2016-08-14
While most people think stock prices included in the major indexes, e.g., S&P 500, have had very little movement in the past year or so, prices actually have been rising at a faster than normal pace.
The S&P 500 ETF (SPY) was up +6.97% over the past year, which is close to its long-term normal performance; however, it is up a fantastic +18.27% in the last six months. Unfortunately, trading this past week has resulted in an index gain of just +0.13%, which is back to the long-term normal, and already the market Bears are out in force.
If you trade Exchange Traded Funds (ETFs), which I don’t because I need to understand the underlying fundamentals of the instruments I am taking positions in, then all you are doing is analyzing momentum, probably seeking to stick with the relative strength out-performers. Such systems are often referred to as Systematic Relative Strength, Tactical Asset Allocation or Sector Rotation Trading. Even if you are a believer in ETFs, and the systematic trading of them in your portfolio, the question is, do these systems work?
There are many studies that have been produced independently and objectively that show there are many failures that promoters of course overlook. Here’s a link to one. Also, here is a link to a study that illustrates the importance of understanding what you are trying to accomplish with simple trading systems.
Edit: In my comments to this blog, I referred to a mini-study I did quickly on an ETF promoter, Dimensional Financial Advisors (DFA). I could not manage to insert the table pdf in the comment, so I will do it here.
2016-08-14 blog illustr re DFA Funds
Some systems work; some don’t. The bigger issue, I feel, is whether a trader is well served trading ETFs. If you believe these ETF trend-following systems work, then you refuse to accept the SEC warning that “Historical stock market performance is no indication of future results.” My guess is that as many people believe that SEC warning as cigarette smokers pay heed to the FDA required packaging notification that “Smoking causes lung cancer.”
A great many people wonder why government even has these regulatory agencies if their warnings are ignored. I on the other hand think the problem lies in the marketing, in systems that are designed to get the public to make decisions that are not in the public’s best interest, but in the promoter’s best interest.
Take the ubiquitous ETF market for instance. An ETF is a packaged service that purports to alleviate risk. But I can make the case that an ETF actually does the opposite. The promoters’ underlying message is that all stock traders are equal when these Wall Street promoters know in fact they are not. They and their friends have more access to useful information, have bigger computer systems to process data, often have substantial insider knowledge, and write compelling sales stories to develop the public’s interest. They also trade differently than the public. As a rule, they don’t buy equity in bad companies, and they don’t buy the stocks of fundamentally good companies at bad times in the market. So they tend to win, and the opportunity to win is why they are on Wall Street in the first place.
In buying an ETF, the public is led to believe that you don’t need to know the difference between a good company and a bad one, but it’s safe to buy them all as a pool. But in their everyday lives, the public does not make decisions like that. In a supermarket, the shopper picks over the fresh produce, never taking the first ones they can pick up from the display. They understand what they are buying.
The supermarket owner does not have to warn the shopper that the produce on display may not all be good purchases. They rely on the public’s common sense. On the other hand, the financial services industry says something like “Investing in this Fund is good for you” and their constant promotion leads the public to override their common sense. They believe the marketing claim and ignore the underlying reason for the SEC warning.
The bottom line is that I have to know what I’m buying before I buy it. Just because the momentum of the stock of a bad company is high at the moment is not a compelling reason to buy it. Worse, just because the momentum of an ETF of stocks you don’t even know the names of happens to be high at the moment, higher than that of other ETFs, you should not buy it on that basis. The SEC warning is there for a reason.
Now that I have cleared out the ETFs in the portfolios that I recently took control of, the performance has improved. As important to me as a brief spurt in performance is the fact I understand what it is I am investing in.
My trading is up +1.362% month-to-date (+3.133%/month or roughly +40% annualized) on a consolidated basis, which is outstanding compared to the market benchmark-weighted average (SPY and GDX) of +0.751% mtd (or about +22% annualized). Most traders would be long non-gold stocks, preferring the S&P 500, so their performance this mtd is +0.021% or roughly a Total Return of +6.5% annualized.
The bottom line is that I sell the S&P 500 company stocks when their relative fundamentals as well as their market price Trends & Cycles deteriorate, not when the overall market begins to look shaky. You see, I prefer investing in Quality as a risk management tool rather than a pool of unknown company stocks, making the participants buyers of the market rather than of the stocks in the market.
Many of you disagree with my thinking and will continue to listen to the sales pitches regarding ETFs. However, I’ll leave you with one thought. I’ve had a good career on Wall Street and know what those people are doing with their money. They pick stocks.
Enjoy your week. There is always something to look forward to. As things pop up during the week, I add my comments below.
/Bill
