Consumer Sentiment Improves

January 27, 2012

The final University of Michigan Consumer Sentiment Index came in at 75.0 for January.  That’s a sharp improvement from where it was last summer and fall, but it’s still in the lower part of the range over the past 30 years.  Check out the fantastic graphic from Calculated Risk:

Source: Calculated Risk  (click on chart to expand)

Maybe the world isn’t ending after all.  One never knows exactly how investors will respond to economic data, but movement from low levels to consumer sentiment to high levels of consumer sentiment is usually associated with decent equity markets.  The best entries tend to occur when sentiment is very poor—i.e., investors are perhaps overly pessimistic.

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Harnessing the Power of Momentum

January 27, 2012

That’s the title of a recent article in Advisor Perspectives about relative strength investing.  (Academics call it momentum.)  The article was written by a principal at a Canadian money management firm, Michael Nairne, so it’s nice to see a little cross-border validation.  From the article:

Numerous academic studies have confirmed that, when measured in periods of approximately three to 12 months, past investment winners tend to keep on outperforming while past losers tend to keep underperforming.

Momentum is not simply a US phenomenon. A recent study2 covering equities in 23 countries from November 1989 to September 2010 found evidence of strong momentum returns in North America, Europe and Asia Pacific; only Japan was an exception. Another study tracking the largest 100 stocks in the British market from 1900 to 2009 found that a portfolio comprised of the 20 best performers over the prior 12 months outperformed the worst performers by 10.3% annually3.  The same authors found momentum in 18 out of 19 markets, dating back to 1975 in larger European markets and 1926 in the US.

Momentum is not confined to portfolios of individual stocks – it exists in a variety of asset classes. A recent study4 has found that momentum exists in government bonds, commodities and currencies as well as country equity indexes. Momentum has also been found in corporate bonds5 as well as the financial futures market6.

The article is well-footnoted.  I recommend you read the original, which I linked to above.  The article does a good job discussing both the pros and cons of relative strength.  For example, the author points out that:

…there are prolonged periods where stocks with positive momentum underperform the market.  Despite an overall annualized premium of 3.9%, there have 22 periods where stocks with positive momentum have underperformed the market by greater than 5%, with durations as long as several years.

Although investors have a marked tendency to abandon strategies when they underperform for a period of time, that might not be a good idea with relative strength.  Despite periods of underperformance, long-term results have been remarkable:

The $1.00 investment in momentum stocks grew to $67,309, nearly 30-times larger than the $2,321 earned in the S&P 500. [August 1927 to July 2011]  For long-term investors, this outperformance has been remarkably enduring. In 99.6% of the 10-year rolling periods since July 1937, momentum stocks have outperformed the S&P 500. [my emphasis]

Investors have a lot of choices when it comes to selecting an investment strategy, but not many have been as well validated over as long a period of time in multiple markets as relative strength.

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From the Archives: Another Way To Look at Modern Portfolio Theory

January 27, 2012

This week the noted management consultant, Russell Ackoff, passed away.  He was famous for gathering data and trying to use it to make the correct decision.  His fundamental theory was this:

All of our social problems arise out of doing the wrong thing righter. The more efficient you are at doing the wrong thing, the wronger you become. It is much better to do the right thing wronger than the wrong thing righter! If you do the right thing wrong and correct it, you get better!

Since the origination of Modern Portfolio Theory in the 1950s, academics and practitioners have been polishing it up and implementing in better and better ways.  It may just have been a case of getting more efficient at doing the wrong thing—and the wronger it got.  After 2008, even many of its supporters began to acknowledge that there were problems with its implementation.

This recognition has fueled a rush to the new magic potion, tactical asset allocation.  If tactical asset allocation is indeed the “right” thing, it should work out better than doing something wrong.  Yet there are significant challenges in the design and execution of a systematic tactical asset allocation process as well.  I think going forward, it’s going to be important to distinguish between marketers who are trying to exploit the latest fad and practitioners who have a well-thought-out and well-executed process for tactical asset allocation.

—-this article was originally published 11/13/2009.  It’s hard to do the right thing right, but don’t settle for doing the wrong thing righter!

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Sector and Capitalization Performance

January 27, 2012

The chart below shows performance of US sectors and capitalizations over the trailing 12, 6, and 1 month(s).  Performance updated through 1/26/2012.

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