To sell or not to sell?

Recent acquisition Northern Star Resources [NST] in the ASX 200 portfolio is a great example of the conundrum faced by long-term investors when a new stock leaps out of the starting blocks. Profit-taking is evident from the tall shadows/wicks early in the week and in the decline of 21-day Twiggs Money Flow. Medium-term selling pressure suggests the stock is likely to retrace and give back some of the gains of the last two weeks. The temptation must be great to sell the stock and lock in profits of close to 30 percent.

NST

It is important, however, to stick to the plan. We are investing for a longer time frame in anticipation of much larger gains. There is no guarantee that any individual stock, including NST, will deliver. But I can guarantee you that they will not deliver long-term gains if you sell within the first few weeks.

Investors in S&P 500 stock Micron Technology [MU] faced a similar conundrum in July 2013. The stock had put in a good run from $9.00 before encountering profit-taking as it approached $15.00. 21-Day Twiggs Money Flow retreated below zero and the stock fell back to $12.50. Many investors would have taken this as a sign to get out.

MU July 2013

With hindsight, the decision to stay the course looks easy: support held at $12.50 and MU is now trading at $33.00. But I am sure that there were many investors who forgot their original plan and took profits at $12.50.

MU 2013/2014

….They just aren’t bragging about it.

Disregarding the big swing and trying to jump in and out was fatal to me. Nobody can catch all the fluctuations. In a bull market the game is to buy and hold until you believe the bull market is near its end.
~ Jesse Livermore

That’s all for today. Take care.

To sell or not to sell?

Recent acquisition Northern Star Resources [NST] in the ASX 200 portfolio is a great example of the conundrum faced by long-term investors when a new stock leaps out of the starting blocks. Profit-taking is evident from the tall shadows/wicks early in the week and in the decline of 21-day Twiggs Money Flow. Medium-term selling pressure suggests the stock is likely to retrace and give back some of the gains of the last two weeks. The temptation must be great to sell the stock and lock in profits of close to 30 percent.

NST

It is important, however, to stick to the plan. We are investing for a longer time frame in anticipation of much larger gains. There is no guarantee that any individual stock, including NST, will deliver. But I can guarantee you that they will not deliver long-term gains if you sell within the first few weeks.

Investors in S&P 500 stock Micron Technology [MU] faced a similar conundrum in July 2013. The stock had put in a good run from $9.00 before encountering profit-taking as it approached $15.00. 21-Day Twiggs Money Flow retreated below zero and the stock fell back to $12.50. Many investors would have taken this as a sign to get out.

MU July 2013

With hindsight, the decision to stay the course looks easy: support held at $12.50 and MU is now trading at $33.00. But I am sure that there were many investors who forgot their original plan and took profits at $12.50.

MU 2013/2014

….They just aren’t bragging about it.

Growth or Income?

Most investors face a decision as to how much of their portfolio to allocate to growth investments and how much to income investments. The mind-set of many income investors is that they cannot afford the volatility of growth investments. The following example illustrates how income investors can use growth investments to protect their portfolio against inflation and enhance overall returns.

Growth investments, historically, have outperformed income investments, but at the expense of greater volatility. They are typically favored pre-retirement by investors with long time horizons who seek to maximise their capital on retirement. Other than improved performance, growth investments also generally receive more favourable tax treatment than fixed income, further enhancing after-tax returns. Income investments historically exhibit lower volatility and are favored by retirees for their consistent income, also by risk-averse pre-retirees who wish to reduce the volatility of their overall portfolio.

Historic Returns

These historic returns to Australian investors from 1981 to 2009 illustrate the differences in returns and volatility. Data was originally provided by AXA:

Asset class: Australian stocks Australian fixed interest International stocks Australian REITS Australian cash
Annualised return (%) 11.38 10.41 10.81 10.49 9.18
Inflation (%) 4.41 4.41 4.41 4.41 4.41
Real return (%) 6.97 6.00 6.40 6.08 4.77
Standard deviation 23.32 7.60 21.41 18.75 4.95

Not all investment strategies are likely to match the broad asset classes, but they are a good starting point for developing an investment strategy.

What the future holds

One thing about the future is certain: it is not going to match the past. It also is not going to match our projections. Without a magic crystal ball, the best we can do is adjust past performance for expected changes and hope we are not too far off course.

My own expectations are that we are entering a low inflation environment. Central banks, after the global financial crisis, are likely to be far more vigilant about rapid credit expansion and asset bubbles. I have therefore adjusted my inflation expectation down to 2.0%. I also expect that low inflation will have greater impact on fixed interest and cash and have adjusted their returns accordingly.

Asset class: Australian stocks Australian fixed interest International stocks Australian REITS Australian cash
Annual return (%) 9.00 7.00 9.00 8.00 5.00
Inflation (%) 2.00 2.00 2.00 2.00 2.00
Real return (%) 7.00 5.00 7.00 6.00 3.00
Standard deviation 25 10 25 20 5

These projections are no more than an educated guess and are used for illustration purposes only. Make your own projections, but understand that unrealistic projections will yield unrealistic results.

Investing for Income

We can now determine how much to allocate to income investments and how much to growth investments.

Take a retired investor whose objective is to earn $60,000 per year (after tax) from investments while protecting capital from inflation.

If he/she earns an average return of 7.0% p.a. on income investments at an average tax rate of 15%, with 2.0% inflation, we arrive at a net return of 3.95% and a required investment of $1.519 million:

Average return: 7.00%
Less tax at: 15%
After tax: 5.95%
Deduct inflation: 2.00%
Net return: 3.95%
Required income after tax and inflation: $60,000
Required capital (60,000 x 100/3.95): $1.519 million

Adding growth investments

If we recognize hedging against inflation as a long-term goal and not an immediate cash flow need, we can consider funding the inflation element of the portfolio with higher-yielding growth investments.

Income Component

First we calculate the capital required to meet current income needs:

Average return on income investments: 7.00%
Less tax at: 15%
After tax: 5.95%
Required income after tax: $60,000
Required income investment: $1.009 million

Growth component

Growth investments typically enjoy higher after-tax returns because of improved performance as well as a lower tax component — through capital gains concessions and franking credits on dividends (for Australian investors).

Average return on growth investments: 9.00%
Less tax at: 10%
After tax: 8.10%
Deduct inflation: 2.00%
Net return: 6.10%
Required income from growth investments ($1.009m x 2.0%): $20,180
Required growth investment ($20,180 x 100/6.1): $0.331 million
Total required capital: $1.340 million

Using growth investments to fund the inflation component reduces required capital to $1.340 million, a reduction of $179,000. Alternatively, if we invest the previously determined capital amount of $1.519 million, we should average close to $11,000 of additional income (after tax and inflation) each year. With higher inflation rates, the difference is even greater.

Remember that this example does not take into consideration your personal needs and circumstances. Also, taxation and investing for retirement are complex subjects and we recommend that you consult a professional adviser before making any decisions.

Understanding Momentum

Since its initial discovery by DeBondt & Thaler in 1985, the momentum effect has been documented and researched in many markets worldwide. Stocks which have outperformed in the recent past tend to continue to perform strongly over the months ahead.

Research conducted by Dr Bruce Vanstone and me indicates that Momentum significantly outperforms the major benchmark indices in both US and Australian markets. Investors, however, tend to focus on the annual rate of return without considering the accompanying volatility. Consider our simulation of Twiggs Momentum on the S&P 500 for the period January 1996 to June 2013 as an example.


S&P 500 TMO Equity Curve: click to enlarge

Dark green areas represent cash holdings, when market risk is identified as elevated. The blue line represents the benchmark S&P 500 index. Click on the image if you need a larger view.

Investment Strategy: Twiggs Momentum Buy & Hold
Starting Capital (USD): $100,000 $100,000
Ending Capital (USD): $4,871,686.27 $258,649.35
Annualized Gain: 24.89% 5.58%
Total Commission Paid (at 5 BPS): $66,194.35 $49.96
Number of Investments: 331 1
Win Rate: 54.38% 100.00%
Average Profit: 44.16% 158.79%
Average Loss: 10.15% 0.00%
Maximum Drawdown: 38.64% 56.77%
Maximum Drawdown Date: 9/11/2006 3/9/2009
Sharpe Ratio: 0.98 0.42

Investors tend to focus on the annualized gain of 24.89% p.a. without really applying their minds to the other statistics in the table. Maximum Drawdown of 38.64%, while lower than the index, means the portfolio is still subject to gut-wrenching volatility. Soaring gains are often followed by sharp falls and it takes strong resolve to stick with the strategy after one of these setbacks. Many investors would have abandoned ship after the first major drawdown in early 2000.

Another factor is the Win Rate of just above 54% which means that over 45% of all stocks purchased are sold at a loss. These are typical statistics for a momentum strategy, but investors should expect a high percentage of stocks to be cut from the portfolio for failing to adhere to the expected growth path. The strength of the strategy, however, is the expected gains on stocks that do adhere to the momentum growth path, with average profits exceeding average losses by a ratio of almost 4 to 1. That is where the excess returns are generated and is the reason why the strategy outperforms the benchmark index.

There are also extended periods when the portfolio remains in cash — long enough for doubts to grow as to whether momentum still works in the markets. My own view is that momentum strategies have been shown to outperform the Dow over the last 100 years and are likely to remain viable for as long as we have stock market cycles.

Coping with the emotional roller-coaster ride of investing in stocks is never easy, but here are some hints.

  • Focus on your investment time horizon of at least 5 years.
  • Check stock prices no more than once a week. Tracking prices daily or more frequently tends to cloud your judgement.
  • Welcome gains ahead of long-term averages, but expect them to fade over time.
  • If something unusual occurs, step back from the market, examine the long-term history, and ask: “Is this really unexpected or were my expectations unrealistic.”

“You know,” said Arthur, “it’s at times like this, when I’m trapped in a Vogon airlock with a man from Betelgeuse, and about to die of asphyxiation in deep space that I really wish I’d listened to what my mother told me when I was young.”
“Why, what did she tell you?”
“I don’t know, I didn’t listen.”
~ Douglas Adams, The Ultimate Hitchhiker’s Guide to the Galaxy

That’s all for today. Take care.

Understanding Momentum

Understanding Momentum

Since its initial discovery by DeBondt & Thaler in 1985, the momentum effect has been documented and researched in many markets worldwide. Stocks which have outperformed in the recent past tend to continue to perform strongly over the months ahead.

Research conducted by Dr Bruce Vanstone and me indicates that Momentum significantly outperforms the major benchmark indices in both US and Australian markets. Investors, however, tend to focus on the annual rate of return without considering the accompanying volatility. Consider our simulation of Twiggs Momentum on the S&P 500 for the period January 1996 to June 2013 as an example.


S&P 500 TMO Equity Curve: click to enlarge

Dark green areas represent cash holdings, when market risk is identified as elevated. The blue line represents the benchmark S&P 500 index. Click on the image if you need a larger view.

Investment Strategy: Twiggs Momentum Buy & Hold
Starting Capital (USD): $100,000 $100,000
Ending Capital (USD): $4,871,686.27 $258,649.35
Annualized Gain: 24.89% 5.58%
Total Commission Paid (at 5 BPS): $66,194.35 $49.96
Number of Investments: 331 1
Win Rate: 54.38% 100.00%
Average Profit: 44.16% 158.79%
Average Loss: 10.15% 0.00%
Maximum Drawdown: 38.64% 56.77%
Maximum Drawdown Date: 9/11/2006 3/9/2009
Sharpe Ratio: 0.98 0.42

Investors tend to focus on the annualized gain of 24.89% p.a. without really applying their minds to the other statistics in the table. Maximum Drawdown of 38.64%, while lower than the index, means the portfolio is still subject to gut-wrenching volatility. Soaring gains are often followed by sharp falls and it takes strong resolve to stick with the strategy after one of these setbacks. Many investors would have abandoned ship after the first major drawdown in early 2000.

Another factor is the Win Rate of just above 54% which means that over 45% of all stocks purchased are sold at a loss. These are typical statistics for a momentum strategy, but investors can expect a high percentage of stocks to be cut from the portfolio for failing to adhere to the expected growth path. The strength of the strategy, however, is the expected gains on stocks that do adhere to the momentum growth path, with average profits exceeding average losses by a ratio of almost 4 to 1. That is where the excess returns are generated and is the reason why the strategy outperforms the benchmark index.

There are also extended periods where the portfolio remains in cash — long enough for doubts to grow as to whether momentum still works in the markets. My own view is that momentum strategies have been shown to outperform the Dow over the last 100 years and are likely to remain viable for as long as we have stock market cycles.

Coping with the emotional roller-coaster ride of investing in stocks is never easy, but here are some hints.

  • Focus on your investment time horizon of at least 5 years.
  • Check stock prices no more than once a week. Tracking prices daily or more frequently tends to cloud your judgement.
  • Welcome gains ahead of long-term averages, but expect them to fade over time.
  • If something unusual occurs, step back from the market, examine the long-term history, and ask: “Is this really unexpected or were my expectations unrealistic.”

That’s all for today. Take care.

Quant Funds Are Hot Again | Morningstar

By Greg Carlson

Funds that use quantitative stock-picking models are on a roll. A list of 52 U.S.-sold quant funds compiled by Morningstar beat more than 80% of their respective peers over the trailing three years through June 13, and the group outperformed its respective peers in 2011, 2012, 2013, and thus far in 2014.

Read more at Quant Funds Are Hot Again.

Quant Funds Are Hot Again | Morningstar

By Greg Carlson

Funds that use quantitative stock-picking models are on a roll. A list of 52 U.S.-sold quant funds compiled by Morningstar beat more than 80% of their respective peers over the trailing three years through June 13, and the group outperformed its respective peers in 2011, 2012, 2013, and thus far in 2014.

Read more at Quant Funds Are Hot Again.

Resist the urge to avoid discomfort

Momentum stocks have suffered a fair degree of turbulence since April, after a strong first quarter. Investors unfortunately have to endure periods like this, when the market appears hesitant or lacks direction, in much the same the same way as travelers can expect turbulence during an air flight. It is important is to resist the urge to avoid discomfort by exiting positions. Enduring uncomfortable parts of the journey are necessary if you want to reach your intended destination. Our research on both the ASX and S&P 500 has shown that attempting to time secondary movements in the markets does not enhance but erodes performance: the average (re-)entry price is higher than the average exit price after accounting for brokerage.

A basic rule of thumb in investing is that investors need to endure higher volatility in order to achieve higher returns. If your investment time frame is long-term, it is important to focus on the end result and not be overly concerned by weekly fluctuations.

S&P 500 Momentum and Economic Outlook

This an example of the monthly updates from the new Research & Investment joint venture between Incredible Charts and Porter Capital.

S&P 500 Momentum – October 2013

Latest Performance

S&P 500 Momentum is based on Porter Capital’s successful ASX200 Prime Momentum strategy which returned +38.43% for the 12 months ended 31st October 2013. Actual historical performance for the S&P 500 is not yet available.

Sectors

The portfolio includes the usual technology, Internet retail and biotechnology sectors but also insurance, airlines, and oil & gas exploration.

Stock Performance

Star performer Netflix (NFLX) climbed from $80 to above $350 over the last year, breaking its 2011 high of $300. Twiggs Money Flow troughs above zero indicate strong buying pressure.

GILD

Stock Selections

Hold

We continue to hold the following stocks:

  • Symbol only available to subscribers
  • NFLX
  • Symbol only available to subscribers
  • Symbol only available to subscribers
  • Symbol only available to subscribers
  • Symbol only available to subscribers

New Additions

There are four new additions this month:

  • Symbol only available to subscribers
  • GILD
  • Symbol only available to subscribers
  • Symbol only available to subscribers

Biotech newcomer Gilead Sciences (GILD) climbed from $20 to above $70 over the last three years. Short corrections indicate buying pressure and respect of support at $64 would signal a fresh advance. Twiggs Money Flow troughs high above zero also suggest strong buying pressure.

GILD

Disposals

Stocks replaced are:

  • REGN (SELL)
  • BSX (SELL)
  • GT (SELL)
  • CELG (SELL)

Regneron Pharmaceuticals (REGN) rose from $30 to $300 over the last three years, but encountered strong resistance at $300/$320 and has fallen outside our top ten ranking. Breach of support at $270 and the rising trendline would warn that the primary trend is weakening. Recovery above $320, however, would most likely see it regain its position in the portfolio.

TRIP

Market Outlook

Market Filters

Our market filters indicate low to moderate risk and we maintain full exposure to equities.

General Outlook

As global growth recovers we expect equity markets to be buoyed by improvements in both earnings and dividends, with strong momentum over the quarter. There is much discussion in the media as to whether various markets are in a “bubble”. Little attention is devoted to the fact that bubbles can last for several years, and sometimes even decades. The main driver of both stock market bubbles and real estate bubbles is debt. Anna Schwartz, co-author with Milton Friedman of A Monetary History of the United States (1963) described the relationship to the Wall Street Journal:

If you investigate individually the manias that the market has so dubbed over the years, in every case, it was expansive monetary policy that generated the boom in an asset. The particular asset varied from one boom to another. But the basic underlying propagator was too-easy monetary policy and too-low interest rates …..

Currently, there is evidence of expansive monetary policy from the Fed, but the overall impact on the financial markets is muted. Most of the QE bond purchases are being parked by banks in interest-bearing, excess reserve deposits at the Fed. The chart below compares Fed balance sheet expansion (QE) to the increase in excess reserve deposits at the Fed.

US Household Debt

A classic placebo effect, the Fed is well aware that the major benefit of their quantitative easing program is psychological: there is little monetary impact on the markets.

Corporate debt (green line below) is expanding rapidly as corporations take advantage of the opportunity to issue new debt at low interest rates, but household debt (red) is still shrinking.

US Household Debt

There are pockets of concern, like the rapid recovery in NYSE margin debt, but risk of a Dotcom-style stock market bubble or a 2002/2007 housing bubble is low while household debt contracts.

Regards,

Colin Twiggs

 

Excellence is an art won by training and habituation. We do not act rightly because we have virtue or excellence, but we rather have those because we have acted rightly. We are what we repeatedly do. Excellence, then, is not an act but a habit.

~ Aristotle

Disclaimer

Research & Investment Pty Ltd is a Corporate Authorized Representative (AR Number 384 397) of Andika Pty Ltd which holds an Australian Financial Services Licence (AFSL 297069).

The information on this web site and in the newsletters is general in nature and does not consider your personal circumstances. Please contact your professional financial adviser for advice tailored to your needs.

Research & Investment Pty Ltd (“R&I”) has made every effort to ensure the reliability of the views and recommendations expressed in the reports published on its websites and newsletters. Our research is based upon information known to us or which was obtained from sources which we believe to be reliable and accurate.

No guarantee as to the capital value of investments, nor future returns are made by R&I. Neither R&I nor its employees make any representation, warranty or guarantee that the information provided is complete, accurate, current or reliable.

You are under no obligation to use these services and should always compare financial services/products to find one which best meets your personal objectives, financial situation or needs.

To the extent permitted by law, R&I and its employees, agents and authorized representatives exclude all liability for any loss or damage (including indirect, special or consequential loss or damage) arising from the use of, or reliance on, any information. If the law prohibits the exclusion of such liability, such liability shall be limited, to the extent permitted by law, to the resupply of the said information or the cost of the said resupply.

Important Warning About Simulated Results

Research & Investment (R&I) specialize in developing, testing and researching investment strategies and systems. Within the R&I web site and newsletters, you will find information about investment strategies and their performance. It is important that you understand that results from R&I research are simulated and not actual results.

No representation is made that any investor will or is likely to achieve profits or losses similar to those shown.

Simulated performance results are generally prepared with the benefit of hindsight and do not involve financial risk. No modelling can completely account for the impact of financial risk in actual investment. Account size, brokerage and slippage may also diverge from simulated results. Numerous other factors related to the markets in general or to the implementation of any specific investment system cannot be fully accounted for in the preparation of simulated performance results and may adversely affect actual investment results.

To the extent permitted by law, R&I and its employees, agents and authorized representatives exclude all liability for any loss or damage (including indirect, special or consequential loss or damage) arising from the use of, or reliance on, any information offered by R&I whether or not caused by any negligent act or omission.

The coach who never punts [video]

Coach Kevin Kelley would make a great share trader/momentum investor. He questions the accepted norms, analyzes the data and plays the percentages, instead of following the herd.

Coach Kevin Kelley of Pulaski Academy in Little Rock, Arkansas, instructs his players to never punt, never field punts, and only do onside kicks, and he claims that math backs up his innovative philosophy. Grantland spent some time with Kelley and his players to learn more about the coach behind the team that once scored 29 points before its opponent touched the ball.

Hat tip to Barry Ritholz