2/27 Portfolio Update

Sorry... I missed a week... Last weekend my wife and I took a wonderful, but short, trip to visit my family to Florida and haven't had much of a chance to update the blog.

Below is the scorecard and although we are still outpacing most global and US stock and bond markets, the GSG (Commodity ETF) has really had a nice run lately.  The inflation chatter is back on the table and the prices of 'stuff' is going up again.  Gas is the most noticeable, which is a real drag on our wallets but is not necessarily a bad thing for our portfolios.

I am not making any major portfolio changes this week, but I am keeping a close watch on commodities relative to the international markets.  If I was a betting man I'd say if there are any asset class changes in the pipeline in the next few weeks it will be there.

For now, we let small caps, materials and the precious metals keep running and see how all of this Libya/Middle East stuff shakes out.  Again, I don't mean to downplay what is going on over there.  We are witnessing history, but keep your investment decisions and the 'news' in separate mental buckets.
Otherwise, full steam ahead and happy investing!

	Jan 24, 2011	today	% Change
My Portfolio	$99,994.75	$103,676	3.97%
S and P 500	1282	1319	2.89%
FTSE 100	5943	6001	0.98%
Commodities Index (GSG)	33.99	36.25	6.65%
20 Year Treasury (TLT)	92.43	92.2	-0.25%
US Dollar Index	78.30	77.21	-1.39%

Part Four: Relative Strength

The 5 Major Forces Affecting Your Investment Performance

by: Ben Crowley

1.Population

2.Supply and Demand

3.Asset Allocation

4.Relative Strength

5.Timing 

Part 4: Relative Strength

December 12, 2000... June 16, 2003.... July, 14 2008... April 9, 2009...

These four dates might not mean anything to any of you, but to me, they are game changing dates.  These dates proved to me (the most skeptical conspiracy theorist I know) that there is a magic bullet when it comes to investing.  Or at least, there is something close to a magic bullet... And I found it at the most unlikely place one would expect to find such information...  while working at a big brokerage firm.  You see most big firms are focused so diligently on the CYA (cover your a**) philosophy that they forget to manage assets. So there I was, in the the mecca of the buy and hold strategy universe, fresh out of school with my shiny new tool kit of financial information and no idea about ACTUALLY managing money.  

Sure, I went to business school, I studied finance and modern portfolio theory and asset allocation and the CAPM and valuation and accounting.  I know how to value companies and analyze data but this is not money management.  That stuff is important to somebody, but not to me and not to my investment strategy.  

I met and became fast friends with a lone wolf financial advisor who was actually MAKING his clients money back in 08 and 09.  Imagine that!  What I learned from this grizzled veteran money manger was that “Fundamental” information is important for helping you to decide WHAT to own, but it does very little to help you decide WHEN or IF you should own it.

I am also, as luck would have it, quite skeptical of "Technical Analysis".  I do not follow charts, or believe in them.  Using candlesticks, head and shoulders, hammers and all of those other charting patterns to guess what a stock price will do next is somewhat ridiculous.  The past does not determine the future and you cannot tell the direction of a stock price based solely on it's past price movements. Charting for charting sake is useless, BUT, in the investing world, you can tell something from performance, relative to something else's performance and the best way to do that is to plot it on a graph.  See: Point and Figure Charting, by Tom Dorsey for some a deep dive into the subject of Relative Strength.

Measuring Relative Strength allows me to know IF I should own something and WHEN I should own it.  Relative Strength compares the price performance of one investment with that of another.  Or another way to look at it is, “how well is this investment performing, in relation to this other potential investment?”  It tells me how an asset class or stock, or bond or ETF or Mutual fund is doing, TODAY, relative so some other metric.  

 The single most important metric in my portfolio decision making process is the relative strength comparison between the S&P 500 and the Money Market.  The Money Market is essentially benchmark for Cash and the S & P is widely accepted as the standard benchmark for the Stock Market.  Generally, the dollar and the stock market are negatively correlated.  That is, when one goes up in price, the other goes down.  So when the relationship between the two point to holding cash, you damn well better get out of stocks and play defense.  The four dates I mentioned at the top of this article are the ONLY four times this relationship has changed in the past eleven years.  When it does, you had better take action.  The chart below is a chart of the S&P since 1999 and I have plotted the four dates and the relationship change.  A buy signal means that the relationship between Cash and Stocks, favors owning Stocks.  A sell signal means that Cash is favored... a very defensive position.

This relationship is always going to be a few weeks or months after the top or bottom of a major market cycle, but I'll take as opposed to inaction or "Buy and Hold" any day. 


Now, let's do some quick hypothetical math.  If you used relative strength as your last line of defense and sold everything out on 12/20/2000 and waited out the down turn by sitting in Cash.  Your $100,000 account would have been blissfully sitting in a bank account missing out on 9/11 and all of the subsequent chaos in the market.  On June 16, 2003 your RS indicators tell you is is safe to jump back in and you are in the Markets until 7/14/08 where your 100,000 has turned into $126,000.  The summer of 08 is a bit rocky but the indicator switches in mid July and you pull out and sit in cash.  The market proceeds to crash nearly 50% but your nest egg is sitting in cash until April of '09.  Well after the bottom of the market back in March.  Today your $100,000 back in 2000 is worth $191,09... up nearly 100% just by reacting to the relationship of Stocks to Cash.


If you bought and held you are just about at 100,000, or the same as where you started... not counting for inflation.  If you sold in a panic twice, you are probably way behind, and god forbid you retired in 2007 and sold in a panic in 2009 with no discernible plan to get back in.


If you used this method to compare other asset classes you would have been a part of the great run up in commodities and emerging markets in the mid 2000's or would have bought gold at about the $550 an ounce mark or owned fixed income in 2002 and 2008.  If you had a plan and stuck to it... you would probably be up over 1000% and would not be reading this blog.  If you want a plan like this....  just 'follow' this blog and watch how I manage my portfolio.


Cash vs. the S&P is just the tip of the iceberg, but it is also the last line of defense.  Choose to ignore it at your own peril.


OTHER USES OF RELATIVE STRENGTH
I use relative strength to compare the performance of the six major asset classes.  I invest ONLY in the top two or three performers at any given time.  The one exception is if cash is performing better than everything... I will be in about 75% cash and will probably be shorting the markets using the short ETF's with about 25% of my portfolio.  


I use relative strength to compare sectors.  The US Stock market is made up of about ten Sectors.  The law of averages say that if the S and P is an average number, half of the sectors will generally perform better than the other half.  So, when it is time to be invested in US stocks, I want to own the 4 or 5 sectors that bring the market up.  I want the leading sectors, not the lagging sectors.  I use relative strength to compare all the sectors and then invest in the best ones.  


I also use relative strength to decide which individual stock to own.  I don't generally like holding individual stocks (another topic all together) but if the markets are really roaring sometimes I'll keep about 5% of the portfolio as "opportunity" money.  So I'll use it to compare  Apple or RIMM, Exxon or Conoco, GLD or SLV.  ....  etc.   In a good strong bull market, like the one we are in now, the question is not whether to own stock, it is which one is performing best. 



WHERE CAN I LEARN MORE?
Dorsey Wright is the best place to go.  For $25 bucks a month you can subscribe to their charting service online and do all the comparisons your heart desires.  (FYI, I am a subscriber to the Dorsey service.) They also have a ton of research and books on the topic.  Point and Figure Charting by Tom Dorsey is the bible on the subject.  I would highly recommend picking up a copy for a deep dive into the subject.  


If you have any specific question or want the formulas for figuring out relative strength, just email me.  Be sure to follow the blog and check the weekly portfolio updates and scorecard for any major portfolio changes.  


Happy Investing!

2/14 Portfolio Update

Happy Valentine's Day!

The top two performing asset classes are still US Equities and International Equities.  The last month or so has really solidified the strong bull market in US equities but in that time we have see some fairly steady flows of cash coming out of emerging markets as well.  Now, a 2.26% decline in an asset class as volatile as emerging markets does not concern me.  If any entire asset class declines 5% then I put it on my radar and if it falls 10% there is usually something fundamentally wrong that might dictate a change.
For now, however... full steam ahead. 

Holdings
US Stock	Type	Ticker	Weight	Shares	Purchase Price	Total Starting Value	Current Price	Total Current Value	% Gain (Loss)
Cons. Disc.	Vanguard ETF	VCR	10.15%	165	$60.50	$9,983	$63.77	$10,522	5.40%
Real Estate	Vanguard ETF	VNQ	10.16%	180	$55.50	$9,990	$58.52	$10,534	5.44%
Materials	Vanguard ETF	VAW	10.19%	123	$81.00	$9,963	$85.89	$10,564	6.04%
Technology	Vanguard ETF	VGT	10.14%	158	$63.25	$9,994	$66.53	$10,512	5.19%
Small Cap	Vanguard ETF	VB	20.92%	279	$72.25	$20,158	$77.71	$21,681	7.56%
Iternational Stock			30.00%
Emerging Markets	Vanguard ETF	VWO	28.28%	638	$47.00	$29,986	$45.94	$29,310	-2.26%
Commodities			10.00%
Gold	IShares ETF	GLD	4.85%	38	$130.00	$4,940	$132.30	$5,027	1.77%
Silver	IShares ETF	SLV	5.29%	188	$26.50	$4,982	$29.16	$5,482	10.04%
						$99,995		$103,632	3.80%

Part Three: Asset Allocation

The 5 Major Forces Affecting Your Investment Performance

by: Ben Crowley

1.Population

2.Supply and Demand

3.Asset Allocation

4.Relative Strength

5.Timing 

Part 3: Asset Allocation

U.S. Stocks, International Stocks, Fixed Income, Commodities, Cash and International Cash.  With the exception of alternative assets like art, collectibles and the like, these six asset classes are a general proxy for what you and I can easily build a portfolio around in a modern day brokerage account.  

(**Real Estate is a bit of a different beast because you can choose to invest in the actual property or buy shares of a real estate investment trust.  If you are dead set on owning property then fine, but for the sake of this discussion, I will consider real estate a sub category of the equities markets and can be owned in the form of REITs (real estate investment trusts).)

If you want to dig into the subject, David Darst is known as the ‘Godfather’ of Asset Allocation and has really done an excellent job of laying out the history, theory and mathematics behind this investment strategy over the years.  Be sure to check out “Mastering the Art of Asset Allocation” and for a little lighter read on the topic, “The Little Book that Saves Your Assets.”

If you, REALLY, want to get into the dirty details about correlation, non-correlation, modern portfolio theory or the really entertaining subject of statistical analysis, then you can call me and we can discuss it individually.  But, if you just want to get the gist of Asset Allocation, then just picture each asset class like you are visiting the primate section of the zoo.  

Fixed income is like the great Gorilla.  He is big, lazy and (at the zoo, at least) generally inactive, but you would not want to be in that cage when he is angry.  US Stocks, are like the chimpanzees.  Strong, intelligent, trainable, orderly and lovable.   Their behavior is generally predictable, but you can never fully trust them because you know in the back of your mind that they are wild animals, after all.  International Stocks, especially emerging markets, are like the Columbian Spider Monkey.  They are volatile, excitable, active during the day and tend to move in packs.   They are generally fun to watch but just when you fall in love with them, they get over-excited and throw their poop at you.      Commodities are like orangutans.  They are rare and wild and some are even endangered.  They are hard to find and sometimes you only get to see the ones that were bread in captivity.  And Cash, the most important of all.  Well, cash is the cage.  Cash is our defense against having these wild animals running all over the city.  No body ever looks at the cage.  It is not sexy or interesting.  But, when these animals get unruly and all act out at the same time, just thank your lucky stars that the cage is there to keep you safe.

In “normal” markets the order of things looks like this: Stocks are more volatile than bonds and typically have an ‘offense vs. defense‘ relationship.  Commodities move to their own beat and are often more directly tied to changes in supply and demand and the ‘economy’.  And cash is usually seen as a ‘safe haven’ when other asset classes are going down in value.  So, in theory, holding a certain percentage of each of these asset classes will smooth out your portfolio’s volatility and create a nice, even positive growth rate into perpetuity and you have portfolio Utopia.  Ahhhhhh... sounds nice doesn’t it? 

  

However, as with many theories, there is a fundamental flaw.  This method of portfolio management, does not take into account the disaster scenario that played out in 2008 and early 2009 where every monkey at the zoo was extremely pissed off all at the same time.  

In times like this, it is prudent to move all of your investments to cash and wait it out.  

Problem is, no professional fund manager in the world will ever, in their right minds, tell you that your money should be in 100% cash.  Why?  Because they don’t make any money that way.  They get paid to be invested and have assets under management.  If you sell your mutual funds and sit in cash, they have no money to manage.  I feel like this wrong on many levels and is one of the reasons I fell “out of love” with the financial services industry.  Throughout the whole time that the markets were plummeting, I never heard anyone who got paid to give advice ever say to move it all to cash and wait it out, or better yet.... “short the market.”  There is nothing wrong with shorting the market when it is appropriate and necessary but this is another topic all together.

My philosophy on asset allocation decisions in my portfolio management is a bit different.  In ‘Part 4, Relative Strength’ I will get into the methodology, but I believe that if you understand how asset classes behave and have a method of tracking their changing prices, you can make money in ANY market cycle.  At any given time, statistically, two of the six major asset classes are performing better than the other four.  On any given day, I own the two that are in the lead.    Sometimes that means being 100% invested in the stock markets and sometimes that means owning 100% cash. (if Cash is the best performing asset class then I am in cash completely.) Usually, however, the portfolio is somewhere in between.  

Since September of 2010, I have been 60% US and 30% Foreign Stocks and about 10% in gold and silver and am up handsomely.  Since the start of this blog in on January 24, 2010, my portfolio is up 3.3% and the S & P 500 is up 2.8%.  I am outpacing my benchmark by 40 basis points in three weeks and only time will tell how it does for the year.  However, I am less concerned with my performance in ‘good times’ because I know a rising tide raises all boats.  The strength of my strategy is in its ability to play aggressive defense when appropriate because we all know that offense scores points, but defense wins championships.  My goal in writing this blog is to teach you to win championships.  

Thus far, I have discussed Population, Supply and Demand and Asset Allocation.  If you can begin to apply this top down approach as a way to build and manage your own portfolio you too will derive the comfort and peace of mind that I have when I make investing decisions.  As always, I look forward to hearing from you and am happy to answer any specific questions.  

Happy Investing!   

2/6 Portfolio Update

No Changes this week.

As expected, the market absorbed and digested the news about unrest in Egypt and continued chugging ahead.  The portfolio is consistently outpacing the overall market and things are looking good.

I am keeping an eye on Gold.  Relative to the other holdings in the portfolio, GLD is underperforming a bit and would consider swapping gold out for a copper ETF like JJC or potentially an overall commodities ETF like GSG.

This week:  If you own it, hold it.  If you are looking for an entrance point, buy on the dips.

Be sure to check out the Cheat Sheet to see the current portfolio breakdown and asset allocation.

The score card at the end of the first week of February reads like this:

	Jan 24, 2011	today	% Change
My Portfolio	$99,994.75	$102,594	2.60%
S and P 500	1282	1310	2.18%

Part Two: Supply and Demand

The 5 Major Forces Affecting Your Investment Performance

by: Ben Crowley

1.Population

2.Supply and Demand

3.Asset Allocation

4.Relative Strength

5.Timing 

Part 2: Supply and Demand

Econ 101 class was at 8:15 AM on Tuesday and Thursday and at the time, I wanted to be anywhere else in the world but in that classroom.  I had a great professor but the content of the material was brutal and boring.  I mean, who in their right mind wants to hear about Nash Game Theory and pricing strategies of an oligopoly first thing in the morning?  Ugh.  Because I am sensitive to the boredom levels of my readers I will do my best to keep it short and concise and get right to the point.  

You don’t have to be an economist to be a good investor but you should know that the price, or value, of all things is primarily shaped by the relationship between the availability of the thing (supply) and the willingness of a person to pay for that thing(demand).

Whether you are talking about a rare baseball card, common stock or a barrel of oil, the price is determined by how much someone is willing to pay for it.  Usually if you introduce more of the item into the known supply, the price will fall.  Conversely, if there is a hot item like a ‘Tickle Me Elmo’ doll, and my kid “HAS TO HAVE IT”, I will typically pay more for it.  This is the law of Supply and Demand at work.

Most people do not consider this force when it comes to investing, but it is most definitely in play.  Supply and Demand rears its head on both the Macro and Micro levels of investing and you have to consider it before pulling the trigger on an investment.

On the Macro level, in part one, I discussed Population.  Population is driver number one of demand.  If the majority of people need a product or service to survive, you better believe there will be a demand for it.  So from an investment standpoint, you better have a general idea of how much supply there is, or have a general understanding of who controls the supply before investing in it.  If the majority of people really want something or better yet, THINK they need something, you better have a good idea of how much it costs.  But most importantly, when it comes to investing, if you know how old the majority of people are in a given population and if you are clever enough to see trends on the horizon, you can invest in a product or service or commodity before the majority of people realize they need it or want it.  This is supply and demand investing on a Macro level.

On the Micro level it is a bit more complicated.  Always remember that a stock is not a company and a company is not a stock.  Two key examples are Microsoft and Apple.  Why has Apple stock gone on a very volatile ride from about $8 a share in 2001 to over $300 in 2011 and Microsoft has basically stayed flat at about $30 since 2001.  Both companies are leaders in the tech sector.   Both are extremely successful.  Both companies seemingly print billions and billions of dollars, quarter after quarter, year after year.  Both are extremely, “fundamentally” sounds companies with great cash flow and great balance sheets.  Both are about 65% to 70% held by institutions or mutual funds.  Why are their stock performances so drastically different? 

    

I believe that part of the reason has to do with the fact that there are 8.5 BILLION shares of Microsoft available to be traded everyday and there about only about 950 million apple shares.  In the case of Microsoft, many of these shares were bought before the end of the tech bubble in 2000 and have been held onto since.  There is just a much greater supply of individual ownership available for Microsoft and it takes a heck of a lot more activity to move the price of something when there is so much available.  The share of individual ownership of Microsoft are just too diluted to make any major price moves.  This is Supply and Demand at work on the stock price of an individual company.

If you must own individual stocks, it is important to know the percentage breakdown of institutional ownership and number of shares outstanding because it affects the supply and demand relationship.  When there is a massive flight to safer assets like cash and fixed income like we saw in 2008 and 2009, a perfectly good stock can take a real beating simply because it is widely held by institutions.  

Take Apple for example.  In July of 2008 it was trading over 200 dollars a share.  When the stock markets began to crumble and the financial world was collapsing, Apple was doing just fine.  In fact, it never missed on its earning expectations and continued to thrive.  But, by March of 2009 its stock price had plummeted to under 80 dollars.  The overall market was down only 45% but Apple was down over 60%.  

How can this be? Well, here is what happens.  Apple is 71% owned by institutions and mutual funds and is one of the top 5 holdings in just about every major stock market fund, load or no load.  So when you and I get defensive and I want to cash out and sit on the sidelines we enter a sell order for that mutual fund.  At the end of the trading day, that fund sells enough shares in proportionate amounts to liquidate our position and get us our cash.  So by selling our share of the fund, we are not only creating more supply of the fund’s shares, we are creating more supple of Apple shares.  Since Apple is so widely held across all types of mutual funds and institutions alike, it took a proportionately larger hit due to this forced selling.  Apple, in this case, decreased in price simply because people did not want to be invested in the stock market at all, fundamentals of the company be damned be damned.  

Remember, a stock is not a company and a company is not a stock.  

It is important to know, not only a company’s fundament financial info, but also its technical statistics if you are going to hold it in your portfolio.  What happened to Apple is another, but slightly different example of price changes as a result of supply and demand in the stock market.  The good news, however, is that is works the other way too.  Today, Apple’s share price is back up over 330 dollars since March of 2009 and inflows jut started coming back in to equity funds a few months ago.  So if you bought Apple back in the summer of ’09... well played.  

Remember, EVERYTHING that has a price, has that price because there is a perceived desire to have it and a known amount of that thing available to be purchased.  Stocks, bonds, products, real estate, art, baseball cards and cash and thousands of other things can be invested in.  Whether you are looking for cash flow or price appreciation from your investments it is crucial to keep the law of supply and demand in mind.  Please feel free to contact me with any specific questions about this topic or any other investing topic you might like to discuss.  

Happy Investing!