An Expanded ETF Relative Strength Rotation System

I previously detailed a relative strength ETF rotation system based solely on three ETFs: SPY, GLD, and SHY. The system was more or less for explanation purposes and not an optimized strategy.

Using ETF Replay‘s relative strength backtest system an investor can backtest various user defined ETF portfolios.  I decided to expand the very basic 3 ETF system that looks at the relative strength return of GLD (Gold), SPY (S&P 500), and SHY (Barclays Low Duration Treasury ETF, a close substitute for cash) to 13 ETFs.  The strategy ranks 13 ETFs based 40% on the 3 month return, 30% on the 20 day return, and 30% based on the 20 day volatility.  The backtest started in 2005 (when some of the ETFs started trading) and rebalanced by purchasing the top 2 ETFs monthly. No commissions, slippage or taxes are assumed.  The benchmark I used was buying and holding SPY. Please check back shortly on Scott’s Investments as I will be expanding this screen and tracking the results on a monthly basis.

The ETFs used in the screen were EEM (emerging markets) ,EFA (EAFE Index) ,GLD (gold) ,HYG (high yield bond), IEF (7-10 year treasury), SHY (short-term bond, close ETF substitute for “cash”), SPY (S&P 500), TLT (20+ year treasury bond), VBR (small-cap value), VNQ (REIT), XLE (energy sector) , XLU (utility sector), and PCY (Emerging market bonds).  Some of the ETFs started trading after 2005, which is one limitation of backtesting ETFs given their limited trading time-frame.

The returns for a relative strength system that rotates between the 13 ETFs, purchasing the top 2 each month, have been impressive over the past 5 years.  The total return to date is 189.5% vs 0.5% for SPY.  More impressive, the volatility for the system is 16.6% versus 23.7% for SPY.  The system made 59 changes or “trades” over the past 5+ years.

There are a number of variations an investor could use with the system as well as different ETF portfolios.  For those interested in reading about relative strength ETF investing, there is also a new book available by Leslie Masonson Buy–DON’T Hold: Investing with ETFs Using Relative Strength to Increase Returns with Less Risk which is on my reading list but which I have not yet reviewed or read.

No positions

More Readings for a Holiday Weekend

Happy Long Weekend!  Below are a few more readings of note for a long weekend:

Nikkei-Nasdaq Analog Update – Tom McClellan

Three Will Get You Two (or) Two Will Get You Three – Bill Gross

Six Impossible Things – John Mauldin (pdf)

Easy Pickings for Dividend Income – Jim Jubak

Adam Hewison Says S&P 500 is a Sell and He is Back in Gold

Two new free videos below on S&P 500 and Gold, which can be traded using SPY and GLD (no current positions).  His commentary is below and the videos are free to watch:

S&P 500

“It’s been just a little over a year since we had our first major buy signal for the S&P 500 at 888.70 on 5/4/09. Since that time, the S&P 500 has climbed approximately 61.8% from the lows that were seen in early March of ’09 and the highs that were seen in October of ’07.

We take our “Trade Triangle” technology very seriously and this signal today (5/25) at 1044.50 is our first major sell signal since 7/1/08 at 1,272.00 and should not be ignored.
There are a whole host of problems that are coming due around the world that will have negative consequences for the equity markets. The problems in Greece and Europe are well known and are likely to continue for the balance of the year. This is going to have a negative impact on markets in general.
In my new short video I show you exactly what I think is going to happen to the S&P 500 market and just how you can protect yourself if we are correct. As always our “Trade Triangles” will dictate all market action. At the present time all of our “Trade Triangles” are negative and pointing to the downside. This indicates that a very strong trend is in place and it likely to continue.
Many traders, especially younger traders, are unaware of how bear markets work. Bear markets tend to be demoralizing as they do not have any strong and sustained rallies. They tend to erode as more and more traders become unnerved and throw in the towel.
I invite you to take a look at this new video with no registration and no charge.”

Gold

“After exiting all long positions at 1217.72 on 5/18, we reinstated long positions seven days later on 5/25 at 1196.57.
As many of you know who watch my videos, we use our weekly “Trade Triangles” for trend direction and our daily “Trade Triangles” for timing entry and exit points. It was those daily “Trade Triangles” that flashed a buy signal on 5/25.
Given the chaotic state of the world and all the cross currents that are running in the banking system, we would not be surprised to see gold once again climb up and challenge the $1,250 level. All of our “Trade Triangles” are green and 100% to the upside. This indicates that a strong trend is once again in place for the gold market.
The video is available for viewing now and there is no charge or registration requirement.
Gold traders are always a very vocal segment of the trading population and so we encourage you to let your voice be heard on our Trader’s Blog.”

More on this topic (What's this?)
Nearly 70% Of S&P 500 Stocks In Correction Or Bear Market Territory
S&P500 Getting Ready to Break
S&P Approaches Critical Tipping Point
Read more on S&P 500 (SPX), Gold at Wikinvest

Relative Strength Papers/Books

A reader asked for some additional papers/background on relative strength.  Below are a few:

Mebane Faber Relative Strength Investing

Dorsey & Wright Bringing Real-World Testing to Relative Strength (pdf)

Leslie Masonson Buy–DON’T Hold: Investing with ETFs Using Relative Strength to Increase Returns with Less Risk (full disclosure: I have NOT read this book but hope to soon)

Top Stocks Based on PEG and Momentum

I have begun conducting the following screen on a monthly basis. Early out-of-sample results have been positive, especially during bullish environments.  Aprils’ list is here, March’s list is here, February’s list is here and January’s here. The screen looks for the following:

  • earnings growers still reasonably priced as judged by the PEG ratio
  • low debt
  • a history of high return on equity and investment, and
  • price momentum as gauged by the percentage the stock is trading to its 250 day high.
January’s list returned 1.39% vs .57% for SPY. February’s list returned a solid 11.78% vs. 6.77% for SPY. March returned 7.91% vs. 4.23% for SPY and April was a tough month returning -11.57% vs -11.52% for SPY. 

When the screen results in more than 10 stocks I have also started tracking returns of the top 10 stocks at the beginning of each list, the top 10 are selected based on fundamental factors.  The top 10 on March’s list returned an average of 10.77% and the top 10 for April did slightly better than the entire list returning -8.01%. For the full list of stocks and results, please see the right hand side of Scott’s Investments.


With the recent pullback in equity markets this month’s list is less expansive since price momentum has waned. The screen has tested well historically in bullish periods so strategies an investor could use to avoid drawdowns would be to either a) abandon this type of strategy entirely when the S&P 500 or another major index is below a long term moving average, or b) hedge positions with a position in SH or write a short option strategy on an equity index or ETF like SPY.


Two possible tools an investor could use to conduct this screen on his/her own are stockscreen123 or Finviz. This screen was conducted using stockscreen123.

No positions in stocks mentioned

 

Ticker Name Free Analysis Last
CTRN Citi Trends, Inc. Here 33.93
JOSB Jos. A. Bank Clothiers, Inc. Here 59.03
PTI Patni Computer Systems Limite Here 26.76
STRA Strayer Education, Inc. Here 236.5
More on this topic (What's this?)
PEG Buys a Fiber Network From Gore
Market Outlook
Read more on Price to Earnings Growth, SPDR S&P 500 ETF, Hang Lung GRP at Wikinvest

A Very Simple Relative Strength ETF Rotation System

Using ETF Replay‘s relative strength backtest system an investor can backtest various user defined ETF portfolios.  I decided to test a very basic 3 ETF system that looks at the relative strength return of GLD (Gold), SPY (S&P 500), and SHY (Barclays Low Duration Treasury ETF, a close substitute for cash).  The strategy ranks the 3 ETFs based 40% on the 3 month return, 30% on the 20 day return, and 30% based on the 20 day volatility.  The backtest started in 2005 (when GLD started trading) and rebalanced monthly. No commissions, slippage or taxes are assumed.  The benchmark I used was buying and holding SPY.

The returns for a relative strength system that rotates between SPY, GLD, and SHY (cash) have been impressive over the past 5 years.  The total return to date is 90.6% vs -1.1% for SPY.  More impressive, the volatility for the system is 14.8% versus 23.7% for SPY.

The system made 37 changes or “trades” over the past 5+ years. GLD was held 34.8% of the time, SHY 37.3%, and SPY 27.9%.  The current signal on April 30th was for GLD, switching from April’s  position SPY.

There are a number of variations an investor could use with the system as well as different ETF portfolios.  For those interested in reading about relative strength ETF investing, there is also a new book available by Leslie Masonson Buy–DON’T Hold: Investing with ETFs Using Relative Strength to Increase Returns with Less Risk which is on my reading list.

No positions

Create Your Own ETF Hedge Fund: A Book Review

My hopes were high for Create Your Own ETF Hedge Fund: A Do-It-Yourself ETF Strategy for Private Wealth Management (Wiley Finance) and unfortunately I was thoroughly disappointed. The book was a long, winding, rambling road to a few small actionable scraps for individual investors. For those who want to create their own hedge fund the author encourages them to invest in ETFs, don’t be afraid to short the market, time the market, and subscribe to the author’s newsletter (all summarized in the last 10% of the book). The book provides very few specific, actionable ideas and on the key issue of market timing (of which I am a proponent) only referring to ‘properietary’ techniques used by his company. 
The positives of the book are some “early days” stories from the author’s experience in the brokerage and financial advice world are interesting for those with a history in the financial world.  In addition, the author provides history on the rise of ETFs and Hedge Funds.  However, that is where the book stops. The book’s title leads a reader to believe the book will read more like Faber’s  The Ivy Portfolio  – full of actionable market timing strategies for individual investors – and less like an autobiography and history book.
Who should read it: Individual investors should skip it, financial advisors may find a few of the anectdotes and history of the brokerage/investing world worthwhile.

T Bill Yield Leads VIX – Will it Be a Bull or Bear Summer?

Below is a great free chart of the week from Tom McClellan. It shows the 3-month T-Bill yield offset 2 years forward compared to the VIX.  The VIX gauges volatility in the market and tends to increase during bear markets and periods of fear.  One impact of the VIX is that as it increases, the implied volatility of options increase and thus the premium an option seller can collect.  Essentially, option sellers are selling insurance for or against price moves in the underlying security.

If we assume McClellan’s chart will hold true, we could see a significant decrease in options volatility over the coming months and most likely a move higher for the market.  Thus, now would be the time to sell options while volatility and fear are still high. I’m torn on whether I’m willing to bet money on McClellan’s implication as it seems there is a lot of nervous investors and the threat of sovereign defaults will loom for the coming months.  In addition, the S&P 500 is overvalued based on historical norms.  It goes without saying that the coming weeks could set the tone for the entire summer.  A rebound above the 50 day moving average for SPY and the 117-118 range could signal the recent sell-off was just a short-term correction. However, if we close below $104.58 (the February low and near the May 6th sell-off low of $105), it may be best to “sell in May and go away”.

This brings me back to an important point – decide what type of investor you are and what metric matters most to you.  Are you a trader, swing trader, or long-term investor? Do fundamentals or technicals drive your investment decisions?  Before deciding whether any of the charts mean anything, decide what type of investor you are. I track several portfolios on my site which are geared towards different types of investors, from shopping list for value investors, momentum stocks for traders, and portfolios with longer-term timing strategies for long-term investors.  In addition, I hope to have credit option trades tracked on my site shortly with some potential trades for collecting premiums.

No positions in SPY

More on this topic (What's this?)
EURO STOXX 50 VIX At Record Wide Spread Versus S&P 500 VIX
Read more on Volatility Index (VIX) at Wikinvest

One Euro = One Dollar?!?

Adam Hewison of MarketClub states “Don’t be surprised when one euro equals one dollar.”
As everyone in the Western World knows, Europe has been having its share of major problems. All of Europe’s trials and tribulations have had a dramatic affect on the performance of the euro, recently putting it under severe pressure.
Unlike the United States, where we can print money and inflate ourselves out of most problems, the Eurozone is accountable to the 16 nations who gave up their own currency to join.
In Hewison’s latest video he shows how their “Trade Triangle” technology has been very accurate since the beginning of the year for the euro. Although they’ve nailed the market thus far, it leads to the big question: Have we seen the euro bottom out?
The video is available for viewing now and there is no charge or registration requirement.