Relative Strength Spread

January 5, 2016

The chart below is the spread between the relative strength leaders and relative strength laggards (top quartile of stocks in our ranks divided by the bottom quartile of stocks in our ranks; universe of U.S. mid and large cap stocks).  When the chart is rising, relative strength leaders are performing better than relative strength laggards.    As of 1/4/16:

spread

This example is presented for illustrative purposes only and does not represent a past recommendation.  The performance above is based on pure price returns, not inclusive of dividends or all transaction costs.   Investors cannot invest directly in an index. Indexes have no fees. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.

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Meet This Year’s Best Consumer Staples ETF

January 2, 2016

Via MarketWatch:

Even with all the concern regarding higher interest rates, a scenario that was realized earlier this month, rate-sensitive consumer staples stocks and exchange traded funds have been solid performers in 2015. Two of the 14 Dow Jones Industrial Average Stocks that are up this year are staples stocks: Procter & Gamble Inc. PG, -0.82% and Wal-Mart Stores Inc. WMT, -0.62%

Add to that, the Consumer Staples Select Sector SPDR XLP, -1.12% and the Vanguard Consumer Staples ETF VDC, -1.10% are up 7.7 percent and 6.7 percent, respectively, this year. Those are solid performances, particularly in the face of rising interest rates, but those are from the best showings among staples ETFs. Honors for 2015’s best staples go to the PowerShares DWA Consumer Staples Momentum Portfolio PSL, -1.01% which is up 14 percent year-to-date.

PSL is a smart or strategic beta ETF, meaning it is not capitalization-weighted as are rivals such as XLP and VDC. That also means PSL is not dominated by the likes of Procter & Gamble and Wal-Mart as are XLP and traditional cap-weighted staples ETFs.
PSL’s stellar year-to-date showing relative to its cap-weighted performers could imply, to some investors, that significant risk is involved with betting on PSL over its more traditional rivals. However, that is not the case. Not only has PSL offered superior returns over standard consumer staples ETFs, the PowerShares offering has posted better risk-adjusted returns. For example, PSL’s volatility this year has been 14.6 percent, according to ETF Replay. That is 100 basis points in excess of VDC, but PSL has outpaced the Vanguard Staples ETF by 730 basis points.

PSL follows the Dorsey Wright Consumer Staples Technical Leaders Index, a benchmark that “is designed to identify companies that are showing relative strength (momentum), and is composed of at least 30 common stocks from the NASDAQ US Benchmark Index,” according to PowerShares, the fourth-largest U.S. ETF issuer.

PSL has swelled in popularity this year. When we highlighted the ETF in late September, it had less than $221 million in assets under management. Since then, PSL’s assets under management tally has surged north of $369 million. Only six PowerShares ETFs have added more new assets in 2015 than PSL.

PSL break from the norm among staples ETFs is okay because over the past year, the Dorsey Wright Consumer Staples Technical Leaders Index has offered nearly double the returns of the S&P 500 consumer staples index and over the past three- and five-year periods, PSL has topped that index. PSL started tracking the Dorsey Wright index early last year.

See www.powershares.com for a prospectus.  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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Weekly RS Recap

January 2, 2016

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 (12/28/15 – 12/31/15) is as follows:

ranks

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

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Q1 2016 PowerShares DWA Momentum ETFs

January 2, 2016

The PowerShares DWA Momentum Indexes are reconstituted on a quarterly basis.  These indexes are designed to evaluate their respective investment universes and build an index of stocks with superior relative strength characteristics.   This quarter’s allocations are shown below.

PDP: PowerShares DWA Momentum ETF

pdp 

DWAS: PowerShares DWA Small Cap Momentum ETF

dwas

DWAQ: PowerShares DWA NASDAQ Momentum ETF

dwaq

PIZ: PowerShares DWA Developed Markets Momentum ETF

piz

PIE: PowerShares DWA Emerging Markets Momentum ETF

pie

Source: Dorsey Wright, MSCI, Standard & Poor’s, and NASDAQ, Allocations subject to change

We also apply this momentum-indexing methodology on a sector level:

sector

See www.powershares.com for more information.  

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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High RS Diffusion Index

December 23, 2015

The chart below measures the percentage of high relative strength stocks (top quartile of our ranks) that are trading above their 50-day moving average (universe of mid and large cap stocks.)  As of 12/22/15.

diffusion

The 10-day moving average of this indicator is 57% and the one-day reading is 58%.

This example is presented for illustrative purposes only and does not represent a past recommendation.  The performance above is based on pure price returns, not inclusive of dividends or all transaction costs.   Investors cannot invest directly in an index. Indexes have no fees. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.

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The Performance Chase

December 22, 2015

Sound advice from James Osborne:

Your strategy is not going to work unless you work with it. I have beaten this dead horse well into the ground, but if you keep looking at your neighbor’s returns, you’re committing investor suicide. Somebody, somewhere did better than you this year. Lots of somebodies. Anyone who works for Facebook or Amazon or Netflix and has a bunch of their net worth in company stock probably crushed you this year. Is that a strategy you should pursue? Probably not, but you need to remind yourself why you have the strategy you do. Everything has a bad year. Value stocks get cheaper. Trendfollowers get whipsawed. S&P 500 investors get caught in tech bubbles. “Factors” don’t show up.

You will either get this or you won’t. If you think you are entitled to the best return of the best strategy every year, good luck to you. You will bounce from strategy to strategy, constantly disappointed with your returns. You will chase performance and fail to capture the long term return of ANY strategy, let alone the “best” strategy. You’ll fire dozens of financial advisors and complain to your friends about what schmucks these clowns are. You’ll say the markets are rigged. For you, they are and always will be.

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In Search of Sustained Success

December 22, 2015

How do you rate an NBA team across a decade of play?  One method is “Elo,” a simple measure of strength calculated by game-by-game results (Source: Nate Silver’s FiveThirtyEight).  A description of Elo is below:

Elo ratings have a simple formula; the only inputs are the final score of each game, and where and when it was played. Teams always gain Elo points for winning. But they get more credit for upset victories and for winning by larger margins. Elo ratings are zero-sum, however. When the Houston Rockets gained 49 Elo points by winning the final three games of their Western Conference semifinal during this year’s playoffs, that meant the Los Angeles Clippers lost 49 Elo points.

A rating of 1500 is approximately average, although the league average can be slightly higher or lower depending on how recently the league has expanded. (Expansion teams begin with a 1300 rating.)

As Nate Silver recently tweeted: “Last time the Spurs were a below-average team was in Jan. 1998, right about when the Lewinsky scandal was breaking.”

spurs

Impressive, is it not?  Talk about an organization that figured out a formula for sustained success.  On the opposite end of the spectrum, consider the Elo of the Clippers as shown below:

clippers

Yes, they have become an above average team in recent years, but man did they stink for the better part of the last several decades!

What stands out to me in flipping through the Elo of the different NBA teams is the outliers.  Yes, there are a lot of teams that hover around average, but there are some stark standouts.

How true this is in the financial markets as well.  In fact, this reminded me of a study completed by BlackStar Funds a couple years ago when they looked at the lifetime total returns of individual stocks relative to the corresponding return for the Russell 3000.  Again, what stands out to me is the outliers.  6.1% of all stocks outperformed the Russell 300 by at least 500% during their lifetime.  Likewise, 3.9% of all stocks lagged the Russell 3000 by at least 500%.

BlackStar

Outliers are what makes this business fun and ultimately where the most money can be made.  Just like with certain NBA franchises, there are multi-year winners and multi-year losers in the financial markets.  Relative strength, much like Elo, can help you stay on the right side of those trends.

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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Relative Strength Spread

December 22, 2015

The chart below is the spread between the relative strength leaders and relative strength laggards (top quartile of stocks in our ranks divided by the bottom quartile of stocks in our ranks; universe of U.S. mid and large cap stocks).  When the chart is rising, relative strength leaders are performing better than relative strength laggards.    As of 12/21/15:

spread 12.22.15

This example is presented for illustrative purposes only and does not represent a past recommendation.  The performance above is based on pure price returns, not inclusive of dividends or all transaction costs.   Investors cannot invest directly in an index. Indexes have no fees. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.

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Dan Draper on DWTR

December 21, 2015

Tom Lydon speaks with Dan Draper, Head of PowerShares, about the PowerShares DWA Tactical Sector Rotation Portfolio (DWTR):

See www.powershares.com for a fact sheet on DWTR. Dorsey Wright is the index provider for DWTR.

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Weekly RS Recap

December 21, 2015

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 (12/14/15 – 12/18/15) is as follows:

ranks

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

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Remember When

December 18, 2015

Ben Carlson prepares you for how to handle all those 2016 forecasts:

Remember when the Fed was never going to raise interest rates?

Remember when QE was going to cause hyperinflation?

Remember when the dollar was going to collapse?

Remember when the Baltic Dry Index was the economic tell of the entire global economy?

Remember when we were going to see a repeat of the 1929 crash because of a chart?

Remember when the end of QE was going to cause an enormous market crash?

Remember when the U.S. credit rating downgrade was going to cause interest rates to skyrocket?

Remember when the fiscal cliff was going to take down the markets?

Remember when we were supposed to be in a recession in 2011?

Remember when Greece was going to cause a global economic collapse in 2010? And 2011, 2012, 2013, 2014 and 2015?

Remember when oil was going to $250/barrel?

Remember when gold was going to $5,000/oz.?

Remember when the Dow was going to fall to 1,000 (or rise to 30,000)?

Remember when Internet stocks during the dot-com bubble era didn’t need earnings because of the new economy?

Remember when stocks couldn’t possibly get cut in half twice in one decade?

Remember when there was no chance the market was going to bounce back after the 2007-2009 crisis?

Remember when interest rates couldn’t possible go any lower in 2010 (and 2011 and 2012…)?

Remember when Cyprus banking issues were the canary in the coal mine of the entire financial world?

Remember when the BRIC countries were the hottest investment trend in the industry because of “growth.”

Remember these types of predictions the next time you hear a market prognosticator tell you they know what’s going to happen in the future. They don’t.

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Embracing Automation

December 17, 2015

The Harvard Business Review has a nice write-up of a McKinsey study looking at the benefits to organizations that automate as many daily tasks as possible:

To pinpoint the opportunities, we have looked at about 2,000 activities that are performed in various occupations across the U.S. economy. We find that, from a technical standpoint, work that occupies 45% of employee time could be automated by adapting currently available or demonstrated technology. However, less than 5% of jobs could be fully automated—that is, every activity could be handled by a machine.We estimate, that for 60% of existing US jobs, 30% or more of current work activities can be automated by with available or announced technologies. In other words, for the majority of US jobs, a day and a half’s worth of activities in each work week can be automated…

…The over-arching implication from our research into automating tasks is that roles will be redesigned and organizations will have to become very good at understanding where machines can do a better job, where humans have the edge, and how to reinvent processes to make the most of both types of talent. The largest benefits of information technology accrue to organizations that analyze their processes carefully to determine how smart machines can enhance and transform them—rather than organizations that simply automate old activities.

Embracing automation has been a hallmark of our work here at Dorsey Wright over the years.  Reading the above referenced study took me on a trip down memory lane as I thought about how automation has changed our business for the better.  When I asked John Lewis, our Senior Portfolio Manager and the person most responsible for automating many of our investment strategies, for feedback on this he gave me the following thoughts:

Automating the investment process allows us to examine a huge universe of securities without needing to have a huge team of analysts.  We can run many strategies and we can follow many different markets (domestic, small cap, emerging, developed, etc….) without having to staff up and get analysts up the curve.  This also helps keep costs down, which is very important as fee compression has been happening since commissions were deregulated in the 1970’s.

Automation has also allowed us to be more disciplined and not let emotion get in the way of the investment process.  That has been one of the largest benefits over time.  We used to do all of the analysis manually, but it wasn’t any better.  You begin to realize that computer rankings are relentless – they never have a bad day or take a vacation.  Day after day you get the exact same unemotional ranking no matter what is happening in the market.

Automating repetitive tasks has also freed up our time to focus on more important things.  You can’t automate everything.  We have a lot of functions that require the time of an experienced person that can’t be automated.  A few examples of this include: new product development, trying to make existing strategies better, and client service.  By automating everyday tasks (like loading data into databases and running ranks and models) we can devote more resources to areas that need experienced people.

We never feel like we are “behind” in the investment process.  When the markets do crazy things, our ranks still run overnight and all of our models are updated and ready for us in the morning.  We are never trying to figure out why something is happening or what we should be doing.  That is a huge deal for that small sample of time when everyone is wondering what they should do.

Nobody likes doing repetitive, clerical tasks day after day so automating them makes for a better quality of life in the workplace.  People are just happier not having to copy column C to column D in Excel every day.  When you have happier people they are more productive.

We’re not far from the time of the year where people get introspective and start making goals for the new year.  It might be a healthy activity to review your business and evaluate what percentage of your time is spent on repetitive tasks.  Automating those tasks may well be the key to taking your business to the next level in the years ahead.

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Relative Strength Spread

December 17, 2015

The chart below is the spread between the relative strength leaders and relative strength laggards (top quartile of stocks in our ranks divided by the bottom quartile of stocks in our ranks; universe of U.S. mid and large cap stocks).  When the chart is rising, relative strength leaders are performing better than relative strength laggards.    As of 12/17/15:

spread

This example is presented for illustrative purposes only and does not represent a past recommendation.  The performance above is based on pure price returns, not inclusive of dividends or all transaction costs.   Investors cannot invest directly in an index. Indexes have no fees. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.

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(Unwarranted?) Pessimism Explained

December 16, 2015

Interesting perspective from Morgan Housel on “Why Your Parents Are Dissappointed In You”:

Baby boomers are disappointed in their children. The younger generation whines too much, feels entitled to success, and lacks the responsibility of their parents, we hear. This is not anecdotal. A Pew Social Trends survey reports, “about two-thirds or more of the public believes that, compared with the younger generation, older Americans have better moral values, have a better work ethic and are more respectful of others.”

Of course, Baby boomers’ parents held their kids in equal contempt. Tom Brokaw’s book The Greatest Generation tells a story of baby boomers’ parents disappointed in their childrens’ lack of values and work ethic. “The morals have changed tremendously,” lamented one. Another’s “only regret is that the lessons of his generation” weren’t passed onto his kids. “The idea of personal responsibility is such a defining characteristic of the World War II generation,’ Brokaw wrote, “that when the rules changed later, these men and women were appalled.”

Decades before, the greatest generation was criticized by their elders, too. Woodrow Wilson, who grew up on horseback, said widespread use of the car promoted “the arrogance of wealth.” The younger generation was criticized for abandoning church, dressing provocatively, and leaving the rigors of farm labor for the ease of factory machines. Modern times stole their grit, as Fortune magazine wrote in 1936:

The present-day college generation is fatalistic. It will not stick its neck out. It keeps its pants buttoned, its chin up, and its mouth shut. If we take the mean average to be the truth, it is a cautious, subdued, unadventurous generation.

This goes on and on, a ritual dating back as far as anyone looks. It’s a time-honored tradition to be disappointed in the younger generation.

Why?

Here’s one explanation: Things get better over time. As you see younger generations bypassing problems you yourself dealt with, you become resentful. People can appear lazy when they don’t have to suffer as much as you did. This comes through as disappointment in younger generations who don’t seem to care about the same threats and worries their elders did. 

My emphasis added.  This does remind me of a quote by Thomas Macaulay: “Why when we see nothing but improvement behind us, do we see nothing but deterioration before us.”

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Sector Performance

December 16, 2015

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

sector

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

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High RS Diffusion Index

December 15, 2015

The chart below measures the percentage of high relative strength stocks (top quartile of our ranks) that are trading above their 50-day moving average (universe of mid and large cap stocks.)  As of 12/14/15.

diffusion

The 10-day moving average of this indicator is 72% and the one-day reading is 47%.

This example is presented for illustrative purposes only and does not represent a past recommendation.  The performance above is based on pure price returns, not inclusive of dividends or all transaction costs.   Investors cannot invest directly in an index. Indexes have no fees. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.

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Weekly RS Recap

December 14, 2015

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 (12/7/15 – 12/11/15) is as follows:

ranks

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

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Managing Momentum Volatility

December 11, 2015

How hard is it to hold onto the big winners?  Michael Batnick takes a look a volatility characteristics of this decade’s best stocks:

The other day I looked at a common theme among the decade’s biggest winners; they tended to be very expensive relative to their peers based on traditional valuation metrics. Today I want to look at another trait these winners share, volatility and big drawdowns.

10-best-stocks

A few things really stand out in this table.

  • Nine of the ten biggest winners were all cut in half. Granted, the S&P 500 was as well, but the point is that even the best stocks gave investors plenty of sleepless nights.
  • Even though these winners returned 23x what the S&P 500 did, only Apple and Priceline hit all-time highs more often.
  • The average standard deviation for these stocks was more than twice that of the S&P 500. No pain, no gain.
  • These stocks spent on average 34% of the time in “bear market territory.” That’s pretty wild. One out of every three days these stocks were at least 20% off their all-time high.

The point of this data is not to suggest that all stock pickers suffer 50% drawdowns. The message is that if you’re looking at long-term charts and and playing the coulda, woulda, shoulda game, don’t kid yourself, it’s never as easy as it looks.

Buying stocks with high relative strength is one thing.  Having the ability to hold on to them and knowing when to get out is quite another.  In fact, most investors probably can’t/won’t hold onto a basket of high relative strength stocks if the entire basket of stocks had double the standard deviation of the S&P 500.  However, when you look at the standard deviation of our PowerShares DWA Momentum ETF (PDP) compared to the S&P 500, the standard deviation of our momentum index is only slightly more:

st deviation

*Source: Yahoo! Finance. Based on monthly returns, price only, not inclusive of dividends, 4/07 – 11/15

What accounts for the fact that PDP’s standard deviation is only modestly more than the S&P 500 even though it is investing in stocks that have high momentum?  First, even if the standard deviation of each of the individual stocks in the index is high, the standard deviation of the entire index will likely be much lower than the standard deviation of the individual stocks because all 100 stocks in the index not are likely to be perfectly correlated.  Also, it is worth noting that it is very possible for stocks with lower standard deviation than the market to have favorable relative strength, especially in environments when equities as an asset class are performing poorly.

There is also something else at work as it relates to the PowerShares DWA Momentum Index (and other indexes constructed using Point & Figure relative strength).  One of the criteria for inclusion in the DWA Technical Leaders Index (index for PDP), is that a stock be on a relative strength buy signal AND in a column of X’s.  This essentially acts as a trailing stop to help us get out of high momentum stocks that have huge reversals.  See below:

sample

The PowerShares DWA Momentum ETF (PDP) is rebalanced on a quarterly basis, so it is possible that a stock reverse to a column of O’s on its relative strength chart mid-quarter and have to wait until the end of the quarter to get removed from the index, thus allowing it more time to underperform even more.  I wanted to make that point so nobody mistakenly thinks that a stock will get kicked out of the index the moment the reversal takes place.  That said, we are of the belief that this requirement that a stock be on a relative strength buy signal AND in a column of X’s helps address some of the volatility concerns that some may have of a momentum strategy.  Learn more about PnF relative strength best practices in Point and Figure Relative Strength Signals, by John Lewis, CMT, which was published last June.

The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  See www.powershares.com for a prospectus on PDP.

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What You Don’t Own

December 8, 2015

What a year for Energy.  Its rout can be seen in the chart of XLE shown below:

xle

Price return only, not inclusive of dividends.  Updated through 12/8/15

However, it is not just 2015 where Energy has been weak.  Consider the relative strength chart below of the Energy Sector SPDR (XLE) vs. The S&P 500 (SPX):

Energy relative strength

Price return only, not inclusive of dividends.  Updated through 12/8/15

As shown above, Energy has been weaker than the S&P 500 for the majority of the time since June 2008—although the worst of the relative performance has clearly come in the last year or so.

When a sector is weak, a relative strength strategy seeks to underweight that sector.  After all, what you don’t own is every bit as important as what you do own.  Consider the chart below of the Energy exposure in the Dorsey Wright Technical Leaders Index (used for the PowerShares DWA Momentum ETF, PDP):

pdp

As of 10/1/15

This index is constructed by taking a universe of approximately 1,000 U.S. mid and large cap stocks and ranking them by their PnF relative strength characteristics.  The top 100 stocks make it into this index.  Each quarter the index is reconstituted to kick out any stocks that have lost sufficient momentum and to replace them with stronger names.  One of the unique characteristics of this index is there are no sector constraints.  If a sector is weak, it may have little or no exposure in the index.  This quarter is now the 4th quarter in a row where PDP has had zero Energy exposure.

Much is made of how momentum strategies seek to own the “hottest” stocks.  Perhaps, more should be made of momentum strategies seeking to avoid the biggest losers.  In the end, that matters every bit as much.

The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  See www.powershares.com for a prospectus on PDP.

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Relative Strength Spread

December 8, 2015

The chart below is the spread between the relative strength leaders and relative strength laggards (top quartile of stocks in our ranks divided by the bottom quartile of stocks in our ranks; universe of U.S. mid and large cap stocks).  When the chart is rising, relative strength leaders are performing better than relative strength laggards.    As of 12/7/15:

spread

This example is presented for illustrative purposes only and does not represent a past recommendation.  The performance above is based on pure price returns, not inclusive of dividends or all transaction costs.   Investors cannot invest directly in an index. Indexes have no fees. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.

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Weekly RS Recap

December 7, 2015

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 (11/30/15 – 12/4/15) is as follows:

ranks

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

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Are Momentum Stocks “Cheap?”

December 4, 2015

Interesting exchange in this paper on momentum by Man.  The response by Nick Barberis, professor of Finance at Yale, is of particular interest given that conventional wisdom is that momentum stocks are often “overvalued.”  According to his response, that momentum stocks are often rising for the very reason that they are “cheap.”

AHL/MSS: Do momentum investors do harm because they do not follow fundamental information?

Doug Greenig: If there are too many momentum investors relative to fundamental investors, capital allocations might get out of whack.

Cam Harvey: Policy makers might choose fundamental traders over momentum traders as value trading moves prices to where they should be, whereas momentum might move them away. Prices moving away from fundamental values could have a social cost. At the same time, momentum traders are good for providing liquidity.

Sandy Rattray: Value investing feels right. It’s a good thing to be doing. Finding cheap stocks is seen as a valuable skill. A value investor is seen to stand on higher moral ground than momentum investors.

Nick Barberis: But value and momentum may be more similar than they appear. According to under-reaction theories of momentum – for example, the slow diffusion of information theory – a stock that has been trending up is also a cheap stock: not all information about it has been absorbed into the price.

HT: Jerry Parker

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RS in Rising Rate Environments

December 4, 2015

With wide expectation that the Fed will raise interest rates this month, it is worth considering how a momentum strategy tends to perform in a rising interest rate environment.  Invesco PowerShares addressed this topic in their September 2015 paper Harnessing the Power of Factor Investing. According to their findings, momentum was able generate excess returns in both rising rate and declining rate environments.  However, the excess returns were higher in rising rate environments.

rising rate_12.04.15

falling rate_12.04.15 

Some thoughts on why this pattern may occur:

  • By the time rates rise you are typically well off the market bottom and well out of a recession.  On average, stocks are at least fairly valued at that point and there aren’t a ton of bargains to be had that are really cheap for obvious reasons.  At that point investors look for growth and that is what momentum is good at picking up.
  • Late cycle also means fewer stocks participating in the rally, which is also good from a momentum perspective.
  • Good momentum stocks usually don’t have to rely on cheap financing (they can generate cash flow organically) so they don’t get crimped like value stocks do when rates rise.

While many seem to fear what affect a rising interest rate environment will have on stocks, it is worth remembering that rising rates have tended to be good for a momentum strategy.

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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Systematic RS Portfolios Update

December 3, 2015

All 7 of our Systematic RS portfolios outperformed their benchmarks in November.  In a year where the broad equity market has been relatively flat, our equity portfolios have excelled by finding pockets of strength.  Detailed performance is shown below:

nov perf

A brief overview of each of these separately managed account strategies is shown below:

Different Portfolios for Different Objectives

Aggressive:  This Mid and Large Cap U.S. equity strategy seeks to achieve long-term capital appreciation.  It invests in securities that demonstrate powerful relative strength characteristics and requires that the securities maintain strong relative strength in order to remain in the portfolio.

Core:  This Mid and Large Cap U.S. equity strategy seeks to achieve long-term capital appreciation.  This portfolio invests in securities that demonstrate powerful relative strength characteristics and requires that the securities maintain strong relative strength in order to remain in the portfolio.  This strategy tends to have lower turnover and higher tax efficiency than our Aggressive strategy.

Growth:  This Mid and Large Cap U.S. equity strategy seeks to achieve long-term capital appreciation with some degree of risk mitigation.  This portfolio invests in securities that demonstrate powerful relative strength characteristics and requires that the securities maintain strong relative strength in order to remain in the portfolio.  This portfolio also has an equity exposure overlay that, when activated, allows the account to hold up to 50% cash if necessary.

International: This All-Cap International equity strategy seeks to achieve long-term capital appreciation through a portfolio of international companies in both developed and emerging markets.  This portfolio invests in those securities with powerful relative strength characteristics and requires that the securities maintain strong relative strength in order to remain in the portfolio.  Exposure to international markets is achieved through American Depository Receipts (ADRs).

Global Macro: This global tactical asset allocation strategy seeks to achieve meaningful risk diversification and investment returns.  The strategy invests across multiple asset classes: Domestic Equities (long & inverse), International Equities (long & inverse), Fixed Income, Real Estate, Currencies, and Commodities.  Exposure to each of these areas is achieved through exchange-traded funds (ETFs).

Balanced: This strategy includes equities from our Core strategy (see above) and high-quality U.S. fixed income in approximately a 60% equity / 40% fixed income mix.  This strategy seeks to provide long-term capital appreciation and income with moderate volatility.

Tactical Fixed Income: This strategy seeks to provide current income and strong risk-adjusted fixed income returns.   The strategy invests across multiple sectors of the fixed income market:  U.S. government bonds, investment grade corporate bonds, high yield bonds, Treasury inflation protected securities (TIPS), convertible bonds, and international bonds.  Exposure to each of these areas is achieved through exchange-traded funds (ETFs).

To receive the brochure for these portfolios, please e-mail andy@dorseywright.com or call 626-535-0630. 

Total account performance shown is total return net of management fees for all Dorsey, Wright & Associates managed accounts, managed for each complete quarter for each objective, regardless of levels of fixed income and cash in each account.  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. 

The S&P 500 is a stock market index based on the market capitalizations of 500 leading companies publicly traded in the U.S. stock market, as defined by Standard & Poor’s.  The Barclays Aggregate Bond Index is a broad base index, maintained by Barclays Capital, and is used to represent investment grade bonds being traded in the United States.  The 60/40 benchmark is 60% S&P 500 Total Return Index and 40% Barclays Aggregate Bond Index.  The MSCI EAFE Total Return Index is a stock market index that is designed to measure the equity market performance of developed markets outside of the United States and Canada and is maintained by MSCI Barra.  The Dow Jones Moderate Portfolio Index is a global asset allocation benchmark.  60% of the benchmark is represented equally with nine Dow Jones equity indexes.  40% of the benchmark is represented with five Barclays Capital fixed income indexes. 

Each investor should carefully consider the investment objectives, risks and expenses of any Exchange-Traded Fund (“ETF”) prior to investing. Before investing in an ETF investors should obtain and carefully read the relevant prospectus and documents the issuer has filed with the SEC.  ETFs may result in the layering of fees as ETFs impose their own advisory and other fees.  To obtain more complete information about the product the documents are publicly available for free via EDGAR on the SEC website (http://www.sec.gov)

There are risks inherent in international investments, which may make such investments unsuitable for certain clients. These include, for example, economic, political, currency exchange, rate fluctuations, and limited availability of information on international securities.

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RS Charts of the Week

December 1, 2015

spy vs agg

spy vs iyr

spy vs gcc

spy vs eem

spy vs efa

Point and Figure RS Charts are calculated by dividing one security by another and plotting the ratio on a PnF chart.  When the ratio is rising, it is plotted in a column of X’s and reflects the numerator outperforming the denominator.  Likewise, when the relative strength ratio is declining, it is plotted in a column of O’s and reflects the outperformance of the denominator.

Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.  This example is presented for illustrative purposes only and does not represent a past recommendation.  The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Nothing contained herein should be construed as an offer to sell or the solicitation of an offer to buy any security.  This post does not attempt to examine all the facts and circumstances which may be relevant to any product 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.

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