Dan’s Blog

Introducing 2.0: Redefining Strength

Dan Calandro - Tuesday, February 25, 2014

Introducing 2.0

At the beginning of the year I began writing my next literary effort, and as stated on the back cover of my first endeavor, "Don’t expect to see a sequel. Lose Your Broker Not Your Money has it all, including an unparalleled guarantee of performance and support via a totally free website…" In other words, everything I have to say about investment is contained in that book and on this website. There’s no room for a sequel. 

So while my next publication will not be an investment book per se, it will be closely connected to markets, people, and success (hey, you can’t change a leopard’s spots.) And the one thing that is consistent with those three nouns is change, which happens to be a major theme in my next book – and the topic of this blog.  

Up until now I have refrained from changing the make-up or balance of the 15-51 Indicator because it has continued to indicate stock market strength and above-average stock market performance. However, times have changed, things have changed, and "the market" has changed. In fact, the Dow Jones Industrial Average has changed so significantly since the last major correction that the 15-51i can no longer be considered a "market portfolio." Its current make-up is just too different than "the market’s."  

Now it cannot be said that I haven’t thought about changing the Indicator before. I have, many times. As a matter of fact I’ve had an updated "version 2.0" portfolio built for several years. But I never pulled the trigger. Allow me to explain…

Some of the most important lessons I tried to demonstrate in LYB are that successful investment follows basic logic and common sense; that it is not hard to do or understand; that patience is a virtue, and that there is absolutely no need to micro-manage and fiddle with your portfolio every time "the market" makes a move with some chutzpah. 

Indeed my approach is much different than the Wall Street establishment who attempts to convince people that they are too stupid to invest their own money successfully, and that successful investment requires minute-by-minute management, by teams of Ivy Leaguers with decades of Wall Street experience, and split-second executions.  

That’s total BS, and nothing more than a modern day version of the high-pressure sales tactics that inspired Martin Scorsese to chronicle Jordan Belfort’s stockbroker life in THE WOLF OF WALL STREET, a disgustingly accurate portrayal of that seedy business – and the exact kind of treachery that inspired me to write LOSE YOUR BROKER NOT YOUR MONEY.

Investing successfully requires only 5 things: basic math skills, common sense, the experiences of your life, a copy of my book, and the will to do it. That’s all.  

LOSE YOUR BROKER debunks every high-pressure sales pitch that has come out of Wall Street before Jordan Belfort stalked prey. The LYB method is easy to understand, simple to use, and produces dominant performance results. The long-term track record of success for the 15-51 Indicator is proof of its effectiveness; it hasn’t changed once in almost twenty years and yet it beat "the market" by more than 550%.

The 15-51 method is incredibly durable. But that doesn’t mean change isn’t necessary, or warranted. It is, and it’s for the 15-51 strength indicator to do what the Dow average has already done several times since the ’08 crash: rebalance and restructure. 

I have one more point to make before moving forward. Some have suggested that I shouldn’t change the 15-51 Indicator in fear that the book might become obsolete, outdated, or insignificant. I don’t buy into that one bit. Nothing on this website, no piece of information, fact, or advice, can diminish the value and worth of the LYB book. The 15-51 method is a unique and innovative approach that is proven to work – and success never goes out of style. That makes it a timeless piece. In fact, the only reason LYB isn’t a household name is because it hasn’t been properly advertised or marketed. That’s my fault, not the book’s content.

LYB was self-published by me, and along with the costs of running this website as part of my chapter 8 guarantee, represent a significant investment for me. And unfortunately every time advertising and marketing got to the top of my priority list something more important operationally came up. That happens – especially when working at the grassroots of business and investment. (Did I mention that patience is a virtue?)   

That said, a substantial investment in technology is required for me to update the 15-51 Indicator page of this website, and while I have sold my share of books, it isn’t enough to justify that level of investment – certainly not before proper investment is made in marketing and advertising. Besides, I can easily update the 15-51 strength indicator using charts prepared in Microsoft Excel and then presented in this blog area. So that’s what I’m going to do.

Redefining Strength 

Restructuring the strength portfolio opens up a new dimension in chart analysis. Comparing the trend-lines of two 15-51 portfolios (a static portfolio that remains unchanged versus one that was rebalanced and restructured) will provide the reader a two-sided picture of strength – a dynamic one and a static one. 

Two quick notes about rebalancing and restructuring: everyone has their own way and time of doing it; and there is no one right way to do it. 

My approach stands on the side of this basic logic: Knowing that the formula to profit is buying low and selling high, then it is only reasonable to over-weight in stocks when they’re low and to under-weight in stocks when they’re high. As such, there are three actionable points to rebalancing: when stocks are "high or low", and when they are at "fair value." 

I use the action zone to gauge those classifications. Here’s a look at it again.  

2-21-14a1

The action zone is a barometer for stock market valuation; according to it stocks remain "high" in value. And even though gold has been securitized the action zone is less helpful when determining its value. However it seems to have found a solid base at $1,260 an ounce (GLD at $122). The action zone can also helpful when determining your stock market allocation. 

Under current Market conditions, for example, if your target stock allocation is 50% then that’s what it should be when stocks are at "fair value" (when the Dow is around the midpoint of the action zone.) That allocation should fall to the low end of your range when stocks are "high," to say 15% of your total portfolio. The time to over-weight in stocks is when stocks are "low," which is when your stock allocation should increase to say 75%. 

This is to say that asset allocations are not, and should not be carved in granite. (It’s impossible to buy low and sell high if they are.) 

With that said, and following the theory and logic presented in LYB and these blogs, the 15-51i portfolio should have been rebalanced when the Dow reached sustainable "fair value" after the last correction. Consistent with my modus operandi, the most appropriate time for to rebalance it was at year end 2011, when "fair value" was calculated to be 11,245 Dow points. Here’s a tighter view of the Dow during that time.

2-21-14b

The Dow ended 2011 at 12,218, about 5% above fair value in Real terms. Using that date as the 15-51i’s rebalancing point will once again demonstrate that there is always plenty of time to make portfolio adjustments, and that perfect timing never factors into the formula for success. Besides, clean cutoffs like calendar year ends are completely logical triggers to rebalance.  

The 15-51i portfolio ended 2011 almost four times better than the Dow’s value, at 48,517 – that’s the amount to rebalance. And even though the strength indicator will be restructured and rebalanced, the unchanged original 15-51i portfolio will continue to be presented in these blogs, but alongside two sibling-like offspring. 

The first is a rebalanced and structurally modified market portfolio committed to indicating stock market strength and above-average sock market returns; that portfolio, a portfolio indicating stock market strength via superior 15-51 design and market diversification, will be signified as 15-51si and/or referred to as Version 2.0 (or V2). Here’s how that portfolio has performed since the end of 2011 compared to the Dow Jones Industrial Average.  

2-21-14c

As you can see the rebalanced 15-51 portfolio moves in the same manner as "the market" but with superior performance. It’s a much better picture of "market strength."

That’s the goal and purpose of 15-51 indication – to indicate the movements of stock market strength through superior construction that is consistent with market diversification. Such a portfolio should consistently produce above-market market returns, which it clearly does.

The original 15-51 strength Indicator, which was truly a "market portfolio" when it began in 1996, has begun to move in a way contrary to "the market." This difference can be seen quite clearly in the chart below that compares activity for the DJIA, the original 15-51 indicator (o15-51i), and the restructured strength indicator (15-51si).

2-21-14d

As you can see the original 15-51 strength indicator was clearly due for a change. It became too volatile and moved contrary to "the market" in dramatic fashion.  

Okay, there’s one more trend-line to show you. Since the rebalancing point of the 15-51 strength indicator is year ended 2011, all activity prior to that will be comprised of the original 15-51 portfolio. This trend-line will thereby show the true trend-line of stock market strength over a longer period of time. Take a look at the chart below that starts at year end 2009.

2-21-14e


The point at which the blue line and the maroon colored line separate is where rebalancing takes place, which occurred long before the 15-51 portfolio reached its all-time high in September 2012. This provides definitive proof that rebalancing does not have to occur at the optimal time to be extremely effective over time.  

The purpose of rebalancing is to minimize volatility, lock in gains, and to ensure stronger future performance.  

The DJIA, which was rebalanced and restructured several times during the period shown in the chart, gained just 54% since 2009. The static original 15-51i portfolio added 99%, and the rebalanced V2 portfolio (15-51si) produced an amazing 122% return. 

Rebalancing works.

And so does 15-51 construction. It’s better than market construction, which is why 15-51 strength consistently outperforms the average over the long-term. 

So going forward from this point stock market strength will be indicated by the bright blue line in charts, signified as 15-51si ("si" stands for strength indicator). The original 15-51 Indicator portfolio, signified as o15-51i ("o" standing for original) will continue to be tracked and presented – but only to illustrate how an unchanged, static 15-51 portfolio performs with complete managerial neglect. 

Below is a look at how these portfolios performed over the last three years. 

2-21-14f


During this time the Dow added 38%, the original 15-51 portfolio returned 46%, and the rebalanced 15-51 strength indicator gained 63%, while closely mimicking the Dow’s trend-line. 

That’s how a strong portfolio with market diversification should perform – and it also highlights the most important element of the LYB method and 15-51 construction: when "the market" is high your portfolio is higher. And that makes making money easier. 

That’s the Lose Your Broker way.  

Until next time, stay tuned…

ShieldThe road to financial independence.™

PS: If you’re interested in seeing the changes made to the 15-51 strength indicator please email me here

Action Zone: 2014

Dan Calandro - Thursday, February 13, 2014

With the recent release of GDP numbers for year ended 2013 it’s an appropriate time to update the action zone – the historical trading range for the Dow Jones Industrial Average.

The action zone is a dynamic range affected by ever changing conditions such as inflation, economic activity, and stock market multiples. It’s meant to be a gauge for assessing stock market values defined by three average price points: a high, low, and middle valuation.

Questions like when to buy or sell, or how to appropriately balance your asset allocations to current risk tolerances are much easier to answer with action zone guidance. Below is a long-term look at the newly calculated Action Zone.

2-12-14a

 

A few things jump out at me when looking at the above chart…

First, by leaping over Nominal GDP the Dow has been indicating a Bull Market since April 2013. A Bull Market is one where the stock market leads an expanding economy upward. Indeed it has taken a long time and a lot of QE to get the Dow up to this point –but should it keep going?

Historically “the market” trades substantially above Nominal GDP during times of robust economic growth, like the tech-boom and housing-boom. It should not be forgotten, however, that the Dow has performed several portfolio changes since the ’08 crash. That will serve as a double edged sword in the near term. The new portfolio forced mutual funds to buy the new Dow components (which forced “the market” higher) even though those new components were already over-valued when they were placed into the Average (this will force “the market” lower during the next correction.) See: Deal – What Deal? for more information.

The second thing that strikes me in the above chart is inflation. Now I know the government loves to say that inflation is mute or hard to see, but the difference between the top green line and the green-dotted line below it is the definition of inflation (Nominal GDP minus Real GDP = Inflation). At the present time there is at least 1,650 points of inflation in “the market.” The action zone makes that easy to see.

Inflation was 13% during the chart’s span; the Dow was up 25%, while the economy grew at just 8.5% in Real terms – a mere 1.9% per year. In other words, half of “the market’s” performance gain was due to inflation, not economic activity.

That’s what makes stocks so pricey here – there is no economic boom yet stocks are being valued as if one is ongoing.

Knowing that new Federal Reserve chairwoman Janet Yellen has committed to sticking to Ben Bernanke’s QE taper plan, stocks will need some other kind of support to maintain their high level – and there isn’t any

The QE-boom is ending, the economy continues to limp along, labor participation is at a 40 year low, government fiscal prudence is non-existent at least until March of 2015, and ObamaCare will hurt future economic activity way more than dreadful winter weather will affect GDP for the first quarter of 2014. 

Nevertheless, if you’re going to be in the stock market at any level your best bet is with a long-term view and a superior 15-51 portfolio. It really does change the investment picture.

 

2-12-14b

Stay tuned…

QE Forcing Fed's Hand

Dan Calandro - Monday, February 03, 2014

Stocks continued their downward trend this week but the move was muted by an overreaction to 4th quarter GDP numbers that were released on Thursday. Growth for the fourth quarter 2013 was announced to be an annual pace of 3.2% in Real terms.

However… 

Growth for the year of came in at just 1.3% – a paltry level at best. Indeed, the second half of 2013 grew at a much faster pace than the first half did – but so what? The year stunk in growth terms.

But even so, the Dow reversed its losing course and gained 110 points on Thursday. The gain, however, was short lived. After giving up 150 points on the last trading day of the week the Dow ended another 1% lighter than the week before. Stock market strength via the 15-51 Indicator lost 5%; and gold pared some its gains but continued to be positive for the year.

The first month of 2014 trading looks like this:

1-31-14

Also this week the Federal Reserve announced another reduction to the monthly level of quantitative easing (QE), which going forward will be $65 billion per month – still a lot of money. While a drop in QE should bring about a rise in yields, that rise doesn’t necessarily have to occur at the time of QE announcement. Recently, yields have been tempered by two things.

First, stock markets are jittery. When stocks are irrationally exuberant like they currently are it takes only little things to reallocate money from high risk stocks to safety – like renewed trouble in already struggling emerging markets. 

The effect of this is relatively simple to swallow. Fund managers, scared of a big stock sell-off, instinctively lower their high risk stock market allocations in favor of safety and security – a.k.a. U.S. Treasury securities. This move causes stock prices and yields to fall, as greater demand for bonds forces their value higher and their yields lower, because less interest is required to entice investors into buying them, because they are buying them for security instead of interest income. 

That’s one reason yields are falling along with another drop in QE.

A second reason for the move is that while the Federal Reserve is cutting one monetary tool (QE) it is employing a new one called Reverse Repurchase Agreements, or Reverse Repo, or RRP, for short. The program is still in its infancy, as testing only began in September 2013.

In the case of Reverse Repos the Federal Reserve sells some of its assets (like U.S. Treasuries and/or toxic asset-backed securities it acquired through QE) to counterparties (like banks, money market funds, and government sponsored enterprises like Fannie Mae and Freddie Mac) with an agreement to purchase those same securities back in the future. The difference between the sales price and the repayment is the effective interest rate, and since most RRP’s are short-term in nature, they essentially define the short-term borrowing rate. 

The RRP is expected to someday replace the Federal Funds Rate of interest for short term bank investments.

The Federal Funds Rate is the interest rate the Federal Reserve pays big banks for their deposits held at the Federal Reserve. For example, the Federal Reserve is Wells Fargo’s bank, and as such, it pays Wells Fargo interest on the deposits it keeps at the Nation’s bank – a.k.a. the Federal Reserve.

When the Federal Reserve wants to raise interest rates it has traditionally raised the Fed Funds rate to banks. Banks in turn raise interest rates to their customers, and the rest of the Market. 

As mentioned many times previously, QE has injected trillions of dollars into the financial system. The problem with that money is that it hasn’t reached the Market level – which is the reason QE has failed to get the economy going.

But that new money hasn’t disappeared, and is still on-hand at big American banks, laying idle in regard to the American economy, and instead invested in stocks and/or sovereign foreign debt.

QE money hasn’t been applied to the economic base or invested in growth and/or expansion for the simple reason that interest rates have been too low for too long. Banks simply don’t have the incentive to lend in any great extent. So they don’t. And because of this dynamic, there is a lot of excess liquidity in the financial system.

Traditionally, when the Federal Reserve wants to remove cash from the financial system it sells Treasury securities and receives cash back for the sale. It’s a straight up sale for cash, where the cash proceeds received by the Federal Reserve remain at the Fed, and thus removed from circulation in the marketplace. A tightening of money generally causes interest rates to rise.

The Fed’s QE program has injected several trillions of dollars of new money into the financial system and most of it has remained at the bank level. As interest rates rise that money will be shifted from expensive, risky, or non-earnings assets to higher interest collateralized loans. This will create a wave of market activity. As a result, there will be a time when the Federal Reserve will have to remove some of the QE money from circulation to avoid an environment of spiking yields and hyper-inflation.

So to remove this new money gracefully, the Fed can’t operate the way it normally has in the past – QE has changed that dynamic. For instance, during QE the Fed prints new money and exchanges it for some value of "toxic" assets leftover from the last financial crisis. Banks get new cash, and the Fed gets some crappy investments. Banks get healthier automatically because they end-up with less crap and more available cash to invest – which they do – ergo stock market inflation. 

So now the Fed has a ton of crappy assets on its balance sheet, and as always, a bunch of U.S. Treasury securities. The Fed can’t sell toxic assets back to the banks they were purchased from because that will make those banks more vulnerable and risky, and thus raise interest rates without intention. It also can’t flood the market with U.S. Treasury securities, as the increased supply will cause bond values to fall and yields to rise. 

Remember, the Fed wants to keep interest rates low. 

So how does the Fed liquidate these bad assets – or more importantly: How does the Fed remove all of the excess cash from the financial system without causing runaway interest rates and inflation?

Enter the Reverse Repo. 

The Federal Reserve has conjured up a new "tool" to parlay in the worldwide monetary shell game – and it’s called the Reverse Repo. This transaction allows the Fed to temporarily rid itself from toxic assets while banks pay them some modicum of interest for the associated risk (remember, the Federal Reserve has the only printing press for American dollars, and as such, it will never run out of money, and therefore, can always borrow money at the lowest rate of interest – even below the U.S. Treasury.)   

The tests conducted for RRP’s have thus far been termed "successful" by the Federal Reserve. That’s great, right?

The cynic doesn’t easily forget that the brain-trust at the Federal Reserve totally missed the last "financial crisis" and also failed to see the stock market bubble it created with QE. So while initial results of the Reverse Repo in this optimal environment have proved "successful", testing has done little to forecast effectiveness during the adversity real world dynamics bring.

For instance, in a world with rising interest rates and escalating inflation – why, let me ask, would banks want to buy low interest products from the Federal Reserve when they can lend those same investment dollars to the marketplace at much higher rates of interest?

Why would they do this? 

Indeed, the Fed wants low interest rates and the Reverse Repo is one way to achieve them – especially when inflation is at historic lows. But banks want higher rates of interest – and the economy needs them. Therein lay the dichotomy.

This Reverse Repo thing has just started to evolve, but it’s something to watch - because, as we know, reality has a habit of throwing a wrench into great new governmental theories.

Stay tuned...

Shield

The road to financial independence.™


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