2005 All Over Again?

December 20, 2010

Michael Santoli highlights the similarities between 2004 and 2010 in his Barron’s column over the weekend:

The year 2004 has served as a useful, if imperfect, touchstone here for at least a year. Some parallels are eerie, some are mere diverting coincidence. As 2004 opened, the Standard & Poor’s 500 index had rallied ferociously off a March bear-market low and sat at 1112; this year it began at 1115, having surged even further from its March 2009 bear-market trough.

In ’04, it knocked around a narrow path until a late-year rally carried it above 1200 to 1211. This year the ride was similar, if more dramatic, rallying into April and then dropping quickly by 17%, before the late-year rally carried it back above 1200, to a current 1243.

In both years, the consensus entering the year was that Treasury yields should rise and the market would remain volatile. In both years, the 10-year Treasury yield, while jumpy, hardly budged from start to finish, and market volatility plummeted all year, reflecting the numbing effects of heavy liquidity.

Then, as now, the market was up respectably, yet finished at a valuation lower than where it started, with corporate earnings advancing far more than share prices did, even as profit growth was about to decelerate sharply.

And the psychology on Wall Street now is pretty close to where it was a few years ago—mostly bullish, with a growing collective belief that things have turned for the better, after months of mass frustration over the unsatisfying pace of economic recovery.

My boldface emphasis added. If the psychology of market participants today is similar to that seen at the end of 2004, it could bode well for relative strength strategies in 2011 as investors increasingly gain confidence in market leadership. As shown in the chart below, 2005 was a very good year for relative strength strategies with our High RS Index gaining 16% while the S&P 500 was up only 3%.

(Click to Enlarge)

“High RS Index” is a proprietary Dorsey, Wright Index composed of stocks that meet a high level of relative strength. The volatility of this index may be different than any product managed by Dorsey, Wright. The “High RS Index” does not represent the results of actual trading. Clients may have investment results different than the results portrayed in this index. Past performance is no guarantee of future results.

 

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Posted by Andy Hyer

The Balance Sheet Recession and Its Consequences

June 2, 2010

Kate Welling is a terrific financial journalist and has had a sterling reputation for years, on her own and at Barron’s. In my opinion, she has just burnished it with this tremendous interview with former Federal Reserve and current Nomura economist Richard Koo. Koo’s book, The Holy Grail of Macro Economics, Lessons from Japan’s Great Recession, discusses how a balance sheet recession is different from a typical cyclical recession. It’s a long article, but you’ve got to read the whole thing to really understand his thesis. This is a five-star article, in my opinion.

Koo’s argument is that in a balance sheet recession, businesses and consumers direct their free cash flow toward paying down debt and saving, rather than on maximizing profits. Koo’s thesis has visceral appeal: we’ve all seen this happening on a micro level within our own circles of acquaintances. During the deleveraging process, the typical rules of macroeconomics and monetary policy do not apply. For example, cutting interest rates should, in theory, stimulate loan demand and thus stimulate the economy. But even with U.S. interest rates near zero, there is no loan demand. Why? Koo’s contention is that, although it may be partly because of a lack of creditworthy borrowers, it’s largely because people are busy rebuilding their balance sheets-they are not interested in borrowing money at any price, even a low one. Koo’s interview is the first discussion I’ve seen by an economist that explains this phenomenon very well-because it also happened in Japan after their asset bubble burst in 1989.

Here’s where it gets interesting: there could be lots of unintended consequences in the market if policy levers do not operate as expected. Assuming that action x will lead to outcome y in the way we are used to expecting may not be applicable. Basing investment decisions on such assumptions could be very dicey. Using relative strength to power a trend-following process may be very useful, since trend following does not require any assumptions about policy outcomes. Global currency relationships may also become prominent as different countries respond to their situations in various ways. We’ve already seen this to some degree with the Euro/Dollar cross during the Greek situation. With policy responses in flux and with unpredictable outcomes potentially in store, a systematic global tactical asset allocation process may be the best defense for investors.

2 Comments | Markets, Tactical Asset Alloc, Thought Process | Permalink
Posted by Mike Moody

DWA 100,000 — New Highs!

May 24, 2010

No, this isn’t the price level on some new-fangled unweighted index. It’s the number of views we’ve had of our blog over the past year or so. In the meantime, we have garnered positive reviews from Barron’s and numerous referrals from other respected websites like Abnormal Returns and World Beta. We appreciate that you and thousands of other investors have made our blog into one of your financial sites of choice and one of the thought leaders in relative strength investing. We will try to continue to provide you with original content, articles, and news pertaining to relative strength and global trends, and to continue to give you our unique spin on the relative strength style of investing.

When I wrote a similar post, DWA 25,000, I mentioned that we wanted to deliver even more value down the road in the form of audiovisual presentations. We’ve done that with new podcasts and on-screen presentations. Check them out! Another valuable and educational feature has been our white papers on important topics like asset class rotation. In everything we do, our intent is to inform, entertain, and provoke thought and discussion. We think we are succeeding, but if you have constructive feedback, we’d love to hear from you. Success is never final and we’re always looking for ways to improve.

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Posted by Mike Moody

We Made Barron’s

May 3, 2010

Our blog received a nice recommendation from Michael Santoli in his May 3rd Barron’s article, The Provisional Pullback:

MOST OF US, IN THIS ONLINE AGE, are hummingbirds of media consumption, flitting from flower to flower for the promise of a little nourishment, expending much energy to travel not very far. So it’s no surprise that the requests come constantly for recommendations for sites worth reading on market-relevant matters. The quick and easy answer is that everything is worth reading if one approaches it in the proper context, but time constraints require shortcuts and edited research itineraries.

An excellent gateway to the daily bounty (or burden) of economic and financial writing is www.RealClearMarkets.com. There’s a barely perceptible pessimistic bias in the arrayed daily links, but on the whole it’s a fine way to get current on the chatter animating the market.

Passionate, cogent and opinionated periodic commentary on financial and related policy matters can be found at www.StumblingOnTruth.com, a blog by Cliff Asness, who runs the quantitative asset manager AQR Capital Management. If there is a cleverer phrasemaker or clearer thinker among finance Ph.D.s than Asness, he or she is a stranger to my Web browser. Be sure to check out his latest riff on the Goldman/credit crisis inquest, “Keep the Casinos Open.”

For worthwhile color commentary on the day-to-day market action, featuring links to more eclectic research as well, close market watchers should check out http://systematicrelativestrength.com, run by the folks at the technical-analysis firm Dorsey Wright & Associates, and www.tradersnarrative.com.

Finally, the quarterly letters of Jeremy Grantham of asset manager GMO are a fun and thought-provoking read. The latest, at www.gmo.com, is noteworthy mainly for a non-consensus view of what would be the gravest long-term risk to markets and the economy. Grantham makes the case that a halting, uncertain economic recovery that would embolden the Federal Reserve to keep monetary policy hyper-easy could produce another bubble in risk assets, driving stocks toward the old highs and then ultimately collapsing, at a time when governments would lack the wherewithal to mute the effects.

For balance, note that Laszlo Birinyi of Birinyi Associates offers a dismissive take on Grantham’s thinking in his own highly readable and caustically contrary monthly newsletter (offered by subscription only, but alluded to on his firm’s blog, www.tickersense.typepad.com).

(Emphasis Added)

Leave a Comment » | Media | Permalink
Posted by Andy Hyer

Advice From #1

April 19, 2010

Brian Pfeifler, who is currently ranked number 1 in Barron’s list of the 100 Top Financial Advisors of 2010, on how he runs his business:

“I don’t want to spend my time dealing with jet charters, dog-walking or bill paying. I want instead to concentrate on asset allocation and manager selection — that is more than a full-time job,” he says. “To say I can do more than that is not being honest about my capabilities.”

Barron’s notes that Pfeifler currently has $4.8 billion in assets under management.

It is so easy for financial advisors to fall into the trap of being a jack of all trades, master of none. Yet, the best in the industry find out where they excel and outsource the rest.

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Posted by Andy Hyer

The Brave New World of Asset Allocation

October 5, 2009

“We think asset allocation, certainly over the next five to 10 years, begs for a tactical component that is very hard for many investors to deal with because they aren’t structured to think about macro things like equity exposure…” Ah, yes. Now everyone is singing the praises of tactical asset allocation. The quotation above is from a major article in Barron’s over the weekend, which is an interview with Mark Taborsky, the head of asset allocation at PIMCO. (subscription required) If you don’t get Barron’s, at the very least you might want to borrow a friend’s copy and take a look at the interview.

Tactical asset allocation is gaining notice because it is a very useful way to navigate what markets are actually doing, instead of what they should be doing in theory. Taborsky says, “The majority of people who use the modern-portfolio-theory approach — and it has been with us for more than 50 years — recognize that it has many shortcomings. Anyone who has done it more than a year recognizes how far off their estimates of expected returns are by asset class and how far off their expectations of volatilities and correlations are. It is a very elegant approach, but it doesn’t really work that well.” It’s refreshing to hear someone else make these points for a change!

Mr. Taborsky sums up the shortcomings of traditional strategic asset allocation very concisely: ”The traditional approach to asset allocation relies on looking back in history to what asset classes returned. There is a huge reliance on mean reversion. There is a huge reliance on historic volatilities and correlations.” The problem with reliance on historical norms is that when there is a regime change, and the norms change, you are completely at sea. PIMCO believes that we have had a regime change, which they call the “new normal.” If they are correct, strategic asset allocation could have a rough go of it for a while.

Tactical asset allocation seems to be the only logical way to respond systematically to the constantly changing relationships between asset classes. Our Systematic RS Global Macro strategy (in separate account form or in mutual fund form in the Arrow DWA Tactical Fund) is designed to handle the rotation among asset classes for investors. Given the fear that retail investors still harbor, it might be just the thing to consider when moving cash from the sidelines back into the markets.

Click here to visit ArrowFunds.com for a prospectus & disclosures. Click here for disclosures from Dorsey Wright Money Management.

Leave a Comment » | Markets, Tactical Asset Alloc | Permalink
Posted by Mike Moody

AQR on Momentum

August 31, 2009

Barron’s has a nice interview with Cliff Asness and David Kabriller of AQR Capital (click here to read.) Subscription required. One noteworthy exchange:

Why do you think momentum investing works?

Asness: No one has nailed down why. We have a lot of theories. When I say “we,” I don’t just mean AQR. I mean the academic community and the practitioner community. Underreaction is probably our universally favorite story. Good news comes out. There is a phenomenon in behavioral finance called anchoring and adjustment, where people go, “Oh, that’s great news,” and they move halfway but they don’t move all the way to incorporate the great news. So if you buy what’s gone up, there’s a little more to go. I won’t pretend I have told you all the different theories.

Leave a Comment » | Investor Behavior | Permalink
Posted by Andy Hyer

Deflation Bites

August 28, 2009

A very interesting article by Randall Forsyth in Barron’s discusses the problem conservative investors are having right now. Economists are worried about inflation down the road if the government chooses to monetize its debt. But the current problem for investors is deflation.

Deflation has driven interest rates on cash to near zero. Interest income is $50 billion lower than a year ago. The recession has caused corporations—many of them financials—to cut dividends as well. I was surprised to learn that overall dividend income is down 25% from a year ago. And it is projected to get worse.

This can’t have a positive effect on consumer spending. And when consumer incomes drop, tax revenues also drop, which puts more pressure on the national deficit.

Investors are also in a bind. The best yields are available, as always, on the riskiest paper. Most of the time, if CDs and Treasurys have reasonable yields, the “widows and orphans” investors ignore high-yield debt. But under the current circumstances, I suppose there is a risk of investors stretching out their risk parameters to reach for yield. Given that bond mutual fund sales have recently been running at five times the level of stock fund sales, I’ve got to wonder whether all of that cash is ending up in an appropriate place on the risk spectrum.

Leave a Comment » | Markets | Permalink
Posted by Mike Moody

Endowment Returns

July 2, 2009

Barron’s recently ran an article on large college endowment returns (see the table below). Most of the schools use a 6/30 fiscal year and are reporting losses on the order of -25 to -30%. Most of these funds use some type of strategic asset allocation, and in recent years they have had large allocations to private equity and hedge funds.

2009 Endowment Returns (courtesy of Barron's)

click to enlarge

Our own Arrow DWA Balanced Fund (DWAFX), rather than strategic allocation, uses tactical allocation to domestic equities, international equities, fixed income, and alternatives. We do not have access to some of the asset classes of the large endowments like private equity and hedge funds, which were believed to be high return-low volatility opportunities. Despite the lack of access, the trailing one-year return for DWAFX compares favorably with the major endowments. Perhaps there is something to tactical asset allocation after all!

Click here to visit ArrowFunds.com for a prospectus & disclosures. Click here for disclosures from Dorsey Wright Money Management.

Leave a Comment » | Tactical Asset Alloc | Permalink
Posted by Mike Moody