Systematic Relative Strength

In a recent blog post we discussed the agricultural markets (corn, soybeans, & wheat) were beginning to exhibit improving relative strength characteristics when compared to their peers within the commodities sector. In this post, we will visit the exact opposite scenario and take at one of the soft commodities which is beginning to display signs of weakening relative strength.

Although not the most commonly discussed market, Cocoa futures have actually outperformed the majority of its peers (exceptions being Feeder Cattle, Live Cattle, & Zinc) over the last 9 months. In fact, the year to date performance (as of 10/27) is up 8.42%. However, as we mentioned above, recent technical developments are starting to show signs that this out performance may be coming to an end. We will keep consistent with our theme of looking at traditional point & figure charts to determine if any of the recent developments may give us an idea what the current supply & demand characteristics are saying.

Point & Figure: Cocoa (Dec 14 – CC/Z4)

The point and figure chart below displays a spread triple bottom break which was confirmed when Dec ’14 Cocoa futures were unable to find a bid at the previous area of demand near the 3080 level. Once price traded below the 3060 level, a new box was formed and confirmed the pattern which currently has a measured move target down at the 2740 level. Let’s think about that in terms of supply & demand. On the two previous attempts the market found a firm bid near the 3080-3060 level and held firm. On the most recent attempt, those same market participants did not show up as they have before and the supply (sellers) of the cocoa market overwhelmed the demand (buyers). Thus far the sell signal has been working quite well, with Cocoa futures trading sharply lower over the past 2 sessions and briefly touching levels not seen since May 2014. This is an example of a market which had been outperforming the majority of its peers and is now beginning to display signs of losing relative strength within the commodities asset class.

Conclusion:

The above blog post provides some insight on using traditional point and figure charts to help identify markets which were once outperforming the majority of their peers but is now showing signs of weakness. In the case of Cocoa futures, the spread triple bottom break which was confirmed on the move through 3060 as thus far ushered a sharp move lower. Time will tell if the measured move target of 2740 is met or not, but one thing we can confirm is that the supply & demand picture for cocoa prices has recent shifted in favor of the bears.

***The relative strength strategy is not a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value. The information found on Dorsey, Wright & Associates’ Web Pages has been prepared without regard to any particular investor’s investment objectives, financial situation, and needs. Accordingly, investors should not act on any recommendation (express or implied) or information in this report without obtaining specific advice from their financial advisors and should not rely on information herein as the primary basis for their investment decisions. Information contained herein is based on data obtained from recognized statistical services, issuer reports or communications, or other sources, believed to be reliable. However, such information has not been verified by Dorsey, Wright and Associates, LLC (DWA) or the information provider and DWA and the information providers make no representations or warranties or take any responsibility as to the accuracy or completeness of any recommendation or information contained herein.

Neither the information nor any opinion expressed shall constitute an offer to sell or a solicitation or an offer to buy any securities or commodities mentioned herein. This report or chart does not purport to be a complete description of the securities or commodities, market or developments to which reference is made. There may be instances when fundamental, technical, and quantitative opinions may not be in concert.

Each investor should carefully consider the investment objectives, risks and expenses of any Exchange-Traded Fund (“ETF”) prior to investing. Before investing in an ETF investors should obtain and carefully read the relevant prospectus and documents the issuer has filed with the SEC. To obtain more complete information about the product the documents are publicly available for free via EDGAR on the SEC website (http://www.sec.gov).

A list of all holdings for the past 12 months is available upon

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 (10/20/14 - 10/24/14) is as follows:

More like that, please.

This example is presented for illustrative purposes only and does not represent a past recommendation. The performance above is based on pure price returns, not inclusive of dividends or all transaction costs. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.

The chart below shows performance of US sectors over the trailing 12, 6, and 1 month(s). Performance updated through 10/23/14.

The performance above is based on pure price returns, not inclusive of dividends or all transaction costs. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss. Source: iShares

It’s no secret the majority of commodities markets have had a very tough year. Some of the hardest hit sectors have been the energies, grains, and metals markets. Over the last 9 months, some of these markets are down as much as 16%. Let’s think about that for a second and compare this to the performance of the S&P 500 which is up 6%. We can get a fairly good idea of where the relative strength has been among asset classes just by stating those figures!

At Dorsey Wright, we use a systematic based investing process focused on relative strength to help minimize our exposure to the under-performing asset classes around the world. This has allowed us to limit our exposure towards commodities, while maintaining exposure towards the stronger performing asset classes around the globe such as US Equities. However, this isn’t to say that down the road the commodities sector won’t come back into favor and having the ability to rotate back into this area should the tide turn is an added benefit of being a tactical investor.

Although the relative strength readings for the majority of commodities remain very weak, it’s worth noting some recent technical developments in the grain markets may be a sign the supply & demand relationship in the agriculture sector may be changing in favor of the bulls for the short term. We will discuss this in further detail below.

Corn Futures (Dec ’14): Point & Figure

In taking a look at the below point & figure chart chart, we can see there have been some positive developments which recently occurred on the Dec ’14 Corn chart. The triple top spread break out which was confirmed with the move above $3.60 currently has a measured move target of $3.96. Time will tell whether or not this target is achieved, but the ability of the market to take out overhead supply which had been rejected on two previous attempts is worth monitoring.

Soybean Futures (Jan ’15): Point & Figure

A similar technical development also recently occurred on the Jan’15 Soybeans chart. The double top break out which was confirmed with the move above $9.84 and currently has a measured move target of $10.60. Again, this re-enforces the idea that the supply of the market which had previous rejected prices has been overcome by demand in the short term.

Wheat Futures (CBOT - Dec ’14): Point & Figure

To round things out, lets take a look at the point & figure chart of CBOT Wheat to see if a similar situation has developed like it did in both corn and soybeans. Sure enough, a double top break out was recently confirmed with a move above $5.15. The measured move price target is currently $5.80.

Conclusion:

Above we have discussed some of the recent positive development on the traditional point and figure charts for a few of the commodities within the agricultural sector. In a beaten down asset class such as commodities, this may be a sign that pockets of relative strength are beginning to show up in corn, soybeans, & wheat when compared to other peers within the commodities asset class. The ability to gain exposure towards these sectors should their relative strength readings continue to improve is just another example in the benefits of following a tactical investment methodology.

***The relative strength strategy is not a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value. The information found on Dorsey, Wright & Associates’ Web Pages has been prepared without regard to any particular investor’s investment objectives, financial situation, and needs. Accordingly, investors should not act on any recommendation (express or implied) or information in this report without obtaining specific advice from their financial advisors and should not rely on information herein as the primary basis for their investment decisions. Information contained herein is based on data obtained from recognized statistical services, issuer reports or communications, or other sources, believed to be reliable. However, such information has not been verified by Dorsey, Wright and Associates, LLC (DWA) or the information provider and DWA and the information providers make no representations or warranties or take any responsibility as to the accuracy or completeness of any recommendation or information contained herein.

Neither the information nor any opinion expressed shall constitute an offer to sell or a solicitation or an offer to buy any securities or commodities mentioned herein. This report or chart does not purport to be a complete description of the securities or commodities, market or developments to which reference is made. There may be instances when fundamental, technical, and quantitative opinions may not be in concert.

Each investor should carefully consider the investment objectives, risks and expenses of any Exchange-Traded Fund (“ETF”) prior to investing. Before investing in an ETF investors should obtain and carefully read the relevant prospectus and documents the issuer has filed with the SEC. To obtain more complete information about the product the documents are publicly available for free via EDGAR on the SEC website (http://www.sec.gov).

A list of all holdings for the past 12 months is available upon request.

As most of our long time followers know, at Dorsey Wright we are interested in keeping our analysis as simple as possible when making investment decisions. When it comes down to it, we believe it’s the supply & demand of the market which actually moves asset prices. Our systematic approach to relative strength based investing allows us to remove human emotion from the investment process and apply a robust investment philosophy to the markets. We believe this approach allows us to eliminate the day to day market “noise.” .

Yesterday, tech giant AAPL reported earnings after the close. This created a buzz among financial news media as AAPL is often looked at as one of the most important leadership stocks in the NASDAQ. We thought it would be interesting to take a look at the technical set up of the traditional point and figure chart too see if the current supply & demand of the market can give us any insight in how the stock will react to the recent earnings headlines.

AAPL: Point & Figure Chart

A quick glance at the point and figure chart below and we can see just how important the $104.00 level is in terms of supply and demand. This is now a quadruple top area in which the bulls have been unable to take out on previous attempts. Note also the previous double bottom sell signal which occurred on 10/15 and had a measured move price target of $88.00. This is now looking more like a “bear trap”, but in order for the signal to be negated AAPL will need to trade above $104.00 to confirm the quadruple top break out mentioned earlier. As we’ve stated in previous blog posts, with false moves also come fast moves. Furthermore, the more often a level is tested and rejected (such as the quadruple top), the more energy this market is building should it eventually break out. Time will tell if the bulls will be able to obtain this in the near future, but it is certainly worth keeping an eye on. A confirmed break out may be a sign that relative strength readings for AAPL are set to increase in the near term.

Dorsey Wright currently has a position in AAPL.

Conclusion:

In the above post, we’ve provided a good example of how analyzing traditional point & figure charts in terms of supply & demand is a simple way of eliminating much of the market “noise” on earnings report days for major market moving stocks such as AAPL. In essence, supply & demand are in equilibrium right now just below the $104.00 level for the stock of AAPL. Thus far, the market has been unable to generate enough momentum to take out the overhead supply and force the next leg up. However, it’s worth keeping an eye on and should the break out be confirmed it may be a sign the relative strength readings for AAPL are set to increase against its peers.

This example is presented for illustrative purposes only and does not represent a past recommendation. The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value. The information found on Dorsey, Wright & Associates’ Web Pages has been prepared without regard to any particular investor’s investment objectives, financial situation, and needs. Accordingly, investors should not act on any recommendation (express or implied) or information in this report without obtaining specific advice from their financial advisors and should not rely on information herein as the primary basis for their investment decisions. Information contained herein is based on data obtained from recognized statistical services, issuer reports or communications, or other sources, believed to be reliable. However, such information has not been verified by Dorsey, Wright and Associates, LLC (DWA) or the information provider and DWA and the information providers make no representations or warranties or take any responsibility as to the accuracy or completeness of any recommendation or information contained herein. Neither the information nor any opinion expressed shall constitute an offer to sell or a solicitation or an offer to buy any securities or commodities mentioned herein. This report or chart does not purport to be a complete description of the securities or commodities, market or developments to which reference is made. There may be instances when fundamental, technical, and quantitative opinions may not be in concert. A list of all holdings for the past 12 months is available upon request.

“Why do we own bonds?” Investor in 2013

“Why don’t we own more bonds?” Same investors, now

The sharp equity market declines in recent weeks have once again confirmed that fixed income remains the ballast and primary diversifier of a portfolio. Investors should expect that when other asset classes are experiencing losses, fixed income investments will remain resilient and mitigate a portfolio’s overall decline. For most investors, fixed income will always remain a meaningful piece of the overall portfolio. As part of that fixed income allocation, unconstrained fixed income strategies are growing in demand. From the September/October 2014 IMCA Journal:

Morningstar’s nontraditional bond fund category, which contains the majority of funds classified as unconstrained, grew from $20 billion in total assets in January 2010 to $119 billion in total assets as of November 2013.

At Dorsey Wright, we believe that this category of unconstrained bond strategies will continue to become more important to investors in the years ahead. In March of 2013, we introduced our “Tactical Fixed Income” separately managed account and we have been very happy with the results since inception. Performance and holdings are shown below:

For more information about this strategy, pleas see the FAQ’s below:

Why is there a need for Tactical Fixed Income?

Bond buyers face a dilemma. Yields are very, very low (and have recently been going even lower). If interest rates stay low this low, bondholders are facing minimal returns, all the while having those returns eaten away by inflation. If interest rates rise, bondholders are facing potentially significant capital losses. Both outcomes, obviously, are problematic. This situation demands a tactical solution that can manage through either outcome.

At Dorsey Wright, we have taken our time-tested relative strength tools and have applied them in a unique way to the fixed income markets. This solution is now available as a separately managed account. We think it will be welcome news for bond holders and prospective bond buyers who are grappling with the current bond market dilemma. Equally important, we think it will be a robust solution in the future across a broad range of possible interest rate environments.

What is the investment universe for the Tactical Fixed Income strategy?

The Tactical Fixed Income strategy can invest in short-term and long-term U.S. Treasurys, inflation-protected bonds, corporate, convertible, high yield, and international bonds. This is a broad universe of fixed income types that have varying yields and volatility characteristics.

How is the risk managed in the Tactical Fixed Income portfolio?

The Tactical Fixed Income model structures the portfolio in a way that balances risk and reward. Certain types of fixed income behave better in “risk-on” environments, while other fixed income categories are more defensive. Our model is built to ensure that the portfolio remains diversified. It’s very important to understand that this is designed as core fixed income exposure. We’re trying to generate good fixed income returns, without creating equity-like volatility.

Our model compares the relative strength of all of the ETFs in the investment universe. Those fixed income sectors exhibiting the strongest trends will be represented in the portfolio.

How does the strategy handle a rising rate environment?

Although the general trend of interest rates has been down over the past three decades, there have been periods where rates have generally risen. The period of mid-2003 to mid-2007 was generally a period of rising interest rates, while the period of mid-2007 to present has generally been a period of declining interest rates. Sectors like long term government bonds tend to perform much better in a declining interest rate environment while sectors like convertible bonds tend to perform much better during rising rate environments.

Our Tactical Fixed Income strategy is designed to be adaptive and seeks to add value in both environments.

Will the strategy invest in inverse bond ETFs?

We do not use inverse bond ETFs in the portfolio due to the cost of carrying the short positions, which includes the management fees of the ETFs as well as paying out the interest payments while you own these funds. However, a rising rate environment typically is accompanied by a strong economy. We do have ample ability to have exposure to sectors of the fixed income market, like high yield, international, and convertible bonds, that may perform well during these environments.

What is the turnover of the Tactical Fixed Income strategy?

Adapting to different fixed income environments is the nature of the Tactical Fixed Income strategy. We built the strategy to be robust across the spectrum of bond market environments. The model typically has about twenty swaps a year. Our model selects approximately six ETFs to be held in the portfolio and each position remains in the portfolio only as long as it retains strong relative strength. We have a disciplined relative strength process in place to replace any positions that weaken beyond an acceptable level.

To receive the fact sheet for this portfolio please e-mail [email protected] or call 626-535-0630.

Net performance shown is total return net of management fees for all Dorsey, Wright & Associates accounts, managed for each complete quarter for each objective. The advisory fees are described in Part II of the adviser’s Form ADV. All returns since inception of actual Accounts are compared against the Barclays Aggregate Bond Index. A list of all holdings over the past 12 months is available upon request. The performance information is based on data supplied by the Manager or from statistical services, reports, or other sources which the Manager believes are reliable. There are risks inherent in international investments, which may make such investments unsuitable for certain clients. These include, for example, economic, political, currency exchange, rate fluctuations, and limited availability of information on international securities. Past performance does not guarantee future results. In all securities trading, there is a potential for loss as well as profit. It should not be assumed that recommendations made in the future will be profitable or will equal the performance as shown. Investors should have long-term financial objectives when working with Dorsey, Wright & Associates.

The chart below shows performance of US sectors over the trailing 12, 6, and 1 month(s). Performance updated through 10/9/14.

The performance above is based on pure price returns, not inclusive of dividends or all transaction costs. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss. Source: iShares

Market volatility has come back to the forefront in recent weeks, with equity indices around the globe experiencing broad swings in both directions. Often times during periods of heightened market volatility, it’s interesting to take a look at the US Treasury market to see if there are any noteworthy technical developments taking shape. The global bond market is massive in size, and developments within in it can often have an outside influence on other asset classes when it comes to asset allocation and money flows. At Dorsey Wright Money Management, investors can gain exposure to the fixed income market in a number of ways. Both the Tactical Fixed Income & Balanced strategies are available through seperately managed accounts. More information on these products can be found here:

iShares Barclays 20+ Year Treasury Bond ETF (TLT): (Point & Figure)

We wanted to take another look at the point and figure chart of TLT in order to get a better idea of the current supply & demand situation for US Treasuries. Previously, we noted the TLT was coming into a major uptrend support line near 113.00. This uptrend line represents an area where buyers (demand) have previously overwhelmed sellers (supply). On the most recent test, the bond bulls once again showed up in force as the level held firm and the TLT has since produced a significant rally. In fact, yesterday’s move above 119.00 produced a double top break out pattern which has measured move price target of 133.00. At Dorsey Wright Money Management, we don’t use these developments as an actual buy signal (we use our RS matrices to determine those), but we do believe it’s a development worth noting. Time will tell if the TLT achieves its measured move target of 133.00, but given the double top break out it is surely something to keep an eye on and may signal a period of even lower interest rates lies ahead.

Dorsey Wright currently has positions in TLT

***The relative strength strategy is not a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value. The information found on Dorsey, Wright & Associates’ Web Pages has been prepared without regard to any particular investor’s investment objectives, financial situation, and needs. Accordingly, investors should not act on any recommendation (express or implied) or information in this report without obtaining specific advice from their financial advisors and should not rely on information herein as the primary basis for their investment decisions. Information contained herein is based on data obtained from recognized statistical services, issuer reports or communications, or other sources, believed to be reliable. However, such information has not been verified by Dorsey, Wright and Associates, LLC (DWA) or the information provider and DWA and the information providers make no representations or warranties or take any responsibility as to the accuracy or completeness of any recommendation or information contained herein.

Neither the information nor any opinion expressed shall constitute an offer to sell or a solicitation or an offer to buy any securities or commodities mentioned herein. This report or chart does not purport to be a complete description of the securities or commodities, market or developments to which reference is made. There may be instances when fundamental, technical, and quantitative opinions may not be in concert.

Each investor should carefully consider the investment objectives, risks and expenses of any Exchange-Traded Fund (“ETF”) prior to investing. Before investing in an ETF investors should obtain and carefully read the relevant prospectus and documents the issuer has filed with the SEC. To obtain more complete information about the product the documents are publicly available for free via EDGAR on the SEC website (http://www.sec.gov).

A list of all holdings for the past 12 months is available upon request.