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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Relative Strength Spread

February 14, 2017

The chart below is the spread between the relative strength leaders and relative strength laggards (top quartile of stocks in our ranks divided by the bottom quartile of stocks in our ranks; universe of U.S. mid and large cap stocks).  When the chart is rising, relative strength leaders are performing better than relative strength laggards.    As of 2/13/17:

spread 02.14.17

After declining for much of the past year, the RS Spread is now on the cusp of moving above its 50 day moving average—a potentially positive development for relative strength strategies.

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

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Traditional vs. Systematic Portfolio Management – What’s the Difference?

February 9, 2017

Click here for a replay of my 2/8/17 webinar.

trad_syst

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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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No Second Chances with Retirement Savings

January 23, 2017

For a financial advisor, providing the right mix of investment strategies to their clients is a critical component of their value proposition.  We all know that each client has unique needs and risk tolerances, but clients can be largely grouped into two major categories, depending on whether they are in the accumulation phase or the distribution phase of their lives.  A recent article by James B. Sandidge, JD, in The Journal of Investment Consulting provides some powerful insights:

There are no second chances with retirement savings.  When saving for retirement, time provides a safety net against short-term risk.  But retirees cannot count on time, so it’s critical to get the risk allocation right.  Figure 3 shows year-by-year account values for a portfolio allocated 70/30 beginning in 2000.  The black line shows that an investor who was accumulating wealth was able to recover from two of the worst stock markets in the past seventy-five years (2000-2002 and 2008-2009) to finish the fourteenth year with 153 percent of the original investment.

With time as a safety net, “focus long-term” or “sit tight” have been effective risk-management strategies for those accumulating wealth.  Conversely, the bars show that if the same investor employed the same portfolio to distribute wealth with a 5-percent initial withdrawal and a 3-percent annual increases, the account value never recovers from the early market losses and finishes the fourteenth year with only 26 percent of the original investment, a pace of principal erosion that could deplete the account in five more years.

Accumulating investors only have to worry about how long it would take to recover from losses.  Retirees must worry about losses triggering accelerated principal erosion and cash-flow risk, and the lack of a safety net exaggerates the importance of even small adjustments to risk.

time

Sandidge, James B. 2016. Adaptive Distribution Theory. Journal of Investment Consulting 17, no. 2: 13–33.

This distinction between the distribution phase and the accumulation phase is critical to determining the appropriate types of investment strategies that should be implemented for different clients.  The bottom line is that investors in the distribution phase no longer have time on their side.  Risk management is of paramount importance in this phase of their lives.

Among the 7 strategies that are part of our family of Systematic Relative Strength Portfolios, Global Macro is among those that would be most appropriate for clients who are in the distribution phase of their lives.  In fact, I believe that this strategy is ideally suited to fit the needs of these clients who are want and need a focus on risk management.  See below for information about this strategy.

Systematic RS Global Macro Strategy

Frequently Asked Questions

What is the investment objective of the strategy?  The strategy seeks to achieve meaningful risk diversification and investment returns.  The historical correlation of this strategy to every major asset class has been relatively low over time.  Our global macro strategy is uniquely positioned from an investment opportunity perspective because it is not limited to a specific market.

What asset classes are represented in the strategy?  The strategy is designed to invest in the following 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 ETFs.

How are the investments selected?  The strategy holds approximately ten ETFs that demonstrate powerful relative strength characteristics.  The strategy is constructed pursuant to Dorsey Wright’s proprietary basket ranking and rotation methodology.

How is this different from strategic asset-allocation?  We do not approach the asset allocation from a strategic standpoint. Instead, we implement a tactical approach. Our tactical overlay is designed to own the areas of the market exhibiting the greatest relative performance and avoid or use inverse funds for the weakest areas. You can expect the weightings to change over time!  When, for example, domestic equities are performing poorly our tactical process will avoid or use inverse funds in these areas or favor an area with better relative performance, like fixed income.  We make changes to the investment mix as markets and leadership change. The portfolio is designed to be quite responsive to emerging strength.

How do all these processes come together?  The investment strategy is 100% systematic. We have designed our processes to remove the portfolio managers’ emotions and biases, which are detrimental to superior long-term performance.

How is risk managed in the portfolio?  Our investment process is designed to systematically rotate the portfolio into the strongest asset classes and individual alternatives within those asset classes. If an asset class is performing poorly the tactical asset allocation overlay will avoid or use inverse funds in that area and buy an asset class with better relative strength.  There is a stop, based on the relative strength ranking, on each holding. The asset classes used in the portfolio are not typically highly correlated, so that our investment guidelines provide enough latitude to deliver solid returns in a variety of market conditions.

Will the portfolio ever go to cash?  Our investment universe includes ETFs that represent the shorter-term sector of the United States Treasury market.  So, yes, we can effectively allocate a portion of the account to cash if that is where the best relative strength is found.

Will you be investing in all of the ETFs?  We have a rigorous process to determine what ETFs we will evaluate for our portfolios. There are many ETFs that are duplicative or not suitable for the investment strategy we are using in this portfolio, and we do not consider these for purchase in the fund. As new ETFs come to market we are committed to evaluating their investment merits and the effect they might have on our investment strategy. Any new ETFs will need to meet the same stringent criteria as existing ETFs for consideration in the portfolio.

How can investors access the Global Macro strategy?  There are three different ways that investors can access this strategy.  It is available as a managed account on a large and growing number of SMA and UMA platforms.  It is also the model used for the Arrow DWA Tactical Fund (DWTFX) and the Arrow DWA Tactical ETF (DWAT).

For more information about this strategy, please e-mail andyh@dorseymm.com or call 626-535-0630.

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.  Dorsey Wright is a research provider for the Arrow DWA Tactical Fund and Arrow DWA Tactical ETF.

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Systematic Relative Strength Portfolios (SMA/UMA Platforms)

January 20, 2017

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Our Systematic Relative Strength Portfolios are available as managed accounts at a large and growing number of firms.

  • Wells Fargo Advisors (Global Macro available on the Masters/DMA Platforms)
  • Morgan Stanley (IMS Platform)
  • TD Ameritrade Institutional
  • UBS Financial Services (MAC Platform)
  • RBC Wealth Management (MAP Platform)
  • Raymond James (Outside Manager Platform)
  • Stifel (Opportunity Platform)
  • Kovack Securities (Growth and Global Macro approved on the UMA Platform)
  • Charles Schwab Institutional (Marketplace Platform)
  • Envestnet
  • Fidelity Institutional
  • Adhesion Wealth
  • FolioDynamix

Different Portfolios for Different Objectives: Descriptions of our seven managed accounts strategies are shown below.  All managed accounts use relative strength as the primary investment selection factor.

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).

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To receive fact sheets for any of the strategies above, please e-mail Andy Hyer at andyh@dorseymm.com or call 626-535-0630.  Past performance is no guarantee of future returns.  An investor should carefully review our brochure and consult with their financial advisor before making any investments.

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ALPS Dorsey Wright Sector Momentum (SWIN) Introduced

January 12, 2017

We are happy to announce the launch of SWIN, the ALPS Dorsey Wright Sector Momentum ETF.  From Yahoo:

ALPS, a subsidiary of DST Systems, Inc. (DST) providing products and services to the financial services industry, today announced a strategic alliance with Dorsey, Wright & Associates, a Nasdaq Company (DWA) to launch a new factor exchange-traded fund (ETF), which is designed to capture momentum investing at both the sector and stock level.

The ALPS Dorsey Wright Sector Momentum ETF (Nasdaq Ticker: SWIN) leverages Dorsey Wright’s proprietary Point and Figure Relative Strength charting to create a high conviction portfolio of 50 stocks. The Fund seeks to track, before fees and expenses, the Dorsey Wright US Sector Momentum Index (DWUSSR), an equally weighted index consisting of 50 large and midcap stocks listed in the US.

“We are excited to collaborate with such a prestigious company,” says Tom Carter, President of ALPS Advisors Inc., “The combination of Dorsey Wright’s research and our focus on product innovation has created a new strategy for enhancing portfolio construction.”

Historically, momentum strategies tend to perform best when clear leadership is established and sustained for a meaningful period; they often lag during time when there is no clear leadership among sectors. “SWIN is the first Momentum ETF to combine both macro (sector) and micro (stock) level screens,” says Mike Akins, SVP & Head of ETFs for ALPS, “We believe its unique two-screen construct creates opportunity for outperformance in strong sector momentum cycles, while simultaneously maintaining a diversification cushion to help weather periods where no clear sector leadership is present.”

Although SWIN is concentrated on the top performing momentum sectors, it maintains an equal-weighted strategy at the stock level. “At ALPS we strive to help investors and advisors build better portfolios,” says Akins, “ALPS Sector Dividend Dog ETF (SDOG), which employs an equal-weight sector and stock strategy with a tilt toward equity income, and SWIN are complementary strategies that provide diversified exposure to both value and momentum.”

Continue reading here.

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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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To constrain or not constrain?

January 4, 2017

Fixed income allocations continue to be a major question in client portfolios. Do you continue to hold traditional long term bonds that will price deteriorate as rates rise with the hopes that clients will be able to hold them to maturity, or do you layer in differentiating bond funds that generate returns through multiple asset classes? Bloomberg wrote:

Donald Trump’s election has reignited the prospects for inflation and growth both in the U.S. and abroad, which will likely lead to higher interest rates and spell the end of the bond market’s three-decade Bull Run.

And that will favor funds that can go wherever the highest returns are — without constraints on maturity, geography or even credit quality.

The buy and hold methodology gives you reliable income flows with the possibility of price deterioration as rates rise. While the multi asset class funds give you more ways to protect your downside and generate upside, which comes with higher volatility and ever-changing sector allocations.

It is our belief that the ability to move between sector allocations will be key moving forward into 2017 as the world continues to change. Unlike most unconstrained bond funds however that shy away from long term bonds, we believe that long Treasuries, at times, are a valuable holding.  Our Tactical Fixed Income strategy can hold up to 40% in long term government exposure, along with the ability to hold convertible bonds, short-term Treasuries, emerging market debt, TIPs, high yield and Investment grade Corporates.

If you would like more information on our fixed income strategy please reach out to Andyh@dorseymm.com.

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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Q1 2017 PowerShares DWA Momentum ETFs

January 3, 2017

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

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DWAS: PowerShares DWA Small Cap Momentum ETF

dwas

DWAQ: PowerShares DWA NASDAQ Momentum ETF

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PIZ: PowerShares DWA Developed Markets Momentum ETF

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PIE: PowerShares DWA Emerging Markets Momentum ETF

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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-momentum

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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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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Top business stories of 2016–PnF Edition

December 29, 2016

USA Today identified the following as “The top 10 business stories of 2016.”  I’ve added PnF charts for some of the topics mentioned in the article to provide some additional insight.

1. Donald Trump elected president. New presidents always portend massive changes. But the election of Trump, with his promises to upend Washington and roll back regulations, could shake business and economic establishments to their foundations. While he has hinted at keeping some popular provisions of Obamacare, Trump will be politically pressured to repeal much of the health care law that mandated universal coverage. Having promised to bring jobs back to Rust Belt states, Trump is likely to renegotiate trade deals and possibly even raise tariffs, a move that could trigger global disputes. The Dodd-Frank Act, enacted after the national financial crisis to lower excessive risk-taking by banks, could be under assault as lobbyists push for easing its restrictions. Trump has professed a desire to maintain the current low-interest-rate policy.

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2. Brexit. In late June, the United Kingdom defied polling forecasts and voted to leave the European Union, setting off reverberations across the globe. U.S. stocks fell 5% as fears spread of disrupted trade relationships with Europe and of other countries that could follow the U.K.’s lead. Yet the market recovered within days as investors realized the immediate effects on American businesses were limited. There were even some winners among U.S. banks and tech firms that may have gained from a shift in investment from the U.K. But the economic fallout won’t really be clear until the U.K. renegotiates trade deals with European countries before it leaves the EU in 2019.

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3. The Dow closes in on 20,000. Wall Street stumbled into 2016, with stocks suffering their worst-ever first week of trading. But the gloom gave way to bullish optimism, especially after the presidential election when the “Trump Rally” put the 120-year-old Dow Jones industrial average on a track for a “Dow 20,000” milestone, racking up more than 25 record highs in 2016 so far along the way. The stock rebound occurred despite the Federal Reserve’s decision to hike short-term interest rates for the first time in 2016  at its December meeting — when the central bank also let investors know it expects three more rate increases in 2017.

djia

4. Prescription drug prices bring controversy. The rising cost of prescription drug prices captured headlines, generated rising criticism and sparked investigations. At center stage was Turing Pharmaceuticals CEO Martin Shkreli’s decision to impose a more than 5,000% price spike of a drug used to treat a parasitic illness suffered by AIDS patients. Summoned to appear before a congressional committee in February, he went silent, invoking his Fifth Amendment right to avoid testifying against himself. But he unloaded after the hearing, calling members of Congress “imbeciles” in a tweet. Turing wasn’t the only drugmaker taking fire. Health care providers, patients and others criticized Mylan for a series of increases that raised the price for a two-pack of EpiPens, a potentially life-saving injection for allergy sufferers, to $600, up from about $100 in 2009. By year’s end, Mylan had introduced a generic version of the medication for $300 per two-pack. All of these events drew fire from a Senate committee report in December that warned “staggering” increases in the cost of some prescription drugs threaten the health of patients and “the economic stability of American households.”

ihe

5. Wells Fargo’s scandal. In September, the San Francisco-based bank agreed to a $185 million settlement with federal regulators after an investigation showed Wells Fargo had secretly opened millions of unauthorized deposit and credit card accounts that weren’t authorized by customers. An estimated 5,300 employees were fired over several years for pressuring customers to accept the largely unwanted accounts, the bank acknowledged in its settlement with the Consumer Financial Protection Bureau, the Office of the Comptroller of the Currency and Los Angeles city and county legal officials. Wells Fargo CEO John Stumpf resigned in October, but investigations of the bank’s conduct continued.

wfc
6. Unemployment rate falls. The unemployment rate, which hit 10% in 2009, continued its remarkable descent, falling to 4.6% in November from 5% early in the year. Many economists believe that rate, the lowest since August 2007, represents full employment and can’t fall much further without generating a run-up in inflation as wages rise. The Federal Reserve is coming around to that view and so, at a mid-December meeting, unexpectedly forecast three interest rate hikes in 2017, throwing cold water on the post-election market rally. The low jobless rate is already pushing up pay increases as employers compete for fewer available workers. That smaller pool of workers is also tempering average monthly job gains, which have fallen from 229,000 in 2015 to 180,000 this year.

unrate

7. Oil prices plunge, then rebound. They fell below $27 per barrel in mid-February as a global glut of production fueled a surplus and concerns about economic growth dealt a blow. The commodity’s sharp descent, dropping nearly in half over a four-month stretch, contributed to bankruptcies of dozens of U.S. energy companies and thousands of layoffs. But oil rebounded to more than $50 per barrel after the Organization of the Petroleum Exporting Countries and certain non-OPEC states, including Russia, agreed in November to slash production in a bid to bolster prices.

crude

8. The U.S. dollar shines. The greenback hit its highest level vs. the euro in 14 years as global investors began pricing in less Fed stimulus and stronger U.S. growth. The dollar surged in value against currencies around the world following the election of Trump. It showed particular strength against the Chinese yuan, which Trump repeatedly targeted in his campaign after accusing the Chinese government of currency manipulation to benefit its economy.

dxy

9. Pressure on free trade. A decades-long movement toward free trade and globalization appeared to stop in its tracks as presidential candidates Donald Trump and Hillary Clinton both vowed to withdraw from the Trans-Pacific Partnership, which would have relaxed trade restrictions with Asian nations. Trump threatened to pull out of the North American Free Trade Agreement if Mexico doesn’t renegotiate the deal and to slap Mexico and China with tariffs of 35% and 45%, respectively. His aim: to partly reverse the millions of layoffs at U.S. factories as jobs were offshored to China, Mexico and other countries. But many economists say those jobs aren’t coming back and tariffs risk retaliation that could ravage U.S. exports and jobs.

eww

mchi

10. Fake news fears. Fake news bubbled up during the political campaign and became a business issue for the place where many people get their news: Facebook. A post-election analysis by BuzzFeed found that fake stories shared on Facebook outperformed real news stories during the final three months of the campaign cycle. The most shared story was a fake report about Pope Francis’ endorsement of then-Republican nominee Donald Trump. Facebook CEO and co-founder Mark Zuckerberg said it was ”extremely unlikely” that it affected the election outcome, but the company is making changes so users of the social network can more easily flag news that is fake. A Pew Research Center survey, released earlier this month, found that 63% say fake news creates “great confusion” among the public about current events.

fb

Source of charts is Dorsey Wright.  Charts are as of 12/28/16.  Dorsey, Wright & Associates, a Nasdaq Company, is a registered investment advisory firm. 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 to which reference is made.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Technical Analysis is not predictive and there is no assurance that forecasts based on charts can be relied upon. Each investor should carefully consider the investment objectives, risks, and expenses of the securities discussed above prior to investing.  Advice from a financial professional is strongly advised.  Dorsey Wright currently owns FB in some of its managed accounts.  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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Momentum Demystified

December 28, 2016

It has been stated by no less than Eugene Fama, the 2014 co-recipient of the Nobel Prize in Economics that “The premier anomaly is momentum.” [1]  This idea that past winners tend to be future winners, while past losers tend to be future losers, has been vetted and established through hundreds of academic white papers on the topic.

Yet, momentum (aka relative strength) continues to be a misunderstood approach to investing.  Why is momentum a strong investment factor that gives investors the potential to outperform over time?  How exactly can momentum be exploited?

I think Tom Dorsey explained the concept of momentum best in a recent interview:

tom-dorsey

If I gave you a list of the 100 best golfers worldwide and asked you to pick who you thought would be in the top 10 at the end of the next quarter, who would you pick? My guess is you would pick the current top ten to be in the top three months from now. Even if I asked you to pick the ones who would be in the top ten after one year, you would probably pick the current top ten.

At the end of the contest some would have fallen out and some would have moved up, but the majority would still be in the top ten. This is outperformance. It relates to Newton’s Law of motion, which suggests that objects that are in motion tend to stay in motion until an external force acts upon them. So, in my world this means that stocks that have good fundamentals, in a market that in general is supporting higher prices, and the chart pattern clearly shows that demand is in control of the stock, tend to continue to do well. Golfers who have good fundamentals, are in good shape, and at the top of their game, tend to continue to do well.

Buy the winners.

[1] Fama, E. and K. French, 2008, Dissecting Anomalies, The Journal of Finance, 63, pg. 1653-1678.

To the Data

For a simple illustration of the power of momentum, consider the following study completed by Nasdaq Dorsey Wright’s Senior Portfolio Manager, John Lewis, CMT, who has done extensive research and published numerous whitepapers on the topic of momentum investing.

Study

Out of an investment universe of the largest 1,000 U.S. stocks by market capitalization, we backtested a strategy that selected the top 100 stocks based on trailing 12 month total return.  The portfolio was rebalanced on a monthly basis.  Each of the 100 stocks in the portfolio was equal-weighted each month.

As shown below, this simple momentum strategy outperformed the Russell 1000 Total Return Index by a meaningful margin during this test period covering 12/31/1989 – 9/30/2016.

momentum-model

Additional data points:

  • Annualized return of the momentum model was 13.45% compared to 9.49% for the Russell 1000 Total Return Index over this period of time.
  • The momentum model outperformed the Russell 1000 Total Return Index in 67 percent of rolling 3 year periods and 70 percent of rolling 5 year periods.

There are a variety of ways to construct and implement a momentum strategy and this is by no means meant to be held out the only or the best method.  Rather, the purpose of this study is to demonstrate that a very simple momentum model has significant performance potential over time.  The bottom line is that any investor who seeks to employ an active investment strategy that strives to generate performance above that of a passive index over time should give strong consideration to making momentum a key component of their portfolios.

Source: FactSet.  Hypothetical Back-test Period: 12/31/1989 – 09/30/2016.  Performance information for the Momentum Model is the result of a strategy back-test on an index that is not available for direct investment.  Back-tested performance is hypothetical and is provided for informational purposes to illustrate the effects of the strategy during a specific period.  The hypothetical returns have been developed and tested by DWA, but have not been verified by any third party and are unaudited.  Back-testing performance differs from actual performance because it is achieved through retroactive application of a model investment methodology designed with the benefit of hindsight.  Model performance data (both back-tested and live) does not represent the impact of material economic and market factors might have on an investment advisor’s decision making process if the advisor were actually managing client money.  Returns include dividends, but do not include fees or transaction costs.  Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.  The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value. 

Accessing Momentum through Managed Accounts

Hopefully, at this point you are starting to wonder how you can put this powerful investment factor to work for your clients.  We have a suggestion: Take a look at our family of Systematic Relative Strength Portfolios, which are available on a large and growing number of separately managed account (SMA) and unified managed account (UMA) platforms.

First, a little history.  Since 1987, Dorsey Wright & Associates has been an advisor to financial professionals on Wall Street and investment managers worldwide, providing technical research and investment solutions.  In 2002, John Lewis joined the portfolio management team at Dorsey Wright and was instrumental in leading an extensive period of research that led to the introduction of our family of Systematic Relative Strength portfolios.  These portfolios have two major objectives:

  1. Systematize the investment management process to remove as much of the element of human emotion as possible.
  2. Focus the investment strategy around the most powerful return factor we could identify: momentum (aka relative strength).

This family of accounts now consists of seven different strategies:

sma-names

Four of the seven strategies now have 10+ year track records.  There are 3 key reasons to consider making these strategies part of your client’s portfolios:

  1. We believe that momentum is the premier investment factor and has the potential to provide meaningful investment performance for your clients.
  2. Momentum can be relatively uncorrelated to other investment strategies, such as value.
  3. Dorsey Wright, a Nasdaq Company, is committed to providing financial advisors with the highest level of investment research, tools, and investment solutions in the industry to help you succeed in serving your clients.

Where Are These Strategies Available

These portfolios are available on over 20 different platforms, including on most major wirehouses, regionals, discount brokerages, and Turnkey Asset Management Programs (TAMPs).

To find out about availability at your firm and to receive the fact sheets on these strategies, please contact Andy Hyer at andyh@dorseymm.com or by calling him at 626-535-0630.

Dorsey, Wright & Associates, a Nasdaq Company, is a registered investment advisory firm. 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 investment strategies to which reference is made.  The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Relative Strength is a measure of price momentum based on historical price activity.  Relative Strength is not predictive and there is no assurance that forecasts based on relative strength can be relied upon. Each investor should carefully consider the investment objectives, risks, and expenses of the strategies discussed above prior to investing.  Advice from a financial professional is strongly advised. 

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Fixed Income Under the Microscope

December 27, 2016

Earlier this month we saw a noteworthy shift in DALI, which ranks six asset classes by relative strength from strongest to weakest.  Fixed Income came into 2016 ranked number two in DALI and spent much of the first half of the year ranked number one.

dali-ranks

As of 12/22/16

As shown below, Fixed Income fell to the fourth rank in the middle of this month after having been ranked three or higher since early 2012.

fixed-income-rank-in-dali

Period: 1/3/07 – 12/19/16, based on weekly tally ranking

Bonds are typically the portion of the allocation that investors worry least about, especially over the past 35 years.  Fixed Income tends to have lower volatility than most other asset classes and if you just look at the nominal returns of bonds over time, you would probably be reassured.  After all, as shown in the first table below, nominal Fixed Income returns have been positive in every single decade since the 1870s.  In the tables below, losing performances are shaded in red, those with annualized gains of 0% to 1.9% in yellow, and left unshaded are any gains of 2% or higher.

morningstar-1

Source: Morningstar, Research Affiliates

However, real annualized returns show a very different story.  After accounting for inflation, bonds have not always been so stellar.

morningstar-2

Source: Morningstar, Research Affiliates

What action should be taken if fixed income were to enter into another extended period where its real returns weren’t so favorable?  That will depend on each client’s circumstances, but DALI will be a good way to gauge the overall environment for this very important asset class.

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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Steve Forbes Interviews Tom Dorsey

December 27, 2016

Steve Forbes Interviews Tom Dorsey, Founder, Dorsey, Wright & Associates

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Weekly RS Recap

December 27, 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 (12/19/16 – 12/23/16) is as follows:

ranks

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.

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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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Quadfecta Highs

December 20, 2016

How uncommon is it to see the S&P 500, Dow Jones Industrial Average, The Nasdaq Composite, and the Russell 2000 Indexes all break out to new all-time highs on the same day?  Since 1979, there have only been 13 such occurrences, including the most recent occurrence on 11/21/2016.  Piper Jaffrey’s December issue of The Informed Investor, included a nice summary the types of market returns we have seen after such “Quadfecta” days.

Following the republican’s ‘trifecta’ sweep during the election, the popular averages posted ‘quadfecta’ highs, representing the rare occurrence when the SPX, DJIA, COMPQ and RUT all close at record highs on the same trading day. The recent November ‘quadfecta’ highs was the first time this has occurred since Dec. 1999. From our perspective, the major averages simultaneously breaking out to new highs confirms broad participation in the rally and provides further evidence to our secular bull market thesis.  A historical review of other ‘quadfecta’ highs offers compelling results in regards to expected future returns.  Although there are a limited number of occurrences since 1979, the major indices have generated meaningfully returns over the ensuing 26-week and 52-week periods. Additionally, the percent of positive returns has far outpaced negative returns on a historical basis.

quadfecta

The table above highlights various return metrics after quadfecta highs have been reached. As you can see, the SPX, DJIA and COMPQ traded higher 75% of the on a 52-week basis. The RUT was higher 67% of the time after the same time period. Average returns also look healthy across the board with at the major indices averaging at least 8% returns over the next 52-weeks.

When clients ask our thoughts on the markets in 2017, this might be something you consider discussing with them.  Strong indications of healthy market breadth have historically tended to be a good sign for future equity returns.

Price performance only, not inclusive of dividends or transaction costs.  Past performance is no guarantee of future returns.

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Some Perspective on Tactical Asset Allocation

December 13, 2016

I recently saw a presentation by Nadia Papagiannis, CFA, of Goldman Sachs Asset Management that provided some important insights into the landscape for asset allocation.  Consider the table below, which shows  the performance of a number of asset classes (Commodities, Emerging Market Debt, U.S. Bonds, High Yield, U.S. Real Estate, International Real Estate, Bank Loans, Hedge Funds, Emerging Market Equities, International Equities, International Small Cap, U.S Small Cap) to the performance of U.S. Large Cap Equities.

imca

imca2

What stands out about the years 2013-2015?  Very few asset classes outperformed U.S. Large Cap Equities during those years.  This goes a long ways towards explaining why most people who have employed some form of asset allocation (anything that diversified away from Large Cap US Equities) have probably been left underwhelmed with their performance during those 3 years.

True to the human condition, recency bias has been in full effect in recent years as it applies to tactical allocation with people questioning the category’s merits.  However, I would suggest that clients may benefit from reviewing a table like that shown above to remember that not all years are like 2013-2015 (if they were there wouldn’t be much need to own anything besides U.S. Large Cap Equities).

To me, there are 5 key reasons why investors would do well to consider making tactical asset allocation part of the mix:

  1. Asset classes go through bull and bear markets.  A relative strength-driven tactical asset allocation strategy can seek to overweight those asset classes in favor and underweight those asset classes that are out of favor.
  2. Many investors can’t handle the volatility associated with a buy and hold approach of investing solely in U.S. Large Cap Equities.  Tactical Asset Allocation has the potential to provide some diversification and help smooth out the ride.
  3. After seeing a couple year environment in which tactical asset allocation struggled, now may be a very good time to beef up that exposure or to make new allocation to tactical asset allocation.
  4. From a client management standpoint, my experience is that clients love to talk about the tactical portion of their overall asset allocation.  Clients like to see how their portfolio is adapting to the current environment.  Give them something they want (flexibility).  This is very different than just giving into their emotional investment desires because a relative strength-driven asset allocation strategy objectively respond to market trends.
  5. Tactical Asset Allocation can be the glue that keeps a clients’ hands off the more aggressive portions of their allocation that may be fully invested in Equities.

Dorsey Wright provides a full suite of tactical asset allocation tools and solutions such as our Global Macro SMA/UMA, The Arrow DWA Tactical and Balanced Funds, The Arrow DWA Tactical ETF, DALI, Tactical Tilt Models, and more.  If you would like to discuss different tools and solutions in this area, please call Andy Hyer at 626-535-0630 or 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.

Indices are unmanaged.  The figures for the index reflect the reinvestment of all income or dividends, as applicable, but do not reflect the deduction of any fees or expenses which would reduce returns.  Investors cannot invest directly in indices.  The indices referenced herein have been selected because they are well known, easily recognized by investors, and reflect those indeces that the Investment Manager believes, in part based on industry practice, provide a suitable benchmark against which to evaluate the investment or broader market described herein.  The exclusion of “failed” or closed hedge funds may mean that each index overstates the performance of hedge funds generally.  Starting point selected given longest common index inception.  HFRI FoF = HFRI Fund of Funds Composite Index; HFRI and related indices are trademarks and service marks of Hedge Fund Research, Inc. (“HFR”) which has no affliation with GSAM.  Information regarding HFR indices was obtained from HFR’s website and other public sources and is provided for comparison purposes only.  HFR does not endorse or approve any of the statements made herein.

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What Winning Looks Like (Probably Not What You Expect)

December 6, 2016

The blog Basis Pointing has an excellent write up on the performance profile of winning funds.  I suspect most investors will be very surprised at its findings.  It’s not that winning funds don’t exist–they most definitely do.  Rather, it is that the path to long-term outperformance is far lumpier than most investors probably expect.

Investors tend to have some pretty ingrained misconceptions of what “winning” funds look like. For instance, winning funds lay waste to the index and category peers; they do so over the short- and long-term; they corner really well, deftly avoiding big drawdowns and rocking during rallies; they don’t rattle around much; they succeed like clockwork. They’re Tom Brady.

For those who have gotten to know markets, randomness, and the resultant unpredictability of short and even intermediate-term performance, we know this is nuts. Winning funds do not succeed anywhere near linearly. Performance is jagged; success and failure arrive abruptly; it often takes years to grind out an advantage; and so forth. This is pure torture for many investors, who bail (and that pattern reveals itself in the form of hideous dollar-weighted returns; if there’s any consistency in markets, it’s that, but I digress).

Study

However, this concept is often too abstract so I thought I’d try to semi-simply illustrate it through an example. Here’s what I did (which will win no points for elegance or precision but last time I checked this blog was free):

  1. Grouped together all diversified U.S. open-end equity mutual funds (i.e., the nine style-box categories; active and index funds; no ETFs)
  2. Limited to unique funds (i.e., oldest shareclass)
  3. Calculated the twenty year annual excess returns of the unique funds I grouped (excess returns = fund’s total return minus return of benchmark index assigned to the category that fund was assigned to)
  4. Sorted the funds into deciles by excess returns (top=group with highest excess returns; bottom=group with lowest excess returns)

There were around 680 unique funds that had twenty-year excess returns, so we’re talking about 68 per decile grouping.

Findings

Here’s the predictable stairstep pattern from the top to bottom decile when sorted by excess return:

bp1

Click here to read all of the different elements of this study, be see below for the one that I found most interesting:

As shown below the more-successful funds did indeed lag less often (measured as number of rolling 36-month periods during the twenty year span where the decile grouping had negative average excess returns) than the less-successful funds.

3-yr-lag

But it’s not like they were strangers to underperformance. In fact, the best-performing funds lagged their indexes in more than one of every three rolling three-year periods.So, investors in these funds spent roughly a third of the past two decades looking up, not down, at the index (when measured over rolling three-year periods).

My emphasis added.  As shown in the first chart, there are plenty of funds that have outperformed over the past 20 years.  However, any investor who expected consistent outperformance would have been sorely disappointed.  Even the best performing funds lagged their benchmark about one third of rolling 3-year periods.  The lessons should be clear.  Investors would be well served to do meaningful due diligence on active strategies before putting money to work.  Once investors feel confident that they have settled on strategies/management teams that they believe are likely to outperform over time, they would be well served to demonstrate a very high level of patience.

There may be times where all investments and strategies are unfavorable and depreciate in value.

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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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Relative Strength Spread

November 29, 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 11/28/16:

spread

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

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Knowing When to Stand Still

November 28, 2016

There has been an enormous amount of commentary following the November 8th presidential election about exactly what a Trump administration will mean for the financial markets, both domestic and international.  Trump’s victory is being called one of the biggest political upsets in modern U.S. history.  I think it is fair to say that the markets were probably expecting a Clinton victory, which may account, to some degree, for the wild swings in the performance of many relative strength strategies in the days following the election.  For example, see below for the performance of our Systematic RS International model compared to its benchmark, the Nasdaq Global ex US TR Index.  In the immediate aftermath of the election, many of our Latin American holdings took it on the chin, perhaps in fears of the perceived protectionists policies that might be associated with a Trump administration.  However, you’ll notice that within a couple of days the performance of the model snapped back.

intl-perf

*Performance of the Systematic RS International model is non-inclusive of dividends or transaction costs.  The performance of the Nasdaq Global ex US Index is inclusive of dividends, but does not include transaction costs.  Period 11/8/16 – 11/22/16.

We received a number of panicked phone calls during the few days following the election when we were experiencing some sharp underperformance.  “Is the model responding too slowly?”  “Wouldn’t it make sense to get out of all Latin American stocks now?”  Those were some of the types of questions we were receiving.  Our response was that we didn’t know if the underperformance would continue or if we would see those positions snap back, but that we would stick with our relative strength discipline.  Positions that deteriorated sufficiently would be removed from the model and replaced with stronger names.  In other words, we were not overriding the model.

This does remind me of a NYT article I read a number of years ago on a related topic:

The soccer field has turned out to be a popular laboratory among economists, with penalty kicks a particular favorite.

Awarded after certain kinds of fouls, or sometimes to decide a championship match, a penalty kick pits one player against the goalkeeper. (Mano a pie instead of mano a mano, though, since the goalie is allowed to use his hands.)

Standing just 36 feet away, the kicker sends the ball hurtling at the goal at 60 to 80 m.p.h., giving the goalie just 0.2 to 0.3 second to respond. Given the speed, the goalkeeper has to decide what to do even before observing the direction of the kick. Stopping a penalty kick is considered one of the most difficult challenges in sports. Not surprisingly, 80 percent of all penalty kicks score.

For their study, Mr. Azar, along with Michael Bar-Eli, a sports psychologist; Ilana Ritov, a psychologist; and two graduate students, scanned the top leagues in the world, collecting data on 311 penalty kicks. Then they computed the probability of stopping different kicks (to the left, the right or center) with different actions (jumping left, right, or staying put) to see which one “maximizes his chance of stopping the ball.”

According to their calculations, staying in the center gives the goalkeeper the best shot at halting a penalty kick — 33.3 percent, instead of 14.2 percent on the left and 12.6 percent on the right.

Yet when the group analyzed how the goalkeepers had actually reacted to these penalty kicks, they discovered the goalies remained in the center just 6.3 percent of the time.

The reason, Mr. Azar contends, is rooted in how the players feel after failing to block the ball.

01kick_600

Source: New York Times

When it comes to soccer and investing, when choosing what to do, sometimes the best thing is nothing.  Overriding models may or may not work out in the short-run.  In the long-run, adherence to disciplined and adaptive models makes all the difference.

Over the last 10+ years the we have been managing the Systematic RS International portfolio, it has certainly had periods of underperformance, but over the last 10 years it has outperformed its benchmark by 6.4 percent annually, net of all fees.

intl-long-term-perf

As of 10/31/16

To receive the brochure on our Systematic RS Portfolios (which are available on a large number of SMA and UMA platforms), please e-mail andyh@dorseymm.com or call 626-535-0630.

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.

The performance shown above is based on monthly performance of the Systematic Relative Strength International Model.  Net performance shown is total return net of management fees, commissions, and expenses 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.  The advisory fees are described in Part 2A of the adviser’s Form ADV.  The starting values on 3/31/2006 are assigned an arbitrary value of 100 and statement portfolios are revalued on a trade date basis on the last day of each quarter.  All returns since inception of actual Accounts are compared against the NASDAQ Global ex US Index.  The NASDAQ Global ex US Index Total Return Index is a stock market index that is designed to measure the equity market performance of global markets outside of the United States and is maintained by Nasdaq.  A list of all holdings over the past 12 months is available upon request.  The performance information is based on data supplied by the Manager or from statistical services, reports, or other sources which the Manager believes are reliable.  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.  Past performance 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 when working with Dorsey, Wright & Associates.

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Weekly RS Recap

November 28, 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 (11/21/16 – 11/25/16) is as follows:

ranks

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.

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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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