Last week’s performance (1/30/12 – 2/3/12) is as follows:

RS laggards had the better performance last week.

Momentum works. Seminal research by Narasimhan Jegadeesh and Sheridan Titman in 1993 first identified momentum as a systematic source of risk for equity investors. Their research—corroborated by numerous subsequent academic studies—revealed that, historically, momentum investing had provided excess stock returns over a market index.

…..

Overall, momentum returns outperformed market returns by an average of 3.13 percentage points on an annualized basis.

You can see the results on a country-by-country basis below.

Source: Forbes/Gerstein Fisher

Leaving aside the ridiculous statement about momentum being first identified in 1993, their study is important because it shows that momentum returns are universal.  Based on their study and others, we agree.  Dorsey Wright has been running a Systematic RS International portfolio since 2006 and the results have been excellent.  Our net returns have exceeded the EAFE benchmark by a similar amount to what Gerstein Fisher found–not surprising given the substantial overlap in time frames.

To receive the brochure for our Separately Managed Accounts, click here.  

Click here and here for disclosures.  Past performance is no guarantee of future returns.

Although early in the year, taxable bond funds are well in the lead–having already attracted over $18 billion in net new money.

No matter how you look at it, the month of January was a month where most of last year’s losers played catch up and most of last year’s winner dropped back with the pack.  The first chart below shows the performance of the S&P 500 (red dot) and each of the ten sectors in 2011 versus their performance in January.  As shown, the three sectors that were down in 2011 (Financials, Materials, and Industrials) rank in the top three in terms of performance so far this year, while the two best performing sectors last year (Utilities and Consumer Staples) are two of only three sectors down so far this year.

Losers playing catch up and winners lagging is obviously not a formula for good performance by relative strength!  January is typically the worst month for relative strength, but it usually gives way to better performance for the rest of the year.

The Conference Board has made the first major overhaul of the components of the LEI since it assumed responsibility of the index in 1996. It replaced real money supply with its proprietary leading credit index, and the ISM supplier delivery index with the new orders index. In place of the Thomson Reuters/University of Michigan consumer expectations measure, it will now use an equally weighted average of its own consumer expectations index and the current measure. Also, the nondefense capital goods gauge was tweaked to exclude commercial aircraft.

The impact of these changes has been shocking, and really questions the credibility of constructing LEIs. The old LEI rose to a new record high in November, exceeding the previous cyclical peak (where it hovered during 2006 and 2007) by 12.7%. The new LEI edged back up in December to its previous high for the year during July, but that’s 13.1% below the previous cyclical peak!

I added the bold, but you can see why economists are shocked when you see the visual difference in the chart reproduced below (I think Dr. Yardeni included the ECRI leading indicator for good measure):

Source: Ed Yardeni/Conference Board/Haver Analytics (click on chart to enlarge)

The old LEI is blasting off into the stratosphere, but the new LEI is still way, way below the old highs.  In addition, the old LEI showed a very modest decline from the 2006 peak, while the new version shows a bloodbath that took out the 2000-2002 recession lows!

Mr. Yardeni has a very apt comment on the problems with indicators that are revised:

These man-made indexes combine a bunch of indicators that purportedly lead the business cycle. When they fail to do so, the men and women who made these indexes recall them, retool them, and send them back out for all of us to marvel at how well these new improved versions would have worked in the past. I can accurately predict that when they fail in the future, they will be recalled and redesigned yet again.

Of course, it’s not just the US LEI that economists revise.  They revise GDP, CPI, employment data, and virtually everything else.  Analysts revise earnings estimates with regularity, which I suppose is a good way to avoid saying “Our old estimate turned out to be wrong.”

Here we see one of the benefits of using relative strength: since it uses only market prices, it is not subject to revision.  Prices reflect true supply and demand.  No one can come back to you and say, “You know those IBM shares you sold in 2010 for $141?  We’ve revised the data and it was really only $123, so you need to send us a check.  Of course, we might revise it again later, so keep your address current.”  It is difficult to make good investment decisions even when using good data!  It’s got to be near impossible using data that turns out to have been completely wrong.

—-this article was originally published 11/12/2009.  Human economics and monkey economics are exactly the same–scarcity creates value.  The story is quite funny too.

The 10-day moving average of this indicator is 88% and the one-day reading is 84%.

The degree to which central banks around the world are printing money is unprecedented.

He proceeds to show the balance sheets for each of the large central banks, converted back into dollars.  Your eyes will bug out when you see the original article.  For the sake of brevity, all I show here is his graphic of the composite of eight large central banks.

Source: Bianco Research/The Big Picture  (click on image for a sharper version)

Jim points out that:

The combined size of  these eight central banks’ balance sheets has almost tripled in the last  six years from $5.42 trillion to more than $15 trillion and is still on  the rise!

I have no idea if this is a good or bad thing.  How you interpret it probably depends on which group of economists you put your faith in.  My guess—and this is only a guess—is that huge increases in the money supply will eventually result in some inflation.  Commodities generally respond fairly well to inflation, while fixed income may be gasping for air.  (This sort of fits the ”retail investor is always wrong” template, given the huge amounts poured into bonds over the last couple of years.)  Inflation might be a good thing from the Federal government’s point of view, as it will make paying off debt a lot less expensive in real terms.  It might not be so good for investors, depending on how their portfolio is constructed.

The one thing I don’t have to guess at is that quantitative easing, whether it continues to accelerate to ever-giddier heights or starts to wind down, will lead to trends of some kind.  When that happens, relative strength will be a useful guide to sort out where the investment opportunities lie.