08/29/2013 sector update

At the close the sectors are XLU & XLK.

XLB fell very slightly into third place, and may revert to second tomorrow.

08/27/2013 sector update

Current positions after today are XLU & XLB.

08/25/2013 "Risk" depends on what would hurt most to lose

Sector Model	XLU & XLP	-0.74%
Style Model	Small Value
Large Portfolio	Date	Return	Days
CAJ	9/25/2012	-11.05%	333
ABX	4/11/2013	-17.07%	135
TTM	5/6/2013	-10.70%	110
DLB	5/13/2013	-5.71%	103
OKE	6/17/2013	17.97%	68
BTI	7/1/2013	3.14%	54
CLH	7/8/2013	9.43%	47
FAST	7/22/2013	-2.99%	33
VAR	8/2/2013	-0.75%	22
OUTR	8/19/2013	1.12%	5
(Since 5/31/2011)
S&P	Annualized	9.97%
Sector Model	Annualized	23.39%
Large Portfolio	Annualized	28.84%

 

I mentioned the other day that OUTR was the first stock selected with a new screening process.  It’s something of a screen within a screen, and backtests on the sector model show a good bit of added value to the process:

 

The blue line is the S&P.  The red line is the Sector Model we’ve been tracking.  The green line is what the Sector Model would look like with the new process.

This is a fourteen year backtest; however, it’s important to note that the new process would have significantly UNDERPERFORMED over the past two and a half years.  There was a sharp drop right at the beginning of the testing period (just after the models were launched on 5/31/2011), and the revised model would have needed to run for well over a year just to get back to zero.

All of which brings me to the subject for today: no matter what your method, you’ll have periods of good and bad luck.  “Risk” depends on how luck would affect your own trading needs.  If you are putting money steadily into the market, the more volatility the better.  If you are steadily taking it out, the less volatility the better.  If you are rotating like the Mousetrap or letting it ride like Buffett, volatility is nothing but noise.

I know, I know, folks like to quote Fama about risk, but Fama’s theories only work if you are close to retirement age or already retired.  If you have at least 4 or 5 years until retirement, following Fama is one of the most destructive things you can do – second only to trying to time (without an extremely sophisticated model).

So let’s look at volatility.  If you are steadily putting 100 a week into your retirement account, a highly volatile vehicle will cause your 100 dollars to represent a higher percentage of your account when it dips than when it is doing well.  The wobbles will actually work to your advantage and you will make money faster.

The flip side is that if you are retired and you take out 1000 a week, that 1000 will be a greater percentage of your account when it is down than when it is doing well.  The wobbles will work against you and you will lose money faster.

In other words, volatility only increases the effect of whatever you are doing to your account.  If you are adding to your account then volatility adds value.  If you are taking money from your account then volatility takes value away.

So, if you are more than five to ten years away from retirement and someone mentions Fama and risk adjusted returns, you may want to get a second opinion.  Fama is great if you are ALREADY rich and don’t want to become poor.  For us working folks Fama is a disaster.

The rule of thumb is that there is no rule of thumb.  Risk is defined by what is most destructive to lose.  For the rich, it is most destructive to lose capital.  For those who are working, it is most destructive to lose opportunity.

My own model looks for sectors and industries that are experiencing extreme panic.  I won’t even look at a stock in a complacent sector.  So Fama is as far away from my own targets as possible, and his only use is in causing these good values to be even better buys for me when I get to them – because none of Fama’s followers are bothering to look.

Am I a fan of Fama?

Nope.

But I do appreciate his scaring away my competition from the bargains that are out there.

Tim

 

 

08/23/2013 Market Top Formation

Sector Model	XLU & XLP	-1.30%
Style Model	Small Value
Large Portfolio	Date	Return	Days
CAJ	9/25/2012	-11.22%	332
ABX	4/11/2013	-19.17%	134
TTM	5/6/2013	-13.54%	109
DLB	5/13/2013	-5.60%	102
OKE	6/17/2013	17.42%	67
BTI	7/1/2013	2.36%	53
CLH	7/8/2013	8.33%	46
FAST	7/22/2013	-2.84%	32
VAR	8/2/2013	-0.59%	21
OUTR	8/19/2013	-0.24%	4
(Since 5/31/2011)
S&P	Annualized	9.79%
Sector Model	Annualized	23.49%
Large Portfolio	Annualized	28.39%

 

As I pointed out yesterday on the blog, the sector model switched from XLU & XLB, to XLU & XLP.  In terms of market rotation, that is moving from a top combination to a bear combination.  However, I don’t just look at sectors, but also market cap and styles (chart below).

So, a quick note on the market.

The recent flash freeze in Nasdaq is a symptom of a bull market that is getting long in the tooth.  Also, the talk of tapering by the Fed has the market spooked to the point that large players are positioning themselves for a bear market.  Accordingly, the combination of sector, market cap, and style configurations are in line for a market top:

 

NORMALLY the market has the following relationship with the Fed…

BEAR

At a market top the Fed starts to lower interest rates.  During a bear market rally the Fed tries to allow interest rates to rise, and the market fails.  During the final throes of a bear, both interest rates and market prices plummet together.

BULL

At a market bottom the Fed holds rates down while the market begins to turn.  At a correction the Fed is tightening rates and the market stumbles, but recovers on its own.  At a market top both prices and rates are rising together.

In a NORMAL market we’d be looking for a correction here, rather than a bear market.

HOWEVER, if we are indeed in the midst of a secular bear market (my own opinion based on the demographic hole in working age vs. non-working age people), then such a “correction” would fail to recover.  A failed “correction” would be akin to 1937, when we had the depression within the depression.

I don’t have a crystal ball, and all this talk of tapering could just be a trial balloon.  The Fed knows about 1937, and would LIKE to avoid it if possible.  So, between the two options of a correction or a deflationary implosion, most large players seem to be positioning themselves for a normal to mild bear.

Since my model is long only, it does not time the market, but instead it rotates between industries and sectors.  In a market dip I will dip too, but will rotate out of stocks that dip less and into ones that have dipped more, so that when a recovery does happen, I will be positioned to recover faster.

If you are faint of heart, though, the next few months could be a good time to take up yoga and meditation…

Tim

 

08/22/2013 sector update

The sector model has changed intraday

from XLU & XLB

to XLU & XLP

08/18/2013 Ask not what stocks can do for you; ask what you can do for stocks...

Sector Model	XLU & XLB	-0.97%
Style Model	Small Value
Large Portfolio	Date	Return	Days
CAJ	9/25/2012	-8.78%	327
ABX	4/11/2013	-20.12%	129
TTM	5/6/2013	-4.99%	104
DLB	5/13/2013	-5.25%	97
MATW	6/6/2013	3.28%	73
OKE	6/17/2013	13.90%	62
BTI	7/1/2013	3.42%	48
CLH	7/8/2013	1.67%	41
FAST	7/22/2013	-3.78%	27
VAR	8/2/2013	-2.02%	16
(Since 5/31/2011)
S&P	Annualized	9.82%
Sector Model	Annualized	23.25%
Large Portfolio	Annualized	28.54%

 

Rotation: selling MATW; buying OUTR.

This rotation marks the beginning of a new phase of the model that will allow it to emphasize the fundamentals of the companies to a greater degree: strong long term growth in cash flow, dividends, and sales; with a recent (atypical) earnings miss.

Basically you want to invest in a company that normally does better than it is doing now.  Most people in the market nowadays are traders instead of investors, and that leaves a good opportunity for us at a time a company most needs it.

That is, you are helping yourself by helping the company.

Traders are trying to take money from others.

Investors are trying to make money with others.

This is an important distinction, and it puts investing back into the real world: people usually pay you for something that you do on their behalf.  Stocks work the same way.  We provide liquidity, and companies do with it what they can.  If the company needs more money now than it usually does, then it is likely to give you more profit than it usually gives its investors.

Sometimes even a historically well-run company may not be able to recover.  But that’s THEIR job.  OUR job is to give them the best chance we can give them when they most need it, and THEIR job is to take advantage of that chance.

Of course, a bad company that always needs money is something to avoid.  And so, we should weed out those companies that normally do poorly, and find worthwhile companies that need a shot in the arm.

In other words, provide a service for those companies that deserve it.

If they don’t deserve it, you’ll lose.

But if they don’t need your money, you’ll also lose.  Giving money to companies that don’t need it isn't providing a service, and doesn’t deserve a reward.

Good companies need good investors.

Good investors need good companies.

The rest is just noise.

Tim

PS – those who are following the blog on a daily basis have seen a lot of whipsawing in the second position of the sector model.  XLB, XLK, and XLP are all neck and neck.  Since I’m following this model in a cash based account, I’m avoiding all the whipsaws by holding XLU by itself.