Systematic Relative Strength

The chart below shows performance of US sectors and capitalizations over the trailing 12, 6, and 1 month(s). Performance updated through 8/15/2013.

Numbers shown are price returns only and are not inclusive of transaction costs. Source: iShares

Mutual fund flow estimates are derived from data collected by The Investment Company Institute covering more than 95 percent of industry assets and are adjusted to represent industry totals.

Yep, factor investing is somewhere between active and passive investing:

However, factor investing has taken off in recent years along with passive investing, though not nearly at the same torrid pace, as the shift away from actively managed equity funds continues.

“Passive and factor investing are joined at the hip,” said Samuel Lee, an analyst at Morningstar Inc.

“Passive is based on a lot of academic and finance theory that says it’s impossible to beat the market. Factor investing is an offshoot of that,” Mr. Lee said.

“Factor investors probably started off as Bogle-style buy-and-hold investors, then looked deeper into the research,” he said, referring to The Vanguard Group Inc. founder John Bogle.

The research shows that over time, overweighting companies with favorable prices, profitability, size or momentum can lead to better overall risk-adjusted returns. The key to that, though, is time.

Source: Investment News

Factor investing is passive in its systematic execution, transparency, and relatively low cost and active in its design to be built around return factors that have demonstrated the possibility of outperforming cap-weighted indexes over time.

HT: Abnormal Returns

Although many technicians consider volume in their analysis, we have chosen to focus solely on price. As pointed out by Business Insider, those waiting for higher volume to confirm this uptrend are still waiting:

Almost every day since the the bull market began in March 2009, some stock market pundit has complained about low trading volumes.

Some fear that low volume means sell-offs could turn sharp due to lack of liquidity.

However, Charles Schwab’s Liz Ann Sonders points us to this interesting counterintuitive chart from the Bespoke Investment Group.

“The chart breaks out performance the current bull market based on days when volume (using the SPY exchange-traded fund as a proxy) has been above and below its 50-day moving average,” explained Sonders.

“On a cumulative basis, the S&P would be up nearly 300% if you were only invested on the days when volume was below average,” she added. “That’s nearly double the return of the entire bull market! On the other hand, if you were only invested when volume was above average, you would actually be down 37%. Complain if you’d like, but gains are preferred over volume, no?”

“Market bears seem never to be short reasons for gloom; but valuation and volume shouldn’t be among them,” she said.

 

The chart below is the spread between the relative strength leaders and relative strength laggards (universe of mid and large cap stocks). When the chart is rising, relative strength leaders are performing better than relative strength laggards. As of 8/12/2013:

The table below shows the performance of a universe of mid and large cap U.S. equities, broken down by relative strength decile 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 (8/5/13 – 8/9/13) is as follows:

7/31/2013

The Arrow DWA Balanced Fund (DWAFX)

At the end of July, the fund had approximately 46% in U.S. Equities, 26% in Fixed Income, 16% in International Equities, and 11% in Alternatives. U.S. equities, our biggest overweight, had a very strong July after pulling back slightly in June. Among our best performing holdings were our positions in Healthcare and Small-Cap Value for the month of July. U.S. equities continue to be the dominant asset class from a relative strength perspective. Developed international equities continued their trend of outperforming Emerging Markets in July. European Central Bank President Mario Draghi sought to dispel doubts about the strength of the central bank’s recent guidance on interest rates by recently reaffirming its commitment to keep borrowing costs low for as long as Europe struggles to recover. The European equity markets responded favorably to those statements. We saw strong performance from our positions in Belgium and Germany in July. Reflecting the superior relative strength of Developed International Markets versus Emerging Markets, all five of our current international equity holdings are from Developed International Markets. After spiking higher in June on fears of Fed tapering of its quantitative easing program, interest rates were fairly stable in July. Our Fixed Income holdings remain near their lower constraint as this asset classes has been among the biggest laggards so far in 2013. Our Alternative holdings of real estate and a currency carry trade were fairly flat in July.

DWAFX gained 3.38% in July and is up 8.95% through 7/31/13.

We believe that a real strength of this strategy is its balance between remaining diversified, while also adapting to market leadership. When an asset class is weak its exposure will tend to be towards the lower end of the exposure constraints, and when an asset class is strong its exposure in the fund will trend toward the upper end of its exposure constraints. Relative strength provides an effective means of determining the appropriate weights of the strategy.

The Arrow DWA Tactical Fund (DWTFX)

At the end of July, the fund had approximately 90% in U.S. Equities and 9% in International Equities. The U.S. equity markets again broke out to a new all-time high in July. It has been more than 10 years since we have seen this kind of superior relative strength of U.S. equities compared to fixed income, international markets, real estate, and commodities. The nature of this strategy is to be flexible enough to adapt to new market environments and the market environment that we are seeing now has little in common with what we have seen for over a decade. For the year, small and mid-cap equities have had better relative strength than large caps and we have a number of small and mid-cap positions in the fund. We have seen fairly stable sector leadership this year with Healthcare, Consumer Discretionary, and Financials. According to Morningstar, this fund is currently outperforming 99% of its peers in the World Allocation category YTD. As trend followers, we benefit from environments with stable leadership and we are seeing that now.

DWTFX was up 5.03% in July and has gained 14.93% through 7/31/13.

This strategy is a go-anywhere strategy with very few constraints in terms of exposure to different asset classes. The strategy can invest in domestic equities, international equities, inverse equities, currencies, commodities, real estate, and fixed income. Market history clearly shows that asset classes go through secular bull and bear markets and we believe this strategy is ideally designed to capitalize on those trends. Additionally, we believe that this strategy can provide important risk diversification for a client’s overall portfolio.

The chart below shows performance of US sectors and capitalizations over the trailing 12, 6, and 1 month(s). Performance updated through 8/8/2013.

Numbers shown are price returns only and are not inclusive of transaction costs. Source: iShares

Mutual fund flow estimates are derived from data collected by The Investment Company Institute covering more than 95 percent of industry assets and are adjusted to represent industry totals.

The chart below is the spread between the relative strength leaders and relative strength laggards (universe of mid and large cap stocks). When the chart is rising, relative strength leaders are performing better than relative strength laggards. As of 8/5/2013:

The table below shows the performance of a universe of mid and large cap U.S. equities, broken down by relative strength decile 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 (7/29/13 – 8/2/13) is as follows:

The chart below shows performance of US sectors and capitalizations over the trailing 12, 6, and 1 month(s). Performance updated through 8/1/2013.

Numbers shown are price returns only and are not inclusive of transaction costs. Source: iShares

Our recent post Relative Strength Dividend Investing highlighted a couple of key ways that relative strength screens have the potential to improve the experience of dividend investors. A “land of agony” for dividend investors is those holdings that cut their dividends. As pointed out in the article, companies that cut their dividends overwhelmingly had negative relative strength.

Today, we see another example of that with Barrick Gold:

The world’s largest gold miner has now written off nearly $13-billion in 2013.

Because of the latest charge, Barrick lost $8.6-billion during the second quarter. Stripping out the one-time item, the company made $663-million, or 66 cents per share, down from $821-million, or 82 cents per share in the same period last year.

To conserve cash, Barrick has decided to slash its dividend to 5 cents per share each quarter , down from 20 cents previously. The cut will help the company save $600-million annually.

And just like that, Barrick Gold has slashed its dividend (which was 4.66%) by 75%. However, the technical case for Barrick Gold has been weak for some time.

Source: Yahoo! Finance, 8/1/12 - 7/31/13, Price return only

Dorsey Wright also ranks all stocks by their “technical attributes” on a scale of 0-5 (5 being the strongest). Four of the attributes are based on relative strength and one is based on trend. The technical attribute history of Barrick Gold (ABX) has also been weak for years:

Source: Dorsey Wright

As Josh Peters of Morningstar recently pointed out, “Investing—even when focused on dividends—is never just about the dividends. Total return, which reflects both income and capital appreciation, is the bottom line for any investment strategy.” Relative strength has the potential to be an effective defense against dividend cutters.

Dorsey Wright manages Relative Strength Dividend UITs for First Trust. Click here for more information.

Past performance is no guarantee of future returns. A list of all holdings for the trailing 12 months is available upon request.

Mutual fund flow estimates are derived from data collected by The Investment Company Institute covering more than 95 percent of industry assets and are adjusted to represent industry totals.

The chart below measures the percentage of high relative strength stocks that are trading above their 50-day moving average (universe of mid and large cap stocks.) As of 7/30/13.

The 10-day moving average of this indicator is 89% and the one-day reading is 88%.

The chart below is the spread between the relative strength leaders and relative strength laggards (universe of mid and large cap stocks). When the chart is rising, relative strength leaders are performing better than relative strength laggards. As of 7/29/2013:

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 (7/22/13 – 7/26/13) is as follows: