Sunday, December 27, 2009
Sunday, December 20, 2009
Sunday, December 13, 2009
Sunday, December 6, 2009
Sunday, November 29, 2009
As you may be aware, 2009 has been a challenging year for the Strategic Growth Model portfolio, this being the first year it has underperformed the broad market since inception. And it is NO real comfort that other hedge fund managers with a similar investment style have produced underwhelming results this year.
It's important to know that ANY systematic approach will have periods where it is in-synch with the market, and periods where it is out-of-phase. The MOST important thing is to keep our losses small during periods where the system is out-of-phase. In fact, I view THAT as our main accomplishment for 2009.
To this regard, the model portfolio is within 10% of its all-time-high made earlier this year, while the broad market remains more than 30% off its all-time-high made in Oct. 2007. For investors with a long-term horizon such as me and hopefully you, the model portfolio has performed very well over the market's full-cycle. THAT is our unswerving goal.
There are a host of reasons why the system has been out-of-phase, and I have appropriately adapted the system to better accommodate the once-in-a-generation conditions of this year should we ever see them again. (Hope NOT)
Over the past couple of weeks you may have noticed that the model portfolio is again holding its full complement of 10 stocks.
What's encouraging to ME is what I see under the hood, where the model's highest performing screens are again producing some high quality growth stocks for our portfolio. This gives me encouragement that the model portfolio may be entering another period of OVER performance, during what happens to be the strongest six months of the seasonal cycle.
I appreciate your continued patience and confidence. Please be assured that you are on the receiving end of my very BEST work. All of our liquid assets are invested alongside yours as we continue on this journey together.
Best wishes to you and your family for the holiday season and here's to a profitable 2010!
Sunday, November 22, 2009
Monday, November 16, 2009
Sunday, November 8, 2009
Sunday, November 1, 2009
Returns for week ending 10/30/09
Model portfolio, hypothetical returns for past…
1 week: -3.0% (S&P500 declined -4.1%)
Value of $10,000 invested at inception in 2003: $54,853
This was an unusually tough week for growth stocks and the indices. Fortunately, our portfolio's losses were buffered somewhat by the large amount of cash being held, and the portfolio's partial hedge against the broad market.
The model portfolio has been "out-of-phase" with the market for several months now, since the March lows. This is reflected in the smaller than normal number of stocks that are passing the model's screens, and the higher than normal amount of cash being held in our portfolio.
For what it is worth, I am reading that other hedge fund managers managing with a similar long/short style are experiencing the same dynamic. Fortunately this dynamic represents the exception since the market doesn't normally decline 55% in a panic driven cascading failure such as we saw last year.
In hindsight, the nature of a snap back rally following a generational decline doesn't favor high quality growth stocks and therefore our stocks didn't outperform the market off the bottom. Unfortunately I don't have the luxury of selecting a strategy in hindsight and so will continue to allocate our capital in accordance with our long-term statistical edge.
The good news is that the model portfolio has retained a large portion of its bear market gains, while the broad market remains significantly below its 2007 peak. It's a good reminder that there will be periods where the model is out-of-phase, and the best we can hope for during these periods is to protect our capital and accumulated gains, which the model portfolio has done.
Many mutual fund managers are reporting significant gains in 2009, but upon closer inspection it is clear that they have not come close to regaining the investor money they lost during 2007-08. It is amusing to see fund marketers hype their short term results now as though their 3 and 5 year returns no longer matter. They really have NO shame!
Fortunately, this endeavor is a marathon and not a sprint. During times like this patience can be a virtue.
Sunday, October 25, 2009
Sunday, October 18, 2009
The Dow Jones Industrial Index passed a psychological milestone this week as the Index broke above the 10,000 level for the first time in a year. The Dow first broke above 10,000 more than ten years ago in 1999 and has since done so on 26 occasions.
Yes, a ten-year buy-and-hold (buy-and-hope) index investor has had NO capital gain over the period!
Sunday, October 11, 2009
Saturday, October 10, 2009
The system's objective remains constant... to significantly outperform our benchmarks over the complete bull/bear market cycle, with smaller periodic losses than experienced by a passive buy-and-hold strategy. While the model portfolio hasn't been winning the sprint over the past 6 months, it is clearly winning the marathon over the full market cycle.
The model portfolio is also doing an excellent job of managing downside risk. The model's largest periodic loss (from peak to trough) is less than 13%, while the S&P 500 index lost more than 55% at its trough in March. The model portfolio is now within 5% of its all-time peak, while the S&P 500 is still trading more than 33% below its all-time peak made in October 2007.
The model portfolio is up more than 43% over the same period.
Sunday, October 4, 2009
In April, I highlighted a market volume study by Bill Hester of Hussman Funds, where he noted in "Trading Volume Separates Bull Markets from Bear Rallies" that bull markets have typically begun on strong volume after selling had become exhausted. Since Supply and Demand are the fundamental drivers for price movement, Hester's analysis provides valuable insight as to the nature of the current rally and possible future outcomes.
In his latest market volume study, Hester writes, "This chart (above) updates one of the graphs for the elapsed time from that earlier piece. The vertical axis measures the six-month percent change in the S&P 500 from the bottom of each bear market going back to the early 1940's. The horizontal axis shows the percent change in volume over that same period.
Familiar durable bear-market bottoms stand out, like in 1982 and 1974. These rallies had strong returns that coincided with large bursts of trading volume during the first six months of the rally. There are a couple of examples, like 1998 and 2003, where bull markets had a good start on mediocre expansions in volume. But for the most part, in the cases where volume contracted the bull market beginnings have been uninspiring. More common is a strong increase in volume that coincides with gains of 20 to 25 percent during the first six months. It's clear that this year's rally is an extreme outlier in the dataset, with above-average returns and a continued contraction in volume from the levels of trading in March."
Hester goes on to break out the volume of a handful of "phoenix" stocks that account for a huge share of the volume of this rally, such as AIG, Fannie Mae, Freddie Mac, Citigroup and Bank of America. When the Phoenix stocks are taken into account, the volume story is even more ominous. For Hester's full report, click here.
Rather than base our investments on predictions, the Strategic Growth Model will continue to align its capital with the current market conditions, profiting from the statistical edge the system provides over the intermediate timeframe. For now, the intermediate market trend is UP.
Sunday, September 27, 2009
Saturday, September 26, 2009
I believe that the Deleverage Process, the self reinforcing cycle of deleveraging or credit contraction, is the cornerstone of the bearish viewpoint. I also believe that attitudes towards home ownership and credit have changed, and the change is long term, not merely cyclical. As evidence that the D-Process is still running its course, consumers saw a record $20 billion of outstanding credit evaporate in August.
The above chart shows that the the private sector has deleveraged (reduced credit/debt) by over $6 trillion since 2006. Meanwhile the government has injected nearly $2 trillion of liquidity through with the help of the Fed's new credit facilities. Basically, the government is printing money like mad, hoping to forestall or at least moderate the destruction of our economy's capital base and prevent an all-out economic death spiral. Until the D-Process runs its course and we see a return to the virtuous cycle of credit formation in the private sector, I believe that the Fed will be more concerned with deflation than inflation. Inflation is a "problem" but deflation would be a full blown crisis.
For more on the D-Process, see this article by Ray Dalio, "Recession? No, It's a D-process, and It Will Be Long"
Ray Dalio of Bridgewater has done a better job than almost anyone of describing the current debt deleveraging process, and how it will play out. This Barron’s article contains a lengthy interview with Dalio, and it is a must-read as he describes the dynamic that has been underway in our markets.
Rather than base our investments on predictions, the Strategic Growth Model will continue to align its capital with the current market conditions, profiting from the statistical edge the system provides over the intermediate timeframe. For now, the market trend is UP.
During the same period, 83% of investment newsletters were down, while the dividend-reinvested Wilshire 5000 Total Stock Market Index also dropped by -18.4%.
The past 52 weeks have been a tenuous time of market turmoil, yet the model portfolio has managed to not only survive the chaos but thrive on it.
Given the severity of the stress test that the market has thrown at our investing system, I am as confident as ever that it will continue to deliver market-beating performance in the years ahead.
Thursday, September 24, 2009
Each week, the system's predictive model selects up to 10 stocks for the ASM-10 portfolio. Many stocks will be held over from the previous week, while a few lower ranking stocks will be replaced with higher ranking stocks. The selection criteria are based on growth characteristics that are common to the "big winners" in the model database. The ASM-10 portfolio is the system's "alpha engine." These stocks are expected to generate above market returns, giving us a winning edge.
The table shows the model's win / loss ratio along with other performance data for three time periods. Data from 2003-06 were used to develop the predictive model. I then used out-of-sample data from 2007 to validate that the model's strong performance wasn't due to over-fitting the data. Over fitting can result in a system that performs well in simulation mode, but fails miserably in the real world. Upon validation it was time for the ultimate stress test.
In January 2008 I began a live system test on my public blog, posting each trade in advance. What I didn't know then was that market conditions were due for a seismic shift, as the economy entered into what some now call The Great Recession.
Over the past 87 weeks of the live test, the system executed over 130 round-trip trades in the ASM-10 portfolio. This sample is large enough to have statistical merit. And when combined with the additional 52 weeks of 2007 out-of-sample data, it is even more significant.
To summarize the performance data shown in the table here, the model's performance has held up very well under the stress of real world conditions. It performed nearly as well in bear market conditions as it did during the preceeding bull market. While its win / loss ratio is close to 50%, nothing spectacular, what makes the model so profitable is that the average percentage gain on each winning trade is more than twice as great as the average loss on each losing trade. This epitomizes the trader's adage, "cut your losses short and let your winners run."
The system's "Tradeable Edge" (TE) Factor is the most meaningful performance measurement shown in the table. This factor multiplies the win / loss ratio and the %gain / %loss ratio to quantify the model's overall statistical edge. Anything greater than 1.0 implies profit potential. The system's TE Factor has maintained above 2.0 for all test periods, implying greater than 2:1 odds of gaining profits on any given trade. This is a powerful edge!
More system performance measures, such as Maximum Drawdown (interim loss), Beta and Sharpe Ratio will be discussed in a future post.
Monday, September 21, 2009
Saturday, September 19, 2009
Sunday, September 13, 2009
Tuesday, September 8, 2009
Here's another look at how the model portfolio has performed compared to the benchmark index. The blue bars show the returns over the past 52 weeks, and the gold bars show the returns over the full 87 weeks of the live test.
You can see from this chart that the S&P 500 index lost an increasing amount of money as the live test progressed, while the model portfolio gained an increasing amount over the same period. This dynamic results in a very rewarding "excess return."
In financial circles, excess return is often referred to as "alpha." The chart shows that the system is generating a lot of alpha. This is good because alpha is the best measure of the "value added" by an active portfolio management system, above the returns generated by a standard buy-and-hold approach.
These results show that the trading system is "durable" because it maintained and actually exceeded its expected performance during the 2o month live test period. The system is also "robust" because its performance held up well under market conditions that were far more adverse than the prevailing conditions during the system development period.
These live test results are consistent with the test results obtained during system development. This is good.
Over the past 87 weeks of the live test, for the period ending 9/4/09, the model portfolio has returned +39.4% while the benchmark S&P 500 Index has lost -30.2%.
Therefore the model portfolio has generated an excess return (relative to the benchmark) of +69.6%, equal to +0.80% per week.
This works out to an annualized excess return of +51.3%, which remarkably exceeds the system's excess return for the 4 year period preceding the live test.
Monday, September 7, 2009
This is the first post to our new "private" blog, intended just for friends and family. If you are receiving this email, it's because I count you as one of my trusted friends or family! BTW, I imported all the old posts from the public blog to the new private blog, so everything is in one place for your easy reference.
Over the next few days I will be winding down the public blog as I wrap up the live test and post my analysis of the system's performance. I will also post the analysis here so that you don't miss anything. The public blog will then remain up as a track record for the system's performance, but no new trades will be posted there. This is to minimize the possibility that somebody might reverse engineer the system, which could degrade its future performance.
Each weekend I will post the next week's holdings here on the new private blog. Please bookmark the new website, FOSteve.blogspot.com. Out of consideration for our small group of investors, please do not re-distribute the new private blog's URL.
Some of you have asked me to supervise the management of various portfolios. I believe it is important to first become licensed as an investment adviser before taking on the management of other people's hard earned money. You may be aware that I recently passed the Unified Investment Adviser Law Exam, FINRA Series 65. I have been told that this exam has the lowest passing rate of any the FINRA law exams. Believe me, it was no cake-walk! Passing the law exam is a major step towards my goal of gaining a license, which I expect to be complete within a few weeks.
I will then be licensed as a "boutique" Registered Investment Advisor, with the aim of helping a small number of people who are close to me and share common goals. For the next few years this will continue to be a weekend endeavor as my full-time career in the software industry remains most important to me. Fortunately, the system I developed accommodates my work schedule since 1) all trades can be entered over the weekend, 2) it is hedged to minimize systemic market risk and 3) does not require close supervision during the week. I guess you could say it is designed to be a stress free approach to profitable investing. Works for me!
This is a pursuit born out of my passion for investing and trading the markets. I am fortunate that my software and systems background has equipped me to develop a unique approach to growing our portfolios while minimizing time and stress. So far, the performance of the system that I developed in 2003-06 has held up very well in 2007-present, as shown in the live test. It is gratifying that the performance over this period also compares extremely well with the top tier of professionally managed hedge funds.
While past performance is no guarantee of future returns (disclaimer!), it is my hope and desire that whatever skills and experience I have gained will also help my friends and family to achieve their financial goals. Thanks so much for your counsel and suggestions as we continue on this journey.
Sunday, September 6, 2009
Sunday, August 30, 2009
Saturday, August 22, 2009
Saturday, August 15, 2009
Saturday, August 8, 2009
Saturday, August 1, 2009
As the popular American humorist, Mark Twain said, "History doesn't repeat, but it often rhymes."
Last week's chart showed a stunning resemblence between the Dow from 1924-38 and the Nasdaq index from 1994-present.
This chart rolls the clock forward 6 years on the Dow Index, from the end of 1938 to the end of 1944. As you can see, while the stock market rallied at several points along the way, the overall action was mostly a slow decline. The final low was eventually reached in April of 1942, 40% below its level at the end of 1938.
So what does this possibly mean for the Nasdaq going forward? Well, as we know, history doesn't repeat! But if history "rhymes" the Nasdaq will bottom out around October of 2012 at a level more than 40% below today’s price level. Regardless of our expectations, we must at least be prepared for this possibility as we make our investment decisions.
Waiting three more years for the stock market to “get going again” is not something that most investors are prepared to do. Any investor who came of age during the bull market of the 1990s is still scratching their head, wondering what went wrong on the path of untold wealth. They may be waiting impatiently for things to “get back to the way they were.”
Of course “what went wrong” is that the stock market moves in unending cycles. Investors have become conditioned over the course of the past several decades to think that the stock market “always moves higher." "Buy and Hold" and "Buy the Dips" were profitable strategies.
You may recall from an earlier post (November 2008) that after the Dow topped out in 1929 it did not make a new all-time high until 1954. That's 26 years, a looong time to be patient! Likewise, the Dow gained no new ground from 1966 to 1982, a patient holding period of 16 years! So if this bear market does not ultimately bottom out until 2012, we will actually be getting off easy compared to other secular bear markets.
None of this should be viewed as a prediction. There is no crystal ball. While the Dow/Nasdaq comparison has been stunningly accurate over the last 15 years, it would be foolish to base our investment decisions on a belief that history will rhyme.
Rather than base our investments on predictions, the Strategic Growth Model will continue to align its capital with the current market conditions, profiting from the statistical edge it provides over the intermediate timeframe. For now, the market trend is UP.
Monday, July 27, 2009
Saturday, July 25, 2009
Here is a chart comparing the Dow Index from 1920-38, and the Nasdaq Index from 1994-present. The resemblence is striking! Assuming this is not due to chance, I attribute the resemblence to never changing human nature, the extraordinary popular delusion and the madness of crowds, the psychology of investors that drives bubbles to inflate and then pop. Over and over again.
Next week I'll roll the clock forward 6 years on the Dow Index to show how that story unfolded, to examine a possible scenario for how today's market may unfold over the next few years.
Saturday, July 18, 2009
Friday, July 17, 2009
How the stock market works
Once upon a time in a village, a man appeared and announced to the villagers that he would buy monkeys for $10 each.
The villagers, seeing that there were many monkeys around, went out to the forest and started catching them. The man bought thousands at $10 and as supply started to diminish, the villagers stopped their effort.
He further announced that he would now buy at $20. This renewed the efforts of the villagers and they started catching monkeys again.Soon the supply diminished even further and people started going back to their farms.
The offer increased to $25 each and the supply of monkeys became so little that it was an effort to even see a monkey, let alone catch it!
The man now announced that he would buy monkeys at $50! However, since he had to go to the city on some business, his assistant would now buy on behalf of him.
In the absence of the man, the assistant told the villagers; "Look at all these monkeys in the big cage that the man has collected. I will sell them to you at $35 and when the man returns from the city, you can sell them to him for $50 each."
The villagers rounded up with all their savings and bought all the monkeys. Then they never saw the man nor his assistant, only monkeys everywhere!
Now you have a better understanding of how the stock market works.
Sunday, July 12, 2009
Thursday, July 2, 2009
Today, the Labor Department reported that nonfarm payrolls (jobs) decreased by 467,000 in June. The stock market declined sharply on the news. This chart puts that decline into perspective by comparing job losses during the current economic recession (solid red line) to that of the last recession (dashed gold line) and the average recession from 1954-2006 (dashed blue line). As the chart illustrates, the current job market has suffered losses that are nearly three times as much as the average. In fact, if this were an average recession/job loss cycle, the number of jobs would have begun to increase three months ago.
Monday, June 29, 2009
The above chart shows the model portfolio returns since inception.
Note that there are three timing signals. BUY signals an intermediate-term uptrend is underway within a long-term market uptrend; this is usually a profitable time to be invested in a stock portfolio. A NEUTRAL signal calls attention to an intermediate-term correction interrupting a long-term market uptrend; usually a good time to remain invested and perhaps add fresh capital to your portfolio. SELL signals that both the intermediate and long-term trends are down; usually a good time to go to cash or take a short position against a market index.
When I initiated this live test in January, 2008, many market pundits were encouraging individual investors to stay the course, and remain fully invested in their stock portfolios, even though it was clear to many at the time that the economy was at the brink of recession. At the time I had no idea how deep the market downturn would be, only that the system's Thrust / Trend Timing model was signaling poor market conditions.
Over the past 40+ years of a secular bull market leading up to this secular bear market, "buy-and-hold" had become dogma. To assert that an agile investor can profitably time the market still invites ridicule from many so called professionals. For many, their primary goal is to retain control of your assets. This is how they are paid, by having your assets under their control. Unfortunately, they are less concerned about growing your assets. Many have been coached that the best way to retain control of your assets is to encourage a passive buy-and-hold mentality.
Now a year later, most of those professionals are busy explaining why their clients' portfolios have been halved. You will often hear, "Nobody saw this one coming." and "There was no safe place to hide." What more can they possibly say. They didn't have a clue!
If nothing else, this live test has shown that a basic Thrust/Trend Timing model can help investors positions their assets in alignment with PREVAILING market conditions, helping to avoid the big loss that can take years to recover.
Saturday, June 27, 2009
Sunday, June 21, 2009
Saturday, June 13, 2009
Saturday, June 6, 2009
Saturday, May 30, 2009
Monday, May 25, 2009
Saturday, May 16, 2009
Saturday, May 9, 2009
Sunday, May 3, 2009
Saturday, April 25, 2009
Returns for week ending 4/24/09
Model portfolio, hypothetical returns for past…
1 week: -2.8%
52 weeks: +19.8%
Value of $10,000 invested at inception in 2003: $52,908
S&P 500 Index, returns (with dividends) for past…
52 weeks: -36.0%
Comment regarding past few week's performance: The model portfolio has not participated in the market gains since the March bottom. This is disappointing of course, but not a complete surprise due to the nature of the current rally, rebounding sharply off of a historic market sell-off.
Market technicians have noted that this rally has been largely fueled by "short covering" as evidenced by the tepid trading volume. This means that the formerly "most heavily sold" stocks with the biggest 52-week losses are now seeing the greatest gains. In other words, the market's lagging sectors have been leading this rally. There is a saying that "even turkeys can try to fly in a windstorm."
It is important to note that the Strategic Growth Model is purposely designed to deliver non-correlated returns over time, and its short term performance will often not mirror the market trend. Of course, when market conditions are poor, this is a very good thing, as evidenced by the model portfolio's 52 week returns vs. the S&P 500 index. The Strategic Growth Model has continued to perform within its design thresholds, even making a new high water mark a few weeks ago.
As for the current rally, market internals currently indicate it is a bear rally and prone to failure. At some point market internals will become more robust and capital will favor growth stocks over the market laggards. At that time, I expect the Strategic Growth Model will again outperform the market as it detects the leading stocks in the ascendant sectors where growth capital is flowing.
In the meantime, the model's stock selection engine is finding very few growth stocks meeting its strict selection criteria. As a result the model portfolio is now holding more than 50% cash which will reduce the portfolio's risk as we await improved market conditions.
Is the current rally the beginning of a new Bull Market, or is it a "Bear Rally?"
Supply and Demand comprise the foundation of market pricing. Research shows that sustained rallies are usually accompanied with expanding volume, signaling increased demand for stocks.
"Volume tends to expand in the main direction of the trend. In a bull market, advances accompanied by increasing volume or declines on diminishing volume are taken to be bullish. Conversly, in a bear market, declines are accompanied by increasing volume and advances show diminishing volume. Volume should always be studied as a trend (relative to what has preceded)." -Richard Russell, The Dow Theory Today
Here is a link to an excellent study of trading volume by William Hester at Hussman Funds.
The chart shows that the current rally is truly historic in terms of percentage gain off the March bottom, but volume has not been expanding enough to instill confidence that this is more than a Bear Rally. To get the most meaning out of the chart, Hester's essay is required reading.
Here is the short course... The chart's blue dates represent the beginning of each bull market since 1940. The red dates represent this decade's bear-market rallies, including 4 during the 2000-2003 bear market and the rally that lasted from November of last year through January.
As Hester summarizes:
"... new bull markets, whether at their inception or soon after, have a history of recruiting noticeable improvements in volume. So far this rally lacks that important quality. Over the next few weeks stock market volume will be a metric to watch closely."
Saturday, April 18, 2009
Sunday, April 12, 2009
The market's recent 25% advance off the March lows meets the technical definition of a "bull" market rally. The Market has rallied 25% in 4 weeks! Such a huge move in such a short period is truly historic.
The only times we have ever seen the stock market surge close to this much in such a short time frame were: December 1929, June 1931, August 1932, May 1933, July 1938 and September 1982.
In September 1982 and in May 1933, the stock market was indeed embarking on a new bull phase. In the the other 4 instances, the stock market went on to make a lower low in the months ahead. So based on this very small sample, there is a 2/3 chance that the market will decline further before making its final bottom. A wise investor will take this possibility into account as he puts capital at risk.
The Strategic Growth Model doesn't depend on predictions regarding where the Market is going from here. Rather it aligns capital in accordance with prevailing market conditions.
Never 100% long nor 100% short, the SGM's ability to generate excess returns depends more on selecting stocks that are likely to outperform the general market, and then managing the portfolio's risk through hedging. The SGM's allocation model also aims to take a defensive stance when market conditions are especially poor. The SGM's combination of stock selection, risk management, and market timing has enabled the model portfolio to generate uncorrelated, excess returns over the past 5+ years.
Market Conditions are currently positive. The Market's intermediate-term trend is UP. During periods such as this, the model portfolio will scale its allocation between market neutral and net-50%-long. This range of allocations takes advantage of the model's statistical edge, hopefully enabling the portfolio to make a profit over the coming weeks.