stage for a very favorable environment for relative strength investing in the coming years.
Leave a Comment » | Markets | Permalink
Posted by Andy Hyer
You are 55 years old and retirement is no longer a thing of the distant future. In fact, you and your spouse seem to find yourselves discussing your retirement goals more and more frequently. You have considered your desire to travel the world, your desire to have the financial flexibility to be able to visit children and future grandchildren who are spread across the country. You consider the quality of healthcare you would like to be able to afford, the type of home you want, the type of cars… Yes, you are very aware that the way that you handle your finances over the next 15 years is going to largely determine the quality of retirement that you enjoy.
When the stock market rises, you feel increasingly optimistic about your financial future. However, when it falls you start to get nervous and have even had knots in your stomach at times. Perhaps, you have even considered leaving the stock market for good in order to just invest your money in certificates of deposit where at least you know that you will get your money back with some modest return.
Some variation of the thought process described above is commonplace among those who see retirement on the horizon. Any time the financial markets experience turmoil, it is natural for investors to ask themselves why they voluntarily signed up for this! During such periods of introspection, it is a must to ponder the reasons for investing in the first place. Despite the ever-present risk of loss that exists in the financial markets, the financial markets also present one of the best available means of accumulating wealth. It is also at times of market turmoil that the consequences of “dialing down the risk” must be considered.
The table below highlights the differences in annual distributions for 6 different investors who each arrive at age 55 with $1 million in savings. It makes many simplifications and does not consider inflation, additional savings, alternative methods of distribution, and other factors. However, its purpose is to highlight the impact that the rate of return earned on the $1 million over the 15 years from age 55 to 70 of the hypothetical investor have on the annual distributions from age 70 through 95. It assumes that the entire value of the portfolio is removed from the markets when the investor turns 70 years old and then simply divides the value of the portfolio by 25 in order to get the annual distribution amount.
(Click to Enlarge)
Molly Mattress decides that she doesn’t need the stress of investing. She is simply going to hide her money under her mattress and enjoy her life without having to worry if her money will be there in the future or not. While it is true that the risk of short-term loss is no longer an issue for Molly, she also is left with only $40,000 per year from age 70 until age 95. Cindy CD at least earns interest on her money (2.78% is the current average interest rate on 5-year certificates of deposits, according to www.bankrate.com.) By taking this action, Cindy is able to bump up her annual distribution to $60,352 per year. On the other end of the spectrum is Venturesome Vic who earns an annualized return of 10% on his money for 15 years and is then able to enjoy distributions of $167,090. Cautious Kate, Average Alex, and Optimistic Oscar fall in between those extremes.
Does this focus on the amount of the annual distributions change anything? It should. After all, it is easy to focus on the here and now and focus on avoiding short-term losses. However, permanent reductions in risk tolerance when an investor is still potentially decades away from “pushing up daisies” may result in a very modest and potentially unpleasant standard of living during the retirement years.
3 Comments | Retirement/Saving, Thought Process | Permalink
Posted by Andy Hyer
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 (6/28/10 – 7/2/10) is as follows:
High RS stocks underperformed the universe in what was a dismal week for equities.
Leave a Comment » | Markets | Permalink
Posted by Andy Hyer
Our last survey’s participation rate fell off its highs. Hopefully we’ll be right back up there this week!
Here we have the next round of the Dorsey, Wright Sentiment Survey, the first third-party sentiment poll. As you know, when individuals self-report, they are always taller and more beautiful than when outside observers report their perceptions! Instead of asking individual investors to self-report whether they are bullish or bearish, we’d like financial advisors to weigh in and report on the actual behavior of clients. It’s two simple questions and will take no more than 20 seconds of your time. We’ll construct indicators from the data and report the results regularly on our blog–but we need your help to get a large statistical sample!
Click here to take Dorsey, Wright’s Sentiment Survey.
Contribute to the greater good! It’s painless, we promise.
Leave a Comment » | Investor Behavior, Markets, Sentiment | Permalink
Posted by JP Lee
The chart below shows performance of US sectors and capitalizations over the trailing 12, 6, and 1 month(s). Relative strength strategies buy securities that have strong intermediate-term relative strength and hold them as long as they remain strong. Performance updated through 7/1/2010.
Leave a Comment » | Markets | Permalink
Posted by JP Lee
The Investment Company Institute is the national association of U.S. investment companies, including mutual funds, closed-end funds, exchange-traded funds (ETFs), and unit investment trusts (UITs). Members of ICI manage total assets of $11.82 trillion and serve nearly 90 million shareholders. Flow estimates are derived from data collected covering more than 95 percent of industry assets and are adjusted to represent industry totals.
Taxable bonds continued to attract the most assets in the week ending 6/23/10. There were no other changes in the flow rankings from the last week’s readings to this week’s.
Leave a Comment » | Markets | Permalink
Posted by JP Lee
You are currently browsing the Systematic Relative Strength blog archives for July, 2010.
