Jim O’Shaughnessy on Active Management

April 23, 2017

If you want to succeed with active management, I would suggest this is a must watch.

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Stat of the Week

April 21, 2017

From Hendrick Bessembinder’s recent white paper.

While the overall stock market outperforms Treasury bills, most individual common stocks do not. Of the nearly 26,000 common stocks that have appeared on CRSP since 1926, less than half generated a positive holding period return, and only 42% have a holding period return higher than the one-month Treasury bill over the same time interval. The positive performance of the overall market is attributable to large returns generated by relatively few stocks. When stated in terms of lifetime dollar wealth creation, one third of one percent of common stocks account for half of the overall stock market gains, and less than four percent of 28 common stocks account for all of the stock market gains. The other ninety six percent of stocks collectively matched Treasury-Bill returns over their lifetimes.

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Market Insights

April 21, 2017

The stock market continued its climb upward during the first three months of the year.  The S&P 500 Total Return index finished with a gain of 6%, and the bull market celebrated its 8th birthday!  The Dow Jones Industrial Average (DJIA) closed at a record high for 12 days in a row during February.  This was a milestone that has been seen very infrequently in the history of the DJIA.  We are constantly hearing opinions and reasons why the bull market’s end is near, but the market has been able to shrug these off for years.

The biggest event during the first quarter was the transition of power from Obama to Trump.  Investors are hopeful that tax reform might be on the way.  There was also initial hope that the repeal and replace of Obamacare would be a huge plus for US stocks.  However, the failure to do anything meaningful with healthcare was a stark reminder to everyone that politicians love to say things and then get nothing done.  This is just the world we live in now, and we don’t see that changing any time soon.  The one thing we do know about politics is it is very dangerous to mix your political views with your investment strategy!  We had conversations with many people who were convinced the world was ending because of one of Obama’s policies or another.  We are hearing the same thing about Trump now (although from different people).  The market did extremely well under Obama and his policies.  Only time will tell if it will for Trump or not.  Keeping your politics out of investing will help you see things much more objectively.

There has also been a lot of talk during the beginning of the year about low volatility levels.  We certainly don’t disagree with that from a broad market point of view.  However, we have noticed more volatility under the surface of the broad market and in high momentum strategies in particular.  There were several days during the quarter that the highest momentum stocks dramatically underperformed the broad market.  We tend to see that happen from time to time, but seemed out of character this quarter considering momentum held up very well relative to the broad market.  We think this speaks to the underlying sentiment of investors who still seem very skittish even after an eight year bull market run.  This is actually a good thing from a longer term perspective.  Once investors turn euphoric it has historically been the precursor to a major top.  That doesn’t seem to be the case right now at all.  Investors are still waiting for the proverbial next shoe to drop.  Climbing the wall of worry has always been necessary in bull markets, and it appears that wall doesn’t show signs of crumbling soon.

The one big area that didn’t do well to start the year were oil and energy prices.  Just one year ago it was a totally different story.  A year ago, we saw a huge laggard bounce from the energy sector that had been beaten down in 2015.  That laggard rally was difficult for momentum strategies because oil had performed so poorly the twelve months prior.  The S&P Goldman Sachs Commodity Index (GSCI), which is dominated by energy prices, was down more than 5% for the quarter.  This caused shifts in a lot of our models and we reduced exposure to energy in a lot of our portfolios.

Despite the commodity weakness, Emerging markets did particularly well to start the year.  Developed markets also outperformed US markets.  Our domestic markets have been performing much better than international markets over the past few years.  We might be in the initial stages of that changing.  The price earnings ratios of emerging and developed markets indexes are well below those of the S&P 500.  We are also seeing international equities demonstrating good relative performance and moving up our asset allocation rankings.  That combination of good momentum with relatively attractive valuations is something to keep an eye on for the remainder of the year.

We are off to a good start to the year.  FactSet is predicting first quarter earnings to grow at a decent pace, and there are a number of other positive factors that support higher prices in the coming months.  If you have any questions about any of our strategies please don’t hesitate to contact us at any time.

This information is from sources believed to be reliable, but no guarantee is made to its accuracy.  This should not be considered a solicitation to buy or sell any security.  Unless otherwise stated, performance numbers are not inclusive of dividends or fees.  Investors cannot invest directly in an Index.  Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.

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Relative Strength Spread

April 18, 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 4/17/17:

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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And The 2016 ETF.com Awards Winners Are …

April 12, 2017

The fourth annual ETF.com Awards was held last Thursday night in New York City  to honor products, people and companies that made a difference in the ETF industry in 2016.  Dorsey Wright and PowerShares were honored to receive the award for Best New Asset Allocation ETF with the PowerShares DWA Tactical Multi-Asset Income Portfolio (DWIN).

From Yahoo! Finance:

PowerShares has an entire line of ETFs that incorporate the Dorsey Wright relative strength model into various segments of the stock market. But in 2016, for the first time, it applied the model to an asset allocation ETF. The “fund of exchange-traded funds” usually holds five ETFs chosen based on yield and price momentum. Those ETFs can be from any asset class, including equities, bonds, REITs, preferred stocks and more. Since its inception in March 2016, DWIN has garnered a strong following, and already has $117 million in assets. It’s a modestly priced fund with an expense ratio of 0.69%, which is in line with other Dorsey Wright ETFs.

We wanted to check in with John Lewis, Senior Portfolio Manager at Dorsey Wright, for his reaction and some additional insights into this strategy.

Q: Can you provide some background on what led to the development of this strategy?

A: PowerShares has a very diverse lineup of funds with good yields.  They were looking for a solution that would allow investors to leverage their lineup while getting away from the issue that has plagued many multi asset income funds.  What you normally see with these types of funds are static sleeves or allocations to certain income producing areas of the markets such as high yield bonds, MLP’s, or REIT’s.  As we have seen over the years, there are times when these asset classes are in favor and times when they aren’t.  Our discussions with PowerShares centered around the premise that we could use DWA tools to time entry and exit into these high income producing asset classes.  The result was something that was very different than what we had done with PowerShares before.  We came up with a multi factor approach that we felt would be extremely robust over time, and, as it turns out, got the attention of many industry watchers as well.

Q: The need for income is ever-present in this industry.  In what ways do you think this strategy addresses investor’s income needs?

A: DWIN remains invested in the highest income producing areas provided they are performing well.  So in risk-on type markets it can throw off a lot of interest income.  But we don’t chase yield for yield’s sake.  Someone once said, “More money has been lost chasing yield than at the end of a gun.”  We think this statement is very true!  There are times when certain high yielding areas have very poor performance so we shift into safer holdings during those times.  So the investor’s income from the product will be variable over time.  We think that approach will be beneficial over time because protecting capital is as (or more) important as generating the income.

Q: Risk management seems to be a key objective with this strategy.  Can you walk us through how DWIN seeks to manage risk?

A:  We run a matrix with everything in our universe.  To qualify for the portfolio each month holdings need to be in the top half of our matrix ranks.  From the top half of the ranks we select the five securities with the highest current yields.  When markets are performing well we wind up with a lot of high yielding securities.  When markets get into trouble these high yielding securities usually fall quickly down the ranks and high quality securities tend to move to the top of the ranks.  These high quality securities are usually US Government Bonds that perform well as investors seek safety.  In these times, we may hold large positions in US Treasuries.  These types of securities generally have much lower yields than other things in our universe.  So during times of stress, we may have a much lower yield in the portfolio because it is positioned for safety rather than appreciation.

Q: What is the potential problem with income strategies that seek for the highest possible yield with few if any other considerations?

A: Reaching for yield can be very dangerous.  High yield investments have always been very enticing for investors because everyone wants more income!  But they have high yields for a reason.  There is risk in them.  You are receiving a high current yield to compensate you for the added risk you are taking.  That is great when things are going well.  But when the economy turns, for example, high yield bonds can come under pressure because many companies have problems making their debt payments.  Another example is what happens to MLP’s when energy prices fall.  While an investor is still receiving a high current yield, a lot of the total return is lost as the prices of those assets go down.  So we think it is prudent to look at the bigger picture with high yielding investments rather than just the current yield an investor will (is supposed) to receive.

Q: What asset classes are included in the investment universe for DWIN?

A:  It is a very diverse group of assets.  We use PowerShares ETF’s to get our exposures so it is very efficient for us to move the money around to different areas as momentum shifts.  We can invest in all sorts of fixed income including US Treasuries, High Yield Bonds, Global Bonds, Munis, and more niche areas like Build America Bonds.  We can also move in to equity income areas (both domestic and international) if that is where the strength is.  There are also a few areas like MLP’s and REIT’s that are more narrowly focused but very high yielding that we include in our universe.

Q: How is the strategy currently allocated?  What parts of the investment universe have been gaining strength in recent months?

A: We are allocated in MLP’s and REIT’s, which are a big driver of yield for us right now.  We also own Short Term Global High Yield bonds and Emerging Markets debt.  Finally, we have a position in Preferred Stocks that has performed well in the model.

Q: Do you have any suggestions for how DWIN could fit in a client’s asset allocation?

A:  We think DWIN can be used in many ways and by a number of different types of investors.  The obvious choice is for clients looking for current income that also want some sort of risk management built in to the strategy.  But this strategy can also be considered for a more aggressive portion of a fixed income allocation.  As interest rates rise, investors are looking for alternative ways to allocate to high yielding and fixed income instruments.  DWIN uses a momentum overlay to shift to areas that may perform better than traditional fixed income in a rising rate environment.  If it turns out traditional fixed income performs well, then DWIN has the ability to allocate there too.  That flexibility comes at a price.  We can’t guarantee any sort of minimum yield over time.  However, we think the ability to adapt to changing markets is more important over time than remaining in asset classes that aren’t performing well.

Neither the information within this article, nor any opinion expressed shall constitute an offer to sell or a solicitation or an offer to buy any securities, commodities or exchange traded products.  This email does not purport to be complete description of the securities or commodities, markets or developments to which reference is made. DWA provides strategies, models, or indexes for the investment products discussed above and receives licensing fees from the products’ sponsors. 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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Shifts in Sector Leadership

April 6, 2017

Trend followers love environments with stable leadership, but the reality is that markets don’t always comply.  As shown below, those sectors that had the best performance in 2016 (Energy, Telecom, Financials) tended to have the worst performance in Q1 2017 while the sectors that tended to have the worst 2016 (Healthcare, Consumer Staples, Consumer Discretionary) tended to have the best performance in Q1 2017.  However, there has been some stability in leadership.  Technology, for example, performed well both last year and in the first quarter of this year.

sector 03.31.17

Source: Twitter @Econompic.  As of 3/31/2017.  Returns are inclusive of dividends, but do not include fees or transaction costs.

Dorsey Wright’s relative strength work is designed to pick up intermediate to longer-term relative strength trends and it is designed to allow us to adapt and change as leadership changes in the market.  In the table below, we show the sector exposure in our Systematic Relative Strength Aggressive Portfolio.  This is a separately managed account strategy that we have been managing since 3/31/2005.  The strategy starts with an investment universe of about 900 U.S. mid and large cap stocks and then ends up with a portfolio of 20-25 stocks.  The nature of the strategy is to seek to overweight strong sectors and to underweight weak sectors.  A relative strength score is assigned to each stock in the investment universe and that score determines when we buy and sell a stock out of the portfolio.  Buys are made from stocks that are in the top decile of our ranks and then stay in the portfolio as long as they remain in the top quartile of our ranks.  Trades are done on a weekly basis if needed.

SRS Aggressive_Sector

Source: Dorsey Wright

As shown above, Technology exposure in our Systematic Relative Strength Aggressive Portfolio has been relatively high over the last number of months.  However, other sectors have had some pretty significant shifts as we have seen some changes in relative strength.  Healthcare and Basic Materials are two sectors where our exposure has increased in recent months (exposure to Consumer Cyclicals has also slightly increased).  Those sectors shaded in gray have seen drops in exposure since the beginning of the year.

Sometimes sector strength can be short-lived; other times sector strength (or weakness) can persist for years at a time.  Outside of Technology, we have seen quite a few shifts in sector strength in recent months.  The great thing about relative strength is that it allows us to be adaptive and to shift exposure as needed.

To learn more about our Systematic Relative Strength Portfolios, please e-mail andyh@dorseymm.com or call 626-535-0630.

Neither the information within this article, nor any opinion expressed shall constitute an offer to sell or a solicitation or an offer to buy any securities.  This email does not purport to be complete description of the securities or commodities, markets or developments to which reference is made. 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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Helping Clients Get Comfortable with ADRs

April 3, 2017

As we noted in one of our recent articles, over the last 20 years, publicly listed companies worldwide have grown significantly in number, while the number of publicly listed companies here in the U.S. has contracted.  Navigating global investment opportunities is a key way that financial advisors can add value for their clients.  The benefit of incorporating ADRs into the mix is that these securities are listed on U.S. exchanges, really making investing in them no more difficult than accessing any other securities that trade on our exchanges.

To get a flavor of some of the investment opportunities in this space, consider the following table which lists the top ten performing ADRs year to date from the investment universe that we use for our Systematic Relative Strength International portfolio (includes around 500 small, mid, and large cap ADRs from Emerging and Developed International markets).

adr_top 10

Source: Dorsey Wright. As of 3/28/2017.  Returns are price only, not inclusive of dividends or transaction costs.  Dorsey Wright currently owns LFL.  A full list of buys and sells in our Systematic RS portfolio over the past 12 months is available upon request.

Part of the reason that clients can be hesitant to invest in foreign securities is simply lack of familiarity—the well-documented home country bias.  See below for a brief description of the businesses of each of the companies listed above (Source: Yahoo! Finance).  This is in no a way recommendation of any of the above-listed stocks, but I do think it serves the purpose of helping pull back the curtain on some of the opportunities that exist when investors look to foreign companies.  Online gaming, flight transportation, semiconductors, plastics, communication equipment, travel agencies, natural gas and more.  We may use relative strength to identify what we believe to be good investment opportunities, but our clients may very well want to get a sense for the businesses before they are willing to allocation a portion of their money to these opportunities.

Gravity Co., Ltd (GRVY)

Gravity Co., Ltd. develops and publishes online games in South Korea, Japan, the United States, Canada, Taiwan, Hong Kong, Macau, China, and internationally. It offers online games; mobile games and applications; and other games and game-related products and services, including character-based merchandise and animation.

GOL Linhas Ãreas Inteligentes S.A. (GOL)

Gol Linhas Aéreas Inteligentes S.A. provides regular and non-regular flight transportation services for passengers, cargoes, and mailbags in Brazil and internationally.

ASM International NV (ASMIY)

ASM International NV, together with its subsidiaries, engages in the research, development, manufacture, marketing, and servicing of equipment and materials used to produce semiconductor devices. The company operates through two segments, Front-end and Back-end. The Front-end segment manufactures and sells equipment used in wafer processing, encompassing the fabrication steps in which silicon wafers are layered with semiconductor devices in Europe, the United States, Japan, and Southeast Asia.

Fuwei Films (Holdings) Co., Ltd. (FFHL)

Fuwei Films (Holdings) Co., Ltd., together with its subsidiaries, develops, manufactures, and distributes plastic films using the biaxially-oriented stretch technique in the People’s Republic of China. Its products include printing base films used in printing and lamination; stamping foil base films and transfer base films used for the packaging of luxury items, such as cigarettes and alcohol; metallized films or aluminum plating base films used for vacuum aluminum plating for flexible plastic lamination; high-gloss films used for aesthetically enhanced packaging purposes; and heat-sealable films used for construction, printing, and making heat sealable bags.

Sharp Corporation (SHCAY)

Sharp Corporation manufactures and sells electronic communication equipment, electronic equipment, electronic application equipment, and electronic components in Japan, The Americas, Europe, China, and internationally.

LATAM Airlines Group S.A. (LFL)

Latam Airlines Group S.A., together with its subsidiaries, provides passenger and cargo air transportation services in South America, North/Central America, Europe, Africa, Asia, and Oceania.

MakeMyTrip Limited (MMYT)

MakeMyTrip Limited, an online travel company, provides travel products and solutions in India and internationally. It operates through two segments, Air Ticketing, and Hotels and Packages.

Intelsat S.A. (I)

Intelsat S.A., through its subsidiaries, provides satellite communications services worldwide. The company offers a range of communications services to media companies, fixed and wireless telecommunications operators, data networking service providers for enterprise and mobile applications in the air and on the seas, multinational corporations, and ISPs; and commercial satellite communication services to the U.S. government and other military organizations and their contractors.

Himax Technologies, Inc. (HIMX)

Himax Technologies, Inc., a fabless semiconductor company, provides display imaging processing technologies to consumer electronics worldwide.

Transportadora de Gas Del Sur S.A.

Transportadora de Gas del Sur S.A. provides natural gas transportation and distribution services in Argentina.

Never before has it been easier for investors to invest in the strongest trends wherever they might be found in the world. Relative strength offers an ideal framework for allocating among those trends. Markets are global and your portfolio should be too.

Two resources for your consideration:

  • Use the query tool on the Dorsey Wright site to evaluate the list of ADRs that we follow (record count is 720 before you narrow it down by any further criteria, such as technical attribute).

query

  • Consider using our Systematic Relative Strength International Portfolio.  This portfolio has a 10+ year track record that we are very proud of.  We evaluate a broad investment universe of ADRs and own 30-40 ADRs in the portfolio.  Buy and sell decisions are determined by relative strength rank.  E-mail andyh@dorseymm.com to receive the fact sheet and see the list of firms where this strategy is available.

Dorsey, Wright & Associates, LLC, a Nasdaq Company, is a registered investment advisory firm.  Neither the information within this presentation, nor any opinion expressed shall constitute an offer to sell or a solicitation or an offer to buy any securities, commodities or exchange traded products. This article does not purport to be complete description of the securities or commodities, markets or developments to which reference is made.  The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value. 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.

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