Rotation Continues

Rotation Continues 2/22/2017
I don't have much to add from last month's post because not much has changed.  The market's uptrend continues despite just about everyone saying how overbought it has been.  Its continues to rotate from group to group.  It really hasn't picked up new groups to move higher, but it seems to be moving back and forth between banks, investment bankers, steels, semi conductor equipment and manufacturing.  If you have a shorter term time frame you have to move to the group that hasn't run in the last couple weeks. One area that seems to picking up is the emerging markets.  The relative strength of that index has been in an uptrend since the November.

Stock lists and charts have been updated for Feb 17, 2017.

Stock Lists and charts have been updated for Feb 17, 2017.

Growth has been doing better than Value, since Dec 2, 2016. This can be seen in the Growth vs value chart. Summation Index is above 1000 since Jan 9, 2017. Read the explanation on the “Summation Index” page to understand the significance of Summation Index being above 1000.

A rule based system for investing:

See the list of stocks in “Model List of Growth Stock Ideas”. Invest in that list with equal dollar amounts in each stock. Next month re-balance your portfolio and invest equal dollar amount in the new list shown on that tab. Even though the list on that tab is updated every week, the system proposed here is re-balancing every month.

The system is bases on two parts.

The first part mentioned above is based on the study of biggest past stock market winners. The philosophy here is that stocks generally sell for what they are worth. It prefers to focus on companies that are still in a stage of earnings acceleration.  The list of stocks in “Model List of Growth Stock Ideas” is based on this principal.

The system identifies companies with strong fundamentals— enjoying big earnings increases — and buying them when they emerge from price consolidation periods or when prices have started to respond to good fundamentals and show a strong upward price movement. This is before they have dramatically advanced in price.

The momentum factor for earnings combined with the momentum factor for prices have produced very good results as shown by the Index performance.

The drawback with this methodology is large drawdowns and high volatility. Upside volatility is a positive factor which produces exceptional upside returns.

To minimize the problems of drawdown and high downside volatility the system incorporates “Tactical Allocation”. This is the second part of this system.

In “Tactical Allocation” asset’s trend (Index trend) is compared to its own performance. If the absolute momentum of the Index is slowing down compared to 12 months ago switch to a mix of Short and Intermediate term bonds. When the Index momentum turns up again, switch back into the selected stocks.

Here’s what is good about the strategy:

1.   It’s rules-based. There’s no discretionary decisions required. The relative momentum rule for earnings and price picks “good” growth stocks. The “Tactical allocation” rule triggers switch between stocks and bonds based on which is performing.

2.   It’s a low activity strategy. The rules are only checked once a month for rebalancing purposes, which leads to a fairly low turnover compared to other momentum strategies. The rules for “Tactical allocation” are checked weekly.

3.   It’s based on both historical evidence and investor behavior.  The back-test makes sense as do the behavioral reasons for the momentum factors. All good investment strategies are based on taking advantage of other investor's behavior.

Now for some drawbacks and caveats:

1.       The psychology of going all-in or all-out. It is a simple strategy, but having any position in the markets is never easy. It can be very difficult to psychologically go from an all stock to an all bond position. Some investors simple cannot stomach following “Tactical Allocation” signals, no matter how simple they may be.

2.       Back-tests only tell you what has happened, not what will happen. This is true of all investment strategies, but it’s worth remembering that the future is promised to no one in the markets.

The verdict?

You have to know yourself as an investor when considering this type of strategy. It’s more about knowing yourself than understanding the strategy.

Even simple strategies are never easy to implement. This system has worked in the past, but investors have to define what “works” means to them. We say an investment strategy “works” if you’re to follow it over many different cycles. It never “works” if you bail out at the first sign of trouble or relative underperformance.

Summary:

The System is an approach to achieving risk-managed exposure to the anomaly across asset classes. It establishes meaningful controls over investment risk, once an asset's value begins to decline. It removes emotional and behavioral biases from the decision-making, while taking advantage of these same biases in others to achieve exceptional returns.