Dorsey, Wright Client Sentiment Survey Results – 5/20/11

May 31, 2011

Our latest sentiment survey was open from 5/20/11 to 5/27/11.  The Dorsey, Wright Polo Shirt raffle was a huge success!  The winning advisor will receive an email today.  Thanks to everyone who participated. This round, we had 117 advisors participate in the survey.  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 five 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 S&P was down fractionally (-0.5%).  Client fear levels nudged higher from 85% to 88%, which is what we would expect to see.  On the other side, the missing opportunity group fell from 15% to 12%.

Considering how big the fear move was the round before, we expected to see these type of numbers.  Despite the S&P’s 2-year performance track record (hint: it’s up nearly +30% since June of 2010), client fear levels hover near 90% on a measly -2% pullback from survey to survey.  Andy’s weekly “Fund Flows” posts also back this up, with client assets still flooding into taxable bond funds (fear).

Chart 2. Greatest Fear Spread.  Another way to look at this data is to examine the spread between the two groups.  The spread edged higher this round from 70% to 75%.

Question 2. Based on their behavior, how would you rate your clients’ current appetite for risk?

Chart 3: Average Risk Appetite.  Average risk appetite bounced slightly this round, from 2.66 to 2.73.  We saw a significant decline in client risk appetite last round, despite the market moving higher.  This could be a case of minor mean reversion, as clients settle into a new risk profile in light of the big, bad scary pullback.  We’re still well off the recent all-time risk appetite 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.  Here we see the majority of clients are looking for moderate to less risk, as evidenced by the large percentage of 2’s and 3’s.

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 had a few outliers in the fear camp who were looking for a risk appetite of 5.  Are those mis-clicks or trolling on the part of survey takers?  Because there was more than just 1 respondent doing that, I’m going to guess that there are people who are afraid of losing money, but also want a risk appetite of 5.  Other than those few participants, the rest of the bell curve sorts out normally, with the fear group wanting less risk and the opportunity group wanting more risk.

Chart 6: Average Risk Appetite by Group.  Here we can see that the overall risk appetite number’s bounce probably came from the fear group, which jumped from 2.54 to 2.66.  The opportunity group’s risk fell, which is what we expect to see when the market falls.  This particular chart has a history of being more volatile than the others, and also bucking the usual trend.

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 fell moderately this round but seems to be sticking within a fairly stable range.

This round, the market fell fractionally from survey to survey, and fear levels continued to rise.  The S&P 500 is up around 30% in less than a year, but still almost 90% of clients are more afraid of losing money than missing a rally.  As we see in the weekly Fund Flows post by Andy, clients are still in total fear and safety mode, adding assets to taxable bond funds at a rate of 3:1 over others.  Once the market has rallied +XYZ%, we will inevitably see a huge swing towards opportunity and risk, but we aren’t there yet.

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.

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Your Personal Inflation Rate

May 31, 2011

I was just made aware of an incredibly cool website called the Khan Academy, which offers short educational videos on a variety of topics from Calculus to Biology to Quantitative Easing.  I just watched this discussion of inflation and the construction of the CPI index.  The video does a great job of explaining some of the nuts and bolts of the CPI index’s construction.  Above all, you will walk away realizing that YOUR inflation rate could be wildly different than that reflected by CPI. For example, if healthcare costs make up more than 6.39% of your disposable income, then CPI may be understating your inflation rate.  Furthermore, for those of us who will be sending multiple children to college our inflation rate is likely significantly higher than CPI (education costs are only a 3% weight in CPI).

This is a crucial topic to have a handle on when devising an asset allocation since maintaining purchasing power for YOU may mean needing to earn much more than the 3.2% currently reflected by CPI.  This is useful information because it should inform the types of investments you choose as well as the amount of money that you will need to save.

Image source: Anyiko

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Strategic Asset Allocation Bites

May 31, 2011

For the record, I love Christine Benz at Morningstar.  She writes great articles that are accessible and informative, and often with a non-traditional take on things.  That’s why I’m so disappointed with her recent article on asset allocation for retirement.  In fact, articles like this make me crazy.

Selecting a stock and bond mix is just a way to try to target volatility.  (Even asset class volatilities can vary over time, so it’s not a perfect solution.  But volatilities tend to be reasonably stable, so I can buy into the idea of volatility buckets.)  But traditional asset allocationists often make much broader claims.  Here are all of the things that typical strategic asset allocation cannot do:

1) It can’t help you predict what your returns will be. It can tell you what your returns would have been in the past, but that has no effect on what returns will look like in the future.  Most asset allocations simply assume that equity returns will always be positive and somewhere around the historical norm.  That’s a crucial problem because most asset allocations count on the equity returns to drive overall growth.

2) It can’t help you predict your risk level. Volatility might be somewhat predictable, but risk is a different animal.  You can’t eat low volatility if it turns out you did not invest in assets with good returns.

3) It cannot make the investing process predictable. Everyone wants certainty.  As long as historical norms continue, it seems like the process is fairly predictable.  If there is a paradigm shift, you will quickly realize it was not.  Markets are not predictable.  The primary function of strategic asset allocation seems to be to generate really nice-looking pie charts.

Yet many, many articles contain these sorts of homilies about asset allocation:

Most experts agree that your retirement portfolio’s asset allocation–its mixture of stocks, bonds, and cash–will have the biggest impact on how much it grows, as well as its risk level.  Unfortunately, retirement savers seeking guidance on what an appropriate asset allocation may have a hard time knowing where to look. Sure, you could certainly do worse than adopting Jack Bogle’s simple formula: 100 minus your age equals how much you should hold in stocks. But what if you want to come at the problem with a greater sense of precision?

Morningstar’s Asset Allocator tool provides another, goal-based view of asset allocation, harnessing your own portfolio information if you’ve saved one on The tool calculates how likely you are to meet financial goals based on your current portfolio value, monthly investments, time horizon, and asset mix, and is useful for fine-tuning your allocation.

I’m not trying to pick on Morningstar.  Their strategic asset allocation tool, I’m sure, is as good as anyone else’s.  The point is that all of the tools are flawed because their fundamental premise is flawed: they rely completely on historic return streams being repeated in one fashion or another.  If you were a Japanese investor in 1990 working with 40 years of data (1950 – 1990) to construct a strategic asset allocation for your retirement, it would no doubt include a large equity component because historic equity returns had been both large and positive for a long period of time.  Asset allocation steered you directly into a disaster.  Since we know this has already happened in other markets, why do we continue to court disaster here?  Do you really believe that other markets can go down, but not the US?  Why would you continue to use a tool that you know will eventually fail?

After all, it’s not as if alternatives do not exist.  There are various kinds of dynamic asset allocation to choose from.  Tactical asset allocation using relative strength is just one form; other analysts try to forecast returns based on asset valuation or to rebalance across asset classes when sentiment gets too one-sided.  How well something works is often a function of how well it is implemented, but no one can make a failed process work regardless of how cleverly it is implemented.  I urge you to rethink your asset allocation methodology before it bites you in the ass.  If your asset allocation is not responsive to actual price changes, it is pretty much useless.

A Regretful Strategic Asset Allocator

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Weekly RS Recap

May 31, 2011

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 (5/23/11 – 5/27/11) is as follows:

High relative strength stocks outperformed by a wide margin last week as the top quartile outperformed the universe by 87 basis points.

Materials and Energy were particularly strong last week.

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ETF Usage Continues to Grow

May 27, 2011

This Advisor Perspectives article is worth reading.  Here is their summary:

More institutional investors are making ETFs part of their portfolio strategy, and that’s good news for retail investors. With many innovations, institutional investors are often the first in. Later the retail investors follow. ETFs, however, have shown a slightly different pattern. After 1993, when the first ETF was introduced in this country, ETFs were primarily of interest to institutional investors. At first, their main use was as a place to hold cash before investing in a new asset class, but institutions soon began using them for other purposes, such as tactical allocations and hedges.
We have seen tremendous interest and growth in our ETF-based separate account and mutual funds, particularly the go-anywhere Global Macro strategy.  There is definitely strong interest among retail investors in a flexible product that uses tactical asset allocation.  From a standing start in 2006 with Arrow Funds, we now manage about $800 million in ETFs!

See for more information on our three DWA Technical Leaders Index ETFs (PDP, PIE, PIZ).

To obtain a fact sheet and prospectus for the Arrow DWA Tactical Fund (DWTFX) or the Arrow DWA Balanced Fund (DWAFX), click here.

Click here for disclosures.  Past performance is no guarantee of future results.

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Quote of the Week

May 27, 2011

We can’t solve problems by using the same kind of thinking we used when we created them—-Albert Einstein

We have a ton of technological innnovation going on all the time.  However, we seem to struggle with new economic ideas because of entrenched political ideals.  I think all Americans would breathe a sigh of relief if the government were willing to innovate and try some new economic incentives, especially on a small, test scale.  Even if the ideas failed, we would learn enough to keep improving. 

Old thinking = same old problems.

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More on Evil Speculators

May 27, 2011

Advisor Perspectives carried a nice piece about speculation, particularly in reference to recent concerns that energy markets have been affected by speculation.  According to experts, speculation is often confused with manipulation.  Manipulation is illegal; speculation is healthy. 

Speculation differs from manipulation, says [Craig] Pirrong, author of The Economics, Law, and Public Policy of Market Power Manipulation.  When looking for signs of manipulation or “bad speculation,” Pirrong pays attention to quantities rather than prices. If speculators are manipulating prices, quantities should reflect that. But in the case of oil, prices have risen when inventories dropped, and later fell when inventories rose. “If speculators were moving the market, prices and inventories would be moving in the same direction,” he says.

Several experts pointed out that speculation often helps stabilize markets, or helps markets to find the correct price.

Despite the common view that speculators cause price volatility, they may sometimes stabilize prices or bring them closer to what they should be. There are two views on speculation, says Wharton finance professor Jeremy Siegel: “One side is that speculation can send the price far from the underlying true economic price of the asset or the stock. The other view is that some speculators know better than the people who are involved what the price actually should be…. Sometimes speculators from the outside can be very shrewd.”

Last year, for example, speculators made bets that Europe was heading for serious financial trouble. At the time, European government leaders dismissed the dire predictions, but as the debt crisis unfolded, the world realized later that the speculators had been right. Siegel wonders if speculators, in similar fashion, could have played a positive role in the early stages of the financial crisis if credit default swaps had been traded more openly. “Speculators might have seen the problems coming,” he says.

Actual manipulation should be punished, but you shouldn’t punish speculators for getting the trade right!  Politicians, it seems, only find it helpful to decry speculation when prices are moving counter to their re-election chances.

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The DJIA and GDP

May 27, 2011

According to an article in the Wall Street Journal, the Dow Jones Industrial Average has tracked GDP pretty closely over its 115-year history.  The most interesting part of the article is what Dow level is implied by the current GDP level:

Depending on growth of the U.S. economy, in 2011 nominal GDP will likely be reported somewhere above $15 trillion, suggesting a Dow trading above 15,000 can also be expected.

This is interesting because the level of the Dow Jones Industrial Average is right now only about 12,400, about 17% below that level.  The article has some caveats and mentions that perhaps stagflation will hold the price back, but it is interesting nonetheless.  My guess is that investor sentiment is the main thing holding price back.  The world economy is actually pretty good, but US investors are still feeling lousy from a poor domestic economy and the 2008 bear market hangover.

17% to run?

Source: Yahoo! Finance  (click to enlarge)

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Sector and Capitalization Performance

May 27, 2011

The chart below shows performance of US sectors and capitalizations over the trailing 12, 6, and 1 month(s).  Performance updated through 5/26/2011.

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CSCO: Still Waiting

May 27, 2011

From Vitaliy Katsenelson comes a reminder that good fundamentals do not necessarily equate to good stock market performance (at least not in an easily predictable time frame):

Imagine an analyst bringing a “fresh” stock idea to a portfolio manager at a large mutual fund.  He’d say something among these lines: Cisco is a buy, it has a bulletproof balance sheet with $25 billion of net cash (cash less debt), the stock is cheap – trading at 9 times earnings (excluding net cash), it’s providing double-digit returns on capital, and it is a dominant player in the industry, which is poised to grow at a faster rate than the economy, since, thanks to iPads, Androids, Kindles, Hulus, and Netflixes, we’ll all continue to consume digital content.

I can just see the portfolio manager’s smile, his laugh and comment that “This stock is a value trap, it has gone nowhere in more than a decade.”  I’m glad I’m not that analyst, as I’d have a huge burden to overcome.  After all, Cisco has shattered the dotcom dreams of many investors in the years following 1999, when it hit $80 a share and, for a brief moment, was one of the most valuable companies in the world, sporting a modest P/E of 100+.  Since then, gravity has caught up with Cisco’s stock (it always does), and it has declined almost 80% from its highs, to $17.  Most investors who bought the stock since ’99 either lost or made no money.  Draw a straight line through its chart (you have more than a decade’s worth of data points), and you see it’s either going to zero or at least will continue to go nowhere.  Now, you add to this performance a few quarters of disappointing Wall Street guidance, and you have an untouchable, un-recommendable stock.

However, fundamentals – take any metric: revenues, earnings, cash flows – will tell a very different story: they either tripled or quadrupled since 1999.   Through no fault of its own, Cisco’s stock was too expensive in 1999, and it took time for the stock to catch up to its fundamentals.  Of course, as usually happens, investors get overexcited on both sides of valuation.   The same investors who could not get enough of Cisco at over 100 times a little more than decade ago, don’t want touch it at 9 times earnings with a ten-foot pole.

Since 2000, CSCO is -69.66% while the S&P 500 is -9.77% (12/31/1999-05/26/2011).  CSCO has underperformed the S&P 500 by nearly 60% over a period of time when its fundamentals have “either tripled or quadrupled.” Value managers may be loading up on CSCO with the expectation that the market will eventually come around to recognizing its apparently strong fundamentals.  They have been waiting for over a decade now.  How much longer will they need to wait?

If the fundamental story on CSCO is right — and it may well be — relative strength will not be the first to pick up on it.  It will take a period of time for CSCO to show positive relative strength versus the market before it would become the type of security that we would add to our portfolios.  The flip side, however, is that relative strength keeps us from sitting in poor performers for years on end while we wait for the market to come around to our way of thinking.

By the way, CSCO is underperforming the S&P 500 by over 25% again in 2011 (through 5/26/2011).

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The Twinkie Defense

May 26, 2011

This derisive term for an improbable legal defense was the first thing that came to mind when I read the article Beware Top Funds With Poor Investor Returns on Yahoo Finance, by way of The  The article takes the top-performing mutual fund of the last decade to task—not because of its returns, which were terrific—but because the typical shareholder over the last decade has been a moron.

Consider the complaint:

If you invested in Fidelity Leveraged Stock a decade ago, your total annual return would have been 14.5%. But the typical shareholder had an investor return of only 4.0%. The reason for the gap is, most investors didn’t buy and hold for the 10 years. Instead, the average dollar in the portfolio stayed invested for short periods.

Fidelity Leveraged Stock has such a poor investor return, partly because the fund is volatile. Holding shares of indebted companies, Fidelity sometimes soars in bull markets and then collapses in downturns. All too often, shareholders buy and sell at the wrong times.

Excuse me.  The fund has a poor shareholder return not because the fund is volatile, but because shareholders buy and sell at the wrong times.  For proof, consider the fact that investors in bond funds have holding periods that are typically just as short as equity fund investors—and they underperform by a similar amount.  It’s pretty hard to blame the bond fund manager for supposedly whipping the poor investor half to death with volatility, but financial journalists try to lay this on the equity manager all the time.  It is simply not true.

The article has some suggestions for investors:

Should you stay away from funds with poor investor returns? Not necessarily. But you should be aware of what you are buying. If you do buy a fund like Fidelity Leveraged Stock, keep your eyes open and be prepared for a rough ride. For investors who don’t have strong stomachs, a better choice might be a fund like Heartland Value Plus , which returned 13.8% annually during the past decade and produced an investor return of 12.0%. Because Heartland delivered a relatively steady ride, shareholders were able to hold through downturns.

The problem is that these assertions are contradicted by the evidence.  For the record, Heartland Value Plus did not provide a steady ride.  And you’re still going to need a strong stomach.  It’s a great fund, but it had a -33.6% drawdown in 2008.  That’s not because the manager is not superb–it’s because it is invested in stocks, and stocks are volatile!  Very few bond funds have 33% drawdowns, but evidence shows that investors can’t hold on to them for the long run either.  I might argue that Heartland has done a better job of investor education than Fidelity because they convinced their investors to stay put, but this says nothing about the great investment performance.  Don’t try to blame the manager for investor performance.  In fact, volatile funds with high returns can be tremendous wealth builders if investors buy the dips instead of panicking.

The truth of the matter is that investors do this to themselves, trying to get something for nothing. In their quest for the free lunch—big returns with no volatility—they discover only a stale Twinkie.

Twinkies made me sell at the low


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Bullish Sentiment Freaks Out

May 26, 2011

Bespoke has a nice chart today of the AAII sentiment poll, which indicates that retail investors rapidly became very bearish, even though the last correction has been very shallow.

Source: Bespoke Investments (click to enlarge)

By the way, our own poll on investor risk appetite shows the same thing.

Source: Dorsey, Wright Money Management (click to enlarge)

Retail investors aren’t always wrong, but if you have to bet, that’s the way to play it.

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Learn to the Bubble

May 26, 2011

Cody Willard has a great article today up at Marketwatch entitled Buy into the tech bubble before it’s too late.  Mike Moody has also written a number of articles on this concept.  Here’s what Mike had to say in April this year.

Given that bubbles are going to be around, what should you do about it?  It turns out that when some asset class blows through its so-called fundamental value, the best way to play it is to overweight it!

Some of the common phrases I hear bandied about by the bubble-haters include, “over-extended, over-valued, missed the rally” and on and on.  People are, quite simply, scared to buy into an asset class or stock that has crossed the imaginary line into bubble territory. Others take it a step further and seek out these stocks mid-bubble, looking to go short and capitalize on a hoped-for imminent collapse back to Earth.  Clusterstock recently came up with a name for these high-flying  shorts that just keep going up – widowmakers.

And now back to Cody Willard.  Cody goes all the way back to 1994 and 1995 searching for references to “tech bubble” in the news.  And guess what?  There are tons of articles from the mid-90’s calling for the imminent demise of the tech industry!  Obviously, they were just a bit early.

Yup, everybody was so smart and so smug saying that tech was already in a bubble as early as 1995. What happened to tech stocks from 1995 to 2000? The tech-heavy Nasdaq was up some 600% in the sixteen quarters from the end of 1995 to the end of 1999.

So what can we learn from this?  We can learn to love the bubble. Because as Mike said, bubbles are going to be around, and research has shown that it’s more profitable to participate in the move up, rather than avoiding it or even trying to short it.

Cody Willard's Dog

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Fund Flows

May 26, 2011

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 bond flows somehow managed to increase their flows from the week before, and have now attracted nearly 3 times as many assets as the next most popular fund.  Domestic equity outflows tapered a bit from the week before.

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High RS Diffusion Index

May 25, 2011

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 5/24/11.

The High RS Diffusion index has been fairly volatile for the last few months.  Yesterday’s one day reading was 52%, and the 10-day moving average is 61%.

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CDs and Inflation: A Discussion of Risk

May 24, 2011

Investment News points out that CD buyers are getting hosed by inflation:

Savers who put their cash in longer-term certificates of deposit are losing out to inflation, according to Market Rates Insight.

The annual inflation rate of 3.16 percent in April topped the best 5-year CD rate of 2.4 percent, according to San Anselmo, California-based Market Rates Insight in a report today.

I bring this up not because CDs are necessarily bad investments, but because it illustrates the nature of risk.  Investors often think of risk far too narrowly—just in terms of volatility or loss of capital.

In fact, risk is all-encompassing, and like energy, can be neither created or destroyed. 

CDs are a good example of the latter point.  When you buy a CD, you have massively reduced your risk of capital loss.  (It would require the bank to go out of business and the government to refuse or be unable to pay off depositors—a vanishingly small risk.)  But you have simultaneously massively increased your risk of losing purchasing power due to inflation.  Your risk hasn’t gone away, it has just changed form.  Remember, risk cannot be created or destroyed.  You can pick your poison, but you can’t opt out.

The former point is almost always much harder for investors to grasp.  Your risk is the sum total of all of your exposures—and the sum total of all of the things you don’t own.  If you own a house, you have real estate risk, and US dollar risk if the asset is held in the US.  Less obvious is the fact that you now have the opportunity risk of not holding everything other than a house!  For example, owning your house precluded you from buying emerging market stocks, or Swiss Francs, or energy futures with the same money.  Depending on the relative performance of that investment opportunity set, your decision to buy a house could end up costing you a lot—relative to what else you might have purchased.

Psychologists will tell you that humans significantly overvalue the tangible relative to the potential.  As the saying goes, a bird in the hand is worth two in the bush.  Losing money that has already been earned hurts much worse than deciding not to put money into a stock that later doubles.  Losing money always feels worse than losing opportunity—and it is for this very reason that investors’ biggest losses are usually the ones they never see.  Opportunity loss typically swamps capital loss over an investor’s lifetime.  Like a black hole, opportunity cost is very real even if you cannot see it.  (Relative strength can be a great help in determining where opportunities lie—and which assets might be wise to avoid.)

Investing, then, is never without risk.  You are just navigating a set of tradeoffs, with different risks inherent in each.  Depending on the assets you own, your specific risks will be different from another investor, but your risk will remain just the same.

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Eat Your Heart Out, Raj Rajaratnam!

May 24, 2011

Over dozens of posts, we’ve reiterated a major theme on this blog, which is that even the most robust and sophisticated of strategies are tough to implement and stick with, and are likely to underperform the market a certain percentage of the time.  Investment managers who can outperform by even a couple of percentage points annually are often household names.

However, a recent study of stock transactions by the same small group of people from 1985 to 2001 found “significant positive abnormal returns,” averaging outperformance of around +6% per year.

What narrow group of investors can consistently and legally outperform the broad stock market?  Why members of Congress, of course!

How is this legal?

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What’s Hot…and Not

May 24, 2011

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, 11iShares Barclays 20+ Year Treasury Bond

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Weekly RS Recap

May 23, 2011

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 (5/16/11 – 5/16/11) is as follows:

All relative strength quartiles pulled back last week, with the bottom quartile showing the biggest underperformance versus the universe.

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SNL with DSK

May 22, 2011

Man, I love SNL skits! This one with two inmates discussing Eurozone issues with DSK has some great lines, including the following:

“You know what the biggest Greek export is? Hard Workin Greeks!”


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Dorsey, Wright Client Sentiment Survey – 5/20/11

May 20, 2011

Here we have the next round of the Dorsey, Wright Sentiment Survey, the first third-party sentiment poll.  We’re also featuring a Dorsey, Wright Polo Shirt Giveaway Contest & this is your last chance to enter! Participate to learn more.

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 Client Sentiment Survey.

Contribute to the greater good!  It’s painless, we promise.


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Modern Portfolio Theory Is All Wrong

May 20, 2011

…according to a speaker at the recent IMCA conference.  The speaker was Arun Muralidhar, an economist trained at the Sloan School of Management at the Massachusetts Institute of Technology.  He is the former head of investment research for the World Bank, a former managing director at J.P. Morgan Investment Management and currently head of AlphaEngine Global Investment Solutions LLC.

What is his specific criticism?  It has to do with the static nature of traditional portfolio theory.  According to an article in Investment News:

The foundation of the CAPM investing model is to construct an optimal desired portfolio based on the investor’s objectives. As the market moves, the portfolio allocations are re-balanced to get it back to its optimal state. For example, if stock prices go up, a portfolio with 60% stocks and 40% bonds will become over-weighted in stocks. To prevent drift in the portfolio, the adviser re-balances by selling stocks and investing the proceeds in more bonds.

The benefit of this process is that it’s simple, transparent and easy to execute. However, a static re-balancing process does not work well in falling markets, Mr. Muralidhar said. The biggest risks faced by investors are large draw-downs in asset values, as it requires more substantial gains to recover the lost value. The re-balancing does nothing to prevent further losses when asset values plummet — as they did in the financial crisis.

“It’s like tieing the rudder on your ship in place and ignoring the winds and currents that you experience,” Mr. Muralidhar said.

How does he believe assets should be managed?  Well, I’m feeling quite validated today.  In fact, it sounds exactly like the systematic relative strength process we use.

The solution is for advisers to focus on using optimal investment strategies rather than maintaining optimal portfolios, he said. These strategies involve managing allocations more actively, based on market conditions. Mr. Muralidhar suggested advisers employ a “systematic management of assets using a rules-based technique” — “smart” investing.

Essentially, that involves an informed re-balancing of the portfolio toward the more-attractive assets and away from the less-attractive ones.

I added emphasis to the good parts.  I think his focus on optimal investment strategies rather than optimal portfolios is quite insightful.  We’ve long argued that the path to constructing better portfolios is to mix strategies, not just assets.  As it turns out, relative strength and value are both excellent strategies—and they work extremely well in combination because the excess returns are uncorrelated.  Unlike asset cross-correlations which can and do swing wildly up and down, strategy correlations are likely to be much more stable.  The reason is simple: trend-following and trend reversion are opposites; stocks and bonds (or pick any asset pair) are not.

It’s nice to see an economist discussing the theoretical flaws in MPT that have been evident to thoughtful practitioners for years and years.

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Sector and Capitalization Performance

May 20, 2011

The chart below shows performance of US sectors and capitalizations over the trailing 12, 6, and 1 month(s).  Performance updated through 5/19/2011.

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Global Macro as a Hedge Fund Alternative

May 19, 2011

Brett Arends of MarketWatch reports on hedge funds from the SALT conference in this video.  He doesn’t like hedge fund fees, often 2% annually along with 20% of the profits, and points out that their long-term performance hasn’t really been spectacular.  There’s nothing wrong with the hedge fund concept, however, and he concedes that some of the new hedge-fund-like mutual funds may perform well.

Our Global Macro strategy, in both separate account and mutual fund form, is not dissimilar to the strategies used by some Global Macro hedge funds.  It can rotate among domestic equities, international equities, fixed income, commodities, currencies, real estate, and inverse funds.  Below, it is compared to the Index IQ Global Macro hedge fund replication index.  Depending on what your client is looking for in terms of uncorrelated assets to build their portfolio, our Global Macro strategy may be worth a look.

Click to enlarge. Source: Yahoo! Finance

To obtain a fact sheet and prospectus for the Arrow DWA Tactical Fund (DWTFX), click here.

Click here for disclosures.  Past performance is no guarantee of future results.

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Fund Flows

May 19, 2011

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 bond funds continued to attract the most new money last week and have attracted over twice as much money as the next most popular group.  Domestic equity funds continue to bleed assets.


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