Portfolio – February Update

Among the more popular portfolios on Scott’s Investments has been the Portfolio. The strategy has been revised and improved for 2013 in order to make it simpler to follow.

I previously detailed here and here how an investor can use to screen for best performing ETFs based on momentum and volatility.   I select only the top 4 ETFs out of a static basket of  ETFs and re-balance the portfolio monthly. Previously, the static basket of ETFs was 25. This number of ETFs creates a high degree of turnover and also creates cross-over among ETFs that have a high correlations. For example, if you are only purchasing 4 ETFs each month and 2 or 3 of the ETFs are highly correlated, there is little benefit in holding more than 1 of the ETFs.

For 2013 the static basket of ETFs has been reduced to 15. From this basket of 15, the top 4 will be selected each month. The portfolio will be re-balanced at the beginning of each month. When a holding drops out of the top 5 ETFs it will be sold and replaced with the next highest ranked ETF. I added the top 5 requirement in order to further limit turnover.

ETFs will be ranked on a combination of their 6 month returns, 3 month returns, and 3 month volatility (lower volatility receives a higher ranking). I will no longer combine these rankings with the rankings based on a combination of 3 month returns, 20 day returns, and 20 day volatility.

In addition, ETFs must be ranked above the cash ETF SHY in order to be included in the portfolio, similar to the absolute momentum strategy I profiled here. This modification could help reduce drawdowns during periods of high volatility and/or negative market conditions (see 2008-2009).

The top 5 ranked ETFs as of 1/31/13 are:

RWX SPDR DJ International Real Estate
WIP SPDR Int’l Govt Infl-Protect Bond (9-10yr)
EEM iShares MSCI Emerging Markets

The position in PowerShares Emerging Mkts Bond (PCY) was closed for a gain of 5.45% (excluding dividends) and an open trade date of June 29th, 2013. PCY is being replaced by iShares MSCI EAFE (EFA), which has catapulted to the top ranking.

The four current positions are below:

Position Purchase Price Purchase Date Percentage Gain/Loss Excluding Dividends
RWX 40.74 10/31/2012 2.04%
EFA 58.98 1/31/2013 0.00%
WIP 63.15 11/30/2012 0.59%
EEM 44.35 12/31/2012 -0.29%
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Stocks and ETFs Still Snoozing
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Ivy Portfolio Month-End Update

Early in 2012  Scott’s Investments added a daily Ivy Portfolio spreadsheet. This tool uses Google Documents and Yahoo Finance to track the 10 month moving average signals for two of the portfolios listed in Mebane Faber’s book The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets. Faber discusses 5, 10, and 20 security portfolios that have trading signals based on long-term moving averages.

The Ivy Portfolio spreadsheet tracks the 5 and 10 ETF Portfolios listed in Faber’s book. When a security is trading below its 10 month simple moving average, the position is listed as “Cash”. When the security is trading above its 10 month simple moving average the positions is listed as “Invested”.

The spreadsheet’s signals update once daily (typically in the evening) using dividend/split adjusted closing price from Yahoo Finance. The 10 month simple moving average is based on the most recent 10 months including the current month’s most recent daily closing price.  Even though the signals update daily, it is not an endorsement to check signals daily. It simply gives the spreadsheet more versatility for user’s to check at their leisure.

The page also displays the percentage each ETF within the Ivy 10 and Ivy 5 Portfolio is above or below the current 10 month simple moving average, using both adjusted and unadjusted data.

If an ETF has paid a dividend or split within the past 10 months, then when comparing the adjusted/unadjusted data you will see differences in the percent an ETF is above/below the 10 month SMA. This could also potentially impact whether an ETF is above or below its 10 month SMA. Regardless of whether you prefer the adjusted or unadjusted data, it is important to remain consistent in your approach.

Top 50 Trending Stocks

I do not track these portfolios as hypothetical portfolios like I do with other portfolios on the site but do periodically backtest the strategy. For the most recent test results, please view December’s update.

The current signals based on January 31st closing prices are below.  International and domestic equities are leading, while bonds are lagging and trading below their 10 month moving average.

The first table is based on adjusted historical data and the second table is based on unadjusted price data:


Portfolio Updates

My recent Dual Momentum articles (available here and here) were well received. I will begin tracking a similar strategy using ETFs on Scott’s Investments, with the first update starting around February 10th. Due to my personal time constraints, the portfolio will replace the High Yield Stock Momentum portfolio that is currently tracked on the site and updated around the 10th of each month.

Stay tuned for further updates!

Thursday Investment Reads

Below are a few articles I’m reading this week:

Precious Metals and Stocks Poised to Ramp Higher in 2013 – Dave Banister

Correction Lurking… Traders Video Playbook

Correlation-Based Allocation – Empiritrage

Quantitative Value – Guess, Apple, and Lockheed Martin –  SumZero / Empiritrage

John Mauldin’s Forecast 2013 (pdf)

10 Trends to Watch in Finance for 2013 – Barry Ritholtz

Satyajit Das: The European Debt Crisis is Not Over

Puppet Show – John Hussman

Market Outlook 2013 – Mebane Faber


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The Trend Following Bible

Below is my book review of Andrew Abraham’s
The Trend Following Bible: How Professional Traders Compound Wealth and Manage Risk (Wiley Trading)

Andrew Abraham is a commodity trading advisor who has traded professionally for 18 years. He specializes in trend following strategies and recently published The Trend Following Bible.

The author profiles successful traders and warns of false messiahs and “geniuses” in the early part of the book. Abraham clearly states the objective of the book (always the first thing I look for!), but does not do so until page 79, which makes the “introduction” lengthy and repetitive.  He promises to show readers how to have an exact trading plan, how to take low risk bets, how to take losses, how to allow profits to run, and how to develop the proper mindset of a trader. These are worthwhile topics and in short I believe he achieved those objectives despite some of the other shortcomings of the book.

His trading plan begins with a discussion of risk and capital management. He then shows how he identifies trending markets, including his use of Rate-of-Change (ROC) and MACD. He then shows precisely where he places his hard stops and trailing stops and how he takes profits.

Abraham’s objective was not to sell his exact trading system to his audience, but rather his process. He encourages readers to create a system which fits his or her personality. As he states “strategies do not make good traders”.  He also notes that the tenets of trend following are simple and intuitive but in practice difficult to apply due to our own fear and greed.

Abraham repeats many trading psychology tips and tricks in an effort to help develop the proper mindset of a trader. While he repeats many of the same slogans pertaining to discipline and patience, they are worth repeating because they are so crucial to long-term trading success. Two notable points he emphasizes are accepting small losses and having and sticking to a trading plan. More experienced traders could be turned off by Abraham’s repetition, but for new or aspiring traders this repetition has value.

The author concludes the book with a trade diary that is helpful for those new to trading. Abraham chronicles his trades from 2009-2011 with a detailed description of many of the trades. These descriptions became a bit repetitive, but for those new to trading it serves as a primer for what to expect as a “trend trader”.

The book was not well edited, with several mistakes that should have been easily caught in the editorial process. I also felt like Abraham had some solid ideas, but since he admittedly is a trader first and author second, there should have been better organization and layout to the chapters. The editor and publisher failed in this regard. The title of the book also over-promises.  I would not classify this as a “bible” or must-read, although it does emphasize several enduring qualities of many successful traders.

Abraham also runs a web site Trend Following Mentor and mentions it briefly in the book, but unlike many other books I have read in recent years there are not the perpetual referrals by the author to his website or material or charts on his site, which was a welcome change.

In short, Abraham does a good job of emphasizing discipline and patience. He achieves his stated goal of the book and provides insight into his precise trading strategy. The book falls short in its prose and editing and much of it is repetitive and disjointed at times. If you can look beyond some of these shortcomings, it is still a decent read, especially for those new to trading or to trend-following.

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Graham Value Stock Portfolio Update

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In January 2012 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 but I would encourage readers to explore additional hedging, diversification, and risk management 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
  • Market capitalization > $100 million
  • 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 up 8.8% including dividends,compared to a positive return of 14% for SPDR S&P 500 ETF (SPY) over the same 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 and also led to some early drawdowns in the portfolio. Given my personal level of discomfort with stocks with ultra low market capitalizations, and especially those based overseas, going forward the screen is required to have a market cap greater than $100 million.

The top 20 stocks based on the screen criteria are listed below:


Ticker Name Rank MktCap
PLPC Preformed Line Products Company 88.9 335.36
WDC Western Digital Corp 88.15 10862.1
HUM Humana Inc. 87 11113.65
TESS TESSCO Technologies Inc 86.97 191.75
CVX Chevron Corp 85.2 220867.88
PAAS Pan American Silver Corp 85.11 2924.39
MANT ManTech International Corp 84.8 953.96
ALG Alamo Group Inc. 83.19 410.3
TRLG True Religion Apparel Inc 82.66 637.8
KNM Konami Corp 81.33 2855.55
SWM Schweitzer-Mauduit Intl Inc 80.46 1274.61
HP Helmerich & Payne Inc. 80.23 6134.71
WMK Weis Markets Inc. 79.64 1044.49
CF CF Industries Holdings Inc 78.63 13748.6
CSH Cash America International Inc. 77.37 1197.7
HFC HollyFrontier Corp 77.36 9326.48
INTC Intel Corp 75.81 109599.02
ABT Abbott Laboratories 74.31 52731.09
VLGEA Village Super Market Inc 72.77 434.67
HAL Halliburton Co 70.66 33324.48

Below are 3, 5, and 10 year backtest results for this screen (with the $100 million market cap requirement) using a quarterly rebalance and .5% slippage to help account for bid/ask spreads and commission costs. The backtest also includes the rule to sell a stock only when it dropped out of the top 20 in the list:

Six stocks were sold today:

Symbol Name Purchase Price Purchase Date Percentage Gain/Loss
JST Jinpan International Ltd 6.73 7/17/2012 -12.33%
SVT Servotronics, Inc. 9.18 1/13/2012 -6.32%
CHRM Charm Communications Inc 5.36 7/17/2012 -12.31%
EEI Ecology and Environment 16.2 1/13/2012 -29.44%
ADTN ADTRAN Inc 15.72 10/15/2012 33.46%
CRR CARBO Ceramics Inc. 64.08 10/15/2012 26.56%

As of today’s close the current portfolio now consists of:

Symbol Name Purchase Date Percentage Gain/Loss
WDC Western Digital 1/15/2013 0.00%
CSH Cash America International Inc. 1/15/2013 0.00%
PAAS Pan American Silver Corp 7/17/2012 31.68%
TRLG True Religion 1/15/2013 0.00%
MANT Mantech International Corp 2/15/2012 -27.17%
HP Helmerich & Payne Inc. 7/17/2012 32.94%
KNM Konami Corp 1/15/2013 0.00%
ALG Alamo Group, Inc. 3/14/2012 22.79%
CVX Chevron Corporation 1/13/2012 6.93%
SWM Schweitzer-Mauduit Intl Inc 10/15/2012 22.82%
WMK Weis Markets Inc. 1/15/2013 0.00%
PLPC Preformed Line Products Company 3/14/2012 -4.58%
HUM Humana Inc. 3/14/2012 -18.01%
TESS TESSCO Technologies Inc 7/17/2012 18.35%
CF CF Industries Holdings Inc 1/15/2013 0.00%

Monday Stuff

When you have a moment take a look at the new additions to the All-Weather ETF Portfolio page. I will be adding more features along with a more in-depth explanation in the coming weeks.

Below are a few readings for Monday Night:

Declaring Victory at Halftime – John Hussman

Japan’s Forgotten Debt Problem – Satyajit Das

Fewer Storms, More Sunny Breaks – The Idea Farm

 The Margin Debate – Mebane Faber

Year-End Capital Markets Forecast – Jason Hsu

The Forecast for Risk in 2013 – Geoff Considine

Simple Models Beat Experts – Turnkey Analyst

Volatility-Based Allocation – Woodshedder

High Yield Dividend Champion Portfolio (New System!)

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.

I am excited to announce some changes to the High Yield Dividend Champion ranking system going forward. The changes are not due to poor performance – the strategy returned over 40% in the past two years:

We still begin with the Dividend Champion list. The  list is first sorted by yield and the lowest 50% yielding stocks are eliminated.

The remaining stocks are then assigned a rank based on their yield (the higher the yield the higher the rank), payout ratio (the lower the payout ratio the higher the rank), 3 year dividend growth rate, and 5/10 year Dividend Acceleration/Deceleration (5-year average increase divided by 10-year average increase).  The objective of the new ranking system is to capture stocks with accelerating dividend growth while still focusing on high yield and low payout ratios. The screen produces many of the same names as the original system but may help reduce turnover going forward. With the old ranking system, some stocks frequently fluctuated on the margin as qualifiers and non-qualifiers, increasing turnover.

The top 10 stocks based on the new ranking system 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 15 (to limit turnover) and are replaced with the next highest rated stock.

After running the new ranking system there is turnover in three positions for this month. Eagle Financial Services (EFSI) was sold for a gain over 25%, McDonalds (MCD) for a gain over 2%, and Mercury General (MCY) for a loss over 4.5% . Individual security returns exclude commissions.

Proceeds were used to purchase Genuine Parts (GPC), Walgreen (WAG) and Questar (STR).

The top 15 stocks based on the new ranking methodology are below and displayed in order of their ranking:

Name Symbol Trend Yield Payout 5 10 A/D* 3-yr DGR %
Chevron Corp. CVX Here 3.33 29.53 0.956 9.70
Universal Health Realty Trust UHT Here 4.9 40.46 0.54 1.10
WGL Holdings Inc. WGL Here 4.08 59.04 1.347 2.90
Universal Corp. UVV Here 4.01 36.63 0.585 2.10
Diebold Inc. DBD Here 3.72 42.86 0.7 3.10
Genuine Parts Co. GPC Here 3.11 49.75 1.17 6.80
Walgreen Company WAG Here 2.97 49.33 1.119 26.00
Questar Corp. STR Here 3.44 58.12 1.035 9.60
American States Water AWR Here 2.96 53.58 1.528 7.90
California Water Service CWT Here 3.43 57.8 1.407 2.20
Community Trust Banc. CTBI Here 3.84 44.06 0.41 1.20
Air Products & Chem. APD Here 3.05 55.05 0.937 11.80
Tompkins Financial Corp. TMP Here 3.83 60.08 0.843 5.70
1st Source Corp. SRCE Here 3.08 34.52 0.46 3.80
Altria Group Inc. MO Here 5.6 91.67 1.251 8.70
‘*A/D=Acceleration/Deceleration (5-year average increase divided by 10-year average increase)

All returns exclude commissions and taxes and are hypothetical. Real results will differ

Weekend Cleaning

The All-Weather ETF Portfolio has been added to the menu and right hand column. Additional features will be added to the sheet as time permits.

A number of people commented and emailed regarding the All-Season ETF Portfolio. The purpose is not to duplicate the Bridgewater–or any other institutional–strategy. An institutional allocation model typically involves leverage and risk-parity (weighting positions based on volatility). My objective was to create a simple, static portfolio allocation with the intention of performing well in different market environments.

I was able to run some backtests of the positions in the portfolio using a risk-parity model (without leverage) as opposed to a static allocation like my original article proposed. Performance was similar in recent years, but risk-parity can involve more re-balancing and hence transaction costs.

Also, I chose to substitute and aggregate bond ETF (AGG) in place of the 7-10 Year Treasury Fund (IEF) in the All-Weather Portfolio. This should provide some additional diversification within the bond holdings.

Regarding the portfolio, I ommitted one position in last weeks article. I referenced the new cash filter in the strategy modification but did not include iShares Barclays 1-3 Year Treasry Bond (SHY) in the list of positions. The spreadsheet has been updated with this new position, and 15 positions (not 14) will be screened each month.