Monday Readings

Everything You Know About Investing is Wrong… Barry Ritholtz

Capital Formation and the Fiscal Cliff (pdf) – John Mauldin

Dollar and Stock Analysis – The Gold and Oil Guy

Forecasting Stock Returns – The Idea Farm

Overlooking Overvaluation – John Hussman

Debt Limit-Fiscal Cliff-Stock Market – Cumberland Advisors

Top Culprit in the Financial Crisis: Human Nature – Barrons

Combining Multiple Market-Timing Systems

One of my primary focuses on Scott’s Investments is studying and tracking various market-timing, trading, and portfolio strategies.  However, no matter how well a strategy tests historically there is always the possibility a strategy under-performs in the future. One way to mitigate this risk is to diversify strategies within a portfolio, and not just securities.

The tests below were conducted using Stockscreen123 (an off-shoot of Portfolio123).  The tests use a combination of two market timing strategies.

The first timing strategy is a “Equities vs. Fixed Income” strategy, which purchases one core equity ETF, the S&P 500 SPDR (SPY) when conditions are deemed bullish, and a core fixed-income ETF, the iShares Barclay 20-year Treasury ETF (TLT), when conditions are deemed bearish. The timing model assumes conditions are favorable for equity investing if EPS estimates are rising and if valuations are reasonable.

  1. The estimates test is whether the 5-week moving average of the aggregate of the consensus current-year estimates for S&P 500 companies is above the 21-week moving average.
  2. The valuation test is based upon risk premium, specifically, whether the S&P 500 risk premium (earnings yield minus 10-year treasury yield) is above 1%

The second strategy is a simple “technical strategy” using moving averages.  When the 50 day moving average of the S&P 500 is above its 200 day moving average, the strategy goes long SPY.  When these conditions are not met the strategy goes long TLT.

While more often than not both strategies share the same signal (i.e. going long SPY), there are times when mixed signals are sent so the hypothetical portfolio goes long both SPY and TLT simultaneously.

For a free 10 page education trading article from Chris Vermeleun click here (clicking the link will automatically download the pdf).

Below is the results of a 10 year backtest with a  4 week rebalance period, compared to SPY (in blue). Dividends are included but no commissions, taxes, or slippage is assumed:

What if an investor purchased an equal weight portfolio in SPY and TLT 10 years ago and rebalanced annually?  The total returns are lower than the combined market timing system but higher than SPY. Standard deviation and max drawdown of the equal weight SPY/TLT portfolio is lower than the combined market timing system and SPY:

What if we incorporate 0.5% slippage into the combined market timing system? Slippage helps accounts for bid/ask spreads that exist in real-world trading and potential commissions.  Total returns decrease but the results are still solid, which is not surprising given that the system only uses two securities and rebalances every 4 weeks:

Below are the test results in table format. The trading systems by themselves are also included. As you can see, both trading systems test well as a stand-alone system, but the highest sharpe ratio is achieved when combining the two systems:

System Rebalance Period Total Return Annualized Return Max Drawdown Sharpe Ratio Standard Deviation Correlation with SPY
Combined Market Timing 4 weeks 188.27% 11.16% -26.99% 0.47 15.80% 0.32
Combined Market Timing .5% slippage 4 weeks 168.80% 10.39% -26.99% 0.42 15.82% 0.32
SPY/TLT Annual 119.05% 8.15% -23.88% 0.41 10.90% 0.74
SPY N/A 83.86% 6.28% -55.42% 0.11 23.90% 1
Equities vs Fixed Income 4 weeks 203.76% 11.75% -26.99% 0.44 18.42% 0.4
Technical Strategy 4 weeks 167.96% 10.35% -26.99% 0.38 17.55% 0.16
all returns include dividends
Tests 11/24/02 –  11/24/12

The two market timing systems presented here are not intended as optimal timing systems – better options may exist for investors. However, the two systems are easy to implement for an individual investor and as stand-alone systems have strong historical results. When combined into a single portfolio the two strategies have led to even better risk-adjusted returns (as gauged by Sharpe Ratio) even when compared to an equal-weight SPY/TLT portfolio.

Holiday Shopping List

Love it or hate it, Black Friday is upon us. I maintain a “recommended reading list” on the menu of the homepage. The list is reproduced below for those looking for holiday gift or shopping ideas.  I have also added some titles at the bottom which are on my current “to-read” list.

If you are going to order any of these books I will receive a small commission from Amazon (and you will pay no more because of that) if you order by clicking any of the links below. It is a great way to show your support for this site, which I share freely:

Reminiscences of a Stock Operator (Wiley Investment Classics)

Trend Trading for a Living: Learn the Skills and Gain the Confidence to Trade for a Living– (my review here)

The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets

The Little Book That Still Beats the Market (Little Books. Big Profits) – (my review here)

The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel (Revised Edition)

Security Analysis: Sixth Edition, Foreword by Warren Buffett (Security Analysis Prior Editions)

Against the Gods: The Remarkable Story of Risk

Stock Market Wizards: Interviews with America’s Top Stock Traders and Hedge Fund Market Wizards

How to Make Money in Stocks: A Winning System in Good Times and Bad, Fourth Edition

Martin Zweig’s Winning on Wall Street

The Fundamental Index: A Better Way to Invest – (my review here)

Jackass Investing: Don’t do it. Profit from it. – (my review here)

Diary of a Professional Commodity Trader: Lessons from 21 Weeks of Real Trading
– (my review here)

Investing in the Second Lost Decade: A Survival Guide for Keeping Your Profits Up When the Market Is Down (my review here)

and a few titles currently on my “to-read” list:

Trade Your Way to Financial Freedom

The Little Book of Bull’s Eye Investing: Finding Value, Generating Absolute Returns, and Controlling Risk in Turbulent Markets (Little Books. Big Profits)

The Daily Trading Coach: 101 Lessons for Becoming Your Own Trading Psychologist (Wiley Trading)

Abnormal Returns: Winning Strategies from the Frontlines of the Investment Blogosphere

Trading in the Zone: Master the Market with Confidence, Discipline and a Winning Attitude

Come Into My Trading Room: A Complete Guide to Trading

Tuesday Investment Articles

Lots of good articles below, enjoy and Happy Thanksgiving!

Jeremy Grantham of GMO has released his quarterly newsletter. It is available on GMOs website with free registration. Always a must read. (For his outspoken thoughts on climate change here is a good primer)

Predicted 10 Year Returns from the Shiller P/E – Turnkey Analyst

The Apple Crush – JW Jones

Next Broad Market Drop Looming? David Banister

The History of Gold Charts – Peter L Brandt

America’s Fisdal Cliffs and Debt Mountains – Satyajit Das

Fiscal Cliff or Slippery Slope? David Kotok

Where Will the Jobs Come From? (pdf) John Mauldin

Little Dutch Boy – John Hussman

 Equity Portfolio Optimization with Factor Tilts – Advisor Perspectives

Mid-Week Readings

Lopsided Risks – John Hussman

 Meaning of 200-Day Average’s Violation – Mark Hulbert

Central Bank Insurance and Four More Years (pdf) – John Mauldin

When Quants Tell Stories – Felix Salmon

The Global Market Portfolio – Mebane Faber

The Green Book – The Idea Farm

Sheila Bair for Treasury Secretary – Forbes

High Yield Momentum Stock Portfolio Update

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 62 results, ten more than last month due in part to the recent equity market sell-off resulting in higher dividend yields.

Now you can follow me on Stocktwits and Twitter!

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 November. Health Care REIT, Inc. (HCN) was purchased in October and sold at a loss of 1.26%. AT&T (T) was purchased in May and sold at a loss of 0.15%. While the portfolio tracks dividends as a whole, discussions of Individual security returns exclude dividends.

The proceeds were used to purchase positions in Leggett & Platt, Incorporated (LEG) and H&R Block, Inc. (HRB). LEG currently yields 4.34% and has 6 month returns of 31.69%.  HRB yields 4.5% and has 6 month returns of 24.96%.

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 and many equity indices are currently very near their 10 month average). 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 November 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)
GCI Gannett Co., Inc. Trend Analysis 4.68% 32.23%
LEG Leggett & Platt, Incorporated Trend Analysis 4.34% 31.69%
FTR Frontier Communications Corporation Trend Analysis 9.20% 30.63%
HRB H&R Block, Inc. Trend Analysis 4.50% 24.96%
CVC Cablevision Systems Corporation Trend Analysis 4.06% 22.13%
LLY Eli Lilly & Co. Trend Analysis 4.13% 16.35%
AEP American Electric Power Co., Inc. Trend Analysis 4.50% 11.41%
CINF Cincinnati Financial Corp. Trend Analysis 4.17% 10.45%
PAYX Paychex, Inc. Trend Analysis 4.10% 9.87%
HCP HCP, Inc. Trend Analysis 4.53% 9.12%
VZ Verizon Communications Inc. Trend Analysis 4.83% 7.51%
DTE DTE Energy Co. Trend Analysis 4.19% 7.23%
GME GameStop Corp. Trend Analysis 4.52% 7.17%
LMT Lockheed Martin Corporation Trend Analysis 5.11% 6.92%
HCN Health Care REIT, Inc. Trend Analysis 5.05% 6.85%

Current Holdings:

Position Shares Purchase Date Cost Basis Percentage Gain/Loss Excluding Dividends Current Yield
LEG 384 11/9/2012 $10,260.48 0.00% 4.34%
VZ 236 7/11/2012 $10,596.40 -5.03% 4.83%
CINF 312 2/10/2012 $10,748.40 13.50% 4.17%
FTR 2349 8/9/2012 $11,063.79 -7.64% 9.20%
LLY 230 9/10/2012 $10,699.60 2.04% 4.13%
HRB 579 11/9/2012 $10,288.83 0.00% 4.50%
HCP 231 9/10/2012 $10,690.68 -4.60% 4.53%
DTE 171 10/11/2012 $10,389.96 -2.58% 4.19%
GCI 656 9/10/2012 $10,692.80 4.97% 4.68%
AEP 246 9/10/2012 $10,673.94 -3.66% 4.50%

Since inception the portfolio is up 5.79% 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:

Post-Election Readings

Below are a few articles I am catching up on this week. Either I am getting busier or there is more and more great reading material available for free on the web:

Post-Election Trading Made Simple –  Chris Vermeulen

Gary Antonacci has updated his momentum paper Risk Premia Harvesting Through Dual Momentum

Tactical Asset Allocation Series: Part 1 and Part 2 – Turnkey Analyst

Turn That Frown Upside Down – World Beta

Re-elected President Obama and Fiscal Cliff – Cumberland Advisors

Want to Fix Congress? Let’s institute pay for performance – Sheila Bair, CNN Money

Don’t Jump into Junk – Institutional Imperative

 Is Trend Following Dead? Attain Capital

Fitting Factors Into the Formula – Morningstar

The Role of Risk in Asset Allocation (pdf) – John Mauldin

High Yield Dividend Champion Portfolio for November

In December 2010, I created a screen/hypothetical portfolio called the “High Yield Dividend Champion Portfolio.” The screen is tracked publicly as a continuous hypothetical portfolio with a starting balance of $100,000 on Scott’s Investments (see the right hand column for a link to the spreadsheet).

Like many of the screens, strategies, and portfolios I track and prefer, the High Yield Dividend Champion Portfolio uses a small number of historically relevant ideas to create a simple, yet powerful investment plan. As I previously detailed, “Some studies have shown that the, highest yielding, low payout stocks perform better over time than stocks with higher payouts and lower yields.”

The High Yield Dividend Champion Portfolio attempts to capture the best high yield, low payout stocks with a history of raising dividends. There are numerous ways to gauge the “best” high yield/low payout stocks. The screening process for this portfolio starts with the “Dividend Champions” as compiled by DRIP Investing. The list is comprised of stocks that have increased their dividend payout for at least 25 consecutive years

We first rank the Dividend Champions based on yield – the highest 1/3 yielding stocks are kept and the rest are eliminated. With the remaining high yielding stocks we eliminate the half with the highest payout ratio. The remaining stocks are then assigned a rank based on the ratio of their dividend yield to payout ratio (the same as a trailing earnings/price ratio, or the inverse of the trailing P/E ratio).

Now you can follow me on Stocktwits and Twitter!

The top 10 stocks based on this ratio make the portfolio. Stocks will be sold at the re-balance date (generally around the 5th of the month) when they drop out of the top 12 (to limit turnover) and are replaced with the next highest rated stock.

For November 6th there was one change to the portfolio.  The 282 share position in Emerson Electric (EMR) was sold for a one month gain of 4.61%. The position was sold due to its drop in dividend yield.

One new stock was added, a position in McDonald’s (MCD). At the end of October MCD yielded 3.55% with a payout ratio of 58%.

Weekly charts courtesy of Finviz:

 

The equity curve of the portfolio is plotted below and since inception it is up 37.73%, including dividends but excluding commissions and taxes. The SPDR S&P 500 ETF (SPY) and iShares S&P Growth Allocation ETF (AOR) are also shown for comparison:

 The top 17 rated stocks based on this portfolio’s criteria are listed below:

Name Symbol Trend Analysis Yield Payout E/P Position
Universal Health Realty Trust UHT Trend Analysis 4.98 40.13 0.1241 Hold
Diebold Inc. DBD Trend Analysis 3.83 42.86 0.0894 Hold
Community Trust Banc. CTBI Trend Analysis 3.71 44.06 0.0842 Hold
Eagle Financial Services EFSI Trend Analysis 3.45 44.71 0.0772 Hold
Universal Corp. UVV Trend Analysis 3.95 59.94 0.0659 Hold
Tompkins Financial Corp. TMP Trend Analysis 3.75 60.08 0.0624 Hold
Sysco Corp. SYY Trend Analysis 3.48 56.84 0.0612 Hold
McDonald’s Corp. MCD Trend Analysis 3.55 58 0.0612 Buy
Air Products & Chem. APD Trend Analysis 3.3 55.05 0.0599 n/a
Consolidated Edison ED Trend Analysis 4.01 67.04 0.0598 n/a
Questar Corp. STR Trend Analysis 3.36 57.14 0.0588 Hold
Sonoco Products Co. SON Trend Analysis 3.85 67.42 0.0571 Hold
Kimberly-Clark Corp. KMB Trend Analysis 3.55 62.32 0.0570 n/a
Clorox Company CLX Trend Analysis 3.54 62.29 0.0568 n/a
UGI Corp. UGI Trend Analysis 3.34 63.91 0.0523 n/a
RPM International Inc. RPM Trend Analysis 3.38 68.18 0.0496 n/a
California Water Service CWT Trend Analysis 3.42 71.59 0.0478 n/a

A note regarding Eagle Financial Services (EFSI). The stock is a Dividend Champion but trades over the counter and has very low volume. Any entry/exits in this stock should be treated with caution and limit orders are highly recommended.

Portfolio Updates & Weekend Readings

For November there was no change in the US Sector Momentum portfolio – it continues to hold Health Care Select Sector SPDR (XLV).

The Basic ETF Portfolio sold PowerShares DB Commodity Index Tracking (DBC) and purchased Vanguard FTSE All-World ex-US ETF (VEU). You will remember last month that DBC and VEU were virtually tied based on momentum.

I will be sitting quietly in a deer stand this weekend so there will be no further commentary on the two portfolios above.

Below are some articles for the weekend:

Distinction Without a Difference – John Hussman

The Quest for Certainty (pdf) – John Mauldin

 Regression to Trend – Doug Short

Is the Stock Market Cheap? Doug Short

Improving on Risk Parity – The Idea Farm

Time to Vote! Bill Gross