Style Model
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Small Value
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Sector Model
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XLU
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1.35%
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Large Portfolio
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Date
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Return
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Days
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ABX
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4/11/2013
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-18.90%
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294
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NEM
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9/30/2013
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-10.38%
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122
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ISRG
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10/21/2013
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10.27%
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101
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EW
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10/28/2013
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-15.46%
|
94
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JOY
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11/18/2013
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-6.25%
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73
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OXY
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11/27/2013
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-9.43%
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64
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MUR
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12/23/2013
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-4.91%
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38
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SWM
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12/31/2013
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-9.82%
|
30
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NKE
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1/7/2014
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-7.31%
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23
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BTI
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1/15/2014
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-3.45%
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15
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(Since 5/31/2011)
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S&P
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Annualized
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10.93%
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Sector Model
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Annualized
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22.69%
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Large Portfolio
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Annualized
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26.93%
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Rotation: selling ISRG; buying MGEE
Yesterday morning I entered limit orders to sell NKE and buy
BBOX and then went to work.
I deliberately ignore the market during the day, and limit
orders prevent me from chasing a trade.
While I was busy with the real world, NKE gapped down and
BBOX gapped up – preventing the exchange.
Though disappointing from a tactical perspective, it is extremely
encouraging from a strategic one, since these trades were calculated on a very
extensive redesign of the full model.
Instead of a one-size-fits-all fundamental screen, I now
have a screening process that is adjusted to match a style model that I run in
the background. I don’t trade the style
model itself, however, because it only outperforms the S&P by 5% per year,
which is not enough to make it useful as a standalone model. The reason for the sluggishness is because
these are typically broad indexes, and the Mid and Blend options largely
overlap with the other styles.
Nevertheless, the style model does tell me when value stocks
should outperform growth stocks, or when small caps should outperform large
caps. I can adjust my fundamental
screens to target these areas. Right
now, for instance, the style model is calling for Small Value stocks to outperform. The sector model is calling for Utilities to
outperform. In theory, Small Value
Utilities should outperform better than Utilities in general.
The full model chooses the best 10% of 98 different industry
groups, and within those industries I should look for Small Value stocks.
Large and Small are rather simple. You just sort by market cap.
But what the heck is the difference between Value and
Growth?
The key difference is the objective: growth tries to
maximize reward and value tries to minimize risk. Growth is a bigger gamble. There may be higher debt loads as the company
seeks to expand, for example. Value
companies are geared for survival. They
may not be after the most aggressive growth, but instead they are trying to be
careful with the resources they have.
There are some overlaps: good long term earnings is a sign
of both value and growth. And that’s
where blended models come into play.
Greenblatt’s GARP (growth at reasonable price) approach is one
simplified version of a blended model.
In terms of “fear” and “greed”, Growth is the greed trade
and Value is the fear trade. A Value
investor wants to know how much the company’s assets are worth if it goes out
of business tomorrow and has to liquidate everything. A Growth investor would never think in such
terms.
Small and Large caps are selected by investors for similar
reasons. Small cap stocks have more room
to grow, but large cap stocks are less likely to fail.
Small caps and Growth stocks, then, are sought by investors
who try to maximize reward.
Large caps and Value stocks, on the other hand, are sought
by investors who want to minimize risk.
A small value stock or a large growth stock would both serve
as a way of blending reward and risk goals.
The question is which is most indicative of a bull or a
bear? Market cap or investment
style? In my observation, small caps
tend to have higher beta than large caps.
And so they will go up more, AND they will go down more, than large
caps.
Value and Growth approaches are imprecise and often working
on outdated information. Market cap is
always known in real time.
For this reason I have estimated the bullish to bearish
matrix in the following table (which gives slightly more weight to market cap
than investment style):
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Small Growth
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Small Blend
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Mid Growth
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Small Value
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Large Growth
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Mid Blend
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Mid Value
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Large Blend
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Large Value
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Cyclicals
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Technology
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Industrial
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Materials
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Hold
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Energy
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Staples
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Healthcare
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Utilities
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Hold
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Buy
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Hold
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Hold
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Finance
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Hold
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In the middle are the blended small value and large growth.
As for sectors: Consumer Staples, Healthcare, Utilities, and
Financial stocks are defensive, per the work of Sam Stovall and John Murphy.
Those cells marked as “Hold” and “Buy” are the ONLY cells in
which the relationship of volume-breadth to price-strength indicates “fair
value” to be above the current price.
At the bottom of a bull market, or at the end of a bear,
most of those cells should be filled. As
the bull reaches its close, the number of cells will dwindle. The small number of listed holds indicates a
market that is overbought, while the placement of 4 out of 6 holds in red cells
indicates a defensive market.
Currently the best combination is that of “Small Value” and
“Utilities.” The best combination is
marked as a “Buy” (there will only be one “Buy” at any given time).
The question that comes to mind is – why bother to invest in
the red cells at all?
A defensive market
is not always a declining
market. My models are geared for relative performance, rather than market
direction. The red cells usually
outperform in declining markets, but there are also such things as “growth
recessions” in which monetary policy or sheer momentum can propel a defensive
market upward.
In the same way, an optimistic market could still collapse.
Green is generally more profitable than red. But red cells
can still make money when investors run for safety. Currently the sector model has been
performing quite well in this most recent decline, and is up for the year –
even as the broad market is down.
In the end, there are two ways to make money: to go up more
than the market, or to go down less than the market. If you can do either of these two things well,
you’ll outperform.
Tim