Performance summary since inception

This chart shows the performance of the model portfolio compared to our benchmark index since the model's inception.

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.

Trading Volume Separates Bull Markets from Bear Rallies - Part 2

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.

Returns for week ending 10/2/09

Model portfolio, hypothetical returns for past…
1 week: -0.4%
52 weeks: +13.0%

Value of $10,000 invested at inception in 2003: $55,643

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%

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.

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.

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%

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.

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