In my earlier “Rant” post (https://itawealth.com/philosophical-rant-momentum-investing-effect-rutherford-portfolio/) I looked at the impact of the 2016 Presidential Elections on the performance of the Rutherford Portfolio, eight days after the elections, using our “Standard” Kipling momentum ranking methodology. The portfolio lost 5% of it’s value in that period and it is a valid question to ask whether this could have been avoided. I think that based on the restrictions we place on ourselves by stipulating that we will only review portfolios on a ~monthly (e.g. 33-day) basis, the answer to this question is – probably not. In addition, the momentum strategy, as setup using the “standard” (~3-month/6-month) look-back periods, is deliberately designed to select assets that have a better-than-average chance of performing well over the next 30 days or so. So, the only “reasonable” possible improvement I see would have been to have had fixed stops in place (with no limit) at the levels calculated in the position sizing sheet. This is one example where this might have been the best option (but would not totally have avoided a loss) – but, as most of us are aware, this is not always the best choice – especially if we believe there is a possibility of a Black Swan “Flash Crash”. There was such an instance in this period but, fortunately, it occurred in after-hours trading, when most markets were closed, and would only have affected Futures traders.
This then raises the question “Is there a better strategy?”. Of course, with hindsight we can usually find a strategy to generate better performance by back-fitting our strategy to fit the historical data – but this “new” strategy is unlikely to generate better results in the future. The alternative to using a trend-following strategy, such as momentum (or simple moving average cross-overs) would seem to be to adopt a mean-reversion strategy that tends to work better in sideways (oscillating/channeling) markets. Such systems are commonly used by short-term traders, and can be quite successful, but it is difficult to design such a system for an “investor” whose goal is to hold a position for a number of months – the periodicity of the “cycles” needs to be large. As an “investor” (with a 33-day review cycle), how would you trade this 2-year chart of VTI – even if you knew it was coming?
….the cycles are too short for an “ investor” to adjust – meanwhile, return from a strategic long holding, while positive, is small (~6%), and yet we would have had to go through a 17.5% Drawdown – poor return/risk (Sharpe <0.2). But this is probably the best performing broad-based asset group over the past 2 years!
What has changed since the elections and what might we expect ahead?
The Rutherford Portfolio is a globally diversified portfolio of broad-based assets and allows us to maintain diversity whilst selecting from a small baskets of ETFs – resulting in the option for us to hold and manage only a small number of assets.
However, since the assets are broad-based and represent holdings in a diverse subset of the asset classes they represent it makes it difficult for us to see exactly what might be changing in the markets. Most successful investors/money managers tend to filter top down – best performing market/asset class – best performing sectors within that market/asset class – best performing stocks within that sector. Here at ITA Wealth we tend to focus on keeping it simple and we tend to use broader based ETFs rather than individual stocks to populate our portfolios (although Lowell does run a few stock screens for members that might be interested). However, it is sometimes useful and interesting to dig a little deeper.
At the moment, we know that VTI (US Equities) is the only ETF passing our momentum ranking screen:
….. all other 9 ETFs are ranked below SHY and are sitting in a field of solid red negative indicators. This is good news in that it tells us that it is probably not wise to be holding these assets at the present time. So, despite the fact that US markets have dominated return performance over the past number of years and we might expect a pullback (I have been looking for this for the past 2 years) it appears that this is still the asset class in which to invest.
So let’s dig a little deeper and look at the performance of the 10 major sectors that comprise the US equity market. Here’s what our “standard” Tranche ranking sheet looks like at present:
We note that XLF (Financials) has been strong over the past 12 (trading) days – at least triggered by the expectation of a rise in interest rates in December – and that XLI (Industrials) has risen to the top since the elections (last 8 days) – presumably on the assumption that Trump will follow through on his election promise to invest in infrastructure projects. XLK (Technology), that had been strong, has dropped back to number 3 and XLE (Energy) has fallen off to 4th in the rankings. Our EMA indicators are all green for XLF, XLI and XLE but we have a negative “golden cross” warning for XLK. However, note that all absolute acceleration numbers, with the exception of Financials, are negative – telling us that momentum is decreasing (at least over the past 63 days compared to the last 126 days – the “standard” settings in my spreadsheet).
Now let’s tighten things up a little and change our short-term momentum to just 8 days (i.e. the period since the elections):
Not a big difference at the front end but notice how the back end has changed. [For simplicity I’ve kept the longer term momentum period fixed at 126 days and I’ve kept the weightings the same – but members wishing to try some of their own ideas can play with these parameters to suit their needs]. Now, look at those absolute acceleration numbers! 300+ for XLF and 140+ for XLI with lots of positives elsewhere – except for XLU (Utilities -180+) and XLP (Consumer Staples -125+). These are the movers and shakers – and the big losers – following the elections. XLRE is down – but this looks like it is more attributable to the expectation of higher interest rates rather than from any direct (impulsive) fallout from the election.
Thus, although we have seen a modest increase in the value of the overall index there has been a significant reshuffling of values within the sectors comprising the broader market.
If we take a look at the (daily) charts, this is what we see:
Financials have broken through the $20 resistance area and are now the big winner trading ~10+% higher…..
Industrials have broken through the $59 resistance area and are trading ~5% higher than pre-election……
The losers ,,,,, XLU down ~4%, through the $47 support level …….
And XLP, down ~3%, through the $51.5 level …….
Before closing I would also like to point out the significant (~12%) move in the Russell 2000 Small Cap Index…. From ~$118, through the $120 resistance level (like a knife through butter) and to the $132 level….
I’m sure this must be telling us something…..
The messages coming out of this post:
- Despite concerns at home, global reaction to Trump’s Presidency suggests that US Equity markets may be the big winner – at least in the short term – most other markets have been hit negatively with the US$ showing increased strength.
- Try breaking broader markets into smaller sectors/styles to see where the action is – even take a look at best performing stocks within those sectors/styles if you are so inclined.
- Don’t necessarily just accept default settings in the Kipling SSs – change some parameters to give you more information (although “default” settings may be more robust to determine allocations for longer term investment)
- Momentum may not be perfect and there will be times when it does not work well – however, the momentum filter will help enormously in bear markets by keeping us out of the market.
Invest sensibly so as to manage risk – the position sizing sheet should help in this regard.
All systems have strengths and weaknesses and, despite it’s limitations and weaknesses, I believe that a momentum system is maybe the best and simplest over the long term.
I hope this gives you even more to think about…..