Weekly RS Recap

December 31, 2012

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 (12/24/12 – 12/28/12) is as follows:

ranks 12.31.12 Weekly RS Recap

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Sector and Capitalization Performance

December 28, 2012

The chart below shows performance of US sectors and capitalizations over the trailing 12, 6, and 1 month(s).  Performance updated through 12/27/2012.

gics 12.28.12 Sector and Capitalization Performance

Numbers shown are price returns only.

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PIE: Inflow Alert

December 27, 2012

Forbes points out that the PowerShares DWA Emerging Markets Technical Leaders Index (PIE) was the recipient of of some rather large flows over the past week:

Looking today at week-over-week shares outstanding changes among the universe of ETFs covered at ETF Channel, one standout is the DWA Emerging Markets Technical Leaders Portfolio (AMEX: PIE) where we have detected an approximate $60.2 million dollar inflow — that’s a 27.8% increase week over week in outstanding units (from 11,850,000 to 15,150,000). Among the largest underlying components of PIE, in trading today Tata Motors Ltd (NYSE: TTM) is up about 0.3%, Cosan Ltd (NYSE: CZZ) is up about 1.4%, and Companhia Brasileira de Distribuicao (NYSE: CBD) is up by about 1.1%.

A chart of PIE over the past 6 months is shown below:

pie yahoo PIE: Inflow Alert

Source: Yahoo! Finance

See www.powershares.com for more information.

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Fascinating Data on Trend Following

December 27, 2012

Very interesting data published by Mark Hanna that explains much of the challenges that trend followers have had over the past couple of years:

Historically the idea with basic technical analysis is to be very cautious when the market breaks key technical moving averages – especially the longer term ones i.e. 200 day moving average; and conversely be aggressive when above said averages.   Since 1940 you’d get an outperformance of some 10% on the S&P 500 by following that simple rule.  However in his weekly letter John Hussman points out that policy makers have created a “new normal” with their interventionist policies since 2009.  It helps explain why things have been quite backwards for much of the past few years and certainly had me a bit shocked at the data.  But it makes sense when you think of all the “V shaped” moves off of broken charts when an explicit intervention was announced by this central bank or that one, or one government body or another.  That said the incredible lack of progress when markets are over their 200 day MA and their incredible bounces when below since 2009 (or even 2010) are quite eye opening.

To put some numbers on this, it’s worth noting that since 1940, the S&P 500 has achieved an average annual total return of 14.5% in weeks where it was above its 200-day moving average as of the prior week’s close, and just 4.4% when it was below its 200-day moving average.

By contrast, since 2009, the S&P 500 has achieved an average total return of just 5.4% annually when it has been above its 200-day average, versus 36.7% when it has been below. Put another way, advancing trends above the 200-day average have repeatedly failed, making limited net progress overall, but declines have been halted and often breathtakingly reversed with each intervention. This pattern also reflects an unfinished cycle, the completion of which is likely to significantly damage the appeal of reflexively “buying the dip.”

The recent pattern isn’t just an artifact of the rebound from the 2009 low. Even since 2010, the S&P 500 has gained just 1.5% annually when it has been above its 200-day moving average, versus a striking 46.3% annual return when it has been below. Needless to say, this pattern is not necessarily indicative of how the S&P 500 will behave in the future, and is in fact contrary to the historical pattern.

It is common to hear explanations for why the interventionist tendencies of policy makers are here to stay.  However, I think it much more likely that “this too shall pass.”  After all, this is surely not the first time in our history where interventionist policies have been elevated for periods of time.

HT: Abnormal Returns

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Pundit Scorecard

December 27, 2012

The WSJ’s article 2012 Was Good for Stocks, Bad for Stock Pundits reviews the track record for some well known pundits.  After detailing some of the blown 2012 calls by Jim Rogers and Jim Cramers, the article provides the following rather dreary summary:

Neither Mr. Rogers nor Mr. Cramer should feel singled out. The business of market punditry is fraught with potholes.

Of the 65 market “gurus” tracked during the last few years by CXO Advisory Group, the median accuracy for market calls is 47%. If that sounds low, or you wonder about the quality of the pundit, consider that the list includes such well-known names as Bill Fleckenstein (37%), Jeremy Grantham (48%), Bill Gross (46%) and Louis Navellier (60%).

The record speaks for itself. Most of the smartest guys in the room are usually about as reliable as a coin flip. After bombing in 2011 with a prediction that Treasury yields would rise, Mr. Gross, founder and co-chief investment officer of Pacific Investment Management Co., didn’t make any sweeping predictions for 2012 except to say he worried about Europe.

Something to keep in mind while reviewing forecasts for 2013.

crystal ball2 Pundit Scorecard

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Fund Flows

December 27, 2012

Mutual fund flow estimates are derived from data collected by The Investment Company Institute covering more than 95 percent of industry assets and are adjusted to represent industry totals.

ici 12.27.12 Fund Flows

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Quote of the Day

December 26, 2012

A man should look for what is, and not for what he thinks should be.—Albert Einstein

Einstein 1921 portrait2 Quote of the Day

 

 

 

 

 

 

 

 

 

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High RS Diffusion Index

December 26, 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 12/24/12.

diffusion 12.26.12 High RS Diffusion Index

The 10-day moving average of this indicator is 80% and the one-day reading is 81%.

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Weekly RS Recap

December 24, 2012

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 (12/17/12 – 12/21/12) is as follows:

ranks 12.24.12 Weekly RS Recap

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Sector and Capitalization Performance

December 21, 2012

The chart below shows performance of US sectors and capitalizations over the trailing 12, 6, and 1 month(s).  Performance updated through 12/20/2012.

gics 12.21.12 Sector and Capitalization Performance

Numbers shown are price returns only.

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Tax-Efficient Alpha

December 20, 2012

As the national debate about taxes, spending, and “fairness” rages on, wealthy investors are justifiably concerned about what this means for their after-tax returns.  We can expect that our clients are going to be asking a lot more questions about tax efficiency in the coming months and years.  With that in mind, consider the good news released by PowerShares this past week:

CHICAGO – December 18, 2012 – Invesco PowerShares Capital Management LLC, a leading global provider of exchange-traded funds (ETFs), announced today that it expects to deliver zero long-term capital gains distributions across 120 of 123 equity and fixed-income ETFs for 2012.

“At Invesco PowerShares we are proud of our product line’s tax efficient track record,” said Ben Fulton, Invesco PowerShares managing director of global ETFs. “For the tenth consecutive year, we are pleased that the vast majority of PowerShares ETFs did not deliver capital gains distributions. This accomplishment highlights one of the many advantages ETFs can potentially provide shareholders seeking to maximize real returns.”

We are pleased to announce that the four ETFs in the PowerShares DWA family of Technical Leaders ETFs (PDP, PIE, PIZ, and DWAS) are among the ETFs that are expected to deliver zero long-term capital gains distributions in 2012.  In fact, PDP is now coming up on six years since its inception and it has not delivered a capital gains distribution in any of those years.  And, it has outperformed the S&P 500 since inception.

That is not a bad combination: Delivering alpha through the investment process AND delivering tax-efficient alpha through the ETF structure.

For a review of the way that ETFs are able to provide tax efficiency, consider the following from PowerShares’ website:

How do ETFs deliver tax efficiency?

Taxes may be one of the most critical and yet overlooked factors in wealth creation over time as they can erode even the best fund’s returns.  Because of their unique structure, ETFs may serve as a tax-efficient investment tool for shareholders who wish to defer capital gains until the point of sale.

While it is not Invesco PowerShares intention, there is no guarantee that the Funds will not distribute capital gains to its shareholders.  Invesco Powershares does not offer tax advice.  Please consult your own tax advisor for information regarding your own tax situation.

How is the in-kind redemption process unique?

PowerShares ETFs use a LI-FO (lowest in – first out) in-kind tax management strategy unique to ETFs.  This method typically allows the fund manager, during the creation and redemption process, to purge the lowest cost basis stocks through in-kind, no-taxable stock transfers.  This unique operational trait leaves the fund with the highest cost basis securities, which systematically reduces tax exposure.

See www.powershares.com for more information.  Past performance is no guarantee of future returns.

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Fund Flows

December 20, 2012

Mutual Fund flow estimates are derived from data collected by The Investment Company Institute covering more than 95 percent of industry assets and are adjusted to represent industry totals.

ici 12.20.12 Fund Flows

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Dorsey: ETF Revolution Just Starting

December 19, 2012

Want to know how important ETFs are to Dorsey Wright and to our entire industry?  Read this Q&A with IndexUniverse and Tom Dorsey.  Here’s the summary:

Tom Dorsey, president and founder of Dorsey Wright & Associates, can’t say enough positive things about ETFs. His business of point and figure technical analysis is now focused on ETFs, and their role in all that he does will only increase.

When IndexUniverse.com Managing Editor Olly Ludwig caught up with Dorsey on the sidelines of IndexUniverse’s Inside Trading ETFs conference last week at the New York Stock Exchange, Dorsey predicted that one of the four ETFs it created with Invesco PowerShares, the PowerShares DWA Technical Leaders Portfolio (NYSEArca: PDP), is likely to cross the $1 billion threshold sometime early next year.

That’s hardly a surprise to Dorsey, who considers the ETF the most important financial innovation in his 37-year career in the money management industry, and sees the development so far amounting to the first foot of a 26-mile marathon.

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High RS Diffusion Index

December 19, 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 12/18/12.

diffusion 12.19.12 High RS Diffusion Index

The 10-day moving average of this indicator is 76% and the one-day reading is 89%.

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Relative Strength Spread

December 18, 2012

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 12/17/2012:

RS Spread 12.18.12 Relative Strength Spread

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Client Sentiment Survey Results – 12/7/12

December 17, 2012

Our latest sentiment survey was open from 12/7/12 to 12/14/12.  The Dorsey, Wright Polo Shirt Raffle continues to drive advisor participation, and we greatly appreciate your support!  This round, we had 58 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 fairly comfortable about the statistical validity of our sample. Some statistical uncertainty this round comes from the fact that we only had four investors say that thier clients are more afraid of missing a stock upturn than being caught in a downdraft. 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?

greatestfear 60 zpsb29b1acc Client Sentiment Survey Results   12/7/12

Chart 1: Greatest Fear.  From survey to survey, the S&P 500 rose by around +0.5%, and our indicators responded as expected.  The fear of downdraft group fell from 89% to 83%, while the upturn group rose from 11% to 17%.  Despite the modest move towards more risk, client sentiment remains poor.

greatestfearspread 2 zps0794d07a Client Sentiment Survey Results   12/7/12

Chart 2: Greatest Fear Spread. Another way to look at this data is to examine the spread between the two groups.  The spread dropped again, from 78% to 65%.

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

avgriskapp 50 zps8f2a85d3 Client Sentiment Survey Results   12/7/12

Chart 3: Average Risk Appetite.  Average risk moved higher this round with the market, from 2.43% to 2.54%.

riskappbellcurve 37 zps082e4f89 Client Sentiment Survey Results   12/7/12

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 round, over 90% of all respondents wanted a risk appetite of 3 or less for the third survey round in a row.

riskappbellcurvegroup 18 zps704c4032 Client Sentiment Survey Results   12/7/12

Chart 5: Risk appetite Bell Curve by Group.  The next three charts use cross-sectional data.  The chat plots the reported client risk appetite separately for the fear of downdraft and for the fear of missing upturn groups.  We can see the upturn group wants more risk, while the fear of downturn group is looking for less risk.

avggrouprisk 1 zps0e8435f5 Client Sentiment Survey Results   12/7/12

Chart 6: Average Risk Appetite by Group.  This round, the downturn group’s average remained exactly the same, while the upturn group’s average jumped by a large degree.

spreadriskapp zpse4fe5b37 Client Sentiment Survey Results   12/7/12

Chart 7: Risk Appetite Spread.  This is a 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 jumped this round.

The S&P 500 inched higher from survey to survey, and our indicators responded in-kind to the same degree.  The greatest fear numbers moved slightly towards the positive, and overall risk appetite nudged higher.  Client sentiment remains poor overall.

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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Fama and French Love Relative Strength?

December 17, 2012

Although relative strength investors are not always happy about having their return factor co-opted by academics (who re-named it “momentum”), it’s always nice to see that academics love the power of momentum.  In their 2007 paper, Dissecting Anomalies, Eugene Fama and Ken French cover the waterfront on return anomalies, examining them both through style sorts and regression analysis.  CXO Advisory put together a very convenient summary of their findings, reproduced below.

famafrench CXO Fama and French Love Relative Strength?

Source: CXO Advisory  (click to enlarge)

CXO’s conclusion is especially succinct: In summary, some anomalies are stronger and more consistent than  others.    Momentum appears to be the strongest and most consistent.

We couldn’t have said it better ourselves.

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Weekly RS Recap

December 17, 2012

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 (12/10/12 – 12/14/12) is as follows:

ranks 12.17.12 Weekly RS Recap

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Relative Strength Everywhere

December 14, 2012

Eric Falkenstein has an interesting argument in his paper Risk and Return in General: Theory and Evidence.  He proposes what is essentially a relative strength argument about risk and return.  He contends that investors care only about relative wealth and that risk is really about deviating from the social norm.  Here is the summary of his draft from the excellent CXO Advisory:

Directly measured risk seldom relates positively to average returns.  In fact, there is no measure of risk that produces a consistently linear scatter plot with returns across a variety of investments (stocks, banks, stock options, yield spread, corporate bonds, mutual funds, commodities, small businesses, movies, lottery tickets and bets on horse  races).

  • Humans are social animals, and processing of social  information (status within group) is built into our brains. People care only about relative wealth.
  • Risk is a deviation from what everyone else is doing (the market portfolio) and is therefore avoidable and unpriced. There is no risk premium.

The whole paper is a 150-page deconstruction of the flaws in the standard model of risk and return as promulgated by academics.  The two startling conclusions are that 1) people care only about relative wealth and that 2) risk is simply a deviation from what everyone else is doing.

This is a much more behavioral interpretation of how markets operate than the standard risk-and-return tradeoff assumptions.  After many years in the investment management industry dealing with real clients, I’ve got to say that Mr. Falkenstein re-interpretation has a lot going for it.  It explains many of the anomalies that the standard model cannot, and it comports well with how real clients often act in relation to the market.

In terms of practical implications for client management, a few things occur to me.

  • Psychologists will tell you that clients respond more visually and emotionally than mathematically.  Therefore, it may be more useful to motivate clients emotionally by showing them how saving money and managing their portfolio intelligently is allowing them to climb in wealth and status relative to their peers, especially if this information is presented visually.
  • Eliminating market-related benchmarks from client reports (i.e., the reference to what everyone else is doing) might allow the client to focus just on the growth of their relative wealth, rather than worrying about risk in Falkenstein’s sense of deviation from the norm.  (In fact, the further one gets from the market benchmark, the better performance is likely to be, according to studies on active share.)  If any benchmark is used at all, maybe it should be related to the wealth levels of the peer group to motivate the client to strive for higher status and greater wealth.

I’m sure there is a lot more to be gleaned from this paper and I’m looking forward to having time to read it again.

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Sector and Capitalization Performance

December 14, 2012

The chart below shows performance of US sectors and capitalizations over the trailing 12, 6, and 1 month(s).  Performance updated through 12/13/2012.

gics 12.14.12 Sector and Capitalization Performance

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Legendary Investors

December 13, 2012

Certain kinds of investment and certain investors have been accorded legendary status in the investment community.  Most of the time, this amounts to worshipping a false idol.  Either that or legendary investors are just exceptionally good at public relations.  Here are some stories about legendary investors you might find illuminating.

 

Ben Graham, the father of Value Investing (from the Psy-Fi blog)

Following the Wall Street Crash he geared up, borrowing money to invest in the huge range of cheap value stocks that were available in the market.  Not being psychic he failed to divine that the recovery in ’30 was the prelude to the even greater drop in ’31.

Faced with ruination for himself and his clients he was lucky enough to be recapitalised by his partner’s father-in-law and restored his and their wealth over the next few years, as the markets stabilised and some sort of normality took hold again.

Yep, Ben Graham blew up and needed a bailout.

 

John Maynard Keynes, the father of Keynesian economics and manager of the King’s College, Cambridge endowment (from the Psy-Fi blog)

For Keynes investing was about figuring out what everyone else would want to buy and buying it ahead of them.  Back in the Roaring Twenties he expressed this approach through currency speculation.  Prior to the First World War this would have been an exercise in futility as major currencies were all pegged to the immovable Gold Standard: exchange rates didn’t move.  However, the disruption to major economies caused by the conflict forced countries off gold and into a world of strangely shifting valuations.

In this new world Keynes saw the opportunity to apply his animal spirits philosophy and rapidly managed to generate a small fortune, by trading heavily on margin, as the German economy collapsed into hyperinflation, France struggled with an accelerating rate of change of governments and financial scandals, Britain failed to recognise its new place in the world order and the USA lapsed into protectionism.  And then, as is the way of the investing world, there was a sudden and inexplicable reversal in the trajectory of exchange rates and Keynes found himself and his fellow investors suddenly short of the cash needed to make good their positions.

As Ben Graham found, when you’re in dire need the best thing to have handy is a wealthy friend.  In this case it was Keynes’ father who bailed him out.

Yep, Keynes blew up and needed a bailout from Dad.

 

Warren Buffett, the King of Buy-and-Hold (from CXO Advisory)

In their July 2010 paper entitled “Overconfidence, Under-Reaction, and Warren Buffett’s Investments”, John Hughes, Jing Liu and Mingshan Zhang investigate how other experts/large traders contribute to market underreaction to Berkshire Hathaway’s moves. Using return, analyst recommendation, insider trading and institutional holdings data for publicly traded stocks listed in Berkshire Hathaway’s quarterly SEC Form 13F filings during 1980-2006 (2,140 quarter-stock observations), they find that:

The median holding period is one year, with approximately 20% (30%) of stocks held for more than two years (less than six months).

Yep, Warren Buffett has 100% turnover.  He blew out 30% of his portfolio selections within six months, and held about 20% of his picks for the longer run.  That is active trading by any definition.

 

All three of these investors were quite successful over time, but the reality varies from the perception.  What can we learn from the actual trading of these legendary investors?

  • Using a lot of leverage probably isn’t a good idea.  If you do use leverage, then make sure you have a big pile of cash set aside for when the margin call arrives.  Because it will arrive.
  • A variety of investment methods probably work over time, but no method works all the time.  All methods have the ability to create a painful drawdown.  In other words, there is no magic method and no free lunch.
  • It makes sense to keep a portfolio fresh.  In Buffett’s portfolio, about 20% of the holdings make the grade and turn into longer term investments.  Things that are not working out should probably be sold.  (In passing, I note that relative strength rankings make this upgrading process rather simple.)  In Buffett’s portfolio, the bulk of the return obviously comes from the relative strength monsters—those stocks that have performed well for a very long period of time.  Those are the stocks he holds on to.  That merits some attention as a best practice.

As in most arenas in life, it is usually more productive to pay attention to what people do, not what they say!

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Fund Flows

December 13, 2012

Mutual Fund flow estimates are derived from data collected by The Investment Company Institute covering more than 95 percent of industry assets and are adjusted to represent industry totals.

ici 12.13.12 Fund Flows

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Winners and Losers

December 12, 2012

If you’ve ever wondered why clients remember their winners so well—and are so quick to sell them–while forgetting the losers and how badly they have done, some academics have done you a favor.  You can read this article for the full explanation.  Or you can look at this handy graphic from CXO Advisory that explains how clients use different reference points for winners and losers.  In short, the winners are compared with their highest-ever price, while losers are compared with their break-even purchase price.

winnersandlosers cxo Winners and Losers

Source: CXO Advisory

It explains a lot, doesn’t it?  It explains why clients make bizarre self-estimates of their investment performance.  And it explains why clients are perpetually disappointed with their advisors—because they are comparing their winners with the highest price achieved.  Any downtick makes it a loser in their eyes.  The losers are ignored, in hopes they will get back to even.

The antidote to this cognitive bias, of course, is to use a systematic investment process that ruthlessly evaluates every position against a common standard.  If you are a value investor, presumably you are estimating future expected returns as your holding criterion.  For relative strength investors like ourselves, we’re constantly evaluating the relative strength ranking of each security in the investment universe.  Strong securities are retained, and securities that weaken are swapped out for stronger ones.  Only a systematic process is going to keep you from looking at reference points differently for winners and losers.

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The ETF Is A Game Changer

December 12, 2012

Tom Dorsey keynotes the IndexUniverse Conference:

Tom Dorsey, president of the investment advisory firm Dorsey Wright Associates, which specializes in technical analysis, said the exchange-traded fund looms largely as the biggest financial innovation of his 37-year career.

“The ETF is a game changer,” Dorsey told attendees at IndexUniverse’s inaugural “Inside ETFs Trading” conference today in New York, saying ETFs have given investors previously nonexistent opportunities to gain access to broad swaths of financial markets in an inexpensive and transparent package.

Dorsey, known for championing point and figure technical charting at Dorsey Wright since about 1987, spoke to the crowd of about 260 financial advisors about his methodology, and stressed that ETFs were now at the center of his firm’s business plan and would only grow in importance in the coming years.

“We’re in the first foot of a 26-mile marathon,” Dorsey said, arguing that most U.S. investors still aren’t aware of ETFs and, internationally, ETF market growth has barely gotten under way.

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High RS Diffusion Index

December 12, 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 12/11/12.

diffusion 12.12.121 High RS Diffusion Index

The 10-day moving average of this indicator is 72% and the one-day reading is 77%.

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