Q&A With John Lewis, CMT

February 27, 2017

As we approach the 12-year anniversary of the launch of our family of Systematic Relative Strength Portfolios, we check in with Senior Portfolio Manager, John Lewis, CMT for an update.

Q: How much of your own personal net worth have you invested in the Systematic Relative Strength Portfolios?

A:  The majority of my personal net worth is invested in the same strategies we run for our clients.  I do have some other investments where DWA investment strategies are not available, such as my 401k, but for the most part we believe in eating our own cooking.

Q: What do you think is the single biggest benefit to a person who commits money to one of our Systematic Relative Strength Portfolios?

A: The discipline in which the strategies are implemented is a huge part of what makes the SRS series so special.  Day in and day out we are using the same models to harness the power of the momentum factor.  The momentum factor isn’t always in favor, but the process is designed to just cut through the noise and keep tilting the portfolio that way so when momentum is in favor we are there to capture it.  These also tend to be concentrated portfolios so the disciplined sell process we use is very important.  We take high conviction positions and if you don’t manage those properly the entire portfolio can quickly get away from you.

Q: What are you most proud of as you look back at the past 12 years of running these portfolios?

A: The performance of the strategies has been very solid over a time period that hasn’t always been the best for the momentum factor.  But more importantly, we are very proud of the fact that the original design of the strategies has been robust enough to handle a number of wildly different markets we have had over the last 12 years.  We shy away from constant tweaking of our models.  That is something we feel is actually detrimental to performance because you are constantly fighting the last battle.  Doing so much research up front has given us tremendous confidence in the strategies going forward, and being able to stick with them through all types of conditions has been one of the big reasons for their success over the years.

Q: The Aggressive portfolio has come on very strong in the last couple of years.  What do you think is going on with that strategy?

A: The aggressive strategy is designed to be a more aggressive application of the momentum factor.  We are taking the highest rated stocks in our rankings and kicking them out quickly if the fail to perform.  When the momentum factor is performing well, the aggressive strategy tends to outperform the other strategies.  We have had a good environment for the quick rotation over the last year or so.  That isn’t always the case.  Also, since the aggressive strategy is very concentrated (20-25 positions) stock picking can play a larger role than in some of our index based strategies.  We have had some very good performance out of a few of our holdings over the last year, and that has really been a key driver of performance.

Q: Why does the Core portfolio tend to have a little lower volatility and a little lower turnover than some of our other portfolios?

A: The Core strategy is also a concentrated strategy (20-25 names), but we don’t kick stocks out as fast as they fall in our ranks.  This allows the portfolio to be more diversified over time, and it also allows for positions to recover in choppy markets where they might get sold our of the Aggressive strategy.  When the momentum factor isn’t in favor the Core strategy tends to perform better than the Aggressive strategy.  That is what we say over a 3 to 5 year period that ended about a year or so ago.   The market (in terms of momentum stocks) was rather choppy, and the Core strategy was able to weather that better than a strategy like Aggressive that rotates more rapidly.

Q: The Growth portfolio has a unique capacity to raise cash in certain types of markets.  Describe what can cause that portfolio to raise cash?

A: The Growth strategy will raise cash in bear markets.  We have a market filter that moves the portfolio from a fully invested mode to a sell and don’t replace mode.  We don’t automatically sell positions when the market filter turns negative.  There are a lot of times when the market filter has a negative reading and out holdings continue to perform just fine.  In that case we won’t sell anything.  If we do need to sell something we wait until it breaks trend or drops to our sell level.  So the cash tends to build slowly as the market drops.  It is designed to be like an insurance policy.  We would rather not use the insurance, but it is comforting for investors in the Growth strategy to know it is there.  We use the same market filter to get back in to the market.  If we raise cash and the market reverses we just go through our disciplined buy process and bring the portfolio back to a fully invested stance.  This actually happens more often than the portfolio getting to very high cash levels.  In strongly trending up markets raising cash tends to hurt performance, but it works very well to protect capital in bear markets.

Q: While the rules of these models might not change over the years, the investment universe can.  How has the investment universe for the Global Macro portfolio changed over time?

A: The Global Macro strategy is a little different because it invests exclusively in ETF’s that represent different asset classes.  It is a tactical asset allocation strategy that can go anywhere we can efficiently find exposure.  We have a predefined investment universe that covers everything from domestic equities, to fixed income, to commodities, to international investments.  There are all ranked unemotionally by our momentum ranking process and we are constantly driving the strategy to where the strength is.  Over the years, the ETF landscape has expanded a great deal.  As new products come to market they are evaluated and if there is a hole in our current lineup we will consider adding new ETF’s to broaden our opportunity set.  In a go anywhere strategy like Global Macro, the more varied exposures we can add to the universe the better.

Q: The International portfolios has been among the best performing strategies in this family of accounts.  From a portfolio construction perspective, how do you think our approach differs from the competition?

A: The SRS International strategy has a few unique features.  First, it is comprised entirely of ADR’s and foreign equities listed on US exchanges.  That means we can get exposure to foreign equities without having to buy the shares on local exchanges, do currency conversions, etc…  It makes it an ideal way to get international exposure through a retail SMA.  We also don’t have minimums or maximums on our developed versus emerging markets exposure.  This has served us well over the last ten years as different markets have come in and out of favor.  Our job is to buy the best momentum securities from the ADR universe so we don’t constrain ourselves to countries or regions.  Wherever the strength is is where the portfolio will be overweighted.  Since the process is very disciplined we are very comfortable that when markets change our models will pick that up and we can change the portfolio accordingly.

Q: A passive approach to fixed income has worked pretty well for the last 35 years, arguably until recent years.  Why do you think there will be a need for Tactical Fixed Income in the years to come?

A: Tactical Fixed Income is one of our newer strategies, and it has also performed very well since inception.  Our process is very much a risk on, risk off approach to fixed income markets.  If rates begin to rise significantly we are able to rapidly rotate into defensive positions and preserve gains made during better times.  Since we use ETF’s in this strategy it is very easy for us to move quickly between different areas of the bond market.  We believe having an allocation to a tactical fixed income strategy will be a great way to diversify your bond holdings in a different interest rate environment.

Nothing contained herein should be construed as an offer to sell or the solicitation of an offer to buy any se­curity. This report does not attempt to examine all the facts and circumstances which may be relevant to any company, industry or security mentioned herein. We are not soliciting any action based on this document. It is for the general information of clients of Dorsey, Wright & Associates, LLC (“Dorsey, Wright & Associates”). This document does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. Before acting on any analysis, advice or recommendation in this document, clients should consider whether the security or strategy in question is suitable for their particular circumstances and, if neces­sary, seek professional advice.  The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Relative Strength is a measure of price momentum based on historical price activity.  Relative Strength is not predictive and there is no assurance that forecasts based on relative strength can be relied upon.

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Weekly RS Recap

February 27, 2017

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 (2/20/17 – 2/24/17) is as follows:

ranks

Good week for the RS laggards last week.

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

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Relative Strength Spread

February 23, 2017

The chart below is the spread between the relative strength leaders and relative strength laggards (top quartile of stocks in our ranks divided by the bottom quartile of stocks in our ranks; universe of U.S. mid and large cap stocks).  When the chart is rising, relative strength leaders are performing better than relative strength laggards.    As of 2/22/17:

spread

The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.

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Politics and Investing

February 21, 2017

Last week Bloomberg reported that Americans recently broke the American Psychological Association’s anxiety meter for a record level of stress.  You read that right.  No, this is not from late 2008.  This is from January 2017.

“The results of the January 2017 poll show a statistically significant increase in stress for the first time since the survey was first conducted in 2007,” the APA said on Wednesday in a report on the survey of 1,019 adults living in the U.S., conducted from Jan. 5 to Jan. 19 by Harris Poll.

Americans’ stress levels in January were worse than in August, in the middle of the angriest, most personal campaign in recent memory, when some believed the anxiety would abate after the election. At 57 percent, more than half of respondents said the current political climate was a very or somewhat significant source of stress. Stressors for everyone, including Republicans, were the fast pace of unfolding events and especially the uncertainty of the current political climate, said Vaile Wright, director of research and special projects at the APA.

What is it that has everyone so worked up?  Politics.  How many of your clients invest their politics?  When the resident of the Oval office is of their same political party, do they tend to be more bullish and when the opposite is true, do they tend to be more bearish?

When I read that article I couldn’t help but think back to something that The Motley Fool wrote last year as it relates to the problem of conflating politics and investing:

Economics is a close cousin of politics, which is dangerous because politics is a close cousin of emotional decisions detached from reality.

Not only do most of us have emotional opinions about who should/shouldn’t run the country, but we unfailingly overestimate how much influence presidents have over the economy and stock market. When presidents do impact the economy, good luck guessing how markets will respond. Lots of smart people predicted that Barack Obama’s spending plans meant surging interest rates and a collapsing dollar.

Growing the economy means getting everyone to win, whereas politics by definition means getting the opposing party to lose. Rationality melts when you set up this kind of my-team-versus-yours dilemma. Psychologist Geoffrey Cohen showed that Democratic voters supported Republican proposals when they were attributed to fellow Democrats more than they supported Democratic proposals attributed to Republicans, and vice versa. Imagine the same part of your brain analyzing investments. It’s a disaster.

I like politics, and I love investing. But I run from anything conflating the two.

Thus, the power of an emotionless method of investing.  The chart just reflects what is, not what we fear might be.  And what does that chart—using the S&P 500 as a proxy for the market—look like right now?

spx

As of 2/16/17

Well it doesn’t look bearish…  Invest accordingly.

Investors cannot invest directly in an index. Indexes have no fees. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.

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Weekly RS Recap

February 21, 2017

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 (2/13/17 – 2/17/17) is as follows:

ranks

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

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Sector Performance

February 16, 2017

The table below shows performance of US sectors over the trailing 12, 6, and 1 month(s).  Performance updated through 2/15/2017.

sector

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

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High RS Diffusion Index

February 15, 2017

The chart below measures the percentage of high relative strength stocks (top quartile of our ranks) that are trading above their 50-day moving average (universe of mid and large cap stocks.)  As of 2/14/17.

diffusion 02.15.17

The 10-day moving average of this indicator is 69% and the one-day reading is 81%.

The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Investors cannot invest directly in an index.  Indexes have no fees.  Past performance is no guarantee of future returns.  Potential for profits is accompanied by possibility of loss.

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A Whole New World for International Investing

February 14, 2017

2016 was a lackluster year for GDP growth in the US, early estimates put 4th quarter estimates at 1.9% with a full year estimate at 1.6%. This is significantly lower than the 4% growth rate the president has targeted for 2017 and is much closer to estimates of an approximately 2.0-2.2% GDP growth rate in 2017 by several international groups.

USGDP Q416

 

2017GDP Est 2.9.17
Sources: www. knoema.com/qhswwkc/us-gdp-growth-forecast-2015-2019-and-up-to-2060-data-and-charts, www.whitehouse.gov/bringing-back-jobs-and-growth

That is not to say the major infrastructure spending that is being proposed, the possibility of corporate tax reform and repatriation of billions in overseas cash will not have an impact on short term growth rates. The questions are how long is it sustainable and what are the risks to the market if we see GDP slow?

For many investors, international markets have a more appealing long term growth story when faced with 2% growth. The IMF has a 1.9% growth projection for the Advanced Economies (Including the US) and a 4.5% growth projection for emerging and developing (frontier) markets.  An accelerated growth rate and a large young population of people striving for a better life are several points investors continue champion when making allocations to emerging markets. Our D.A.L.I. model currently has international equities in the number two position behind US equities with the emerging markets, specifically Latin America showing stronger indicators than the majority developed regions.

DALI INT 2.9.17

 

 

 

 

The problem that many face when making international allocations is do they stick to the less volatile developed markets or do they dip their toe into riskier emerging and frontier market countries that have the potential for higher returns? It is our opinion that an either or philosophy will not be a winning strategy, if you bind yourself to only developed or emerging markets you are leaving returns on the table.  Below is a relative strength chart of emerging markets (EEM) vs. developed markets (EFA) over that past 10 years.  Each market experienced different period of strength. By widening your investment universe you can rotate markets as the trend shifts over time allowing for the opportunity of a better risk adjusted return.

EEMEFA RS CHART

 

 

 

 

 

 

 

 

 

The added portfolio diversification achieved by including emerging alongside developed markets is notable. When looking at asset correlations between 1/1/2009 to 12/31/2016 shifting from developed only (EFA) to global ex US (ACWX) which has a 16% allocation to emerging markets reduced correlation by almost 5% against US large cap equities (SPY) and US small cap equities (IWM) by 2.5%. Holding just emerging markets (EEM) for your international allocation is the best tool for diversification in this example, with only a 0.57 correlation to large and small cap equities. However this over exposes you to a high volatility asset that some investors would not be comfortable in for long periods of time.

Correlation of Asset Classes

Int Corr 2.9.2017

 

 

 

 

In our SRS International strategy we have chosen to widen our investable universe to include the global ex US market. The wider universe allows for the ability to select from more securities that have higher technical attributes. Over the past 10 years we have used Relative Strength as a main factor to find the best performing securities agnostic to developed and emerging markets.

SRS INT EMDM Allocation

 

As shown above, nearly 70% of our Systematic RS International strategy is currently allocated to emerging markets. This however was not the case in 2012 when emerging markets only held 30% of the portfolio. Flexibility, especially when it comes to international equity exposure can make a big difference in investment returns if you are willing to expand your investable universe.

Nothing contained herein should be construed as an offer to sell or the solicitation of an offer to buy any se­curity. This report does not attempt to examine all the facts and circumstances which may be relevant to any company, industry or security mentioned herein. We are not soliciting any action based on this document. It is for the general information of clients of Dorsey, Wright & Associates, LLC (“Dorsey, Wright & Associates”). This document does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. Before acting on any analysis, advice or recommendation in this document, clients should consider whether the security or strategy in question is suitable for their particular circumstances and, if neces­sary, seek professional advice.  The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Relative Strength is a measure of price momentum based on historical price activity.  Relative Strength is not predictive and there is no assurance that forecasts based on relative strength can be relied upon.   Past performance is no guarantee of future returns.

 

 

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Relative Strength Spread

February 14, 2017

The chart below is the spread between the relative strength leaders and relative strength laggards (top quartile of stocks in our ranks divided by the bottom quartile of stocks in our ranks; universe of U.S. mid and large cap stocks).  When the chart is rising, relative strength leaders are performing better than relative strength laggards.    As of 2/13/17:

spread 02.14.17

After declining for much of the past year, the RS Spread is now on the cusp of moving above its 50 day moving average—a potentially positive development for relative strength strategies.

The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.

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Traditional vs. Systematic Portfolio Management – What’s the Difference?

February 9, 2017

Click here for a replay of my 2/8/17 webinar.

trad_syst

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Diversification and Asset Class Rotation

February 7, 2017

Diversification is the cornerstone of Modern Portfolio Theory (MPT), introduced by Harry Markowitz in 1952, with the goal of achieving higher risk-adjusted returns overtime.  The problem with diversification is that it works great until the markets are dominated by one asset class for multi-year stretches. This is what we have seen for the past four years as the S&P 500 Index SPX has climbed to new highs and has continued to extend our current bull run. If your portfolios have diversified away from US equities during this time, you have more than likely under performed on a total return basis. This often raises the question from clients of “What have you done for me lately that I cannot do myself with SPY?” What many investors tend to forget is that market cycles change and so too does leadership.

The chart below is a take on the classic Callan chart with 11 asset class returns over a 16 year period. In this chart we compare 10 asset classes to large cap equities (S&P 500), which is held in a static position on the chart.

 

2017-01-27_12-42-09

(performance data in the image above from FactSet from 12/31/99 – 12/31/16)

For the last four years, US equities have been the best place to invest. In the prior 12 years, however, you would have been well-served incorporating other asset classes. In fact, during the 2000-2001 and 2008-2009 downturns you would have been better off owning almost anything other than Large Cap equities. Going forward, is Large Cap equity domination going to continue, or are we going to see markets revert back to pre-2013 distribution of returns?  One of the tools that can help you in evaluating both current leadership and potential opportunities is the Dynamic Asset Level Investing (D.A.L.I) ® tool. On a high level, D.A.L.I uses relative strength to rank six asset classes, and then allows you to delve into sub-asset class opportunities for each. The result is an unbiased, objective view of the markets that is adaptive to change.

Our Systematic Relative Strength Global Macro Portfolio is another solution that is easy to utilize at numerous custodians and trading platforms. The Portfolio provides broad diversification across markets, sectors, styles, Fixed Income, Currencies, Commodities as well as inverse domestic and international equities. The Portfolio is positioned to efficiently take advantage of risk capital globally where leadership trends are compelling. For the past four years we have seen a large allocation to US equity markets, although this has not always been the case.

GM Allocation

If you would like more information on the Dorsey Wright SMA or would like a handout copy of the charts in this presentation please contact Andy Hyer at andyh@dorseymm.com.

The relative strength strategy is not a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Relative strength is a measure of price momentum based on historical activity.  Relative strength is not predictive and there is no assurance that forecasts based on relative strength can be relied upon.

 

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