Dorsey, Wright Client Sentiment Survey Results – 5/11/12

May 22, 2012

Our latest sentiment survey was open from 5/11/12 to 5/18/12.  The Dorsey, Wright Polo Shirt Raffle continues to drive advisor participation, and we greatly appreciate your support!  This round, we had 53 advisors participate in the survey. If you believe, as we do, that markets are driven by supply and demand, client behavior is important.  We’re not asking what you think of the market—since most of our blog readers are financial advisors, we’re asking instead about the behavior of your clients.  Then we’re aggregating responses exclusively for our readership. Your privacy will not be compromised in any way.

After the first 30 or so responses, the established pattern was simply magnified, so we are comfortable about the statistical validity of our sample. Most of the responses were from the U.S., but we also had multiple advisors respond from at least four other countries.  Let’s get down to an analysis of the data! Note: You can click on any of the charts to enlarge them.

Question 1. Based on their behavior, are your clients currently more afraid of: a) getting caught in a stock market downdraft, or b) missing a stock market upturn?

 

Chart 1: Greatest Fear.  From survey to survey, the S&P 500 fell -3.5%, and client sentiment worsened as expected.  The fear of downturn group rose from 80% to 85%, while the fear of a missed opportunity group fell from 20% to 15%.  Client sentiment remains poor overall.

Chart 2. Greatest Fear Spread.  Another way to look at this data is to examine the spread between the two groups.  The spread ticked higher this round, from 60% to 71%.

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

Chart 3: Average Risk Appetite.  Once again, the average risk appetite performed as expected, falling from 2.77 to 2.55.  Technically speaking, this indicator has broken through solid support on the downside.

Chart 4: Risk Appetite Bell Curve. This chart uses a bell curve to break out the percentage of respondents at each risk appetite level.  We’ve seen a dramatic shift to less risk over the last few surveys.  right now, the majority of clients want either a risk appetite of 2 or 3.

Chart 5: Risk Appetite Bell Curve by Group. The next three charts use cross-sectional data. This chart plots the reported client risk appetite separately for the fear of downdraft and for the fear of missing upturn groups.  This chart sorts out mostly as expected, with the upturn group wanting more risk than the downturn group.

Chart 6: Average Risk Appetite by Group.  This round, both groups’ risk appetite fell with the market.

Chart 7: Risk Appetite Spread.  This is a spread chart constructed from the data in Chart 6, where the average risk appetite of the downdraft group is subtracted from the average risk appetite of the missing upturn group.  The spread fellthis round and is sitting pretty in its normal range.

The S&P 500 fell by -3.5% from survey to survey, and all of our indicators responded in-kind.  The fear of a downturn group rose, and overall risk appetite fell.  We’d expect to see both of those occuring when client sentiment is worsening.

No one can predict the future, as we all know, so instead of prognosticating, we will sit back and enjoy the ride. A rigorously tested, systematic investment process provides a great deal of comfort for clients during these types of fearful, highly uncertain market environments. Until next time, good trading and thank you for participating.

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Posted by JP Lee

Relative Strength Spread

May 22, 2012

The chart below is the spread between the relative strength leaders and relative strength laggards (universe of mid and large cap stocks).  When the chart is rising, relative strength leaders are performing better than relative strength laggards.    As of 5/21/2012:

Even during the correction of the past couple of weeks, the RS Spread has continued to rise—a potentially good sign for RS going forward.

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Posted by Andy Hyer

The New Death of Equities

May 21, 2012

From AdvisorOne, yet another article about how much investors hate the market these days:

Despite strong U.S. equity market returns in early 2012 that sent the Dow back above 13,000 by the end of February, indications are that many Americans remain investment spectators, reluctant to participate in the equity market rally, a Franklin Templeton global poll has found.

Investor skepticism appears to be tied to the extreme volatility witnessed in 2011, in which the Dow Jones Industrial Average had 104 days of triple-digit swings-representing a significant portion of the 252 total trading days last year. Indeed, when asked about the importance of various market scenarios when deciding to purchase an equity investment, market stability was most frequently identified by U.S. respondents as an important factor.

“The market volatility that has persisted since 2008 is keeping many investors on the sidelines, and their ability to view positive equity market performance constructively has been thwarted by the market ups and downs that are at odds with the stability they are seeking,” John Greer, executive vice president of corporate marketing and advertising at Franklin Templeton Investments, said in a statement. “But the reality is that investors who have been waiting for ‘the right time’ to get back into the equity market have been missing out on the market rally we’ve witnessed over the past few years.”

This is sadly typical of retail investors.  Volatility tends to be greatest at market bottoms, and volatility tends to be what investors most avoid.  As a result, investors often avoid returns as well!

This period strikes me as psychologically reminiscent of the late 1970s, when Business Week famously published a cover announcing the death of equities.  Consider what investors had been through: in the late 1960s, the speculative names had gotten torched.  By 1973-74 even the bluest of the blue chips had gotten ripped.  By the late 1970s, 20% annual corrections were the norm.  The economy was a mess and investors simply opted out.  The Business Week cover just reflected the spirit of the time.

The late 1970s are not so different from now.  The speculative names collapsed in 2000-2002, followed by a bear market in 2008-2009 that got everything.  The last couple of summers have been punctuated by scary 15-20% corrections.  The economy is still a mess.  Psychologically, investors are in the same spot they were when the original cover came out.  Based on fund flows, “anything but stocks” seems to be the battle cry.

Yet, consider how things unfolded subsequently.  Only a few years later both the market and the economy were booming.  (High relative strength stocks began to perform very well several years ahead of the 1982 bottom, by the way.)  The Business Week cover is now famous as a contrary indicator.  It wouldn’t shock me if the current investor disdain for stocks has a similar outcome down the road.

Business Week: the famous "Death of Equities" cover

 

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Posted by Mike Moody

Option Sentiment

May 21, 2012

A nice chart from the blog of Horan Capital Advisors of the put-call ratio:

Source: Horan Capital Advisors  (click on image to enlarge)

Their observation is that ratios near one are often lows.  There’s no way to know if the same thing will happen this time, but it fits in with the generally negative sentiment we see in our client behavior survey as well.

via Abnormal Returns

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Posted by Mike Moody

Beautiful Deleveraging

May 21, 2012

Ray Dalio of Bridgewater Associates is an interesting and pragmatic economic thinker.  He had a recent interview with Barron’s, in which he described the deleveraging process in the US as “beautiful.”  Here’s a snippet:

A beautiful deleveraging balances the three options. In other words, there is a certain amount of austerity, there is a certain amount of debt restructuring, and there is a certain amount of printing of money. When done in the right mix, it isn’t dramatic. It doesn’t produce too much deflation or too much depression. There is slow growth, but it is positive slow growth. At the same time, ratios of debt-to-incomes go down. That’s a beautiful deleveraging.

We’re in a phase now in the U.S. which is very much like the 1933-37 period, in which there is positive growth around a slow-growth trend. The Federal Reserve will do another quantitative easing if the economy turns down again, for the purpose of alleviating debt and putting money into the hands of people.

We will also need fiscal stimulation by the government, which of course, is very classic. Governments have to spend more when sales and tax revenue go down and as unemployment and other social benefits kick in and there is a redistribution of wealth. That’s why there is going to be more taxation on the wealthy and more social tension. A deleveraging is not an easy time. But when you are approaching balance again, that’s a good thing.

What makes all the difference between the ugly and the beautiful?

The key is to keep nominal interest rates below the nominal growth rate in the economy, without printing so much money that they cause an inflationary spiral. The way to do that is to be printing money at the same time there is austerity and debt restructurings going on.

It’s interesting that he seems pretty satisfied with the process the US has taken so far, in the sense that we may avoid significant inflation or deflation.  The deleveraging process won’t be easy socially or economically, but it’s certainly preferable to a Japan-type scenario.  His opinion is interesting to me because so many other commentators are falling into the doomsday camp, although half are expecting Japan-style deflation and the other half are counting on Weimar-style inflation.

I suppose it is human nature to worry about the worst thing that can happen, but Mr. Dalio suggests a middle path might be the most realistic.

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Posted by Mike Moody

Weekly RS Recap

May 19, 2012

The table below shows the performance of a universe of mid and large cap U.S. equities, broken down by relative strength decile and quartile and then compared to the universe return.  Those at the top of the ranks are those stocks which have the best intermediate-term relative strength.  Relative strength strategies buy securities that have strong intermediate-term relative strength and hold them as long as they remain strong.

Last week’s performance (5/14/12 – 5/18/12) is as follows:

The worst performance for the week actually came from the bottom quartile of the ranks (laggards).

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Posted by Andy Hyer

Sector and Capitalization Performance

May 18, 2012

The chart below shows performance of US sectors and capitalizations over the trailing 12, 6, and 1 month(s).  Performance updated through 5/17/2012.

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Posted by JP Lee

Beanbag Economics and Relative Strength

May 17, 2012

By now, it’s pretty apparent that the Euro is eventually going to be toast, just like the ERM imploded before it.  (Perhaps it was never logical to assume that one currency and one central bank would be able to satisfy many different cultures and political regimes?)  Of course there is a lot of hand-wringing going on about all of the bad things that will happen, but no one is talking about the offsetting good things that will happen.

We’ve written before about beanbag economics, the essence of which is that when you smush in one part of a beanbag, it just poofs out somewhere else.  Relative strength is a simple and effective way to see where trends are underway.

Consider a typical bad news lead in this Reuters article:

Worries about a run on Greek banks has rattled Athens this week, after savers withdrew at least 700 million euros on Monday alone…

That sounds quite scary.  However, buried deep in the article, at the very end, is the beanbag economics section:

Deposits shifted around Europe dramatically last year, analysis of data from more than 120 listed European banks show.

More than 120 billion euros was taken from two banks in Belgium alone, including an exodus of customer deposits from Dexia (DEXI.BR) which had to be bailed out and restructured. KBC (KBC.BR) also saw a big outflow.

Some 90 billion euros was taken from France’s banks, including around 30 billion each from Credit Agricole (CAGR.PA) and BNP Paribas (BNPP.PA). French banks were hit last year by their heavy exposure to Greece and concerns about their liquidity that forced them to accelerate plans to shrink.

Worries the euro zone crisis would spread also saw about 30 billion euros in deposits leave Italian banks, although inflows to BBVA (BBVA.MC) helped limit the net outflow from Spain.

Cash flooded into Britain; more than 140 billion euros was deposited in four big banks alone. The UK benefits from its position outside the euro zone and its Asia-focused banks HSBC (HSBA.L) and Standard Chartered (STAN.L) are seen as particular safe-havens.

Other banks to see big inflows included Barclays (BARC.L), Germany’s Deutsche Bank (DBKGn.DE), Switzerland’s Credit Suisse (CSGN.VX) and UBS (UBSN.VX) and Russia’s Sberbank (SBER.MM) and VTB (VTBR.MM).

Banks that were in trouble had deposits leave, but they didn’t vanish into thin air.  Other banks saw massive inflows at their expense.  And—think about it—the Greek and French banks had the money in the first place because depositors saw them as relatively more attractive than European stocks or their mattresses, or whatever, at the time.  Times have now changed and the flow of money is being directed somewhere else.  It’s not the end of the world when some asset class implodes, unless, of course, you have 100% of your assets in it.  That implosion works to the benefit of another asset class somewhere else.

There are always relative winners and losers; things are rarely completely one-sided.  This is the primary attraction of using relative strength for tactical asset allocation.  It is able to identify shifts in supply and demand by measuring what assets are strong and what assets are weak.   Markets all over the world operate and interact in this same way.

Beanbag Economist: Someone has to get those asset flows!

Source: www.indyagenda.com

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Posted by Mike Moody

Fund Flows

May 17, 2012

The Investment Company Institute is the national association of U.S. investment companies, including mutual funds, closed-end funds, exchange-traded funds (ETFs), and unit investment trusts (UITs).  Members of ICI manage total assets of $11.82 trillion and serve nearly 90 million shareholders.  Flow estimates are derived from data collected covering more than 95 percent of industry assets and are adjusted to represent industry totals.

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Posted by JP Lee

Relative Strength Still Off the Radar

May 16, 2012

The Big Picture has a thumbnail summary of the annual Merrill Lynch US Equity and US Quant Strategy pieces, where they interview 100 large institutional managers.  Of particular interest to me was the top ten return factors by popularity.

via The Big Picture  (click on image to enlarge)

You can see that relative strength did not crack the top ten.  On the bigger chart, which you can see in the article, relative strength came in at #11.  Of course, there are many formulations of relative strength, so even that ranking probably covers a lot of different methods.

A number of the popular factors are value-related and some are based on profitability.  All of these factors ultimately interact in complicated ways, but you don’t have to worry about a crowded trade in relative strength.

Value, quality, and risk-related factors are all much more popular than relative strength.

via The Big Picture     (click on image to enlarge)

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Posted by Mike Moody

The Not-So-Normal Bell Curve

May 16, 2012

Matt Koppenheffer nicely makes the case for holding on to your winners and cutting out your losers (exactly what relative strength is designed to do):

When it comes to investing, there’s no shortage of bad advice floating around out there. Among the worst, though, is the old saw, “You can’t go broke by taking a profit.”

The saying refers to the belief that if you have a stock that’s gone up in value, it’s hard to go wrong selling that stock and “locking in” the gains. But while the saying is technically true — it’s hard to picture a scenario where an investor is suddenly bankrupt after selling a stock at a profit — it’s a dangerous platitude for investors to follow.

There’s a name for that
The practice of selling winning stocks and hanging on to losing ones is a practice that’s familiar to behavioral-finance experts. It’s a behavioral bias known as the disposition effect and has been revealed to be quite harmful for investors. A number of academic papers have shed light on the subject, including Berkeley professor Terrance Odean’s 1998 study that concluded that individual investors’ “preference for selling winners and holding losers … leads, in fact, to lower returns.”

A possible explanation
If the long-term returns from stocks were distributed normally — that is, they formed the familiar bell-shaped curve and most stocks’ returns clustered around the average — selling winners and holding losers might actually work. If the returns from most individual stocks were likely to be right around the average for all stocks, then a big winner would be more likely to stall out after its winning streak than continue climbing. At the other end, it wouldn’t be unreasonable to expect a stock that’s been a big loser to climb back closer to the average.

But that’s not how it works.

I was reminded of this by a recent report by Shankar Vedantam for NPR, called “Put Away the Bell Curve: Most of Us Aren’t Average.  Vedantam reviewed the research and work of Ernest O’Boyle Jr. and Herman Aguinis, who studied the performance of 633,263 people involved in academia, sports, politics, and entertainment.

In short, the pair’s finding was that the performance distribution in these groups wasn’t bell-shaped. Instead, many participants clustered below the mathematical average, while a group of superstars produced results far above the average and pulled the overall average up.

Stock returns have a similar distaste for fitting to a bell curve. Over the past 10 years, 63% of the S&P 500 companies underperformed the average. Meanwhile, a large group of significant outperformers delivered returns that were well above the average.

As compared with the bell curve in the background, the data plotted here is a mess. And it should be. Stock returns are not normally distributed — which is what produces that nice bell-shaped curve. And though stats-stars who are much smarter than me often try to describe stock returns as “lognormal” — a mathematical transformation of the returns that gets them to more closely fit a bell curve — they’re not that, either. Stocks are typified by “fat tails” on either end — that is, more seriously outperforming and underperforming stocks than is easily captured by streamlined mathematical models.

So no matter how you look at stock returns, a surprising number of stocks end up returning far more and far less than the average. Practically, this means that the practice of “locking in gains” and hanging on to losers is a good way to miss out on the market’s huge outperformers, stay stuck with poor performers, and earn lackluster overall returns.

HT: iShares

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Posted by Andy Hyer

Morningstar Fair Value

May 16, 2012

We use relative strength, not fundamentals, but that doesn’t mean we ignore it.  Now that we have powered through another earnings season and we’re having another Greek crisis moment in Europe, it’s interesting to see that the good folks at Morningstar calculate that the market is about as undervalued as it has been all year.  I know it’s trendy to hate stocks and love alternatives, but analysts who follow these companies—and don’t have an axe to grind—don’t think they are expensive.

Stocks still undervalued according to Morningstar

Source: Morningstar  (click on image to enlarge)

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Posted by Mike Moody

High RS Diffusion Index

May 16, 2012

The chart below measures the percentage of high relative strength stocks that are trading above their 50-day moving average (universe of mid and large cap stocks.)  As of 5/15/12.

The 10-day moving average of this indicator is 54% and the one-day reading is 40%.

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Posted by Andy Hyer

Navigating the ETF Galaxy

May 15, 2012

ETFdb describes the growing ETF universe as follows:

At times, it seems as if the number of ETFs available to U.S. investors will soon exceed the number of stars in the sky. That might be overstating things a bit, but the pace of expansion in the ETF industry has truly been impressive over the last several years. With multiple products seemingly debuting every week and very few shutting down (despite countless predictions to the contrary), the size of the ETF lineup has effectively doubled in a relatively short period of time. And there’s no indication that the product development front is going to be slowing down any time soon; issuers continue to file for both innovative and duplicative products, producing a pipeline full of hundreds of funds that could debut at some point in the next several months.

The proliferation of ETFs, ETNs, and other exchange-traded cousins of these vehicles is, in many ways, a very positive development for investors. There are now ETPs for just about every investment objective, ranging from the very broad and very straightforward to the hyper-targeted and rather complex. And many of the more recent additions to the ETF lineup have further “democratized” the business of investing, delivering cheap and easy access to sophisticated strategies that would otherwise be time consuming and expensive to implement.

My emphasis added.  Up to this point, I wholeheartedly agree–the expansion of the ETF universe has been extremely beneficial to investors.  It has also played right into our hands here at Dorsey Wright because it has provided a very tax-efficient means of getting exposure to relative strength (See PDP, PIE, and PIZ).  Furthermore, the expansion of the ETF universe has enabled us to provide innovative global tactical asset allocation strategies (See DWAFX and DWTFX) where we can efficiently get exposure to a wide variety of global asset classes.

However, ETFdb then states the following:

But the growth spurt for the industry has also made it increasingly difficult to navigate. Moreover, the tremendous variance in level of sophistication and risk tolerance among ETFs can set the stage for confusion and potentially lead to a less-than-ideal experience with ETFs.

That last part is only true if there is no framework for efficiently and thoroughly evaluating each of the ETFs.  Without such a framework then, yes, I can certainly understand why some find it “increasingly difficult to navigate.”  However, within the context of a relative strength model, more choices are potentially a good thing.  The more options for finding uncorrelated returns, the more likely it is that a global tactical asset allocation strategy can generate favorable returns in a variety of market environments.  Furthermore, relative strength models evaluate each member of the universe in a systematic fashion and only allocate if dictated by the relative strength rank–a true meritocracy!

Source: Wikipedia

See www.powershares.com and www.arrowfunds.com.

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Posted by Andy Hyer

What’s Hot…and Not

May 15, 2012

How different investments have done over the past 12 months, 6 months, and month.

 1PowerShares DB Gold, 2iShares MSCI Emerging Markets ETF, 3iShares DJ U.S. Real Estate Index, 4iShares S&P Europe 350 Index, 5Green Haven Continuous Commodity Index, 6iBoxx High Yield Corporate Bond Fund, 7JP Morgan Emerging Markets Bond Fund, 8PowerShares DB US Dollar Index, 9iBoxx Investment Grade Corporate Bond Fund, 10PowerShares DB Oil, 11iShares Barclays 20+ Year Treasury Bond

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Posted by Andy Hyer

Weekly RS Recap

May 14, 2012

The table below shows the performance of a universe of mid and large cap U.S. equities, broken down by relative strength decile and quartile and then compared to the universe return.  Those at the top of the ranks are those stocks which have the best intermediate-term relative strength.  Relative strength strategies buy securities that have strong intermediate-term relative strength and hold them as long as they remain strong.

Last week’s performance (5/7/12 – 5/11/12) is as follows:

High RS Stocks underperformed the universe last week, as did the laggards.  It was the stocks in the middle of the ranks that actually held up the best.

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Posted by Andy Hyer

Dorsey, Wright Client Sentiment Survey – 5/11/12

May 11, 2012

Here we have the next round of the Dorsey, Wright Sentiment Survey, the first third-party sentiment poll.  Participate to learn more about our Dorsey, Wright Polo Shirt raffle! Just follow the instructions after taking the poll, and we’ll enter you in the contest.  Thanks to all our participants from last round.

As you know, when individuals self-report, they are always taller and more beautiful than when outside observers report their perceptions!  Instead of asking individual investors to self-report whether they are bullish or bearish, we’d like financial advisors to weigh in and report on the actual behavior of clients.  It’s two simple questions and will take no more than 20 seconds of your time. We’ll construct indicators from the data and report the results regularly on our blog–but we need your help to get a large statistical sample!

Click here to take Dorsey, Wright’s Client Sentiment Survey.

Contribute to the greater good!  It’s painless, we promise.

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Posted by JP Lee

Sector and Capitalization Performance

May 11, 2012

The chart below shows performance of US sectors and capitalizations over the trailing 12, 6, and 1 month(s).  Performance updated through 5/10/2012.

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Posted by Andy Hyer

Dimon: “We Have The Royal Straight Flush”

May 10, 2012

Great words of wisdom from Jamie Dimon.

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Posted by Andy Hyer

Fund Flows

May 10, 2012

The Investment Company Institute is the national association of U.S. investment companies, including mutual funds, closed-end funds, exchange-traded funds (ETFs), and unit investment trusts (UITs).  Members of ICI manage total assets of $11.82 trillion and serve nearly 90 million shareholders.  Flow estimates are derived from data collected covering more than 95 percent of industry assets and are adjusted to represent industry totals.

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Posted by Andy Hyer

Warren Buffett vs. Gold

May 9, 2012

Warren Buffett reiterated at his recent “Woodstock for Capitalists,” otherwise known as Berkshire Hathaway’s annual meeting, that he much preferred productive assets to gold.  Charlie Munger agreed.  For the record, I’ve got nothing against productive assets.  They produce earnings and sometimes dividends and that’s nice.  However, a global tactical asset allocator should not be too eager to count out gold.

Gold has had good relative strength for much of the last decade—and as a result it has dramatically outperformed Warren Buffett.  Bespoke took up this exact issue and had this to say:

Given the fact that BRK/A does not pay a dividend, no matter how much a holder ‘fondles’ or looks at their holdings, one share of BRK/A stock purchased twelve years ago is still one share today.  Sure, you can sell it for more now than you bought it then, but the same is true of gold.  In fact, your gain on gold is considerably more than your gain would be on BRK/A.  Looking at the performance of the two assets since the start of 2000 shows that the value of gold has increased considerably more than the value of Berkshire Hathaway.  In fact, with a gain of 466% since the start of 2000, gold’s gain has been nearly four times the return of BKR/A (466% vs 120%).

Their nifty graphic follows:

Source: Bespoke   (click on image to enlarge)

Relative strength has no axe to grind.  One of the great benefits of using relative strength to drive tactical asset allocation is that it is objective and adaptive.  Relative strength does not have a philosophical bias in favor of, or against, gold.  If relative strength is high, perhaps it should be included in the portfolio.  If relative strength is low, it’s out—period.

The point of investing is not to serve our biases, but to own the best-performing assets that we can identify.

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Posted by Mike Moody

High RS Diffusion Index

May 9, 2012

The  chart below measures the percentage of high relative strength stocks that are trading above their 50-day moving average (universe of mid and large cap stocks.)  As of 5/8/12.

The 10-day moving average of this indicator is 69% and the one-day reading is 50%.

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Posted by Andy Hyer

Dorsey, Wright Client Sentiment Survey Results – 4/27/12

May 8, 2012

Our latest sentiment survey was open from 4/27/12 to 5/4/12.  The Dorsey, Wright Polo Shirt Raffle continues to drive advisor participation, and we greatly appreciate your support!  This round, we had 55 advisors participate in the survey. If you believe, as we do, that markets are driven by supply and demand, client behavior is important.  We’re not asking what you think of the market—since most of our blog readers are financial advisors, we’re asking instead about the behavior of your clients.  Then we’re aggregating responses exclusively for our readership. Your privacy will not be compromised in any way.

After the first 30 or so responses, the established pattern was simply magnified, so we are comfortable about the statistical validity of our sample. Most of the responses were from the U.S., but we also had multiple advisors respond from at least three other countries.  Let’s get down to an analysis of the data! Note: You can click on any of the charts to enlarge them.

Question 1. Based on their behavior, are your clients currently more afraid of: a) getting caught in a stock market downdraft, or b) missing a stock market upturn?

Chart 1: Greatest Fear.  From survey to survey, the S&P 500 rose +2.4%, and client sentiment improved as a result.  The fear of downturn group fell from 90% to 80%, while the upturn group rose from 10% to 20%.  Client sentiment is still poor overall, but it’s nice to see a rally have some effect.

Chart 2. Greatest Fear Spread.  Another way to look at this data is to examine the spread between the two groups.  The spread dipped lower this round, from 80% to 60%.

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

Chart 3: Average Risk Appetite.  After falling for two straight surveys, the overall risk appetite bounced back this round (barely), from 2.70 to 2.77.

Chart 4: Risk Appetite Bell Curve. This chart uses a bell curve to break out the percentage of respondents at each risk appetite level.  We saw a more even distribution this round, though tilted towards less risk.

Chart 5: Risk Appetite Bell Curve by Group. The next three charts use cross-sectional data. This chart plots the reported client risk appetite separately for the fear of downdraft and for the fear of missing upturn groups.  This chart sorts out mostly as expected, with the upturn group wanting more risk than the downturn group.

Chart 6: Average Risk Appetite by Group.  This round, the upturn group’s average shot higher, while the downturn group’s average fell slightly.  Keep in mind that overall risk ticked slightly higher with the market.

Chart 7: Risk Appetite Spread.  This is a spread chart constructed from the data in Chart 6, where the average risk appetite of the downdraft group is subtracted from the average risk appetite of the missing upturn group.  The spread moved higher this round and seems to be settled into a new range.

From survey to survey, the S&P rallied over +2%, and our client sentiment indicators responded as they should.  The fear of a downturn group moved lower, while risk appetite moved higher.  All in all, it was a pretty standard client sentiment reaction to market behavior.

No one can predict the future, as we all know, so instead of prognosticating, we will sit back and enjoy the ride. A rigorously tested, systematic investment process provides a great deal of comfort for clients during these types of fearful, highly uncertain market environments. Until next time, good trading and thank you for participating.

1 Comment | Investor Behavior, Markets, Sentiment | Permalink
Posted by JP Lee

Factor Investing

May 8, 2012

Diversification, risk management, and returns are all important in investing.  Increasingly, factor exposure is being used to accomplish these goals.  A Wall Street Journal article covered the issue very well (may be behind a pay wall, sorry).

By changing the way you spread out your stock holdings, you can reduce risk and boost returns—even in a highly correlated market like today’s.

The trick? A concept known as “factor investing,” which originated in academia two decades ago and now is finding favor among institutional investors and high-end financial advisers.

Factor investing replaces traditional asset allocation—such as a portfolio with 30% in U.S. stocks, 20% in developed international markets, 10% in emerging markets and 40% in bonds—by focusing on specific attributes that researchers say drive returns. These “risk factors” include the familiar—like small versus large-size companies or growth versus value stocks—as well as more esoteric measures such as volatility, momentum, dividend yield, economic sensitivity and the health of a company’s balance sheet.

As a reader of this blog, you’re probably already familiar with factor investing through relative strength—something that academics call momentum.  Using factors rather than style boxes has some advantages.

“There are a lot of nuances you may be missing by focusing only on style and size,” says Savita Subramanian, head of equity and quantitative strategy at BofA Merrill Lynch Global Research. “You may be missing a whole layer of outperformance you could have gotten.”

Some fairly high-end investors are converting portfolios to focus on factor exposures.  By converting to factor exposure, investors are trying to drill down to the actual return drivers.

Big investors are taking heed. In 2009, researchers assigned to analyze the Norwegian Government Pension Fund recommended it reorient its portfolio around risk factors. And the California Public Employees’ Retirement System underwent a similar change in approach in 2010.

After 2008, big investors discovered that they had factor exposure anyway—it was just exposure they were not aware of and hadn’t controlled.  There’s a lot less potential for surprise if the factor exposures are constructed deliberately!

New products are becoming available to feed the demand for factor exposure as well.

Until recently, it was hard for small investors to dabble in factor investing. But that is changing.

In the past year at least six firms—BlackRock’s iShares, Russell Investments, Invesco PowerShares, Factor Advisors, QuantShares and State Street Global Advisors—have launched factor-based exchange-traded funds, or have filed paperwork to do so.

Of course, overlooked among the rush of big firms racing to create factor exposure is the grand-daddy of relative strength, the Powershares DWA Technical Leaders Index (PDP).  It’s actually been around more than five years and has performed nicely over that time, beating the S&P 500 despite a market environment that has been hostile to relative strength strategies.  (We’re looking forward to seeing how it performs in a better RS market!)

One of the big advantages of factor exposure is that some factors offset one another beautifully.  We’ve written before about the nice efficient frontier that is created by combining relative strength and low volatility.  (You can see the chart below.)  These factors work well together because the excess returns are uncorrelated.

Source: Dorsey Wright    (click to enlarge to full size)

In short, there’s more to portfolio construction than asset allocation and style boxes.  Factor exposure should be considered as well if the result is a better portfolio for the client.

See www.powershares.com for more information about PDP.  Past performance is no guarantee of future returns.  A list of all holdings for the trailing 12 months is available upon request.

4 Comments | From the MM, Markets, Thought Process | Permalink
Posted by Mike Moody

Relative Strength Spread

May 8, 2012

The chart below is the spread between the relative strength leaders and relative strength laggards (universe of mid and large cap stocks).  When the chart is rising, relative strength leaders are performing better than relative strength laggards.    As of 5/7/2012:

The RS Spread continues to trade above its 50 day moving average.

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Posted by Andy Hyer

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