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Dual ETF Momentum February Update

Scott’s Investments provides a free “Dual ETF Momentum” spreadsheet which was originally created in February 2013. The strategy was inspired by a paper written by Gary Antonacci and available on Optimal Momentum . Antonacci’s book, Dual Momentum Investing: An Innovative Strategy for Higher Returns with Lower Risk , also details Dual Momentum as a total portfolio strategy. My Dual ETF Momentum spreadsheet is available here and the objective is to track four pairs of ETFs and provide an “Invested” signal for the ETF in each pair with the highest relative momentum. Invested signals also require positive absolute momentum, hence the term “Dual Momentum”. Relative momentum is gauged by the 12 month total returns of each ETF. The 12 month total returns of each ETF is also compared to a short-term Treasury ETF (a “cash” filter) in the form of iShares Barclays 1-3 Treasury Bond ETF (NYSEARCA: SHY ). In order to have an “Invested” signal the ETF with the highest relative strength must also have 12-month total returns greater than the 12-month total returns of SHY. This is the absolute momentum filter which is detailed in depth by Antonacci, and has historically helped increase risk-adjusted returns. An “average” return signal for each ETF is also available on the spreadsheet. The concept is the same as the 12-month relative momentum. However, the “average” return signal uses the average of the past 3, 6, and 12 (“3/6/12″) month total returns for each ETF. The “invested” signal is based on the ETF with the highest relative momentum for the past 3, 6 and 12 months. The ETF with the highest average relative strength must also have an average 3/6/12 total returns greater than the 3/6/12 total returns of the cash ETF. Portfolio123 was used to test a similar strategy using the same portfolios and combined momentum score (“3/6/12″). The test results were posted in the 2013 Year in Review and the January 2015 Update . Below are the four portfolios along with current signals. “Risk-Off” is the current theme among all four portfolios: Return Data Provided by Finviz Click to enlarge As an added bonus, the spreadsheet also has four additional sheets using a dual momentum strategy with broker specific commission-free ETFs for TD Ameritrade, Charles Schwab, Fidelity, and Vanguard. It is important to note that each broker may have additional trade restrictions and the terms of their commission-free ETFs could change in the future. Disclosure: None

How To Pick Value Stocks

I find it ironic that more research is being done today than at any point in time in the past, yet a lot of value investors are failing to beat the market. Ironically, the mountain of articles on popular investing websites just aren’t helping. Part of the problem might be due to the “more brains” problem Graham cited years ago. Since everybody on Wall Street is so smart, all those brains ultimately cancel each other out. This glut of brain power, investment research, and investors clamoring for bargains does not mean that you can’t beat the market. But, knowing how to pick value stocks is a key requirement, along with having a good strategy and being prepared to do things that most other investors aren’t. Where You Should Hunt When Picking Value Stocks One core piece of the puzzle is leveraging your biggest competitive advantage as a small investor: your size. Let me explain… Professional money managers manage billions of dollars each year. In fact, the entire mutual fund industry in the USD in 2012 amounted to $13 Trillion and the size of the average mutual fund was a staggering $1.72 Billion. Legal regulations make owning more than 10% of a single company, or having a single company make up more than 5% of assets, a real burden for a fund company. Given that managers want to keep positions below 5% of their fund, the pool of investment candidates open to money managers is tiny. These restrictions essentially limit a manager’s universe of stocks to firms that are $860 Million in market cap or larger. That means focusing on roughly 500-600 of the largest companies in the US. With that much money sloshing around the markets, small, medium, and large cap companies are, understandably, extremely picked-over. This suggests a powerful advantage that small investors can leverage: investing where the pros aren’t investing. That really comes down to investing in micro cap and nano cap companies. It’s in this universe, among the thousands of tiny publicly traded companies available, that a small investor can pick the most promising value stocks. What Value Stocks to Concentrate On 15 years of experience in investing has taught me a few very valuable lessons. The first is that, despite your research, you’re probably not as important to the end result as you’d like to think you are. Sure, you can conduct an analysis and your stock can go up just as you predicted, but it may not have advanced for the reasons you thought. Sometimes the stocks that you assume that will work out well… don’t. And, at other times, the stocks you thought were real dogs will advance in price. Another core insight I’ve had over the previous decade is that I (and likely you, as well) am not Warren Buffett . Small investors can’t bring the same amount of skill and experience to investing as he does, and blindly following how he invests today is what I call falling into the Warren Buffett trap . Luckily, a small investor doesn’t have to have Buffett’s investing prowess to know how to pick value stocks and succeed as an investor. Investing is a probabilistic exercise, and I’ve found leveraging a statistical investment strategy (i.e. “Mechanical” investing style), extremely rewarding. Leveraging them means being able to earn the same investment returns that drew you to value investing in the first place… without you having to be an investing guru. By simply buying a basket of stocks that are undervalued relative to some value metric, you can leverage those statistical returns to propel your portfolio to large profits. What Sorts of Strategies am I Talking About? The sorts of strategies that I’m talking about fall into the “classic value investing” or “deep value investing” categories. These are the value strategies that Benjamin Graham talked about years ago when he taught his students how to pick value stocks. These strategies have been extensively tested, and used successfully in practice for decades. Low PE – One of these strategies is the classic Low Price to Earnings strategy. This strategy has been employed successfully by contrarian managers such as David Dreman , whose funds returned 16-17% per year over decades. In general, as reported by Tweedy Browne , a Low PE strategy is good for an average annual return of 16%. Low PB – Low Price to Book value is another classic value metric that yields market beating results. Using the strategy investors should expect to bag a CAGR as high as 14.5%. That’s a fat 45% in excess of the market return over the course of your life. Low PC – One of the more recent classic value strategies, and focuses on finding stocks low relative to Cash Flow. This strategy performs a bit better, recording a CAGR of just over 18% . High Dividend Yield – Mario Levis at the University of Bath conducted a study called, “Stock Market Anomalies: A Reassessment Based on the UK Evidence.” He found that the highest dividend yielding stocks returned 19.3% on average. Not bad for a basket of cheap stocks! Net Nets – But the king of these strategies is Ben Graham’s famous net net stock strategy. This strategy has consistently beaten the market both in studies and in practice by roughly 15% per year. That amounts to a 25% CAGR, and you can achieve even higher returns with a basket of net nets by screening for other key characteristics . And, my own portfolio has done very well using this strategy. Of course, the catch is that while you can always find enough stocks to fill a portfolio using the first 4 strategies, during bull markets domestic net nets dry up, making it almost impossible to use the strategy. At least, that’s what popular websites will tell you — which tripped me up years ago. By expanding your universe of investment candidates to include friendly international markets you can fill your net net stock portfolio under all market conditions. How to Pick Value Stocks Once You’ve Nailed Down a Core Strategy This is where hunting for tiny stocks comes into play. When picking value stocks, you’re going to find your best opportunities within the universe of small companies. I’m going to come at this from the perspective of a net net stock investor, since this is where I’ve chosen to specialize. That being said, the process is the same for any statistical value strategy. As it turns out, not only do small stocks offer the best opportunities for value investors, but statistical portfolios of the smallest value stocks also offer the best portfolio returns. When it comes to net net stocks, Xiao & Arnold found that a portfolio of the smallest net nets returned significantly more than the largest net nets studied, 30.6% per year vs. 17.2% per year. That’s a staggering difference in return. The same trend is found among other sorts of classic value stocks. Tweedy, Browne found that the smallest 1/5th of Low PE stocks outperformed the largest, 19.1% to 13.1%. So, no matter what strategy you use, go small. Go tiny, in fact . This is where major investing websites really start to trip up investors. The focus on large investing sites is almost always on large stocks, and that causes small investors to give up a much more promising universe of investment opportunities in favor of trying to compete against the pros. Plus, you can only take advantage of a net net stock strategy if you’re buying tiny companies. Once I’ve narrowed down my list of possible investment candidates to the smallest, I like to look for additional metrics that are highly correlated to outperformance versus the benchmark. For net nets, one of those characteristics is a Debt to Equity figure below 20%. Companies with low Debt to Equity ratios drastically outperformed the benchmark in Tweedy, Browne’s study, What Has Worked In Investing , recording a CAGR of nearly 35% compared to their universe of net nets which returned 28.8%. That’s 6% per year of extra return! I also avoid firms with major Chinese operations, due to the flood of reverse merger scams , as well as resource exploration companies, pharmaceutical companies, real estate companies, and companies in regulated industries such as finance. None of these make for the highest quality net nets, and I’m after the highest possible returns. In the end, you have to stick to the most promising industries, and this usually means focusing on your domain of competence. How to Craft Your Portfolio If you do a good enough job using additional criteria to screen out the less promising candidates, building a portfolio really takes care of itself. At the end of the process you should be left with a very manageable number of firms. From there, spend time ranking the firms from most to least promising and then spend an equal dollar amount on the 20 most promising investments. That’s it. ….sort of. There are also nuances in portfolio construction and management that can really impact your returns, but that’s not the focus of this article. I’ll write that article at some point in the future. By now, you should have a great idea of how to pick value stocks for your own portfolio. Investing is really not as difficult as you think it is but, ironically, a lot of people try to make it more difficult than it needs to be. The hardest part is really sourcing the investment ideas and then narrowing down the pool of investment candidates you pick from. At Net Net Hunter, we start with over 450 statistical international net nets but then narrow the pool down to the 30 most promising, which gives you some idea of the amount of work to do if you want to buy the best investment opportunities. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

What Should You Do In The Next Bear Market Rally?

Bull markets have corrections. Specifically, long-term uptrends often hit roadblocks where stock assets may pull back by 10%, 14%, even 19%. Those who may have been holding some cash typically benefit from buying into weakness at significantly lower prices. Bear markets have bear market rallies . Selling pressure typically abates long enough to allow buyers to push stocks higher by 10%, 14%, even 19%. During long-term downtrends, however, attempts at “bargain purchases” can exacerbate portfolio losses and damage psychological resolve . Consider what transpired in 2008. In the first half of the year between March and May, the Dow rallied 11% off its lows from 11,740 to 13,028. The ten weeks of “good vibes” had convinced many people that the worst was behind them. They were wrong. Now look at the epic one-week period from October 27, 2008 through November 4, 2008. The Dow catapulted from 8175 to 9675 for a monster 18% rally. Surely the worst had to be in the rear-view mirror, right? Unfortunately, many buyers who bought in those early days of November later found themselves with assets worth roughly 70 cents on the dollar. (Again, attempts to eat directly out of a bear’s paw can exacerbate overall portfolio loss as well as kill one’s psychological commitment to market-based investing.) Not surprisingly, there was a third head-fake. The Dow’s late November mark of 7550 jumped all the way back up to 9034 by the first trading day of 2009. That’s a 19.6% bear market rally that, ultimately, failed to inspire investor confidence. “But Gary,” you protest. “The Dow and the S&P 500 are currently trading between 13%-14% off of there all-time highs. How do you know this isn’t just another stock market correction in a longer-term uptrend?” I don’t know for sure. Nobody can. I may have made the case for the strong probability that the market had hit the top in the summertime. (Review August’s Market Top? 15 Warning Signs , or July’s 5 Reasons To Lower Your Allocation To Riskier Assets .) Nevertheless, there are no certainties when it comes to percentage moves for stocks, bonds, currencies or commodities. There’s more. If the Fed came to the rescue on a shining white unicorn with QE4 tomorrow, then a bear market for these two indexes might be stopped in its tracks. That is not an endorsement for quantitative easing; rather, it is an acknowledgement that an open-ended 4th iteration of electronic money creation could indeed inflate asset prices yet again. On the flip side, the evidence for why the bear market likely began in May of 2015 is colossal. For example, in bear markets, impressive rallies fail to recapture former high-water marks. Both the S&P 500 and the Dow failed to eclipse respective highs initially set in May – first in July, then again in October. What’s more, the long-term (200-day) moving averages of the indexes began sloping downward in August-September. The failed rallies as well as the negative slope for the Dow Jones Industrials are shown in the chart below. Failed rallies and downward sloping trendlines are only part of the story. In a bull market, investors embrace a wide variety of different risk assets. People go after growth, momentum, small caps, foreign, high yield, MLPs, REITs, IPOs; there is very little in the way of discrimination. As a bull market matures, many gravitate to the safest and largest stocks, eschewing asset groups that they once owned with reckless abandon; they crowd into fewer and fewer companies in fewer and fewer economic sectors. As a bull market transitions to a bear market, falling prices across an array of individual securities and key economic sectors eventually drag down market-cap weighted benchmarks. An observer of U.S. stocks can see the transition from indiscriminate risk-taking to guarded skepticism via breadth indicators. For example, when the bull market is robust, an equal-weighting of stocks in the S&P 500 usually outperforms the market-cap weighted index. As participation in the bull market wanes, and as fewer and fewer corporate shares succeed, equal-weighted proxies typically under-perform their market-cap weighted benchmarks. Not surprisingly, then, by July of 2015, the Guggenheim S&P Equal Weight ETF (NYSEARCA: RSP ) had struggled to make any progress for eight months, even as the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) was close to an all-time record high. Similarly, RSP outperformed SPY right up to April of 2015. The RSP:SPY price ratio demonstrates that it has been in a downtrend ever since. Another measure of breadth is the New York Stock Exchange (NYSE) Advance/Decline (A/D) Line. It measures the extent to which advancing stocks are outpacing declining stocks, and vice versa. When the Dow and the S&P 500 are near their highs, but the A/D Line is falling, participation in the bull market is becoming increasingly narrow. It follows that narrow participation by stocks listed on the NYSE regularly precedes bearish downturns. In July of 2015, the NYSE A/D Line’s 50-day moving average crossed below its 200-day moving average for the first time since the beginning of the euro-zone crisis in 2011. (See Remember July of 2011? The Stock Market’s Advance Decline Line Remembers .) The Fed launched “Operation Twist” to lower longer-term borrowing costs in late September of 2011 and, in October of 2011, the European Central Bank (ECB) provided a series of bailouts to ailing countries and banks in the European Union. Today, there are no plans for extraordinary U.S. central bank stimulus, only “gradual” stimulus removal. The ongoing deterioration in the A/D Line since July increases the likelihood that the bear will officially come out of hibernation. Unfortunately, the problems are not solely technical in nature. There are precious few bright spots for the U.S. economy. Manufacturing has contracted for 4 consecutive months. The services sector (non-manufacturing) is at a 27-month low. Major financial institutions have raised the odds of a U.S. recession to 40%-50%. Even strength in jobs data ignore the declines in both household income and labor force participation . There’s another way to gauge economic weakness versus economic strength. Specifically, one can examine the spread between 10-year U.S. Treasury bond yields and 2-Year Treasury bond yields. The spread tends to widen during expansion; it typically narrows when there is economic distress. The current spread of less than 1 basis point (.99) is the narrowest since 2009. Meanwhile, going into 2015, nearly every traditional measure of valuation (e.g, price-to-earnings P/E, price-to-sales P/S, CAPE PE10, Tobin’s Q, market-cap-to-GDP, etc.) placed stocks at extremely overvalued levels. Going into 2016, very little had changed because corporate earnings had declined for three consecutive quarters and corporate revenue had declined for four consecutive quarters. The contraction in both top-line sales and bottom-line profits may not mean as much when treasury spreads are widening and/or market breadth is strengthening. However, when these market internals are deteriorating, fundamental valuation suddenly starts to matter again. Many of my moderate growth and income clients at Pacific Park Financial, Inc. remain significantly less exposed to stock risk than they had eighteen months earlier. Then, the reward for a typical allocation of 65%-70% stock (e.g., large-cap, mid-cap, small-cap, foreign, etc.) was worthy of the risk. Since that time, a gradual scaling back toward our current allocation of 45%-50% stock – only large-cap U.S. stock – has been decidedly beneficial. We continue to own lower volatility securities via the iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ), better balance sheet corporations via the iShares MSCI USA Quality Factor ETF (NYSEARCA: QUAL ) and dividend aristocrats via the SPDR Dividend ETF (NYSEARCA: SDY ). Would I make a tactical decision to lower the current allocation to stock even further? If market internals (e.g., breath, credit spreads, etc.) continue to weaken alongside increasing economic strain, I would use the inevitable bear market rallies to lower the allocation from 45%-50% U.S. stock to 35%-40% U.S. stock. Moreover, I might increase exposure to ETFs that track the FTSE Multi-Asset Stock Hedge Index . The “MASH” Index currently boasts a 20% differential with the S&P 500 over the past 3 months. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.