Systematic Relative Strength Blog Now at MarketInsite

May 24, 2017

Eight years and 3,822 posts later, we are shifting venues for our Systematic Relative Strength blog to the Nasdaq MarketInsite – Systematic Relative Strength.  Thank you to everyone who has followed our posts over the years and we look forward to continuing to share research and commentary on the markets and specifically on relative strength investing for many years to come!  We have a couple new posts now up on the new blog: Nasdaq MarketInsite – Systematic Relative Strength.  Thanks again!

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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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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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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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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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Q4 Manager Insights

January 6, 2017

The stock market had a solid end to the year and finished up the year strong. U.S. equities, as represented by the S&P 500 Total Return, were up 3.8% for the quarter and 12.0% for the year. Many people had predicted a poor year for U.S. equities so these strong returns caught a lot of investors off guard. The returns for other asset classes were mixed during the fourth quarter, but on a year-to-date basis most of the broad asset class benchmarks finished in positive territory. One standout was small cap U.S. equities. The Russell 2000 Total Return Index was up 8.8% in the last three months of the year and 21.3% for the year. Bonds lagged equities, but did end the year with positive returns. Another big story was commodities, which had seen dreadful returns for the past couple of years. The rally in energy propelled the S&P GSCI Commodity Index to a gain of 11.4% in 2016.

The biggest story during the fourth quarter had to be Trump winning the election. Very few people predicted that outcome, and even fewer predicted what the market’s reaction would be with a Trump victory! Once again, we learned how difficult it is to mix politics with investing. We have always focused on price and left things like political forecasting to the people that need material for their television appearance. Initially, the market had a huge selloff when it became clear Trump was going to win. But before the dust even settled the market turned right around and shot higher as confused investors looked on. A Trump presidency will no doubt be filled with a lot of uncertainty. However, there are a few themes that have emerged since the election that have affected our portfolios. Financials (specifically Banks) have rallied on the hopes of looser government regulation. Whether or not that is good for Americans as a whole is not really for us to decide, but it should make it easier and cheaper for banks to do business going forward and the market recognized that very quickly. We saw our exposure to Financials increase after the election as a result of the sector’s relative strength. Trump’s plans for improving infrastructure also helped Industrials rally in to the end of the year. Again, we have seen that strength flow through to our momentum models, and we have large allocations to that sector in most of our strategies.

Lost in the shuffle of the fourth quarter was the Federal Reserve raising rates for the first time in a year. The move was largely expected, but that didn’t prevent bonds from having a rough quarter. The positive return from bonds for 2016 was largely earned in the first part of the year. The Barclays US Aggregate Index was down –3.0% for the quarter so the fear of rising rates among investors is real. Our Tactical Fixed Income strategy navigated the choppy waters very nicely in 2016. We were able to post nice gains at the beginning of the year by being in long maturity bonds as well as areas that do well in a strong bond market (High Yield, Emerging Markets, Corporates). As the probability of a rate hike grew and bonds began to falter we were able to switch the portfolio out of the “risk-on” bonds and into short term U.S. Treasuries to preserve those gains.

The two major events discussed above caused quite a bit of change in our models. That was really the theme all year. While the market posted impressive gains as a whole, there were a lot of crosscurrents under the surface. All year long, old trends died, and new ones emerged. At the beginning of the year, investors were favoring Low Volatility stocks and equities with high dividend yields. As the year wore on that leadership began to fall apart and investors began favoring more “risk on” investments like small caps that are more volatile and don’t provide as much current income. Gold was also a theme that came and went during the year. There were many themes like that over the course of 2016 and that led to us making a lot of changes in the portfolios throughout the year. Trading activity was much higher than normal as our models continued to adapt to emerging themes and get rid of old ones. It was definitely a transition year, but it looks like we are well positioned heading in to the new year. The crosscurrents under the surface will eventually subside. When they do, we should be well positioned to capture the trends in the new leadership.

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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Looking to 2017

December 30, 2016

As we close out 2017 the final week of the year the markets have not been as cooperative as investors would have liked.  The markets have pulled back from historic highs and the Dow was not able to hit the elusive 20,000 mark. Looking forward to 2017 here are several issues that may impact clients and markets.

Political

New President: President elect Trump takes the oath of office on Friday January 20th in Washington, D.C.  The US markets have reacted mostly positive to the Trump election based on promises of lower taxes, faster growth and more US based jobs. Here is a link if you would like more information on the inauguration.

Tensions with Russia?: Obama announced sanctions against Russia yesterday afternoon and expelled 35 Russian official in response to the allegations of Russian cyber-attacks during the election. Russia has not yet retaliated but Russian Foreign Minister Sergei Lavrov “We of course cannot leave these stunts unanswered. Reciprocity is the law in diplomacy and international relations.”

Social Security

Tax cap increase: Workers and employers each pay in 6.2% of wages into the Social Security system until the salary cap of $118,500. In 2017 the tax rate will stay the same but the cap is being raised to $127,200 to adjust for higher wages in the US.

Payments increase: The cost of living adjustment for 2017 will be a modest 0.3% or about $5 per month. This increase is in line with 2016  which did not see any raise. Increases to Social security are based on the Consumer Price Index for Urban Wage Earners and Clerical Workers.

Earning Limits: The earnings limit for people  65 and younger will increase from $15,720 in 2016 to $16,920 in 2017. While those who turn 66 in 2017 the limit increases by $3,000 to $44,880.

For a full list of changes, here is the 2017 Social Security Changes Fact Sheet.

Currency

China: China is trying to reduce the impact of the Dollar on the Yuan as the Yuan trades at an eight year low. They are introducing 11 more countries into its currency basket.

Euro: The Financial Times polled 28 economists and over 60% believe that the Euro and dollar will hit parity next year for the first time in 14 years. Rising interest rates in the US and continued QE in Europe are thought to be two of the main factors in the shift.

Dorsey, Wright & Associates, LLC, a Nasdaq Company, is a registered investment advisory firm

 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 article does not purport to be complete description of the securities or commodities, markets or developments to which reference is made.

Past performance, hypothetical or actual, 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.  Advice from a financial professional is strongly advised.

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All I want for Christmas is… low volatility?

December 23, 2016

The month of December sees some of the lowest volume trade days of the year. People are on vacation, holiday parties are in full swing and allocations for the next year are being finalized. S&P 500 volatility has also decided it wants to take a step back from the roller coaster of the year. VIX futures hit a 16 month low on Wednesday to 10.97, a level not seen since August of 2015.

The VIX had sharp increase in volatility leading up to the election, post-election it has been on a sharp decline following the announcement that Trump beat Clinton.

vix-price-12-22-2016

With the S&P 500 trading almost flat for the week as of market close on December 22nd  and today shaping up to be another non eventful day, all eyes will be looking to the markets next week. In the next week we will see the final tax loss trades of the Obama Presidency and we may even see the Dow Jones finally break through 20,000.
Investors cannot invest directly in an index. Indexes have no fees. Past Performance is not indicative of future results. Potential for profits is accompanies by possibility of loss.

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The roller coaster ride of oil

December 1, 2016

Millions of American every year pay a hefty sum of money to be thrilled by some of the world’s fastest rollercoasters. The feeling of being suspended above the world as you climb higher and higher only to have crashing down is an amazing feeling.  If you have not conquered the rational part of your brain that says that it is not logical to put yourself in those metal contraptions I highly recommend a trip to your local amusement park. Another option has been to stay long oil over the past year, below is a chart showing roller coaster ride of Brent Crude Futures over the past year.

brent-cude-chart-1-year-11-30-2016

In January we hit the bottom turn of the roller coaster and analysts did not have a consensus on oils next direction.

“The price of Brent crude fell to $27.67 a barrel at one point, its lowest since 2003, while US crude fell as low as $28.36.

Many analysts have slashed their 2016 oil price forecasts, with Morgan Stanley analysts saying that “oil in the $20s is possible”, if China devalues its currency further.

Economists at the Royal Bank of Scotland say that oil could fall to $16, while Standard Chartered predicts that prices could hit just $10 a barrel.”1

Looking back now it was just a market overreaction. The client calls and excessive worry that the world was slowing down are now just a bad memory. Since the bottom in January: oil prices have recovered, China is still growing at a respectable rate and Latin America did not fall apart as many people feared. After the OPEC meeting yesterday we saw oil prices once again climb above $50.00 to close out the day over 8% ahead.  Today as of writing this the Brent Crude markets are up over 3% and gasoline futures are up over 5%. While we do not how the cuts to oil production that have been approved will happen or if the countries involved will follow through, we have a short term relief in the energy market’s low prices.

In our Aggressive SRS mode we rotated two additional energy names into the model in the past month allowing us to capitalize on the energy spike, while at the start of the year we held no energy names going into the January selloff.  That account is a concentrated portfolio (20-25 holdings). Two of our energy names were up mid 20% and a third was up 10%. Needless to say, we haven’t seen a day like today since Hurricane Katrina caused all the refiners to have problems.  The long term goal like every other money manager is to outperform our index, while that does not always happen in short time periods, days like yesterday are the reason you invest for longer periods and follow your investment thesis.

If you would like more information on our Systematic RS Aggressive Portfolio, please e-mail andyh@dorseymm.com or call 626-535-0630. Andy will also be hosting a webinar on Friday December 2, 2016 at 2 PM ET introducing our family of Systematic Relative Strength Portfolios.

 Upcoming Events

Please join Andy Hyer, Client Portfolio Manager at DWA, for an introduction to our family of Systematic Relative Strength Portfolios on Friday, December 2nd at 2 p.m. ET.  These portfolios provide disciplined access to relative strength strategies including U.S. Equities, International Equities, Fixed Income, and Global Macro and are available on UMA and SMA strategies at a large and growing number of firms.  Click here to register for the webinar. The event password is dwadwa.

 

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.

1 West, Matthew. “Just How Low Can Oil Prices Go and Who Is Hardest Hit?” BBC News. January 18, 2016. Accessed December 01, 2016. http://www.bbc.com/news/business-35245133.

 

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Recap of November so far

November 25, 2016

As we recover from the great national holiday of turkey, family and football we see the world of securities start to slow down. According to Market Watch the days before and after Thanksgiving make up two of the five slowest trade days for the year. This slow down allows us time to reflect on what we have seen so far in the month of November.  So far this month we have seen:

  • The Cubs win the World Series for the first time in 108 years
  • Donald Trump gets elected President of the United States
  • Major earthquakes hit Fukushima, Japan in similar fashion to the 2013 triple disaster
  • Vin Scully us award the Presidential Medal of Freedom

We have also seen global markets increase volatility from fear of a changing trade environment, US equity markets have a surprise rally in the wake of possible corporate tax reform and US interest rates start to climb. Looking forward we will continue to have major events as the global markets will need to digest what policies the new president will put into place and what Brexit is going to really look like for the EU.

We will continue to hit these bumps in the road, but we need to plan for the full journey and not focus on the potholes along the way. People fled from Latin American banks over the past couple of weeks resulting in a rough patch for our International accounts. Over the past week we followed our game plan of watching the signals and trusting our process. The results have been a strong week of outperformance vs. our benchmark; we continue to be very happy about how this strategy has performed compared to its benchmark over time. The process while it does not have the sizzle of a hot stock picker does have a great story of out performance over full market cycles and exposure to places in the world that an individual investor often does not have the knowledge to invest.

When talking to clients, friends and family this holiday season I always like to have a good story. The story this year is about finding value in places others have abandoned out of fear or taking a step back, staying true to a thoughtful investment thesis.

If you are interested to learn more about our investment thesis in our International strategy,  Andy Hyer can be reached at andyh@dorseymm.com or 626 535-0630

Charles Coleman
Associate Portfolio Manager
Dorsey Wright & Associates

The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.

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Manager Insights: Third Quarter Review

October 10, 2016

The stock market spent the majority of the summer months moving sideways in a tight trading range.  The S&P 500 finished the quarter up almost 4%, and is sitting on a gain of 7.8% so far this year.  International equity markets were a bright spot, and outperformed domestic markets.  Developed markets finished up 6.5% and Emerging markets finished with a gain of 9.2%.  Bonds also finished in positive territory with a 0.5% gain.  Commodities were a weak spot in the third quarter.  After strong gains in the first six months of the year, the S&P GSCI Commodity Index gave back 4.2% over the summer and now sits at a gain of 5.3% for the year.

We continue to see rotation below the surface in a number of different asset classes.  This is nothing new, but we think the rotations we are seeing now have the potential to be very beneficial to our strategies.  In the U.S. equity markets there has been a momentum shift out of areas such as high dividend and low volatility stocks.  The relentless reach for yield drove many investors into stocks instead of bonds, and drove valuations to historically high levels.  The same valuation issues cropped up in low volatility stocks, which have been quite the hot ticket for the last year or so.  These are not the areas that usually lead a robust bull market.  Low Volatility, especially, tends to lead during down markets.  As a result, there was a lot of hand wringing about how solid the market actually was with that kind of leadership.  We felt the leadership we were seeing was more a result of investor’s preference for yield (and the lack of good fixed income options) rather than an indictment on the overall market.

The new leadership that appears to be emerging is what is traditionally considered positive for a strong bull market.  Small capitalization stocks have had spotty performance for a while, but they really picked up steam in the third quarter.  The Russell 2000 Total Return index finished with a gain of 9% moving it well ahead of the S&P 500 for the year.  Technology stocks also dramatically outperformed what could be considered the old leadership (Utilities, Consumer Staples, and Low Volatility) over the summer.  The relative improvement in these higher volatility areas shows investors are gaining more confidence in the market.  Confidence is an incredibly important piece of the puzzle for momentum strategies so we are looking at this new development very favorably.

The appetite for higher volatility investments is also increasing internationally.  As previously mentioned, Emerging markets had a fantastic third quarter.  Latin America has been the biggest driver of that performance so far this year.  For the past couple of years, international markets have not fared as well as our domestic markets.  That appears to be changing, and we are seeing increasing allocations to Emerging markets in those account styles that allocate internationally and globally.  The overall composition of those portfolios has changed dramatically over the course of the year.

As we head in to the final three months of the year it is impossible not to think about the upcoming election.  Frankly, it is nothing short of a circus sideshow at this point.  We fully understand the uncertainty people feel because neither candidate seems like a good choice.  That, however, is politics, and we are investing.  We encourage you not to get caught up in the headlines.  We do expect some volatility around election time, but we don’t think either candidate’s victory means doom or exuberance for the stock market.  It is incredibly difficult to forecast how politics will affect the market, and most so called experts get it wrong.  Keep your politics out of your investing plan and you will be much better off for it in the long run.  Never forget that there is always some reason not to invest, but the reality is that investing in stocks is a tremendous way to build wealth over time.

The final three months of the year should be interesting to say the least.  There are pieces falling in to place that lead us to believe our relative strength strategies can do quite well if these trends are sustainable.  If you have any questions about any of our strategies please give us a call 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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Q&A with John Lewis, CMT

August 1, 2016

John Lewis is the Senior Portfolio Manager at Dorsey Wright.  Since joining Dorsey Wright in 2002, Mr. Lewis has developed strategies for the firm’s Systematic series of separate accounts, the Technical Leaders Index methodology, global asset allocation strategies, and multiple series of UITs. His work is technically driven and focuses on relative strength and momentum as the main factors in the investment process.

Q: What is the role that computer programming plays in your portfolio management responsibilities?

A:  Computers play an integral part in designing new strategies and maintaining existing ones.  We have designed a ton of different investment processes over the years and we have done so much testing that we have a pretty good idea of what will and won’t work and how to integrate that into a portfolio.  That knowledge base is really invaluable and is really the most important part of the process.  But we can harness the power of the computer to validate and stress test all of those ideas.  We are able to run tens of thousands of tests if we need to in order to make sure our ideas have merit.  On an ongoing basis, our strategies are designed to be systematic so using a computer to do all of the calculations for us is a huge time saver and allows us to run a large number of strategies with minimal human capital.

Q: How did you develop those computer programming skills?

A:  This story is 100% true.  I was working in San Diego and part of my job function required me to stay later than everyone else to get data loaded into our systems for the next trading.  All of my friends on the floor were leaving early (remember, the market closes at 1:00 on the West Coast) to go to the beach, golfing, or whatever, and it was always difficult for me to cut out a little early.  When faced with such a large problem it often takes drastic measures to solve it.  So I taught myself how to program visual basic and I set up a bunch of Excel macros to run stuff while I was out of the office.  It would up working really well so I just kept going and figuring stuff out along the way.  Computer programming has always been pretty easy for me, and I have had any formal training or anything like that.  The result of that decision to teach myself how to program in order to leave work early was the launching pad to what we are doing today.  However, my golf game is still terrible and my beach body has rapidly become something that shouldn’t be allowed on the beach.

Q: What led to the development of the family of Systematic Relative Strength portfolios (separately managed accounts)?

A: We did a review of our portfolios and tried to figure out what was working and what wasn’t.  As we dug deeper into the data it became clear that relative strength was really driving the performance and not any of the other “stuff” that went into the decision making.  Our testing process actually led us down a totally different path than how most things get tested.  We started with a bunch of inputs and kept whittling down the list.  Instead of finding something that worked and trying to add additional things to the model, we kept asking ourselves if we could accomplish the same goal with fewer things in the model.  The more streamlined you make a model the more robust it should be over time.  There are fewer things to break.  Whenever we talk about the process for our portfolios, people seem to think we aren’t as sophisticated as other managers who use a bunch of different factors and constantly reoptimize them.  But the fact of the matter is that we have computers too and we could do that if we wanted to.  There is a very elegant simplicity to how we set up our models, and sometimes that is actually harder to accomplish than making something that is very complex.

Q: Many in the industry argue for multi-factor investment models.  The family of Systematic Relative Strength portfolios employs just one input—relative strength.  Why?

A: Relative Strength (momentum) is one of the premier investment factors out there.  Our expertise lies in building and implementing investment processes using momentum.  That is really where our edge is so we try to exploit that as best as we can.  Over the years we have gained a lot of experience in using other factors along with momentum so you have probably seen us write about other factors, but they are still centered around relative strength.  Momentum is a great factor, it is very objective, and it lends itself very well to the type of systematic models we are good at building.

Q: Of the 7 strategies in the family of Systematic Relative Strength portfolios, one can’t help but take note of the International portfolio.  Is there anything unique about the way that this strategy is managed that may have contributed to its success?

A:  The International strategy uses a universe of ADR’s.  It is one of our smaller strategies in terms of assets under management, but one of our best performers.  The ADR universe is very unique.  There is a ton of dispersion in that universe meaning there are a lot of stocks that have tremendous performance and others that have dreadful performance.  That is great for any relative strength strategy.  In addition, it is a very flexible strategy so we can swing the allocation between developed and emerging whenever we need to.  The ADR strategy is really unique and now that we have a 10 year live track record under our belt I would not be surprised to see interest in that strategy pick up dramatically in the coming years.

Q: What is the trade-off investors face when they choose between our Aggressive, Core, and Growth portfolios, all of which invest in U.S. mid and large cap equities?

A:  It is a classic risk and return tradeoff.  The Aggressive strategy is the most aggressive application of momentum.  That means it has more turnover, more volatility, and over long periods of time higher potential return.  However, it can go quite a while underperforming the other strategies if we aren’t in a good momentum market.  The difference between Core and Growth really comes down to the cash component.  We can raise cash in the Growth portfolio if necessary.  Obviously, that is very beneficial in down markets, but can result in lagging performance in up markets.  All three of those strategies have done well despite not having a real good momentum environment for a while.

Q: Our most popular separately managed account by assets continues to be our Global Macro portfolio.  Why do you think this portfolio has seen so much demand?

Global Macro is a very flexible global tactical asset allocation strategy.  This appeals to a lot of investors because it is so difficult to determine where the best returns will be in the future.  A strategy like global macro just goes to where the momentum is and can invest in a number of different asset classes.  If equities are doing well, we are overweight there.  If things shift and commodities start doing well the portfolio will shift along with it.  What is also appealing is the disciplined application of the process.  Making global trend predictions is darn near impossible.  We know that so we don’t even try to do it.  We are wrong a lot, but the goal is not to stay wrong.  We don’t paint ourselves into a corner and hold on to a prediction we made.  We just position the portfolio to wherever the strength is and make changes when that strength changes.  That is a very appealing way to capitalize on global trends in a very uncertain environment.

To receive the brochure for our Systematic Relative Strength portfolios, please e-mail andyh@dorseymm.com or call 626-535-0630.

The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.

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Q1 Manager Insights

April 15, 2016

The year got off to a rocky start.  After the holidays ended and everyone returned to work, the stock market had a sharp selloff that left it in negative territory for January.  The market would eventually bottom out in mid-February and continue to recover through the end of the quarter.  Despite the early selloff, the S&P 500 actually finished up 1.3% for the quarter.  Small cap and International stocks didn’t fare as well as both of those categories finished in negative territory for the first three months of the year.  Fixed Income and interest rate sensitive securities were some of the best performing areas during the first quarter with broad bond market indexes finishing up about 3%.  Commodities also finished the quarter in negative territory, but did stop the relentless slide they had been on since last year.

Looking at the summary numbers for the first quarter might lead you to believe it was a ho-hum first three months of the year, but that was certainly not the case.  We saw a tremendous amount of rotation under the surface that had a big impact on all of our strategies.  In this piece, we normally like to update you on some big picture items that are affecting the markets and economy, but we felt it was more appropriate to go into greater detail about the specifics of the rotation we saw and how it affected our strategies.

The overarching theme for our investing style was that the laggards finally had their day in the sun.  Simply put, the stocks and asset classes that had been leading the market lower since last summer finally stopped going down and actually went up a lot from the lows.  This is known as a laggard rally, and is never a time when we perform well.  These laggard rallies come along every so often so we are used to them by now.  Everyone realizes the leaders can’t lead forever so we view these periods as an opportunity to refresh the portfolios and find new leadership.  More importantly, they don’t cause a change in our strategy, but they do cause trading activity to pick up as the old leadership is removed from the portfolios and our process tries to find the emerging leadership.  So, if you have noticed a lot more trading in your account recently, that is the reason why.

The changes we have made in the portfolios really changed the characteristics of some of the strategies.  One example of this was the weakening U.S. Dollar.  The Dollar had been strong for quite some time, and finally exhibited enough weakness that we needed to remove it from the portfolios.  We saw a weak dollar asset, Gold, added to many of the strategies.  The strong Dollar had caused quite a headwind for assets such as international equities and commodities, which generally do better in a weak dollar environment.  If the dollar continues to weaken, we expect to see more of these types of assets come into the strategies.  That would actually be a welcome change as it would allow our strategies to do what they do best: find bull markets anywhere around the globe (and in places many people are overlooking).

On the individual equity side, it was much the same as the asset class side.  The so-called FANGs (Facebook, Amazon, Netflix, and Google) were stellar performers last year, but had a difficult start to the year.  What really performed well were the things like energy and basic materials that had such dreadful performance last year.  In some of our other writing we touched on these issues during the quarter.  One example of this is when we look at the S&P 500 industry groups.  The worst relative strength groups outperformed the best performing group by more than 12% during the first quarter!  That was completely opposite from last year when just avoiding the worst groups was the key to outperformance.  Whether these groups can continue to perform is anyone’s guess, but often times they have a large rally off the bottom and then settle in as average performers while they work out their issues.

We are 100% sure (which you almost never hear in this business!) that some of the changes we made to the portfolios won’t work out and we will have to continue to search for leadership.  That is totally normal, and we expect that to be the case over the coming months.  If you have any questions, please don’t hesitate to call us.

Performance numbers provided are the performance of indexes that are not available for direct investment and do not include dividends or transaction costs. Past performance is not indicative of future results and there is no assurance that any forecasts mentioned in this report will be attained.  Stocks offer growth potential but are subject to market fluctuations. Dividends are not guaranteed; companies can reduce or eliminate their dividend at any time. There are special risks associated with an investment in real estate, including credit risk, interest rate fluctuations and the impact of varied economic conditions.  Technical analysis is just one form of analysis. You may also want to consider quantitative and fundamental analysis before making any investment decisions.  The information contained herein 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 material 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 (“information providers”).  However, such information has not been verified by Dorsey, Wright & 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.  DWA and the information provider accept no liability to the recipient whatsoever whether in contract, in tort, for negligence, or otherwise for any direct, indirect, consequential, or special loss of any kind arising out of the use of this document or its contents or of the recipient relying on any such recommendation or information (except insofar as any statutory liability cannot be excluded).  Any statements nonfactual in nature constitute only current opinions, which are subject to change without notice.  Neither the information 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 document does not purport to be complete description of the securities or commodities, markets or developments to which reference is made. Potential for profits is accompanied by possibility of loss.    You should consider this strategy’s investment objectives, risks, charges and expenses before investing.  The examples and information presented do not take into consideration commissions, tax implications, or other transaction costs.  The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy.

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Q4 Manager Insights

January 7, 2016

Despite a decent fourth quarter, global equity markets had a volatile year in 2015.  U.S. and global equities both finished the quarter with solid gains.  After the summer correction in the S&P 500, U.S. stocks snapped back quickly.  This was a surprise to many investors who were looking for the end of one of the longest bull markets on record.  After the snapback, equities treaded water and moved in a very tight trading range to close out the year.  Fixed Income (measured by the Barclay’s Aggregate Index) finished the fourth quarter down slightly, but held on to scrape a 0.55% gain for the year.  Commodities, led by oil, continued their sell off and were the worst performing class of the year.  The trouble in commodities also affected emerging markets, which finished the year down over -14%.

If you were left scratching your head and wondering why it was so difficult to make money in 2015 you are not alone!  According to data from Societe Generale, 2015 was the hardest year to make money in 78 years.  U.S. equities (measured by the S&P 500 Total Return Index) were the best performing major asset class, but only managed to squeak out a gain of 1.38% for the year.  That paltry gain was more than bonds, international equities, and short-term T-bills.  Way back in 1937 (despite what my kids say I was not around to witness that market!) short term treasuries were the best performing major asset class with a gain of only 0.3%.  Even in 2008, bonds were up over 20% so there was somewhere to make money.  This year’s environment was very difficult for hedge funds and for strategies that try to capitalize on major global trends.

Momentum and Relative Strength was a bright spot for the year.  We noticed that more focused (i.e., focused on one specific market) and concentrated (i.e., fewer holdings) strategies performed better.  For example, a concentrated U.S. equity momentum strategy did much better than a strategy with a large number of holdings or a strategy that was invested in multiple asset classes.  It was also advantageous to have a momentum overlay combined with other factors.  Value strategies didn’t fare well in 2015, but value stocks that also had good momentum did very well.  A lot of the momentum outperformance this year came from what momentum strategies avoided rather than what they held.  When we looked at the performance of the S&P 500 industry groups and broke them into quintiles (based on a monthly rebalance), the top four quintiles all had similar performance for the year.  The performance of the bottom quintile, however, was dreadful.  That quintile was made up mainly of Energy and Basic Materials groups.  It is rare to see one group underperform the other four groups by such a large margin (over -13%) for the year.

The Federal Reserve finally took action and raised interest rates by 0.25% during the fourth quarter.  The move was long anticipated, but had been put off due to market volatility and concerns about the health of the global economy.  It is important to keep in mind that even with the hike, rates are still historically low.  We have seen some studies recently that show equities are not as affected as you might think until rates get up around 5%, and we are a long way from that now.  This may be more of a problem for the fixed income markets than equities, but only time will tell.

As the current bull market continues to age we expect a few things to happen we believe will be positive for our strategies.  First, you will begin to hear more cries that the market is “expensive.”  That usually affects valuation based strategies more than relative strength based processes.  Second, the market will continue to narrow.  That is natural and totally expected as the bull market matures.  A narrow market is very positive for our strategies because we can overweight the small pockets of strength that are performing well and avoid the areas that are weak.  As a result, we are encouraging people to take a look at their portfolios and overweight momentum relative to value.  If you have any questions about your allocations or the best way to get exposure to momentum strategies please call us at any time.

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.  Past performance should not be considered indicative of future results. Potential for profits is accompanied by possibility of loss.

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Q3 2015 Manager Insights

October 8, 2015

The third quarter was a difficult one for the stock market as U.S. stocks fell by -6.4% (measured by the S&P 500 Total Return Index).  The decline in equities actually began in May, so the August selloff caused the S&P 500 to fall by more than 10% from its high, which is considered to be a “correction.”  It had been nearly three years since  the market had last entered correction territory, which made it the fifth-longest correction-free streak on record.  Other markets fared even worse than U.S. stocks.  International Developed Markets stocks were down over -10%, and Emerging Markets equities fell nearly -18% during the third quarter.  Commodities were also terrible as Energy prices tumbled.  The one bright spot was Fixed Income, which managed to eke out a small gain of 1.2% (measured by the Barclay’s Aggregate Index).

The main catalyst for the selloff in the third quarter was China.  The Shanghai Composite Index was down more than -25% over the last three months.  The drop in Chinese equities was so severe that the government intervened during the summer and halted trading in some companies, as well as purchasing massive amounts of stock.  The Chinese economy has been slowing, and in August the government devalued the Yuan.  The official reason for the devaluation was to give market forces a bigger role in setting the exchange rate.  Market participants viewed the devaluation as a way for the Chinese government to prop up the ailing industrial sector.  If the government was going to such extreme measures to prop up industry then many people thought they might be in worse shape than we think.

The Federal Reserve was also in focus during the third quarter.  Everyone has been waiting for that first rate hike for what seems like forever.  It seemed like the consensus was that there would be a rate hike during the September meeting.  The Fed, however, decided to leave rates unchanged for the time being.  The issues in China were certainly part of this decision to postpone the rate increase.  Normally, investors are happy with the Fed when they don’t raise rates, but that wasn’t the case this time.  We had another selloff after the lack of a rate increase because people are worried that the global economy might be slowing too much to handle a rate increase.  If that is the case, it will be difficult to use monetary policy to kick start the economy because we are already starting from historically low interest rates.  We also think the disappointment over a lack of a rate increase is because people are simply tired of waiting for it to happen.  The Fed has telegraphed this move so far in advance it is hard to believe anyone will be caught off guard by it.  At this point, it seems like the Fed risks being the parent who constantly threatens punishment, but never follows through with the discipline.  Eventually, the kids stop listening and chaos ensues.  Looking at the big picture, a 0.25% rate increase really isn’t a big deal, and rates will still be historically low.  It seems like raising rates in the near future would signal that the Fed feels the economy is strong enough to handle it and would be welcomed by most investors.

The news hasn’t been all bad though!  High Relative Strength stocks continued to maintain their spread over the broad market on a year to date basis.  Momentum stocks generally performed in-line with the broad market over the summer, which leaves them ahead of the benchmarks for the year.  The biggest area of excess performance this year has come from avoiding the laggard stocks.  Energy and Basic Materials have performed terribly this year, and avoiding those areas has been crucial.  Owning the highest RS stocks has helped, but not as much as avoiding the losers.  That situation isn’t common, but we do see it happen from time to time.

Heading in to the fourth quarter we are optimistic that we are near the bottom of the correction.  Many of our indicators are in oversold territory where historically, we have seen significant rallies develop.  We do anticipate more volatility in the near term, but we believe the environment is setting up nicely for a rally late in the year.

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.  Past performance should not be considered indicative of future results. Potential for profits is accompanied by possibility of loss.

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Q2 Manager Insights

July 8, 2015

Stocks managed small gains in the second quarter of 2015.  The S&P 500 was up slightly, leaving it up about 1.2% so far this year.  Bond yields also rose during the second quarter as investors braced for upcoming rate hikes from the Federal Reserve.  Despite the underperformance of international equities during the second quarter, they remain ahead U.S. equities on a year–to-date basis.

High relative strength equities had much choppier returns during the quarter than the broad market.  After their stellar performance during the first three months of the year we expected there might be some giveback this quarter.  Right out of the gate, high momentum equities began underperforming the broad market, and reached a relative low during the last part of April and beginning of May.  But the second half of the quarter was very good for our strategies.  We made up a lot of the performance lag during the last six weeks of the quarter.  High momentum stocks generally finished slightly behind their benchmarks for the quarter, but that still leaves them well ahead of the broad market for the year.  We were pleased to see the rebound in the types of stocks we buy given the exceptionally strong performance to begin the year.

The circus in Greece dominated the headlines at the end of the second quarter.  There is really no question whether Greece will default on their debts to their creditors – they are going to.  The big question seems to be whether Greece will accept austerity measures that will allow them to borrow even more money, and if not, whether they will abandon the Euro as their currency and return to the Drachma.  To put things in perspective, Greece has spent a good portion of its modern history in some sort of financial crisis so this is really nothing new.  What is new is that Greece doesn’t have its own currency any more so that can not be used as a tool to inflate their way out of debt.  The political and economic ramifications of any scenario in Greece are, quite frankly, impossible to determine.  There is no shortage of opinions being expressed in the media about what should happen, but nobody knows for sure.  We do know, however, that this will play out in the price action of various securities and asset classes around the globe.  It appears U.S. investors have been largely shrugging off the news so far.  If that changes, new trends will emerge and our process is designed to shift the portfolios to those emerging trends.

The economic data received during the second quarter confirmed that the economy is slowing down.  Gross Domestic Product decreased 0.2% during the first three months of the year.  There were some mixed data points that were released later in the quarter so it is really too early to tell if the slowdown in Q1 was the beginning of something bigger or just a small dip within a larger trend.  The economic data did seem to have an effect on Federal Reserve policy.  It appeared as if the Fed was looking to raise rates over the summer (as early as June), but the slowing economy seems to have delayed those plans.  The Fed minutes indicated they would like to begin rate increases some time this year, but the pace of those increases might not be as rapid as people thought.  The Fed has spent an enormous amount of time and energy (and money!) helping the economy limp along, and their statement confirmed they are not about to abandon that policy any time soon.

Overall, we were pleased that our strategies held their own during the quarter after such a strong start to the year.  We believe this leaves us well positioned to capitalize on the second half of the year.  There are definitely some news headlines that will get a lot of attention and add to the volatility over the summer.  However, it is important to remember there have been numerous “problems” that have cropped up during the entire bull run over the last 5 plus years, and nothing has been able to derail this bull market yet.

E-mail andy@dorseywright.com to request the brochure for our Systematic Relative Strength portfolios.

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Q1 Manager Insights

April 9, 2015

The stock market chopped its way to a small gain in the first three months of 2015. February was definitely the best month of the first quarter and made up for negative returns in the other two months. That pattern held true for international markets as well. Bonds also turned in a positive performance for the quarter, but, like equities, experienced some volatility along the way.

One of the biggest stories of the first quarter continued to be the decline in oil prices. As the world continues to have an oversupply of oil, it is a double-edged sword as far as the markets are concerned. Obviously, weak oil prices are not good for the Energy sector which has been one of the worst performing areas lately, and we are seeing a major slowdown in capital spending for new and existing energy projects. On the other hand, lower energy prices are very good for consumers. Many of you have probably noticed much lower gasoline prices. I just drove by a gas station with gas under $3.00 per gallon, which is unheard of in our area of Southern California. Lower energy prices give consumers more spending power, and they seem to be taking advantage of it. Our strategies have recognized this and have allocated more toward areas benefitted by increased consumer spending while underweighting energy companies. It will be interesting to see how this dynamic plays out, but for now it appears the consumer is the biggest beneficiary of the oil price decline.

The big news overseas was the European Central Bank announcement of a bond buying program that could top $1 trillion. That sent the euro into a tailspin, but also helped buoy the European equity markets. In contrast to last year when international markets dramatically underperformed U.S. markets, international markets performed much better during the first three months of the year. Most of the performance came from Developed Markets (reflecting the strength in Europe). Emerging Markets performed better than U.S. markets, but didn’t perform as well as Developed Markets.

Investors are also becoming more concerned with when the Federal Reserve is finally going to raise rates. That possibility was once way off in the distance, but now it appears it may come later this year. Even if the Fed does raise rates later this year, interest rates will still be low by historical standards so the move will be mostly symbolic. It will also be symbolic of a move toward a more “normal” market with much less government intervention. This would be a welcome sign for our strategies. Our decision-making process is primarily focused on market price movements. Less government intervention should mean fewer price shocks and less correlation among stocks and sectors than during the risk on, risk off environment of the last few years.

Our relative strength strategies performed well across the board in the first quarter. We track a Relative Strength Spread, which measures the performance of a basket of strong momentum stocks versus a basket of weak momentum stocks. That measure exploded higher during the first quarter. The spread has been moving sideways for a couple of years, so seeing it begin to move upward again is a very good sign. The strong momentum performance was fairly broad- based, and wasn’t the result of a few lucky stocks. We track a number of strategies that mix momentum with value, dividends, or some other factor. In each case, the strategy with the momentum overlay was superior to the other factor by itself this quarter. The momentum move was very broad based and appeared in numerous segments of the market.

As the bull market continues to mature we are expecting the leadership to narrow. Valuations are up and it is getting more difficult to find bargains. When investors can’t find enough value they often turn to companies that can continue to grow earnings despite a slowing economy. This is usually a very healthy period for momentum strategies. We think we are entering that phase of the cycle and are quite optimistic for what that will mean for our strategies for the rest of 2015.

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

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DWA Q3 2014 Update Webinar

July 18, 2014

Click here for our quarterly DWA webinar with Tom Dorsey, Tammy DeRosier, and John Lewis.

DWA Webinar

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Q2 Manager Insights

July 2, 2014

Click here.

q2

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Q1 Manager Insights

April 1, 2014

Click here for our review of the first quarter and for our market outlook.

mgr insights

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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The Coming Mega-Bull Market?

March 2, 2014

Investor behavior has a lot to do with how markets behave, and with how investors perform.  To profit from a long mega-bull market, investors have to be willing to buy stocks and hold them through the inevitable ups and downs along the way.  Risk tolerance greatly influences their willing to do that—and risk tolerance is greatly influenced by their past experience.

From an article on risk in The Economist:

People’s financial history has a strong impact on their taste for risk. Looking at surveys of American household finances from 1960 to 2007, Ulrike Malmendier of the University of California at Berkeley and Stefan Nagel, now at the University of Michigan, found that people who experienced high returns on the stockmarket earlier in life were, years later, likelier to report a higher tolerance for risk, to own shares and to invest a bigger slice of their assets in shares.

But exposure to economic turmoil appears to dampen people’s appetite for risk irrespective of their personal financial losses. That is the conclusion of a paper by Samuli Knüpfer of London Business School and two co-authors. In the early 1990s a severe recession caused Finland’s GDP to sink by 10% and unemployment to soar from 3% to 16%. Using detailed data on tax, unemployment and military conscription, the authors were able to analyse the investment choices of those affected by Finland’s “Great Depression”. Controlling for age, education, gender and marital status, they found that those in occupations, industries and regions hit harder by unemployment were less likely to own stocks a decade later. Individuals’ personal misfortunes, however, could explain at most half of the variation in stock ownership, the authors reckon. They attribute the remainder to “changes in beliefs and preferences” that are not easily measured.

The same seems to be true for financial trauma. Luigi Guiso of the Einaudi Institute for Economics and Finance and two co-authors examined the investments of several hundred clients of a large Italian bank in 2007 and again in 2009 (ie, before and after the plunge in global stockmarkets). The authors also asked the clients about their attitudes towards risk and got them to play a game modelled on a television show in which they could either pocket a small but guaranteed prize or gamble on winning a bigger one. Risk aversion, by these measures, rose sharply after the crash, even among investors who had suffered no losses in the stockmarket. The reaction to the financial crisis, the authors conclude, looked less like a proportionate response to the losses suffered and “more like old-fashioned ‘panic’.”

I’ve bolded a couple of sections that I think are particularly interesting.  Investors who came of age in the 1930s tended to have an aversion to stocks also—an aversion that caused them to miss the next mega-bull market in the 1950s.  Today’s investors may be similarly traumatized, having just lived through two bear markets in the last decade or so.

Bull markets climb a wall of worry and today’s prospective investors are plenty worried.  Evidence of this is how quickly risk-averse bond-buying picks up during even small corrections in the stock market.  If history is any guide, investors could be overly cautious for a very long time.

Of course, I don’t know whether we’re going to have a mega-bull market for the next ten or fifteen years or not.  Anything can happen.  But it wouldn’t surprise me if the stock market does very well going forward—and it would surprise me even less if most investors miss out.

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How Not to be a Terrible Investor

February 27, 2014

Morgan Housel at Motley Fool has a wonderful article on how investors can learn from failure.  He sets the tone with a few different quotes and anecdotes that point out that a lot of being a success is just avoiding really dumb mistakes.

At a conference years ago, a young teen asked Charlie Munger how to succeed in life. “Don’t do cocaine, don’t race trains to the track, and avoid all AIDS situations,” Munger said. Which is to say: Success is less about making great decisions and more about avoiding really bad ones.

People focus on role models; it is more effective to find antimodels—people you don’t want to resemble when you grow up.    Nassim Taleb

I’ve added the emphasis, but Mr. Housel makes a good point.  Learning from failure is equally important as learning from success.  In fact, he argues it may be more important.

If it were up to me, I would replace every book called How to Invest Like Warren Buffett with a one called How to Not Invest Like Lehman Brothers, Long-Term Capital Management, and Jesse Livermore. There are so many lessons to learn from these failed investors about situations most of us will face, like how quickly debt can ruin you. I’m a fan of learning from Buffett, but the truth is most of us can’t devote as much time to investing as he can. The biggest risk you face as an investor isn’t that you’ll fail to be Warren Buffett; it’s that you’ll end up as Lehman Brothers.

But there’s no rule that says you have to learn by failing yourself. It is far better to learn vicariously from other people’s mistakes than suffer through them on your own.

That’s his thesis in a nutshell.  He offers three tidbits from his study of investing failures.  I’ve quoted him in full here because I think his context is important (and the writing is really good).

1. The overwhelming majority of financial problems are caused by debt, impatience, and insecurity. People want to fit in and impress other people, and they want it right now. So they borrow money to live a lifestyle they can’t afford. Then they hit the inevitable speed bump, and they find themselves over their heads and out of control. That simple story sums up most financial problems in the world. Stop trying to impress people who don’t care about you anyways, spend less than you earn, and invest the rest for the long run. You’ll beat 99% of people financially.

2. Complexity kills. You can make a lot of money in finance, so the industry attracted some really brilliant people. Those brilliant people naturally tried to make finance more like their native fields of physics, math, and engineering, so finance has grown exponentially more complex in the last two decades. For most, that’s been a disservice. I think the evidence is overwhelming that simple investments like index funds and common stocks will demolish complicated ones like derivatives and leveraged ETFs. There are two big stories in the news this morning: One is about how the University of California system is losing more than $100 million on a complicated interest rate swap trade. The other is about how Warren Buffett quintupled his money buying a farm in Nebraska. Simple investments usually win.

3. So does panic. In his book Deep Survival, Laurence Gonzalez chronicles how some people managed to survive plane crashes, getting stranded on boats, and being stuck in blizzards while their peers perished. The common denominator is simple: The survivors didn’t panic. It’s the same in investing. I’ve seen people make a lifetime of good financial decisions only to blow it all during a market panic like we saw in 2008. Any financial decision you make with an elevated heart rate is probably going to be one you’ll regret. Napoleon’s definition of a military genius was “the man who can do the average thing when all those around him are going crazy.” It’s the same in investing.

I think these are really good points.  It’s true that uncontrolled leverage accompanies most real blowups.  Having patience in the investing process is indeed necessary; we’ve written about that a lot here too.  The panic, impatience, and insecurity he references are really all behavioral issues—and it just points out that having your head on straight is incredibly important to investment success.  How successful you are in your profession or how much higher math you know is immaterial.  As Adam Smith (George Goodman) wrote, “If you don’t know who you are, the stock market is an expensive place to find out.” 

Mr. Housel’s point on complexity could be a book in itself.  Successful investing just entails owning productive assets—the equity and debt of successful enterprises—acquired at a reasonable price.  Whether you own the equity directly, like Warren Buffett and his farm, or in security form is immaterial.  An enterprise can be a company—or even a country—but it’s got to be successful.

Complexity doesn’t help with this evaluation.  In fact, complexity often obscures the whole point of the exercise.

This is actually one place where I think relative strength can be very helpful in the investment process.  Relative strength is incredibly simple and relative strength is a pretty good signaling mechanism for what is successful.  Importantly, it’s also adaptive: when something is no longer successful, relative strength can signal that too.  Sears was once the king of retailing.  Upstart princes like K-Mart in its day, and Wal-Mart and Costco later, put an end to its dominance.  Once, homes were lit with candles and heated with fuel oil.  Now, electricity is much more common—but tomorrow it may be something different.  No asset is forever, not even Warren Buffett’s farmland.  When the soil is depleted, that farm will become a lead anchor too.  Systematic application of relative strength, whether it’s being used within an asset class or across asset classes, can be a very useful tool to assess long-term success of an enterprise.

Most investing problems boil down to behavioral issues.  Impatience and panic are a couple of the most costly.  Avoiding complexity is a different dimension that Mr. Housel brings up, and one that I think should be included in the discussion.  There are plenty of millionaires that have been created through owning businesses, securities, or real estate.  I can’t think of many interest rate swap millionaires (unless you count the people selling them).  Staying calm and keeping things simple might be the way to go.  And if the positive prescription doesn’t do it for you, the best way to be a good investor may be to avoid being a terrible investor!

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The Growing Case Against ETFs

February 21, 2014

That’s the title of a Marketwatch article by mutual fund columnist Chuck Jaffe.  I have to admit that usually I like his columns.  But columns like this make me nuts!  (See also The $ Value of Patience for an earlier rant on a similar topic.)

Here’s the thesis in a nutshell:

…safe driving comes down to a mix of equipment and personnel.

The same can be said for mutual funds and exchange-traded funds, and while there is growing consensus that ETFs are the better vehicle, there’s growing evidence that the people using them may not be so skilled behind the wheel.

The article goes on to point out that newsletters with model portfolios of mutual funds and ETFs have disparate results.

Over the last 12 months, the average model portfolio of traditional funds—as tracked by Hulbert Financial Digest—was up 20.9%, a full three points better than the average ETF portfolio put together by the same advisers and newsletter editors. The discrepancy narrows to two full percentage points over the last decade, and Hulbert noted he was only looking at advisers who run portfolios on both sides of the aisle.

Hulbert posited that if you give one manager both vehicles, the advantages of the better structure should show up in performance.

It didn’t.

Hulbert—who noted that the performance differences are “persistent” — speculated “that ETFs’ advantages are encouraging counterproductive behavior.” Effectively, he bought into Bogle’s argument and suggested that if you give an investor a trading vehicle, they will trade it more often.

Does it make any sense to blame the vehicle for the poor driving?  (Not to mention that DALBAR data make it abundantly clear that mutual fund drivers frequently put themselves in the ditch.)  Would it make sense to run a headline like “The Growing Case Against Stocks” because stocks can be traded?

Mutual funds, ETFs, and other investment products exist to fulfill specific needs.  Obviously not every product is right for every investor, but there are thousands of good products that will help investors meet their goals.  When that doesn’t happen, it’s usually investor behavior that’s to blame.  (And you’re not under any obligation to invest in a particular product.  If you don’t understand it, or you get the sinking feeling that your advisor doesn’t either, you should probably run the other way.)

Investors engage in counterproductive behavior all the time, period.  It’s not a matter of encouraging it or not.  It happens in every investment vehicle and the problem is almost always the driver.  In fact, advisors that can help manage counterproductive investor behavior are worth their weight in gold.   We’re not going to solve problems involving investor behavior by blaming the product.

A certain amount of common sense has to be applied to investing, just like it does in any other sphere of life.  I know that people try to sue McDonald’s for “making” them fat or put a cup of coffee between their legs and then sue the drive-thru that served it when they get burned, but whose responsibility is that really?  We all know the answer to that.

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Is Sector Rotation a Crowded Trade?

January 16, 2014

As sector ETFs have proliferated, more and more investors have been attracted to sector rotation and tactical asset allocation strategies using ETFs, whether self-managed or implemented by an advisor.  Mark Hulbert commented on sector rotation strategies in a recent article on Marketwatch that highlighted newsletters using Fidelity sector funds.  All of the newsletters had good returns, but there was one surprising twist:

…you might think that these advisers each recommended more or less the same basket of funds. But you would be wrong. In fact, more often than not, each of these advisers has tended to recommend funds that are not recommended by any other of the top five sector strategies.

That’s amazing, since there are only 44 actively managed Fidelity sector funds and these advisers’ model portfolios hold an average of between five and 10 funds each.

This suggests that there is more than one way of playing the sector rotation game, which is good news. If there were only one profitable sector strategy, it would quickly become so overused as to stop working.

This is even true among those advisers who recommend sectors based on their relative strength or momentum. Because there are so many ways of defining these characteristics, two different sector momentum strategies will often end up recommending two different Fidelity sector funds.

Another way of appreciating the divergent recommendations of these top performing advisers is this: Of the 44 actively managed sector funds that Fidelity currently offers, no fewer than 22 are recommended by at least one of these top five advisers. That’s one of every two, on average, which hardly seems very selective on the advisers’ part.

Amazing, isn’t it?  It just shows that there are many ways to skin a cat.

Even with a very limited menu of Fidelity sector funds, there was surprisingly little overlap.  Imagine how little overlap there would be within the ETF universe, which is much, much larger!  In short, you can safely pursue a sector rotation strategy (and, by extension, tactical asset allocation) with little concern that everyone else will be plowing into the same ETFs.

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Systematic Relative Strength Portfolios: Q4 Manager Insights

January 7, 2014

Fourth Quarter Review

After a short dip to start the fourth quarter, the stock market moved strongly higher through the end of November.  The marked moved sideways during December, never giving up any substantial ground.  What a remarkable year for the stock market!  Despite some choppiness, every quarter this year has had positive equity returns!

The S&P 500 finished up over 30% for the year.  The last time the S&P accomplished that feat was all the way back in 1997.  That was quite a while ago.  In fact, it was the longest streak without a 30% up year since the drought from 1959 to 1974.  The 10.5% return in the fourth quarter made that possible.

Other asset classes didn’t fare as well as equities in 2013.  Continuing to fear tapering by the Federal Reserve, the bond market was lackluster during the final three months of the year.  Many broad fixed income indexes finished 2013 with losses.  Other asset classes, like commodities, performed poorly as well.  Gold, in particular, had a very difficult year after being a darling of the fear mongers for many years.  Diversification, which provided improved returns over the past few years, was definitely not the way to go in 2013.  It was all about equities.

Economic growth may be starting to pick up.  The final estimate for Q3 GDP growth is now 4.1%.  That’s stronger annual growth than we’ve seen for at least six quarters.  Another positive is the Conference Board’s Leading Economic Index, which is up 3.1% over the past six months.  Industrial capacity utilization is still slack and employment still fairly weak, suggesting that there will be little pressure on consumer prices for now.

Although there was some political wrangling about the government healthcare website, the big story for the market this quarter was the December Fed meeting.  Would the Fed taper or not?  The stock and bond markets both seemed apprehensive that the Fed would decide to reduce bond purchases, especially given the negative market reaction in May.  In the end, the Fed decided to taper slightly—and the stock market vaulted upward.

Part of the explanation may have been that the taper was more modest than expected, but a bigger factor was likely the Federal Reserve making it clear that its low interest rate policy would continue even after employment begins to pick up.  Although a new Fed chair, Janet Yellen, is scheduled to be installed in January, observers don’t expect significant policy changes.  The stock market seems to like quantitative easing and there is no end in sight.

While all of this is good news for equities some people are beginning to wonder if we have reached the end of the bull market.  The S&P 500 closed the year at an all-time high.  It has only done that five times since 1929, so it is a rare event.  The good news is that, according to Standard and Poor’s, equities were up an average of 8.5% in the years following a close at an all-time high.  The base rates were also good with equities being up four out of those five years.

We also aren’t seeing the type of euphoria from retail investors that often accompanies major market tops.  In a recent survey, Blackrock found that affluent investors were holding 48% of their investable assets in cash!  This despite expressing greater confidence about their financial futures.  Their allocation to equities was only 18% in the survey.  During the late 1990’s stock assets were closer to 40%, so despite reaching all-time highs equities are still not universally loved.

We are heading into the part of the cycle that tends to be very good for relative strength.  We believe equities can continue to deliver solid returns, and as the market narrows that should be a major positive for our methodology.  As always, we continue to focus on implementing our process in the most disciplined way possible, and if you have any questions we are always happy to speak with you about them.

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