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 11/16/10.
After holding above 90% for over 2 months, the one-day reading of this index has now fallen to 75%. Dips in this indicator have often provided good opportunities to add to relative strength strategies.
Leave a Comment » | 
Markets | 
Permalink
Posted by Andy Hyer
I’ll be your savior, steadfast and true. I’ll come to your emotional rescue.—The Rolling Stones
I’m pretty sure that Mick Jagger attended the London School of Economics at some point. I’m pretty sure that Keith Richards was otherwise occupied. But their lyrics shed light on a big part of what a financial advisor is asked to do. Besides figuring out what strategies actually work in the market over time-we happen to favor strategies that adapt-it’s important to keep clients on an even keel. DALBAR data makes it clear that intestinal fortitude is just as important as investment acumen.
Warren Buffett, in the preface of Ben Graham’s The Intelligent Investor, writes, “To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.”
I added the boldface type to emphasize the point, which is all too often completely lost on investors. They place money into a strategy, presumably one that they believe has the opportunity to perform well over time, and then yank money out willy-nilly every time they get uncomfortable. In the market, sad to say, you get uncomfortable a lot. It’s a perfect example of emotions corroding an otherwise good decision framework.
We think our systematic relative strength process is a good way to make sure emotions don’t corrode our decision framework, but we still spend time with clients to keep them on an even keel. I admit that my emotional wiring should probably come with a warning label, but after 25 years I find it hard to get too worked up about the ups and downs of the markets. Clients, naturally, respond a bit differently! It’s important to be able to reframe things for them, to broaden their perspective, and to help them cope with their nervousness. Distraction is good too. (I’m not joking about this-the psychological literature is pretty clear on this point. I tell clients to read the sports pages and let us lose sleep over the market.)
Relationships and trust often matter more than what is bought or sold. A good decision framework is only half the battle. When you look at investor results over time, it’s quite possible that financial advisors can add more performance through good emotional support than through good investment selection.
Leave a Comment » | Investor Behavior, Markets | Permalink
Posted by Mike Moody
Globalization may have come slowly to the U.S., but it seems to have finally arrived. According to a recent article in Financial Planning Magazine, investors are open to thinking about cross-border securities:
A nationwide survey of mass-affluent investors conducted in August by Allianz Global Investors Distributors and GfK Roper found that most (71%) are looking for the best investment, and they don’t really care if that investment is foreign or domestic.
It seems that the trend toward global tactical asset allocation (Go Global Macro, Go!) and international investing may just be picking up steam. Clients also shouldn’t overlook that many domestic equities have significant overseas exposure. Right now the U.S. equity market is still the largest in the world, but that may change over the next generation or two.
Although investors are open to foreign securities, are they really ready for it? After all, because our domestic market is so deep, it’s quite possible to be fairly diversified without ever going outside our market—something that might not be true if, for example, you lived in Belgium. On the other hand, perhaps Belgians are used to thinking in global terms. Americans are not.
…when it comes to international investing, the survey also points to a huge educational need: Two-thirds of investors (67%) admitted they lack knowledge about investing overseas and more than half (54%) said they wanted to learn more.
So there is your challenge and your opportunity in a nutshell. Investors are interested but they are going to need your help. The advisor who is willing to show the client global investment products and bring them up the learning curve may do very well indeed.
Leave a Comment » | Markets, Tactical Asset Alloc | 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 11/15/2010:
RS leaders and laggards continue to perform similarly-as they have for roughly the last 18 months. Relative strength leaders have historically shown a tendency to assert themselves as bull markets age. From that perspective, we believe it is likely that we will see a rising spread in the coming years.
Leave a Comment » | Markets | Permalink
Posted by Andy Hyer
Our latest sentiment survey was open from 11/5/10 to 11/12/10. We had a few more respondents than last survey, with 107 readers participating. 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. From survey to survey, the market rallied over 3%, and client fear levels dropped in kind. Only 71% of clients were afraid of losing money in the market, versus last survey’s reading of 81%. On the flip side, 29% of clients are now afraid of actually missing out on the rally. In late August, 94% of clients were afraid of losing money in the market. It took a 15% market rally to move fear levels to their current reading at 71%.
Chart 2. Greatest Fear Spread. Another way to look at this data is to examine the spread between the two groups. The spread remains skewed towards fear of losing money this round, but significantly closer to par. Right now the spread is sitting at 42%, the furthest towards 0% we’ve seen since April of 2010. We would consider this recent move a significant technical breakout.
Question 2. Based on their behavior, how would you rate your clients’ current appetite for risk?
Chart 3: Average Risk Appetite. Risk appetite levels continued higher in their breakout, but not to the same degree as client fear levels. This survey round, risk appetite came in 2.72, up just a little over last survey’s 2.62. Considering that client fear levels fell by such a large degree, it seems like this move is a bit more muted than we’d expect. Average risk appetite is still around its 6-month highs.
Chart 4: Risk Appetite Bell Curve. This chart uses a bell curve to break out the percentage of respondents at each risk appetite level. This week we saw a continuation from last survey’s shift to more risk. We had a smattering of 5′s this round, whereas in the past few months we were lucky to see even one.
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.
Chart 6: Average Risk Appetite by Group. A plot of the average risk appetite score by group is shown in this chart. This chart highlights one of the more nuanced stories of this round of surveys — that average risk appetite has not moved as strongly as client fear levels. In a rally market, we’d expect to see shifts in fear levels to move lower, and risk appetites to move higher. And while this did happen, the fear of missing an upturn group dropped the ball. The upturn group’s risk appetite actually fell this round, to 3.1 from 3.2, possibly suggesting concern that the rally is near the end. The downturn group performed as expected, as their average risk appetite was slightly higher.
We’ve noted before that the upturn group has a much more volatile risk appetite, and this is again what we are seeing here. Could this be a divergence pattern?
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 this week fell by around .10 points, which can be attributed to the upturn group’s falling risk appetite.
There are two big stories in this client sentiment survey — the significant drop in client fear levels, and the muted move in risk appetite. Client fear levels dropped by around 10% from survey to survey, fueled by a market rally that started in August and is now up around 15%. If the rally can manage to sustain itself, it’s likely that client fear levels will continue to drop. Maybe one day, we’ll even see client fear levels at the exact opposite end of the range, below 10%. On the other hand, we would expect risk appetite to continue to rise in-line with the market. This week, we saw the upturn group’s average actually move lower, which may be a divergence pattern (we would expect the risk appetite to move higher with the market, versus diverging from the expected pattern-but that dataset is so young that we may just not yet know what to look for or how to interpret it).
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 » | Investor Behavior, Markets, Sentiment | Permalink
Posted by JP Lee
In theory, there’s no difference between theory and practice. In practice, there is.—Yogi Berra
On Friday, an article in the Wall Street Journal highlighted a bizarre situation: the average U.S. homebuyer can now borrow at a lower rate than the U.S. government, which is no doubt creating havoc for leveraged convergence traders. Several observers had comments that indicated how unusual the situation was:
“This is fascinating,” said Michael Shaoul, chief executive at brokerage firm Oscar Gruss, who spotlighted the screwball market action in one of his intraday market notes. “You have, in theory, an impossible event, which is that the man in the street is paying less interest than the government is.”
The hullabaloo was caused by the occasion that a weekly survey of 30-year mortgage rates showed that consumers could borrow at 4.17%, while the federal government is paying 4.24% on 30-year Treasury bonds. As we’ve discussed before, lots of things happen in real life that are impossible in finance textbooks. This is just another one.
Below: an interest rate convergence trade viewed from a safe distance
It goes without saying that it is extremely hazardous to your wealth to assume that something can’t happen just because it hasn’t happened before, or just because it’s not supposed to happen. Assumptions like that can be expensive.
Systematic application of relative strength avoids this assumption completely. Instead of forecasting what will happen, the trend follower simply adapts to trends as they change. Strong in, weak out, and around and around we go.
2 Comments | Markets, Thought Process | Permalink
Posted by Mike Moody
A balanced fund is a fund that is designed to balance income, growth, and capital preservation. Balanced funds have some special attributes, a couple of which are summarized in this article in the Baltimore Sun.
1) The SEC requires that any fund purporting to be balanced maintain at least 25 percent of its assets in fixed-income senior securities — that is, debt securities, such as bonds and notes, and preferred stocks.
2) A balanced fund is designed to be a complete investment program. As the prospectus for American Balanced Fund puts it, “The fund approaches the management of its investments as if they constituted the complete investment program of the prudent investor.” The prospectus for Dodge & Cox Balanced Fund refers to investors finding it “suitable for their entire long-term investment program.”
3) The Department of Labor has established “safe harbor” regulations for pension plans. The regulations set out certain investment alternatives that pension sponsors under ERISA are allowed to use for default options for employee pensions. The approved default categories in the DoL proposal - now known as qualified default investment alternatives (QDIAs) - include:
“The new default options will help workers accumulate larger nest eggs for retirement,” said [Assistant Secretary of Labor, Ann] Combs. “Workers who don’t feel equipped to make investment decisions will be automatically invested in a mix of stocks and bonds appropriate for long term savings.”
The basic idea is that balanced funds conform to the prudent investor rule and that employers, assuming they continue to monitor the investment managers, cannot be sued (hence “safe harbor”) for lack of suitability.
Clearly, if you own just one fund, a balanced fund is probably the best choice. A balanced fund would be the logical choice for the smaller accounts in your book, or as the first fund for a beginning investor. A balanced fund is also an excellent choice for a systematic investment plan, where the investor places a fixed dollar amount in a fund each month. (I think advisors who are not urging their clients to use a systematic investment plan alongside their other investments are missing the boat.) It would make sense to have a balanced fund in a 401k plan. Finally, a balanced fund can help protect you from legal liability.
Traditional balanced funds often stayed close to the 60% equity/40% bond mix. Modern balanced funds now often include international stocks as part of the equity mix and have some latitude to change the mix slightly over time.
Fun fact: the first balanced fund was started by a Philadelphia accountant named Walter Morgan. He was the founder of Wellington Management. Vanguard’s Wellington Fund is still one of the largest balanced funds today.
Most of the giant balanced funds in the investment industry are large because they have had long track records of superior performance. Some of the largest funds currently are Capital Income Builder ($58 billion), Income Fund of America ($51 billion), Franklin Income Fund ($33 billion), American Balanced Fund ($30 billion), Vanguard Wellington Fund ($28 billion), Fidelity Balanced Fund ($17 billion), and Dodge & Cox Balanced Fund ($14 billion). [These asset numbers came from Lipper.] Chances are that you have holdings of one or more of these funds in your book.
Each fund approaches the balanced mandate slightly differently. Franklin Income Fund tilts toward a large chunk of fixed income (55% of the portfolio), including a slug of high yield bonds. Capital Income Builder has the largest part of its equity investments overseas (39% of the portfolio), while Dodge & Cox Balanced Fund stays close to home (61% of the portfolio). [This asset allocation information came from Morningstar.]
The Arrow DWA Balanced Fund (DWAFX) has a similar mandate. Like all balanced funds, we have a minimum of 25% bond exposure at all times. However, there are a couple of things we do rather differently than many balanced funds.
1) Different from most balanced funds, DWAFX has a sleeve dedicated to alternative assets. This is because the fund is run along the lines of the Yale Endowment model, with a very broad mix of investable asset classes. Right now those alternative assets (19%) are gold and real estate, which have been quite additive to returns.
2) Different from most balanced funds, DWAFX allocates assets dynamically based on relative strength. The four sleeves within the portfolio-domestic equities, international equities, fixed income, and alternative assets-can have their weights vary dynamically within broad bands depending on the strength of the asset class. For example, right now the bond allocation is 27%, but it has been as high as 52% during periods of market stress. Similarly, the international equity allocation is currently 21%, but it has been as high as 38% during periods of U.S. dollar weakness.
Here’s a snapshot of DWAFX’s allocation as of 9/30/10:
Source: ArrowFunds.com
We think systematic application of relative strength across a broad range of asset classes-otherwise known as global tactical asset allocation-within a balanced fund can be a superior strategy for an investor that is looking for a complete investment solution. Although the Arrow DWA Balanced Fund does not yet have the long tenure of many of the other excellent balanced funds, performance has been strong since inception. (For an interactive price chart of performance of DWAFX versus the other industry heavyweights, click here. Select “max” under the chart to see full performance since inception.) We hope that at some point in the future we will be mentioned in the same breath as the other top balanced funds.
For information about the Arrow DWA Balanced Fund (DWAFX), click here. Click here for disclosures. Past performance is no guarantee of future returns.
Leave a Comment » | From the MM, Tactical Asset Alloc | Permalink
Posted by Mike Moody
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 (11/8/10 – 11/12/10) is as follows:
After several weeks of strong gains, the market gave some back last week. The top quartile underperformed the universe (and the bottom quartile outperformed) the universe by a very small amount for the week.
Leave a Comment » | Markets | Permalink
Posted by Andy Hyer
Consider a recent headline at CNNMoney.com:
China’s sell-off spills over to U.S. markets
It used to be that our market was the lead market that other financial markets reacted to. Things have changed. Many of the most successful domestic companies are now global. Your portfolio should probably have global exposure too.
Leave a Comment » | Markets, Thought Process | Permalink
Posted by Mike Moody
I belong to a number of professional associations. One of my colleagues was doing serious historical research and asked if anyone knew what the oldest chart in the world was. This was my less-than-serious nomination for that distinction. I’m pretty sure that even Neanderthal man bought at the highs and sold at the lows. In fact, most of them died broke, as there are no surviving Neanderthal mansions.
Source: NY Times
Leave a Comment » | Investor Behavior, Just for Fun | Permalink
Posted by Mike Moody
(Click to Enlarge)
Source: Compass EMP Mutual Funds
Did you know that 92% of the top 3 performing asset classes in the last 20 years were something other than U.S. Stocks (S&P 500). Click here to see the full table of asset class returns.
To learn more about Dorsey Wright’s approach to global investing, click here to watch a 14-minute video presentation on our Global Macro strategy.
Leave a Comment » | Tactical Asset Alloc | Permalink
Posted by Andy Hyer
Leave a Comment » | Investor Behavior | Permalink
Posted by Andy Hyer
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 11/11/2010.
Leave a Comment » | Markets | Permalink
Posted by Andy Hyer
We are pleased to announce that Crescendo Business Services and Los Angeles Magazine have recently selected Dorsey Wright Money Management as a FIVE STAR Wealth Manager.
Program Overview
Crescendo Business Services contracts a third party research firm, QMI Research, to conduct the FIVE STAR Wealth Manager research methodology using objective market research methods. The research objective is to develop a list of wealth managers in a given market who score highest in overall satisfaction, based on an objective market research methodology that takes into account client evalutions in nine categories, with adjustments to reflect inputs from peers, regulatory compliance reviews, and Blue Ribbon Panel review. In each geographic market the Program is conducted, QMI Research administers a survey, by mail and phone, to approximately 1 in 4 high-net-worth households and identified FINRA registered representatives. Respondents are asked to name and evaluate up to three wealth managers.
Less than 7%, but no more than 1,000, of the wealth managers in a market are included on the final published list. The full list of those wealth mangers awarded FIVE STAR Wealth Managers will be published in the January 2011 issue of the Los Angeles Magazine.
More information about the award can be found here.
At Dorsey, Wright our clients are held in great esteem, putting them first and foremost in all that we do. We appreciate this recognition and we look forward to many more decades of service to our clients.
Leave a Comment » | Media | Permalink
Posted by Andy Hyer
We admit it. Pundits who make market forecasts with lots of articulate reasons sound much smarter than we do.
Our business model is simple: buy what is strong and hold it until it becomes weak. Although I admit that doesn’t strike anyone as overly clever, let’s consider the odds behind making predictions. The best-known study on the accuracy of pundits was done by Philip Tetlock at the University of California, Berkeley. The Wall Street Journal recently carried an article (wonderfully written by Jonah Lehrer, author of How We Decide, a book I highly recommend) about his investigations right before the recent election. Dr. Tetlock first got interested in predictions in the runup to the 1984 presidential election. He starting tracking pundits to see who would be right. And here’s what he found:
Mr. Tetlock began to monitor their predictions, and a few years later, he came to a sobering conclusion: Everyone was wrong.
Of course, many of the soothsayers later claimed to have predicted everything that happened! Dr. Tetlock’s investigation turned into a 20-year obsession.
The dismal performance of the experts inspired Mr. Tetlock to turn his case study into an epic experimental project. He picked 284 people who made their living “commenting or offering advice on political and economic trends,” including journalists, foreign policy specialists, economists and intelligence analysts, and began asking them to make predictions. Over the next two decades, he peppered them with questions: Would George Bush be re-elected? Would apartheid in South Africa end peacefully? Would Quebec secede from Canada? Would the dot-com bubble burst? In each case, the pundits rated the probability of several possible outcomes. By the end of the study, Mr. Tetlock had quantified 82,361 predictions.
More than 82,000 quantified predictions, I think, counts as a statistically valid sample size. There was really only one problem. Unfortunately, it was a rather large problem.
How did the experts do? When it came to predicting the likelihood of an outcome, the vast majority performed worse than random chance. In other words, they would have done better picking their answers blindly out of a hat. Liberals, moderates and conservatives were all equally ineffective. Although 96% of the subjects had post-graduate training, Mr. Tetlock found, the fancy degrees were mostly useless when it came to forecasting.
The main reason for the inaccuracy has to do with overconfidence. Because the experts were convinced that they were right, they tended to ignore all the evidence suggesting they were wrong. This is known as confirmation bias, and it leads people to hold all sorts of erroneous opinions. Famous experts were especially prone to overconfidence, which is why they tended to do the worst. Unfortunately, we are blind to this blind spot: Most of the experts in the study claimed that they were dispassionately analyzing the evidence. In reality, they were indulging in selective ignorance, as they explained away dissonant facts and contradictory data. The end result, Mr. Tetlock says, is that the pundits became “prisoners of their preconceptions.” And their preconceptions were mostly worthless.
The problems with predictions are manifold. 1) Experts have preconceptions, 2) experts have confirmation bias, and 3) experts are blind to their blind spot. Post-graduate degrees and fame didn’t help. In fact, prominent experts tended to do the worst. And, frankly, it’s not just experts who are blind to their blind spot—we all are. Our mental software is just built that way.
Why not admit to the blind spot and go with a method that ignores your own preconceptions? Systematic trend following with relative strength is just a recognition of what forecasters refuse to admit: their predictions are worthless. According to Dr. Tetlock’s data, you would have a better track record if you flipped a coin. Although systematic trend following doesn’t earn style points, it can be quite profitable. (It may even earn anti-style points. One of our colleagues was once referred to as a “trend following moron.”) The next time you hear a prediction on CNBC, cover your ears and just look at the trend.
Hat tip to NS and DL.
Leave a Comment » | Investor Behavior, Markets, Thought Process | Permalink
Posted by Mike Moody
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.
Week after week, the picture remains mostly the same. Taxable bonds are out-selling all other mutual fund products by a long shot. Domestic equities continue to bleed money.
Leave a Comment » | Markets | Permalink
Posted by JP Lee
Like every participant in the financial markets, I’ve seen numerous opinions on quantitative easing, both pro and con. But I’ve never seen this take on it, which comes from a piece in the Economist:
My more fundamental point is that the US is a debtor nation. It has committed to borrow money from other countries in the form of dollars. Printing money to repay those debts (which is what the Fed is doing by creating money to buy government bonds) is, in essence, a partial default. It is as if you tried to pay your supermarket bill with Monopoly money, on the grounds that it was the only paper money you could find in the house.
[Bold is my emphasis.] I’m not an economist so I have no real way to evaluate the merits of the partial default case, but it is interesting that investors are suddenly attracted to tangible assets like commodities and precious metals, and not so much to U.S. dollars and Treasury bonds. I’ve included a couple of charts that contrast the recent price movement of precious metals (DBP) versus long Treasuries (TLT) and of a continuous commodity index (GCC) with the U.S. dollar (UUP). If you swap the comparisons, it looks pretty much the same.
Click to enlarge. Source: Yahoo! Finance
It seems to me that tactical asset allocation may be a useful way to respond to performance differentials that are this large. Relative strength would dictate that you want to own more of what is strong and avoid what is weak. Overdiversification might really water down the gains from areas that are strong, or leave an investor with significant exposure to disastrous performance in a weak area. Does Mr. Jones really want 60% exposure to fixed income in an inflationary environment just because he is 70 years old? Systematic rotation to strong asset classes might have a better shot at preserving Mr. Jones’s purchasing power, even if it comes at the cost of higher volatility.
Leave a Comment » | Markets, Tactical Asset Alloc, Thought Process | 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 11/9/10.
After pulling back to the middle of the distribution in August, high relative strength stocks have moved sharply higher over the last 9 weeks and over 90% continue to trade above their 50 day moving average. This won’t last forever, so hang on tight!
Leave a Comment » | Markets | Permalink
Posted by JP Lee
2010 has been good to the PowerShares DWA Technical Leaders ETFs. Performance has been much better than their cap-weighted benchmarks and assets have increased fourfold in 2010 to now over $700 million in PIE, PIZ, and PDP.
(Click to Enlarge)
Fact Sheets
PIE: PowerShares DWA Emerging Markets Technical Leaders
PIZ: PowerShares DWA Developed Markets Technical Leaders
PDP: PowerShares DWA Technical Leaders
Past performance is no guarantee of future returns.
Leave a Comment » | Markets | Permalink
Posted by Andy Hyer
I suspect that many of us find it entertaining to listen to colorful tales of investment managers who comb the world for uncovered pieces of information that have not been fully priced into the financial markets. These clever investors then reap enormous profits as the market comes around to their way of thinking. Surely, many of us also feel sorrowful as we listen to the stories of investment managers who rack up enormous losses while sitting in positions only to find out that the market never comes around to their way of thinking….oh wait, the latter version of the stories are never told are they! The losing managers are never paraded around CNBC to tell their sorry story; that is the role reserved for the seers of finance who just might give us insight into what will come next. Because of this one-sided coverage, investors can be led to believe that the key to outsized returns is to “know something that others don’t.”
We have chosen a different path. We are aware of the potentially disastrous effects of overconfidence in the financial markets. What if our insight turns out to be flat out wrong? How long should we stay with such a position? Furthermore, we have great respect for the financial market’s ability to weigh all the evidence and for the supply and demand relationship to render a judgement about the direction of given trend. We are also aware of the potential to generate superior performance by implementing a systematic trend-following approach to investing.
Karl E. Weick and Kathleen M. Sutcliffe have written an excellent book, Managing the Unexpected, about why some organizations perform so much better than others. According to them, a key to good performance over time is to minimize the tendency to always seek confirming evidence for our current positions:
Many of your expectations are reasonably accurate. They tend to be confirmed, partly because they are based on your experience and partly because you correct those that have negative consequences. The tricky part is that all of us tend to be awfully generous in what we accept as evidence that our expectations are confirmed. Furthermore, we actively seek out evidence that confirms our expectations and avoid evidence that disconfirms them. For example, if you expect that Navy aviators are brash, you’ll tend to do a biased search for indications of brashness whenever you spot an aviator. Your’re less likely to do a more balanced search in which you weigh all the evidence and look just as closely for disconfirming evidence in the form of aviator behavior that is tentative and modest. This biased search sets at least two problems in motion. First, you overlook accumulating evidence that events are not developing as you thought they would. Second, you tend to overestimate the validity of your expectations. Both tendencies become even stronger if you are under pressure. As pressure increases, people are more likely to search for confirming information and ignore information that is inconsistent with their expectations.
From our perspective, a key to our long-term success is to remove the element of emotion from the investment process. Sure, we have strong emotions about what is going on in the financial markets just like everyone else. However, our emotions or our perceived insight into uncovered value will never be the impetus for any of our buys or sells. We will always defer to the market to tell us when it is time to move in or to move on.
Leave a Comment » | Relative Strength Research, Thought Process | Permalink
Posted by Andy Hyer
By definition, financial markets and their sewing circles are rife with predictions.
The bond bubble is about to burst
China will become the next superpower
Equities will NEVER regain their footing
Unfortunately, these predictions are mostly useless. Quite simply, we have no idea what’s going to happen in the future. It’s impossible to predict the future accurately over a large sample-set. It’s impossible. That goes for stock market prices, macroeconomic trends, socioeconomic trends, the weather, and how long it’s going to take you to get home from work today. There are just too many variables to accurately predict the future with any sort of reliability.
In the spirit of bashing any and all de-facto predictions, then, we turn to a Newsweek article written in 1995 by a pseudo-famous PhD astronomer-techie-pundit, Clifford Stoll. The article, entitled The Internet? Bah!, was written at just around the time when PC computing on the internet was just beginning to hit the mainstream US consumer market.
After two decades online, I’m perplexed. It’s not that I haven’t had a gas of a good time on the Internet… But today, I’m uneasy about this most trendy and oversold community. Visionaries see a future of telecommuting workers, interactive libraries and multimedia classrooms. They speak of electronic town meetings and virtual communities. Commerce and business will shift from offices and malls to networks and modems…
Baloney.
The future of the internet summed up in a word – BALONEY! This is coming from a professional on the cutting edge of internet usage (two decades of use in 1995). He’s not some media hack just firing from the hip – with a PhD in astronomy, Mr. Stoll was quite literally a part of the birth of the internet (in a broader sense of the word, a la academia).
It’s important that we give Mr. Stoll a sense of professional expertise, because it’s that very professional expertise that leads to a false sense of confidence in knowing the future (from us, for believing him, and from him, for predicting in the first place). The guy’s a computer engineer astronomer academic. If there was somebody in the room who everyone could agree could shed some light on the future of internet computing…it would be him.
You have to read the whole article to get the full flavor of his prediction. Why would ANYONE buy ANYTHING on the internet? There are no salespeople on the internet! There’s no order on the internet! (Google was founded in 1998, just 3 years down the road).
My point is this – no matter who you are, no matter how smart you are, no matter how exalted you are within your chosen field – it’s impossible to predict the future. On the other side, the same is true for the people he is arguing against, who predicted the internet would become the nexus of information and commerce that it’s grown to be. Both sides’ predictions are equal as probable outcomes. It’s quite literally a coin-flip, just with more variables. We can sit here Monday Morning Quarterbacking, and laugh at Mr. Stoll and how wrong his predictions were, etc. That’s not the point. The point is to beat into your brain that predicting the future is an impossible task.
The future is unknowable. We solve this philosophical quandary by systematically following an adaptive rule set that has been rigorously tested and can be shown to have outperformed over a long period of time. We buy what is strong and continue to hold it until it becomes weak. It really is that simple.
Leave a Comment » | Just for Fun, Markets, Thought Process | Permalink
Posted by JP Lee
HT: The Leuthold Group
Leave a Comment » | Just for Fun | Permalink
Posted by Andy Hyer
From mid-2008 to mid-2009, momentum (aka relative strength) as a return factor was very much out of favor as the market experienced frequent leadership changes. One way to deal with such periods of underperformance is to change or tweak your model, as no doubt many did. However, those of us with an eye on the long-term results of momentum investing were well aware of the fact that momentum (as well as all long-term winning investment factors) goes through periods of underperformance. Sticking to the discipline has been heartily rewarded in 2010.
The chart below shows monthly cumulative performance of the seven different baskets of factors tracked by The Leuthold Group-specifically, it shows the “spread” of returns after grouping each factor into quintiles at the beginning of the time frame. The spread is the return for the first (best) quintile minus the return for the fifth (worst) quintile.
(Click to Enlarge)
Shown by permission from The Leuthold Group
The two obvious standouts are momentum (good) and growth (poor). Value ends up being fairly trendless in 2010. Given the historical tendency for momentum to enjoy multi-year periods of outperformance, we think that the next couple years could continue to be very favorable for momentum investing.
Leave a Comment » | Markets, Relative Strength Research | Permalink
Posted by Andy Hyer
How different investments have done over the past 12 months, 6 months, and month.
1PowerShares DB Gold, 2iShares MSCI Emerging Markets ETF, 3iShares DJ U.S. Real Estate Index, 4iShares S&P Europe 350 Index, 5Green Haven Continuous Commodity Index, 6iBoxx High Yield Corporate Bond Fund, 7JP Morgan Emerging Markets Bond Fund, 8PowerShares DB US Dollar Index, 9iBoxx Investment Grade Corporate Bond Fund, 10PowerShares DB Oil
Leave a Comment » | Markets | 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 (11/1/10 – 11/5/10) is as follows:
Excellent week for the market last week! The bottom quartile had the best returns for the week, while the top quartile was in line with the universe.
Leave a Comment » | Markets | Permalink
Posted by Andy Hyer
You are currently browsing the Systematic Relative Strength blog archives for November, 2010.
