Alternative Weighting Methodologies

February 8, 2012

ETFdb recently carried an article about alternative weighting methodologies for ETFs. It’s a good primer to a few different ways in which some indexes are constructed differently from typical capitalization weighting. Some of the methods covered include equal weighting, dividend weighting, revenue weighting, and RAFI (fundamental) weighting. The article points out that no weighting method is a panacea and that all have pros and cons:

Ultimately, there is no universally superior weighting methodology that holds the secret to excess returns. Cap weighting will perform well in certain environments, while equal weighting will lead the way in others. The same can be said for all the other strategies out there; dividend-weighted ETFs enjoyed a banner 2011 as interest in stocks offering meaningful current returns surged.

The choice of weighting methodology is a very important one that has the potential to have a major impact on bottom line returns. But keep in mind that weighting methodologies essentially reflect a tilt towards one factor another, whether it be small cap stocks, value stocks, or leveraged stocks. There are environments in which each of those methodologies will perform well, and others in which they will struggle.

Of course, prominently excluded is relative strength weighting! Just in case you were curious, I included all of the various indexes for the last two years in the chart below, using PDP for relative strength weighting.
Trailing Two-Year Returns
(Click to Enlarge)
The article’s point about no method being magic is well-taken, however. If you look at different time frames, different factors will come to the forefront. For a one-year period, dividend weighting would have been the winner.

See www.powershares.com for more information about PDP. Past performance is no guarantee of future returns. A list of all holdings for the trailing 12 months is available upon request.

1 Comment | Markets, Thought Process | Permalink
Posted by Mike Moody

Thanks, Bank of America!

February 8, 2012

Funny or Die put out a video that encapsulates how consumers felt about the proposed $5 debit card fee. Then it veers off and gets really ridiculous. In truth, financial advisors everywhere-including at Bank of America/Merrill Lynch-are very client-friendly or they wouldn’t be able to make it in the business. Senior managements are sometimes temporarily tone deaf. In real life, the fee idea was dumped, but it did result in this over-the-top video!

Thanks, Bank of America! - watch more funny videos

Source: Funny or Die/Clusterstock

HT: Clusterstock

1 Comment | Just for Fun | Permalink
Posted by Mike Moody

Learning From History

February 8, 2012

The only thing we learn from history is that we learn nothing from history. — Friedrich Hegel

Bloomberg had an interesting article on how much investors currently hate stocks. Consider, for example, the following excerpts:

[The S&P 500] traded at an average of 14.1 times earnings since the start of 2011, the lowest annual valuation since 1989. More than $469 billion has been pulled from U.S. equity mutual funds over five years…

Sentiment is the worst since the early 1980s, when 17 years of equity market stagnation gave way to the biggest rally in history.

Investors pulled money from mutual funds that buy U.S. stocks for a fifth year in 2011, the longest streak in data going back to 1984, according to the Investment Company Institute in Washington.

Valuations have fallen even as the S&P 500 rallied 21 percent since the end of 2009 because profits increased five times as fast. The price-earnings ratio for the benchmark gauge of American equities has fallen to 14 times reported income, down from 24 at the end of 2009.

That’s the backdrop. Profits have increased five times as fast as the market has gone up, but money is still flowing out of US stocks! What happened last time sentiment was so negative?

The past decade parallels the span between Dec. 31, 1964, and the end of 1981, when the Dow added less than 1 point after surging interest rates diminished the appeal of equities. While the 115-year-old stock gauge ended the period at 875, it ranged between 577.60 and 1,051.70.

After stalling for 17 years, the U.S. stock market staged the biggest bull market in history through early 2000, driving the Dow up 15-fold from its low point in 1982.

The retreat leaves stocks in position to rally because so many bearish investors can be lured back to equities and the market is cheap, according to Scott Minerd, the chief investment officer of Santa Monica, California-based Guggenheim Partners LLC, which oversees more than $125 billion.

“Stocks are poised for a generational bull market, whether it starts this year, or next year, or in five years, is anybody’s call,” he said. “Even if we had a 50 percent increase in multiples, stocks would still be cheap.”

History is useful principally because we can go back and check what happened last time. The caveat is that things are never exactly like last time. There’s also no requirement that things operate on the same timetable as before. What does seem apparent, however, is that there is a bigger margin of safety built into the valuations of many stocks than there was even a few years ago. I wouldn’t even hazard a guess as to when the market might take off, but if it does, relative strength will probably be a pretty good way to identify the leadership.

Leave a Comment » | Investor Behavior, Markets, Thought Process | Permalink
Posted by Mike Moody

High RS Diffusion Index

February 8, 2012

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 2/7/12.

The 10-day moving average of this indicator is 86% and the one-day reading is 90%.

Leave a Comment » | Markets | Permalink
Posted by Andy Hyer