Miguel Barbosa has posted his interview with James Montier here and here.  There are some gems in the interview that I agree with such as:

• the dangers of irrelevant information
• volatility is not a measure of a risk
• the uselessness of pro forma earnings
• mastering emotions is one of the most important things an investor can and should do

FJP

With this post two years ago, I began publicly discussing my market timers and the relevant models.  It has been an interesting two years with lots of volatility in the markets. When I began blogging, the intent wasn’t to attract an audience but to become a better investor.  Having your investment decisions in the public domain for all to see can be a very humbling experience.  On the other hand, discussing your investment decisions has to make you a better investor because you have to back up your decisions in public and that is what makes one think through decisions more so than he might otherwise.

Let’s review the performance of my models over the past two years.

Canadian Leveraged Models

US Leveraged Models

US Non-Leveraged Models

Personally speaking, I think the returns are excellent but I’m biased!

Are there any caveats with my models? Of course there are – nobody can produce the consistent returns Bernie Madoff claimed to have made.  By definition, a trend following system will have drawdowns that will make the system’s followers wonder why they didn’t sell at higher levels.  If you apply tight stops to a trend following system the whipsaws will deteriorate the overall performance of the system.  You have to keep in mind, though, that the maximum drawdowns for my models are much less the the maximum drawdown experienced by a buy-and-hold investor.

Returns produced by my models are lumpy and the leveraging increases the “lumpiness”.  This characteristic of the models may make it difficult for some investors but when you look at the performance over a longer term, the end result is well worth it.

FJP

After my last post I decided to change my plans for the day and run a backtest on the model discussed in my last post.  I ran the test from June, 2000 to present and each time my US timer gave a long signal the model bought the two ETF’s having the best prior six-month performance and went to cash on a sell signal.  This model produced an 8.5% compound annual growth rate with a 21.7% maximum drawdown versus a compound annual growth rate of 2.1% and a maximum drawdown of 59.9% for the Russell 2000.  However, a model based on simply buying IWM (iShares Russell 2000) each time my US timer went long and going to cash on a sell signal produced an 11.6% compound annual growth rate with a maximum drawdown of only 14.3%.

There may be a way to improve the two sector ETF model: instead of holding the two ETF’s for the duration of the long signal we could run the selection process every month and switch ETF’s as necessary.  In order to match the IWM model, this monthly switching would have to add 3.1% per year.  That’s a study for a rainy day!  For now, I’ll leave my IWM/RWM model on Collective2 as it is – hold IWM when my US timer is long and hold RWM when my US timer is short.

FJP

After preparing my last post, I decided to test the thought of selecting ETF’s representing the top two best performing sectors over the previous six months each timer my timer generates a long signal.  These two ETF’s would then be held until my timer generates a sell signal.  I randomly selected six trades between 2007 and present and the average return on IWM (iShares Russell 2000 ETF) was 4.2% but the average return on the two selected ETF’s was 8.5%.

Obviously six trades doesn’t constitute a statistically significant sample size but I don’t have the time to test my hypothesis on every long signal my timer generated going back to 2000.  However, I am reasonably comfortable recommending to subscribers that, if you are using my US timer to buy and sell IWM, you should consider splitting your purchases to 1/3 IWM and 1/3 for each of the two ETF’s selected as noted above.

One area for further study is whether we should evaluate the two ETF’s after holding them for one month.  For example, if after holding the two ETF’s for one month we check the past six month’s performance and find that two different sectors are now the top performers should we sell our existing two ETF’s and purchase the two representing the noted sectors?  One consideration here that is specific to the investor is the level of activity one is prepared to take on.  Evaluating the holdings every month may be more than some investors want to perform.

I am considering changing my IWM/RWM model on Collective2 to buy IWM and two of the top performing sector ETF’s based on the previous six months when my timer goes long.  If I do make the change and you want to follow this strategy, you can autotrade through Collective2 or follow the signals which are e-mailed by Collective2.

FJP

Click on this link to view a paper prepared by Dorsey Wright & Associates Money Management which presents their findings relating to their study of investing in stocks on the basis of 1-month to 5-year relative performance.

In 1993, Jegadeesh and Titman published the paper, “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency.” Their research showed momentum strategies based solely on historical pricing data outperformed over time. This was a serious blow to the Efficient Market Hypothesis because it had been commonly assumed no investment strategy based solely on publicly available data could outperform the market over time. Their work has spawned scores of research papers on the topic of momentum and relative strength. Over time, research has shown that momentum exists over intermediate time horizons. Momentum also exists across asset classes, countries, and in many other areas. There has been so much research showing that momentum works that academics no longer dispute its value as an investment factor.

The paper is an easy read and may give you some investing ideas.  For example, when my timer goes long you could buy ETF’s covering two of the top performing sectors over the past six months.

As per the above chart, if you were to buy two ETF’s based on the best six-month performance you would select XME (Metals) and XLY (Consumer Discretionary).

The folks at Dorsey Wright have a blog called Systematic Relative Strength which is worth a look.

FJP