Sunday, September 27, 2009

Returns for week ending 9/25/09

Model portfolio, hypothetical returns for past…
1 week: +1.2%
52 weeks: +21.20%

Value of $10,000 invested at inception in 2003: $56,103

S&P 500 Index, returns for past…
52 weeks: -13.5%

Saturday, September 26, 2009

If you are bearish...

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.

How does our performance compare?

During the final 52 weeks of the live test, the model portfolio returns were up +20.1%. According to an investor service where I subscribe, that would place the Strategic Growth Model portfolio third among nearly 200 investment newsletters, based on performance.

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

Live Test - Performance Summary #3

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

Returns for week ending 9/18/09

Model portfolio, hypothetical returns for past…
1 week: -1.1%
52 weeks: +23.0%

Value of $10,000 invested at inception in 2003: $55,452

S&P 500 Index, returns for past…
52 weeks: -14.0%

Saturday, September 19, 2009

On vacation today and tomorrow. Will post last week's results when I return.

Here are the changes to the portfolio for next week:

1) New position: Buy CHBT
2) New position: Buy RAX
3) Sell half of our hedge (TWM). e.g. For next week, the TWM position should equal 25% of your total stock positions.

We've seen a nice run in some of our stock positions. If you haven't already done so, this would be a good time to trim those positions that have become outsized due to large gains.

Sunday, September 13, 2009

Returns for week ending 9/11/09

Model portfolio, hypothetical returns for past…
1 week: +0.7%
52 weeks: +21.4%

Value of $10,000 invested at inception in 2003: $56,032

Tuesday, September 8, 2009

Live Test - Performance Summary #2

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.

Live Test - Performance Summary #1

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

Friend of Steve, allow me to introduce you to...

our new blog.

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, 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.

Best Regards,

Sunday, September 6, 2009

Returns for week ending 9/4/09

Model portfolio, hypothetical returns for past…
1 week: +0.3%
52 weeks: +20.1%

Value of $10,000 invested at inception in 2003: $55,660

S&P 500 Index, returns for past…
52 weeks: -18.5%