ETFReplay.com Portfolio for November

This month’s ETFReplay.com Relative Strength ETF Portfolio has been updated at Scott’s Investments and includes turnover in two out of four positions.

I previously detailed here and here how an investor can use ETFReplay.com to screen for best performing ETFs based on momentum and volatility.   I select only the top ETFs out of a static basket of 25 ETFs and re-balance the portfolio monthly.

The portfolio strategy is to purchase the top  ETFs based on a combination of their 6 month returns, 3 month returns, and 3 month volatility (lower volatility receives a higher ranking) and the average of  the 3 month return, 20 day return, and 20 day volatility.  I refer to these two different sets as “6/3/3″ and “3/20/20″.  The top 2 ETFs in the 6/3/3 ranking and top 2 in the 3/20/20 ranking are purchased each month.  When there are duplicates in the top 2, I look to the third ranked ETF in the 3/20/20 and, if necessary, the third ranked ETF in the 6/3/3.  The strategy always holds 4 ETFs. 

I track this strategy as a public portfolio on Scott’s Investments.  As of the close October 31st the hypothetical portfolio was up 13.38%, since inception on January 1st, 2011. Returns include dividends but exclude commissions and taxes and all trades are hypothetical so real results will differ.  For some backtests on these strategies please see a recent post here.

For October 31st the portfolio sold its positions in SPDR Gold Shares (GLD) and (iShares MSCI EAFE Small Cap Index (SCZ).

Proceeds were used to purchase iShares S&P US Preferred Stock Index (PFF) and SPDR DJ International Real Estate (RWX). The portfolio also continues to hold its position in the PowerShares Emerging Markets Bond (PCY) and iShares iBoxx Invest Grade Bond (LQD). 

Top 50 Trending Stocks

Minor fluctuations in rankings may not always justify selling positions each month. For example, if one ETF drops from the second highest rated to the third or fourth highest rated, it may not warrant selling the position. An investor could only sell a position when it drops out of the top 4 or 5 at the end of the month. This type of modification could be used when someone is looking to limit turnover; however, I think it is important to have whatever rule you prefer to use in place prior to making the investment decision in order to avoid discretionary or emotional decision making.
Below are the top 6 ranked ETFs for this month, using both the 6/3/3 and 3/20/20 strategy:
6mo/3mo/3mo
PCY PowerShares Emerging Mkts Bond
PFF iShares S&P US Preferred Stock Index
RWX SPDR DJ International Real Estate
LQD iShares iBoxx Invest Grade Bond
HYG iShares iBoxx High-Yield Corp Bond
GLD SPDR Gold Shares

3mo/20day/20day

PCY PowerShares Emerging Mkts Bond
RWX SPDR DJ International Real Estate
PFF iShares S&P US Preferred Stock Index
LQD iShares iBoxx Invest Grade Bond
SCZ iShares MSCI EAFE Small Cap Index
HYG iShares iBoxx High-Yield Corp Bond

Below is a performance graph of the portfolio (green) versus SPY (SPDR S&P 500 ETF) and AOR (S&P Growth Allocation) from the portfolio’s inception until October 31st, 2012.

Gold and Oil Year End Outlook

Chris Vermeulen of the The Gold and Oil Guy wrote two year end outlooks for oil and gold / gold miners.

He has a negative outlook on oil based on seasonality and technical patterns:

His more bullish gold outlook is based on seasonality patterns, the long-term basing pattern of gold, and the leading movements of junior gold miners (via GDXJ):

Both articles are available here in full and for free.

Counter-Trend ETF Trading System

In my reading list for this past weekend there was a Counter-Trend Trading article (courtesy of  The Idea Farm).  The article from 361 Capital argues counter-trend systems are frequently overlooked but deserve consideration.

The article by 361 Capital used a 10 day high/low system as an example of a counter-trend system.  The model went short when the S&P 500 hit a 10 day high and went long when the S&P 500 hit a 10 day low. Positions were held for 3, 5, and 10 days in their backtests. The model was intended as an example of a counter-trend system and not as an optimized system, but it did perform well in their tests.

Counter-trend systems like the one constructed in the paper are intended to have more trades, shorter holding periods, and  a higher percentage of small winning trades. This contrasts to trend-following systems that tend to have fewer winners but much larger returns on those winning trades. In theory, trend following works in trending markets (either up or down), while a counter-trend system should flourish  more in volatile and directionless markets.

Using some of the examples in the paper I created a very simple counter-trend system.  I tested a relative strength system using SPDR S&P 500  (SPY) and ProShares Short S&P 500 (SH).  The ETF with the highest 5 day relative returns was sold short and held for 2 weeks. The closing price the following day was used as the entry price for the short.  This strategy was tested from 2007 until October 26th, 2012.  The results are below and compared to a benchmark (buy and hold of SPY).  I used return data from ETFReplay.com and then built a custom excel sheet to test the system.

No slippage or commissions were assumed in this test. In addition, no margin costs for a short-sale were assumed. The system used shorting for simplicity sake in the backtesting.  However, given the prevalence of 1x inverse ETFs, shorting is most likely not necessary in many ETF based systems:

The tests show a compound return of 122.3% versus 12.7% of SPY over the same time period. The max drawdown (at each re-balance date) of the counter-trend system was 24.6% versus 52.9% for SPY. However, 26 trades per year in the counter-trend system and any potential tax consequences, margin costs (if any), and slippage would reduce the tests results.  By using the closing price the following day a signal was generated, I attempted to make the system more realistic in terms of trade execution. However, using the closing price on the date the signal was generated presented similar returns.

These tests and results are preliminary and caution is warranted, but I have been experimenting with different timeframes (all of them less than 20 days) and different baskets of ETFs with some mixed success. Relative strength may not be the optimal method for creating a counter-trend system; a system based on absolute returns (i.e. a 10 day high or some other time period) for a single security -as opposed to a basket of securities for which relative strength depends–may be more appropriate.  However, I think relative strength counter-trend systems are an under-studied area and at the very least deserve further attention.

Weekend Research & Readings

Posting has been lighter than normal of late.  I have been exploring some new ideas which take time that could otherwise be used for articles. Needless to say I am still reading quite a bit, below is my recent reading list:

Nasdaq Proposes ETF Trading System – ETF Trends

iShares Launches 4 New Core Funds – Index Universe

Memo to Central Banks: You’re Debasing More Than Our Currency (pdf)

Sector CAPE – Mebane Faber / World Beta

The Perils of the Fiscal Cliff (pdf) John Mauldin

See also the following research papers: Global CAPE Model Optimization & Momentum Strategies in Futures Markets and Trend-Following Funds (hat tip Faber) & Counter-Trend Trading (via The Idea Farm)

Weekend Readings

Gold Is Not Back In Favor Yet… Chris Vermeulen

When Bonds Go to 0% – World Beta

What’s An Index Worth? Index Universe

Who Wins In an ETF Price War? Abnormal Returns

Wealthy Advised to Sell for Gains Before Unfriendly 2013 – Bloomberg

 6 Wall Street Blogs You Should Be Reading – MarketWatch

Hoisington Investment Management Quarterly Review and Outlook (pdf)

Global CAPE Strategies – World Beta

20% Returns for 100 Years – The Idea Farm

Tuesday Investment Links

Below are some investment related articles I am reading this week:

Option Strategy to Trade Google Earnings – JW Jones

Passed Pawns – John Hussman

Is David Rosenberg Right About Utilities? – Geoff Considine

Out of Office Reply – The Reformed Broker

Fading into the refi boom horizon? FT Alphaville

Why Are You Underperforming? Why Are You Outperforming? Mebane Faber

Mebane Faber’s most recent weekly Idea Farm post with lots of great data from CXO Advisory

John Mauldin Economic Singularity (pdf) and A Little Chronic Deflation (pdf)

Graham Value Portfolio Update

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In January I announced a new portfolio, a Benjamin Graham “inspired” value stock portfolio.  The purpose of the hypothetical portfolio is to track returns for a portfolio of 15 stocks selected based on a variety of valuation metrics.  I originally intended to update the portfolio monthly; however, in the spirit of creating a lower turnover, value-driven portfolio it is now updated approximately once per quarter. I have also added an additional criteria to limit turnover in the portfolio (see below).

The Graham portfolio is an attempt to add a value strategy to Scott’s Investments, which is otherwise focused on momentum, trend, income and market timing strategies. There are numerous ways to add market timing or hedging techniques to any stock portfolio, such as shorting the S&P 500 when it trades below a long-term moving average while simultaneously holding a portfolio of long stock positions. However, for the purposes of this portfolio there will be no additional timing or hedging techniques.

The criteria used to select the stocks are listed below.  The tools used to perform the screen and backtests are courtesy of  Stockscreen123 (“SS123”) and Portfolio123 (“P123″).

The actual screen factors are below:

  • Liquidity filter: No OTC Stocks
  • Eliminate companies classified in the Miscellaneous Financial Services Industry, most of which are investment companies and funds and not the kind of stocks this all-star tended to seek
  • Current ratio must be at least 1.5
  • Long-term debt must be no higher than 10% above working capital
  • EPS must be above breakeven in each of the last four quarters and in each of the last five annual periods
  • Trailing 12 month EPS most be above EPS in the latest annual period
  • EPS in the latest annual period must be above EPS in the prior year and five years ago
  • The company must have paid common dividends in the last 12 months

The ranking system used as a basis for selecting the top 15 based among those stocks that pass the Graham screen are below:

  • Valuation – 60% of total
  • Trailing 12 month P/E (15% of this category)
  • Price-to-Book (15% of this category)
  • Price-to-Tangible Book Value (35% of this category)
  • Operating P/E, defined as Market Capitalization divided by Business Income, which is Sales minus Cost of Goods sold minus Selling, General & Administrative Expense and omits unusual items (35% of this category)
  • Earnings – 40% of total
  • 5-year EPS Growth Rate (50% of this category)
  • EPS Stability, defined as the standard deviation of EPS over the past 16 quarters, lower being better (50% of this category)

I began tracking this portfolio real-time on January 13th, 2012.  As of this writing, the portfolio is down 2.11% including dividends,compared to a positive return of 11.63% (excluding dividends) for SPY over the same period and 10.5% for Vanguard Small Cap Value ETF (VBR) over the same time period.

The portfolio has been hampered by big drawdowns in a handful of names, which the quantitative rules continue to define as undervalued. These are excellent examples of the challenges in value investing – a stock could be defined as under-valued for a good reason, and may remain so for a significant period of time, perhaps years or forever if the company has experienced a permanent and material change in operations (a “value trap”). On the other hand, under-valued stocks may lag longer than investors wish, but patient, longer-term investors who aptly select value stocks can be rewarded in the long-run.

A real-world application of this portfolio could also utilize stop losses in order to prevent large drawdowns in single positions. However, for the purposes of tracking the portfolio results, all positions are bought and held until rebalancing.

In July a rule was added to help limit portfolio turnover – stocks will only be sold when they drop out of the top 20 in Graham Value screen.  Thus, a stock could theoretically drop to the 20th ranking but remain in the 15 stock portfolio if it is a current holding.

An interesting early trend in live tracking is that of smaller, less liquid equities appearing frequently on the list. This makes for a potentially more volatile, higher beta list of equities. This could also be of concern for those nervous about equity markets.  As mentioned earlier one potential strategy for hedging equity positions would be to short the overall equity market when an index such as the S&P 500 drops below a long-term moving average.

Another filter worth consideration is one based on market capitalization. Given my personal level of discomfort with stocks with ultra low market capitalizations, and especially those based overseas, going forward any new additions to the portfolio will be required to have a market cap greater than $100 million. Three stocks remain in the portfolio with market caps below $100 million but no new stocks will be added with market caps below $100 million.

The top 20 stocks based on the screen criteria (no market cap requirement) are listed below:

 

Ticker Name Rank MktCap
JST Jinpan International Ltd 98.96 75.72
SVT Servotronics Inc. 96.31 17.66
CHRM Charm Communications Inc 94.22 194.25
EEI Ecology and Environment Inc. 91.32 50.52
PLPC Preformed Line Products Company 90.95 292.78
TESS TESSCO Technologies Inc 89.13 157.45
MANT ManTech International Corp 87.78 813.7
HP Helmerich & Payne Inc. 85.12 5242.03
SWM Schweitzer-Mauduit Intl Inc 84.59 1010.4
CVX Chevron Corp 84.56 219897
HUM Humana Inc. 84.3 12099.29
ONP Orient Paper Inc 84.22 36.92
ADTN ADTRAN Inc 84.06 993.61
ALG Alamo Group Inc. 83.58 391.58
PAAS Pan American Silver Corp 83.46 3233.72
CRR CARBO Ceramics Inc. 82.24 1488.75
KNM Konami Corp 80.84 3012.19
CSH Cash America International Inc. 80.31 1142.93
TRLG True Religion Apparel Inc 78.67 668.48
HFC HollyFrontier Corp 77.89 7609.13

Below are 3, 5, and 10 year backtest results for this screen (with no market cap requirement) using a quarterly rebalance and .5% slippage to help account for bid/ask spreads and commission costs:

The 10 year results with the added $100 million market cap criteria is below:

Three stocks were sold at today’s close – Formula Systems (FORTY), Walgreen (WAG) and Deer Consumer Products (DEER). The proceeds were used to purchase Schweitzer-Mauduit Intl Inc (SWM), ADTRAN Inc (ADTN), and CARBO Ceramics Inc. (CRR). Current holdings are below:

 

Symbol Name Shares Purchase Price Purchase Date Percentage Gain/Loss
JST Jinpan International Ltd 990 6.73 7/17/2012 -31.05%
SVT Servotronics, Inc. 726 9.18 1/13/2012 -8.93%
PAAS Pan American Silver Corp 465 14.3 7/17/2012 48.18%
CHRM Charm Communications Inc 1244 5.36 7/17/2012 -8.77%
MANT Mantech International Corp 208 36.11 2/15/2012 -38.41%
HP Helmerich & Payne Inc. 149 44.41 7/17/2012 13.29%
EEI Ecology and Environment 411 16.2 1/13/2012 -26.05%
ALG Alamo Group, Inc. 243 27.77 3/14/2012 20.06%
CVX Chevron Corporation 62 106.09 1/13/2012 6.34%
SWM Schweitzer-Mauduit Intl Inc 213 33.61 10/15/2012 0.00%
ADTN ADTRAN Inc 457 15.72 10/15/2012 0.00%
PLPC Preformed Line Products Company 101 66.66 3/14/2012 -17.70%
HUM Humana Inc. 77 87.3 3/14/2012 -14.40%
TESS TESSCO Technologies Inc 316 21.04 7/17/2012 -5.23%
CRR CARBO Ceramics Inc. 112 64.08 10/15/2012 0.00%

 

 

High Yield Stock Momentum Portfolio

Once per month I update a high yield dividend stock momentum portfolio on Scott’s Investments.  The portfolio is comprised of the highest yielding stocks in the S&P 500 with high price momentum.

The portfolio is a simple quantitative strategy and begins by screening the S&P 500 for stocks yielding greater than 4%. The results are then ranked by their 6 month returns.  The top stocks are then added to a hypothetical portfolio and tracked publicly on Scott’s Investments.  This month there were 52 results, one less than last month.

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Per a previous article, the highest momentum, high-yield stocks have historically out-performed lower yielding, lower momentum stocks.  The screen is more of a trading strategy and less of a passive income strategy, although the dividends do play an essential component in the overall returns. Thus, turnover could be high and the strategy is not for everyone but I have added one modification to the strategy to minimize turnover.

In order to limit turnover stocks with yields that have fallen below 4% due to share price appreciation will remain in the portfolio. Stocks will only be sold when yield falls below 4% due to dividend cuts or when the six-month performance would otherwise lag the top 12 stocks in the screen.

The portfolio has turnover in two positions for October.  Altria Group (MO) was sold for a gain of 2.89% and a purchase date of May 11th. CenturyLink (CTL) was sold at a loss of 7.9% and an original purchase date of August 9th. While the portfolio tracks dividends as a whole, discussions of Individual security returns exclude dividends.

The proceeds were used to purchase positions in Health Care REIT (HCN) and DTE Energy (DTE).  HCN currently yields 4.98% and has 6 month returns of 14.43%. DTE yields 4.08% with 6 month returns of 14.3%.

The High Yield Momentum Portfolio was designed to be fully invested at all times regardless of market conditions. However, as part of a larger portfolio there may be additional steps an investor can take to reduce risk and diversify strategies.  For example, the Ivy Portfolio uses a 10 month moving average to dictate an invested or cash position (signals are updated daily at Scott’s Investments). An investor could hedge long positions by shorting (or purchasing an inverse ETF) an equity market index such as the S&P 500 when it trades below a long-term moving average.

Below are the top 15 high yield momentum stocks as of October 11th.  Keep in mind that only 10 stocks are held in the portfolio, the current holdings can be viewed on the right-hand side of Scott’s Investments and in the second table below.

Data source: Finviz

Ticker Company Trend Dividend Yield Performance (Half Year) 200-Day SMA
VZ Verizon Communications Inc. Trend 4.56% 24.04% 11.47%
FTR Frontier Communications Corporation Trend 8.23% 23.98% 18.41%
T AT&T, Inc. Trend 4.85% 21.60% 10.39%
GCI Gannett Co., Inc. Trend 4.51% 21.42% 22.74%
AEP American Electric Power Co., Inc. Trend 4.25% 21.41% 11.15%
HCP HCP, Inc. Trend 4.42% 18.98% 8.26%
CINF Cincinnati Financial Corp. Trend 4.22% 16.62% 9.52%
HCN Health Care REIT, Inc. Trend 4.98% 14.43% 6.36%
DTE DTE Energy Co. Trend 4.08% 14.30% 8.59%
LEG Leggett & Platt, Incorporated Trend 4.68% 14.02% 12.81%
CMS CMS Energy Corp. Trend 4.02% 13.07% 6.25%
PPL PPL Corporation Trend 4.89% 12.91% 6.52%
PEG Public Service Enterprise Group Inc. Trend 4.34% 12.68% 6.10%
SCG SCANA Corp. Trend 4.08% 11.85% 6.01%
ETR Entergy Corporation Trend 4.70% 10.50% 5.31%

Current Holdings:

Position Shares Purchase Price Purchase Date Cost Basis Current Value
HCN 175 59.39 10/11/2012 $10,393.25 $10,393.25
VZ 236 44.9 7/11/2012 $10,596.40 $10,667.20
CINF 312 34.45 2/10/2012 $10,748.40 $12,061.92
FTR 2349 4.71 8/9/2012 $11,063.79 $11,416.14
LLY 230 46.52 9/10/2012 $10,699.60 $11,638.00
T 295 33.59 5/11/2012 $9,909.05 $10,696.70
HCP 231 46.28 9/10/2012 $10,690.68 $10,457.37
DTE 171 60.76 10/11/2012 $10,389.96 $10,389.96
GCI 656 16.3 9/10/2012 $10,692.80 $11,637.44
AEP 246 43.39 9/10/2012 $10,673.94 $10,883.04

Since inception the portfolio is up 10.29% including dividends. Returns exclude commissions and taxes. Given the high turnover of the strategy, the results to this point are underwhelming. The chart below compares the returns of this strategy to SPDR S&P 500 ETF (SPY) and AOR, the iShares S&P Growth Allocation ETF:

 

Bill Gross Says Gold Should Thrive in ‘Ring of Fire’

A hat tip to Chris Vermeulen of The Gold and Oil Guy who brought two gold related articles to my attention. Both articles are from PIMCO and they discuss the present and future outlook for Gold.

The first is Bill Gross’ monthly investment outlook which I posted in my reading list last week, but I missed the second article, Gold – The Simple Facts.

Chris posted his own analysis of gold and he argues gold could reach $2400/oz in 2013.

Monday Investment Readings

Below are investment related articles I am reading this week:

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Presenting the World’s Biggest Hedge Fund You Have Never Heard Of – Zero Hedge

Tactical Asset Allocation for Dummies – Turnkey Analyst

Number Five – John Hussman

Global Economy Health Check – Satyajit Das

Who Destroyed the Economy? The Case Against the Baby Boomers – The Atlantic

When Career Risk Reigns (pdf) and The Unemployment Surprise (pdf) – John Mauldin