Dan’s Blog

Killing the Markets, All by Myself

Dan Calandro - Thursday, March 26, 2015

One of the most paralyzing conditions for investors is when they’re scared of making a move – afraid of what might unexpectedly happen. How often things don’t go as planned -- and so they sometimes decide to leave well enough alone and hope issues magically disappear and/or correct, and that robust gains will automatically incubate out of thin air. Indecisiveness – that is, not taking action when a different outcome is desired – is an ingredient to failure.

Another tenant to failure is making changes to your portfolio simply for the sake of change. This will only produce change – and it will be luck that determines the outcome, be it good or bad. Gambling requires good luck. Investment requires no such thing.

Positive, long-lasting change comes most easily from logical, calculated reasoning, and superior 15-51 construction.

Confidence begins with an understanding of how your portfolio is built.

As you know, the Dow Jones Industrial Average recently made a component change, replacing perennial underperformer AT&T with consummate highflier Apple. The change was announced on March 6, 2015, two weeks prior to the move taking effect. The announcement, on March 6, caused me to reconsider my portfolio.

Because I know the Dow Jones Industrial Average and the 15-51 strength indicator like the backs of my hands, I instantly knew the impact the Apple change would have on both portfolios. This isn’t because I’m so smart, but because both portfolios are so easy to understand.

For instance, you don’t have to be a rocket scientist to figure that replacing a dog with a dynamo has no choice but to bolster performance. The Dow is comprised of just 30 stocks, after all. A one stock change represents 3% of the entire bunch – until you consider price. 

The Dow is a price weighted average. So at $120 per share, Apple will have about four times the weight as the stock it replaced, AT&T, which is currently trading around $30 per share. That puts Apple at fifth position from the top in Dow Jones ranking – a significant move from AT&T.   

The Apple change has no choice but to dramatically affect the trajectory of the Dow Jones Average.

Knowing this, and that one of my core objectives for the 15-51 strength indicator is to move in a market-like way as defined by the Dow, I knew instantly that the 15-51 indicator had to change when Dow Jones made their announcement. (For more information see: Today’s Paradox: Success with Less Money).

The objective for my 15-51 move was to keep that portfolio on the same trajectory as the Dow Jones Average.

Below is a one month chart of the Dow and 15-51. The dates changes were made to the portfolios are signified with diamonds on their according trend lines.

3-27-15

As you can see, 15-51 continues to move in a "market-like" way. It is also plain to see that it operates in an above-average way. That, by definition, is what it is supposed to do. In other words, my 15-51 portfolio does reliably what it is expected to do. 

Nothing breeds confidence and comfort more than executing objectives.

That’s a key benefit of the 15-51 system. Because it’s so easy to understand and use, desired results are more easily achieved.

Smaller portfolios are easier to understand, manage, and predict.

To prove that point, let’s once again turn to the S&P 500. The S&P is a much larger and more complex portfolio than the two previously mentioned, and because of that, has to change more to achieve its market objective. For instance, the S&P 500 has changed eight times so far this year – and six of those changes were made in the month of March 2015, with four coming on March 23 alone. The chart below includes S&P 500 activity (March 23 is noted with a black diamond on its trend line.)

3-27-15a

Remember, both the Dow and S&P have the same exact objective – to indicate the market average of stock market activity. The 15-51 objective is to indicate stock market strength. All three portfolios should move in a similar "market-like" way.

As you can see, the S&P 500 is struggling to achieve this core objective with its most recent moves. But that’s not because the people who manage it aren’t smart investment managers, or because they are trying to make the portfolio move in a contradictory way as the Dow. That’s not it at all. It’s because the portfolio is too big.

Managing a portfolio the size of the S&P 500 or bigger is so much harder than tending to the Dow or 15-51. That’s the reason S&P trends sometimes get away from what their management team wants. Its size makes it too easy to fall short of expectations. 

Smaller portfolios also produce greater investment returns.

This is also the reason teams of skilled fund managers consistently fail to achieve market returns while I routinely kill every mutual fund and market index from here to Shanghai, all by myself. 

And you can do it too.

Easy to understand. Simple to use. Superior results.

ShieldThe road to financial independence.™

Can One Export Derail Them All?

Dan Calandro - Sunday, March 15, 2015

Stock prices and yields are key indicators of economic vitality. In healthy markets they move together higher during expansions, and lower during downturns. These are both choreographed moves from central government planners as well as natural results from free market activity.  

Investors are naturally pulled towards higher rewards – and nothing outperforms the stock market during economic booms. As a result, capital leaves the bond market and enters the stock market during sturdy expansions. In order to lure that capital back to the bond market, borrowers (those who issue bonds) must raise interest rates, or sell their low interest rate bonds at a discount (thus causing the yield to rise), to incentivize those with capital to acquire debt rather than stocks.

In addition to the natural momentum of rising yields during expansions, central bankers add further impetus by raising core interest rates to control growth and thwart inflation. Core government rates drive all other interest rates, so a rise in them pushes all other yields higher than they would otherwise be.

Government action to raise interest rates is known as a "tightening" event.  Tight money and higher interest rates are generally associated with "strong dollar" conditions. 

Rising interest rates and the tightening of money makes a country’s exports more expensive to foreign customers. Such a dynamic causes foreign demand to fall by some measure, which in turn causes corporate profits to fade by a correlating metric.  That’s the reason there has been so much ruckus surrounding the "strengthening" U.S. dollar.

But that’s not the whole concern facing American multi-nationals.

First a quick reiteration of the international environment. The entire Euro Zone has been in a no growth condition for a very long time and Japan (the world’s third largest economy) isn’t much better, growing at a sluggish 1% clip per year. China (the world’s largest economy) has been slowing for several consecutive quarters and recently downgraded their growth target; and Russia is a total mess (more on that a little later). But none of this – repeat, none of it – is new news. American export activity has been weak and unreliable for a long, long time.

So what’s different now – why all the hubbub?

It is important to note that Japan, and more recently Europe, have initiated multi-billion quantitative easing programs – and that is the fly in the ointment.

In America, quantitative easing (QE) was born from the subprime mortgage debacle termed "the financial crisis" which ended with the crash of the financial system in the fall of 2008. An emergency measure called TARP (Troubled Asset Relief Program) was installed just before President G. W. Bush left office – and that’s when the monetary ponzi scheme began. So TARP is the forefather of QE, and the last QE effort in the United States ended in late 2014.

The point here: QE lingers around for a long time once initiated.

QE is monetary technique used to lower yields and devalue currency. QE is a "loosening" monetary event. So it should be no surprise that currencies who deploy it depreciate against those that don’t – as the U.S. depreciated against the Euro when its QE began in 2008, and how Europe is now depreciating against the dollar with its new QE effort.

And let there be no mistake, Europe and Japan are devaluing their currencies with reason. They want to make their products cheaper in their country, for their constituents, and their consumers. Their hope, without question, is for their producers to grow at the expense of foreign competitors like the U.S. and China. It’s quite logical really, and can be tied directly to the U.S. stock market.

Will newly installed QE programs in foreign countries start to steal profits from American producers – and if so, how will that affect the U.S. economy and stock market?

It is important to note that while Europe is the latest to join the QE folly, not every country is playing the same kind of game. China does things much differently, but has recently injected billions of dollars into their banking system to loosen things up. Russia, a country with a $2 trillion GDP, doesn’t know what to do. After raising rates sharply they’re now cutting interest rates to fight inflation and recession at the same time. They’re losing the money game – which is the reason they’re picking on the Ukraine, but that’s another story.

The point here: all major economies have engaged in the first money war of the 21st century – so the ending can’t be good.

Up until now central bankers have been in a collective race to the bottom. The U.S. led the world by aggressively devaluing the dollar with TARP, QE, aggressive interest rate cuts and massive central government spending. Most major countries followed suit with ambitious interest rate cuts and central government stimulus programs, but all opted to stay away from schemes like QE – until recently, that is.

The U.S. was first-in and now it is trying to be first-out of the money pyramid. It is widely expected that the Federal Reserve will start raising interest rates in just a few months (June 2015) – this after exiting QE a similar short time ago. These tightening events are taking place while the rest of the world is loosening monetary policy.

This opposing dynamic adds fuel to the export fire.

Consider that U.S. exports are roughly 14% of GDP. At that contribution a 10% drop would cut U.S. growth in half for 2015. That’s the economic issue to consider – and as we know, economic threats factor greatly into stock price speculation. 

Another speculative threat to prices is the strange new trading environment for stocks. It has been so long since the U.S. operated in a rising yield, tight money environment – especially one that follows such a prolonged period of inflation induced by QE intoxication. This historical first will be interesting to watch.

And since so many foreign countries waited so long to loosen monetary policy as aggressively as the U.S. did, an equally long delay to their tightening events should be expected. That means the pricing disadvantage for U.S. exports will last for some time. Call it a new normal.

Investors need to realize that a tightening monetary event totally changes the stock market dynamic.

Strong expansions like the tech-boom and housing-boom were able to handle strong dollar and tight money dynamics – higher yields and taxes, and costlier exports – and still produce solid growth rates. But this expansion isn’t like those. This economic expansion is centrally levered and directed. The other two were consumer driven, which is the reason GDP growth was so much stronger then than it is today – which is also the reason this economy, corporate profits, and stock prices are so vulnerable.

Confusion about the market’s susceptibility festers because the U.S. economy appears to be strong when it really isn’t. Unemployment is 5.5% – but labor participation is at a 40 year low; the stock market is at all-time highs – but economic growth is weak and uneven; the dollar is strengthening – but that’s only because major global currencies are aggressively devaluing.

These are the same reasons the Dow Jones Industrial Average has been scared away from the 18,500 top, the 10 year yield remains near the basement at 2%, and gold appears weak, down 10% in the most recent month. Below is a two year chart.

3-13-15a

Weak and strong are only appearances in these crazy and unprecedented times. After all, we live in a world where the mass media is consumed with speculation about the condition of corporate exports when the root cause of the problem isn’t even mentioned, let alone in proper context. That could lead some investors to question what they’re seeing and believing.

Indeed, American goods are going to get a lot more expensive overseas for a long period of time. Demand for U.S. products over there should fall, and corporate profits and stocks prices here should follow to a correlating metric. And it will be one U.S. export -- a government product called QE – that will cause it all.

Stay tuned…

ShieldThe road to financial independence.™

Today's Paradox: Success with Less Money

Dan Calandro - Monday, March 09, 2015

Last week Dow Jones announced that Apple will replace battered telecom giant AT&T in the Industrial Average. The change will take place on March 19, 2015, and while most theories regarding the change point to the impending 4-to-1 stock-split of another Dow component (Visa), I suggest a very different motive: Poor Performance. See below.

3-6-15a

There is only one reason a 500 stock portfolio consistently outperforms a 30 stock portfolio for three consecutive years – inferior construction and/or components. And no one knows this better than the members of the Dow Jones selection committee.

People who have read my book know how much respect I have for those responsible for the Dow Jones Industrial Average. It really is a brilliant piece of work. But to be fair they’ve had a tough time solidifying the portfolio since the ’08 meltdown.  This Apple move will represent the tenth change to the Industrial Average since trading began in the ’08 year. While I’m sure they didn’t want to make another move so soon – they had to.

Despite all the hype and hoopla surrounding the Dow’s recent streak of new record highs, its performance has been weak as comapred to the S&P 500. In the three year trend shown above the S&P 500 outgained the Dow Average 65% to 46%, respectively. That's too much, for too long. The Dow needed a change to improve its performance.

So not the case with the 15-51 strength indicator.

As you know, the objective of that portfolio is to indicate how stock market strength is performing. It should produce above-average market returns on a consistent basis, which it reliably does. See below.

3-6-15b

The 15-51 Indicator produced an index-leading 77% gain in this three year period while also moving in a "market-like" way. That’s what it is supposed to do. And while I believe it will continue to produce above-average returns in its current form, I’m not so sure it will continue to move in a market-like way.

The Dow Jones Industrial Average is replacing AT&T with Apple, a stock that produced a 31% gain in the last five years with one that added 291% in the same time. Needless to say, the move will significantly change the trajectory of the Dow Average. That dynamic, all by itself, might cause the 15-51 Indicator to move in an "un-market-like" way. So after much thought and analysis, I decided to again modify the 15-51 Indicator. 

The last time the Indicator was altered was year-end 2011; it was the first change in its history. (See: Re-defining Strength) I took some heat over that move because it was announced in arrears. Some thought the after the fact announcement was intended to enhance or protect the 15-51 indicator’s performance trend, which is silly. The original and unchanged 15-51 portfolio detailed on page 162 of my book continues to outperform all others; it was up 92% in the same period shown above. A comparison of the portfolios is below. 

3-6-15c

As you can see, the original 15-51 portfolio wasn’t moving in a market-like way – and Apple was the reason for that. Its performance was too strong, too volatile, and too contrary to market movements. It constantly pushed the portfolio’s performance and allocations far beyond market boundaries -- so much so it was making it impossible for the portfolio to meet its objectives.

Performance – and market movement – are key objectives for the 15-51 Indicator. It must produce above-average returns and move in a market-like way. If it fails in either of these cases it must be changed. That’s why Apple was removed in 2011.

And that’s why it will return.

15-51 component IBM has a similar five year return as AT&T (24% versus 31% respectively) which is way below the market average during the time. IBM also has some significant operating issues to face; it no longer has a dominant position in the marketplace, suffers from an identity crisis, and seriously needs to reinvent itself. It really doesn’t deserve a place in a strength-oriented portfolio. 

As a result, Apple will replace IBM in the 15-51 indicator at the IS: 2-2 position. The portfolio will also be rebalanced at the same time. The change will take effect at the close of trading on March 18, 2015, one day after Visa splits 4-for-1 and one day before Apple appears in Dow trading. The move will elevate the 15-51’s technology allocation similar to that of "the market," and should keep it on the same trajectory as the Dow.

Success is about achieving goals – and comfort-level is a key component.

Movement is a key objective for me because I take comfort in knowing exactly how my portfolio will act under any condition. Prior to making the changes to the 15-51 portfolio in 2011, its movement became more about Apple and less about "the market." I’m not comfortable with that dynamic, so I made the change.—And I wasn’t scared about losing the powerful performance of Apple because I knew I could get robust performance with a less volatile, less risky, 15-51 portfolio. Proof of that can be seen in the table of three-year returns shown below. 

 

 

ROI

Pts Off

% Off

o15-51  (original, static)

92%

 

 

 15-51si (strength)

77%

-15%

-16%

S&P 500 (average+)

65%

-27%

-30%

DJIA (average)

46%

-46%

-50%

Apple more than doubled during this time (132%) and the stock I replaced it with only grew 76%, which is better than the market average but half of what Apple produced. 

There is no such thing as a free lunch with investment.

There was a cost to achieving my desired pattern of movement. However, by earning less return the portfolio went from failure (not achieving objectives) to success (achieving objectives). Success, therefore, was obtained by earning less money and gaining more comfort. That's a trade I was more than willing to make - and it was made easier by my 15-51 method. 

The 15-51 method has a lot of good traits; it’s simple, stable, and flexible. But perhaps its best feature is the long-term profit power it produces. The method allows investors to be more cautious while still earning great rewards. See below.  

3-6-15d

Since inception in 1996, stock market strength via the 15-51 Indicator has produced an amazing 1,606% return – despite my efforts to produce less. The market average added just 243% in the same time – despite their efforts to produce more.

That’s today’s paradox. 

LYB_Cover-NEW

PS: Email me if you want the indicator’s change list.


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