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On Stock Crashes, Hindsight, And Anger

“You will not be punished for your anger, you will be punished by your anger.” – Buddha US stocks just had their worst start to a year in history last week going all the way back to 1928. The bears have come roaring back. As investors and traders frantically deal with clients and their own personal emotions, let’s put things into factual perspective. Those that have seen my presentations, met with me or read our writings for years are aware that we quantitatively test indicators and create strategies we believe have merit. Backtesting, like any form of analysis, does not guarantee exceptional performance in the future, but it can at least provide information on anomalies or market patterns which have persisted over time. So here’s a very simple and powerful backtested strategy. The 200 day moving average is popular as an indicator used to buy or sell stocks. Let’s make a simple rule. If a stock fund is trading above its 40 week (200 day) moving average, buy that stock fund. If below, then instead, buy Treasuries as your “risk-off” trade. For the below backtest, I used the Vanguard 500 Index (MUTF: VFINX ) as the stock proxy, and the Vanguard Long-Term Treasury Fund (MUTF: VUSTX ). Want to get more creative? Use the same rule, but leverage up the stock fund VFINX by an extra 30% to juice returns. Yellow uses that leverage, blue is the rotational risk-on/off strategy using Treasuries, orange is VFINX, and gray is VUSTX. VFINX mimics the S&P 500 SPDRs ETF (NYSEARCA: SPY ), while VUSTX mimics the iShares Treasury 20+ Year ETF (NYSEARCA: TLT ). Click to enlarge Looks pretty good right? Most of the time you’re trending higher, though it is worth noting that there are several flat volatile years where those who invest over a 1, 2, 3, or 4-year period are frustrated by a lack of returns and volatility/whipsaws. However, over longer periods of time and full cycles, both the unleveraged rotational strategy between stocks and Treasuries, and the leveraged one not only outperform on an absolute basis in terms of pure performance, but also do so on a risk-adjusted basis. The blue version’s cumulative return is 1,545% going back to 1986, versus the stock fund itself at 1,274%. That’s 1.2x better. The leveraged version which magnifies by 30%? Cumulative return is 2,756%, resulting in 2.16x stronger performance against VFINX as a buy and hold investment. Note that the extra 30% leverage over time significantly magnifies results. Compounding leverage can be a wonderful thing when it works over time if you have a strategy for it. It is worth noting that the 40 week MA’s strength is more about avoiding big declines rather than participating in big upside, though that upside exposure is most conducive towards using leverage. Also worth noting that if you added other momentum areas, notably emerging markets, the return path gets even more extreme. Great! Let’s buy into that. Now instead of the chart above, you’re living performance day to day. Feel good about the rotational strategy? Well, let’s now dig a little deeper. Let’s look at the worst weeks in the strategy. Any of these percentage declines feel familiar? Date Stocks/Bonds Leveraged Stocks/Bonds 4/10/2000 -10.52% -13.67% 10/12/1987 -9.21% -11.97% 9/8/1986 -7.84% -10.19% 12/8/1986 -7.66% -9.96% 8/1/2011 -7.15% -9.30% 10/9/1989 -6.91% -8.98% 10/11/1999 -6.63% -8.62% 5/3/2010 -6.35% -8.26% 8/17/2015 -5.71% -7.43% 1/24/2000 -5.62% -7.30% 10/5/1987 -5.07% -6.59% 8/24/1998 -4.97% -6.46% 7/23/2007 -4.89% -6.35% 1/5/1998 -4.83% -6.28% Herein lies the point of this backtest and any strategy employed. It is completely and utterly impossible to avoid weeks like what happened at the start of 2016 from impacting your portfolio and creating an emotional response. In the rotational strategy outlined here, there are numerous large declines throughout history. In each and every single one of these weeks, the response by investors and traders is the same. “What the hell is going on?” “I can’t invest in this!” “You should have sold out!” “Sell! SELL!!!!!” “Change the strategy!” Nothing can get everything right. Even if you used stop orders or decided to trade out of one of these big declines mid-week, historically it doesn’t do anything to mitigate those losses, even though one believes deeply that it would. The anger that comes from weeks like last week is no different than the emotional response that comes from other worst weeks in history in any strategy. Hindsight creates anger, but that doesn’t mean that anger is right. In the 2014 Dow Award paper on Beta Rotation, (click here to download) for example, we show that 80% of the time Utilities outperform the broader stock market before an extreme VIX spike. That means it also missed it 20% of the time, just like any indicator used to mitigate risk over much longer periods. That in no way shape or form invalidates the indicator. My point here is that sometimes these things happen. Long duration Treasuries did not confirm ahead of time that last week would happen based on indicators we have tested. Following the decline last week, things do look ugly. The decline could get worse, or the market could V, or W, or L, or do anything it wants to do. Hindsight is the only way we will know after such a major break. One cannot control for the madness of sudden markets. All any of us can do is prevent that madness from impacting rational decision making. The year is not written yet. There will come a major up move in reflation trades which would undo in the blink of an eye any damage done to portfolios so far in 2016. In the meantime, don’t let hindsight make you angry, because every strategy will have weeks in the dataset as violent as the one just experienced. That does not mean one should abandon the approach. It is easy to forget one simple rule when it comes to investing passively or using active management. The best time to buy in is after a significant drawdown. After drawdowns is the time to rationally examine data, rather than make rash decisions failing to understand that sometimes, you just can’t avoid bad luck. This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

ETF Update: A Look Back At December And 8 Funds To Kick Off The New Year

Welcome back to the SA ETF Update. My goal is to keep Seeking Alpha readers up to date on the ETF universe and to gain some visibility, both for the ETF community, and for me as its editor (so users know who to approach with issues, article ideas, to become a contributor, etc.) Every weekend, or every other weekend (depending on the reader response and submission volumes), we will highlight fund launches and closures for the week, as well as any news items that could impact ETF investors. Recently, Zacks published a piece on the funds that launched in 2015 and gained in assets under management right away. They were the S PDR DoubleLine Total Return Tactical ETF (NYSEARCA: TOTL ), the SPDR S&P North American Natural Resources ETF (NYSEARCA: NANR ), the iShares Exponential Technologies ETF (NYSEARCA: XT ), the Goldman Sachs ActiveBeta Emerging Markets Equity ETF (NYSEARCA: GEM ) and the SPDR Russell 1000 Momentum Focus ETF (NYSEARCA: ONEO ). While all of these funds saw strong support from investors, none ended the year with positive returns. Overall, markets took a turn for the worse in end of Q3 and beginning of Q4 and had to spend the rest of the year climbing out of that hole (most sectors are still stuck). There were 23 launches in December and no closures for the month. December Total Launches Fund Name Ticker SPDR S&P 500 Fossil Fuel Free ETF SPYX MomentumShares U.S. Quantitative Momentum ETF QMOM SPDR Russell 1000 Momentum Focus ETF ONEO SPDR Russell 1000 Low Volatility Focus ETF ONEV SPDR Russell 1000 Yield Focus ETF ONEY Direxion Daily S&P Biotech Bear 1X Shares LABS Direxion Daily Natural Gas Related Bear 3X Shares GASX Daily Healthcare Bear 3x Shares SICK Tierra XP Latin America Real Estate ETF LARE Elkhorn FTSE RAFI U.S. Equity Income ETF ELKU iShares FactorSelect MSCI Emerging ETF EMGF Pacer Trendpilot European Index ETF PTEU Pacer Autopilot Hedged European Index ETF PAEU Guggenheim Dow Jones Industrial Average Dividend ETF DJD SPDR S&P North American Natural Resources ETF NANR JPMorgan Diversified Return Europe Equity ETF JPEU WisdomTree Dynamic Long/Short U.S. Equity Fund DYLS WisdomTree Dynamic Bearish U.S. Equity Fund DYB MomentumShares International Quantitative Momentum ETF IMOM Legg Mason Developed ex-US Diversified Core ETF DDBI Legg Mason Emerging Market Diversified Core ETF EDBI Legg Mason US Diversified Core ETF UDBI Legg Mason Low Volatility High Dividend ETF LVHD Only a couple of these funds ended December with positive returns; it was a hard month to jump into the market. Hopefully, our rocky start to 2016 doesn’t set any trends in motion, otherwise these new launches from the last two weeks could have a hard time finding traction. There were 12 funds launched in the last 2 weeks, including the last 4 funds on the December launch list above. With tons to cover, let’s jump right in. Fund launches for the week of December 28th, 2015 Fund launches for the week of January 4th, 2016 Reality Shares launches its second ETF (1/6): The Realty Shares DIVCON Leaders Dividend ETF (BATS: LEAD ) was launched just over a year after the company’s first offering, the Realty Shares DIVS ETF. “Unlike many dividend funds based on decades-old dividend history or yield, the new passive ETF features rules-based stock selection and weighting using a proprietary dividend health rating methodology, DIVCON, which systematically ranks companies’ future dividend growth prospects based on a weighted average of seven factors,” according to a press release on Reality Shares’ site. WisdomTree rolls out 4 new Dynamic Currency ETFs (1/7): The following newly issued funds offer currency hedged exposure to international equities, each indicated in their names, and weighted by dividend yield: The WisdomTree Dynamic Currency Hedged International Equity Fund (BATS: DDWM ), the WisdomTree Dynamic Currency Hedged International SmallCap Equity Fund (BATS: DDLS ), the WisdomTree Dynamic Currency Hedged Europe Equity Fund (BATS: DDEZ ) and the WisdomTree Dynamic Currency Hedged Japan Equity Fund (BATS: DDJP ). iShares launches 3 Adaptive Currency Hedged ETFs (1/7): The iShares Adaptive Currency Hedged MSCI Japan ETF (BATS: DEWJ ), the iShares Adaptive Currency Hedged MSCI Eurozone ETF (BATS: DEZU ) and the iShares Adaptive Currency Hedged MSCI EAFE ETF (BATS: DEFA ) are new additions to the iShares lineup. Like the WisdomTree funds launched on the same day, these funds offer currency hedged exposure to international equities, but weighted by market capitalization rather than dividend yield. All 7 of these funds were launched on the BATS exchange. There were no fund closures for the weeks of December 28th, 2015 or January 4th, 2016 Have any other questions on ETFs or ETNs? Please comment below and I will try to clear things up. As an author and editor, I have found that constructive feedback is the best way to grow. What you would like to see discussed in the future? How can I improve this series to meet reader needs? Please share your thoughts on this first edition of the ETF Update series in the comments section below. Have a view on something that’s coming up or a new fund? Submit an article.

Playing Offense With Defense Stocks

Increased government spending is boosting the prospects of aerospace, defense and related firms By Nick Kalivas After years of decline, 2015 saw a rebound in plans for government defense spending – a trend that shows no signs of abating. At the same time, valuations on aerospace and defense stocks are attractive relative to the broader market. With these trends in mind, I believe now might be a good time for investors to consider adding potential offense to their portfolios with defense stocks. Defense dominates the headlines in 2015 The following news stories were reported in November and December, illustrating global interest in boosting defense programs. “Japan to spend a record $41 billion on defense.” 1 “War on Islamic State brings $50 billion European defense boost.” 2 “The House and Senate Armed Services Committees … increased the fiscal 2016 spending caps for defense and nondefense activities by $25 billion each.” 3 “South Korea approves 3.6% increase in 2016 defense budget.” 4 “US said to move ahead with $1.83 billion arms sale to Taiwan.” 5 Defense orders pop in November These headlines indicate a shift from a four-year trend of declining defense orders, which appears to be bottoming even before newly expanded budgets can be deployed and reflected in government data. The US Commerce Department’s November durable goods report showed a 44% jump in defense orders from October. 6 Defense orders are highly volatile, but the six-month average is starting to climb after an extended period of weakness. Notice the upward trend in defense orders in the following chart. Unfulfilled defense orders have been declining since late 2012, which has hurt the defense industry’s performance. However, the defense order-to-shipment ratio is trending upward over the past year, which suggests that there could be a firming in industry order backlogs (unfilled orders). 6 A rising backlog could, in turn, boost confidence in defense company earnings and garner the attention of investors. In addition, computer and electronic equipment orders rose 0.4% from the previous month in November – building on October’s 2.1% gain. 6 This is relevant, as the defense industry has become more high-tech over time. In my view, technology companies with exposure to the defense industry are likely to benefit from higher defense spending and increased computer and electronic equipment orders. Civilian aerospace is still strong It’s also important to note that many defense contractors have exposure to commercial aerospace firms. Examples include Boeing (NYSE: BA ), United Technologies (NYSE: UTX ) and Honeywell (NYSE: HON ). 7 Cheap energy prices support airline industry profits and often lead to lower air fares, which can boost aircraft and aircraft maintenance demand. In its third quarter 2015 business outlook, Boeing projected higher air passenger traffic and meaningful replacement demand in its outlook for the commercial airline business. As indicated in the graphic below, unfilled aircraft orders reported by the US Commerce Department are at historically high levels – underscoring the continued strength of commercial aerospace. 6 Source: Bloomberg L.P. as of Dec. 23, 2015 Defense and aerospace valuations are attractive Valuations for defense and aerospace firms are also compelling. As of Dec. 23, the S&P 500 Aerospace and Defense Industry Index was trading at an 8.0% discount price-earnings (P/E) ratio to the S&P 500 Index. Relative valuations were richer in the mid 1990s and mid-2000s, but have come down since early 2014. 6 Source: Bloomberg L.P. as of Dec. 28, 2015 A potential alternative for investors interested in defense and aerospace Investors looking for access to the aerospace and defense sector might consider the PowerShares Aerospace & Defense Portfolio (NYSEARCA: PPA ). PPA holds a mixture of traditional aerospace and defense companies, as well as information technology and materials companies that are involved in the defense industry. Sources: 1 RT.com, Dec. 22, 2015 2 Bloomberg L.P., Nov. 24, 2015 3 Bloomberg L.P., Nov. 4, 2015 4 Bloomberg L.P., Dec. 3, 2015 5 Bloomberg L.P., Dec. 15, 2015 6 Bloomberg L.P., Dec. 23, 2015 7 As of Dec. 31, 2015, Boeing, UTX and Honeywell make up 6.46%, 6.40% and 6.35% of PPA’s holdings, respectively. Important information The S&P 500 Aerospace & Defense Index is a capitalization-weighted index designed to capture a composite return of the stocks in the S&P 500 Index that are operating in the aerospace and defense industry, according to the Global Industry Classification Standard. An investment cannot be made in an index. Past performance cannot guarantee future results. Price-earnings (P/E) ratio, also called multiple, measures a stock’s valuation by dividing its share price by its earnings per share. There are risks involved with investing in ETFs, including possible loss of money. Shares are not actively managed and are subject to risks similar to those of stocks, including those regarding short selling and margin maintenance requirements. Ordinary brokerage commissions apply. The Fund’s return may not match the return of the Underlying Index. The Fund is subject to certain other risks. Please see the current prospectus for more information regarding the risk associated with an investment in the Fund. Investments focused in a particular industry, such as aerospace and defense, are subject to greater risk, and are more greatly impacted by market volatility, than more diversified investments. Stocks of small and mid-sized companies tend to be more vulnerable to adverse developments, may be more volatile, and may be illiquid or restricted as to resale. The Fund is non-diversified and may experience greater volatility than a more diversified investment. Before investing, investors should carefully read the prospectus/summary prospectus and carefully consider the investment objectives, risks, charges and expenses. For this and more complete information about the Funds call 800 983 0903 or visit invescopowershares.com for prospectus/summary prospectus. The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals. NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE All data provided by Invesco unless otherwise noted. Invesco Distributors, Inc. is the US distributor for Invesco Ltd.’s retail products and collective trust funds. Invesco Advisers, Inc. and other affiliated investment advisers mentioned provide investment advisory services and do not sell securities. Invesco Unit Investment Trusts are distributed by the sponsor, Invesco Capital Markets, Inc., and broker-dealers including Invesco Distributors, Inc. PowerShares® is a registered trademark of Invesco PowerShares Capital Management LLC (Invesco PowerShares). Each entity is an indirect, wholly owned subsidiary of Invesco Ltd. ©2015 Invesco Ltd. All rights reserved.