CPM Investing LLC - Investment Publications
Our research on loss-avoiding techniques for the stock market produced algorithms that have avoided losses over the last 100 years of the Dow Jones Industrial Average (brown line, shown on a log scale). Our algorithms produced the performance indicated by the green line. Please see the article "Understanding Market Resilience" for a more detailed discussion of the Market Resilience Index® series.
The image below shows the loss avoiding signals as used in our Diamond sleeve, which is used in many comprehensive portfolios. We use five separate algorithms to avoid losses in the DJIA and we call that set of signals the "D5" signal set. We typically use levered ETFs to manage the risk level of the portfolio. Over the 100-year period both DJIA (buy and hold) and the D5 signal set have a variability of about 17% (measured as the annualized standard deviation of weekly returns).
The Diamond sleeve is designed to substitute for the stock segment of a multi-asset class investment account. It can also be used for the entire investment account of those with a long investment horizons and/or high risk tolerance.
D5 is used throughout our comprehensive model portfolios. The main algorithms were developed in 2008, indicated by the vertical line above. Historically, the algorithms have not avoided all losses, but the record is strong. Performance has been especially smooth since 2008.
We have algorithms for other major stock indexes as well, but, since 2008 and earlier, the DJIA and the D5 signal set have been most reliable over long periods.
Effects of Pandemic
In 2020, the DJIA lagged the returns of other major US stock indexes during the rebound after the March 2020 decline. We introduced an add-in sleeve in April 2020 to participate in the technology-based NASDAQ index that would likely be favored in a work- and shop-from home economic environment of the pandemic. The 2020 Recovery add-in is temporary. We believe the reliability of the D5 signal set and the industry leading nature of the companies in the DJIA will again serve our purposes well.
The image below shows the performance of the algorithms for the signal sets for the DJIA, NASDAQ, and S&P 500.
While the DJIA has the best performance over the recent 20 years, the NASDAQ has had clearly better performance since early 2020. This pattern is unfortunate for portfolios focused on the DJIA. But we believe the DJIA will again produce reliable performance. NASDAQ is prone to sharp declines - even with our loss-avoiding algorithms - as one can see in the 2000 to 2003 period.
We provide sub-portfolios, or sleeves, that incorporate the indexes mentioned above. However, we still consider the DJIA using the the D5 signal set to be the most reliable way of producing high returns with low variability.
We apply the same tools and techniques to determine which ETFs are most resilient and rotate among them. The Onyx sleeve rotates among four low volatility ETFs. The purpose of this sleeve is to give very stable returns and to adjust to rising interest rates. It uses both loss avoiding signals and relative leadership signals to rotate assets among the four ETFs.
We mix the Diamond and Onyx sleeves to create one of our main model portfolios, the Diamond-Onyx Mix. We show the Vanguard fund VBINX to represent a fund that holds both stocks and bonds at a 60/40 mix that is common in the industry. See "Publications" for performance figures for the main model portfolios in each publication. The Diamond-Onyx Mix is designed for an entire investment account.
Over the period shown, the Diamond-Onyx Mix had a return of 13.4% (annualized) and variability of 11.8%. The ratio of these two numbers is 1.14.
The return for VBINX was 9.1% with a variability of 10.7%. The ratio of these two numbers is 0.85.
Our goal is to create portfolios with high return for the level of variability endured. The Diamond-Onyx Mix is better than VBINX using this measure. In the investment industry, a return-to-variability ratio of roughly 0.90 over long period is considered attractive.
We achieve these results by trading based on the MRI conditions of the various ETFs in the model portfolios.
Investment Strategy Driving the Model Portfolios
Focused 15 Investing® model portfolios are designed to do the following:
The measure of our portfolios' success can be seen in their high return relative to the variability of that return. Our target is to have a RoR/Var (Rate-of-Return to Variability ratio) above 1.00 and to be higher than relevant benchmarks by about 0.30. For example, if the comparative benchmark has a RoR/Var ratio of 0.90 over a particular period, Focused 15 Investing model portfolios aim to have a ratio of 1.20.
Focused 15 Investing model portfolios indicate representative ETFs (exchange traded funds) that can be used to implement our research. The ETFs invest in well-known companies and in government and corporate bonds. The model portfolios do not require investments in individual companies. The representative ETFs are large and liquid vehicles.
The Focused 15 Investing approach does not make forecasts about the economy, political shifts, or how current events will unfold. We believe that the adage "never make forecasts, especially about the future" has merit.
Instead, the Focused 15 Investing approach is driven by each market's resilience. When the stock market is determined to have low resilience (high vulnerability), money is removed from the stock market and shifted to bonds or cash. Conversely, when the stock market is resilient, money is moved into stocks. Thus, money moves based on assessments of the market's ability to tolerate bad news and events, rather than forecasting the events themselves. The latter is a much more difficult and complicated task that very few have been able to do successfully over long periods of time.
We analyze the full history of a market (such as the US equity market as measured by the 100 years of the Dow Jones Industrial Average) to determine how prices typically relate to changes in our resilience indexes. Our research shows that major declines in the stock market are typically preceded by declines in resilience. Our research indicates that the way a market responds to changes in resilience is remarkably stable over time.
The relationship between prices and resilience stays very consistent throughout the market’s history. The relationships between prices and resilience in the 1920s are very similar to those in the 1930s, 1940s, 1950s, and so forth. Our assumption is that those relationships will continue to be stable going forward. While the events that drive the markets up and down over time may be different, the human behavior underlying changes in resilience is relatively constant over time.
This is the reason we focus on assessing the market resilience rather than on the forecasting specific events, trends, or outcomes to news stories. If markets are vulnerable and negative news and events do occur, the market declines can be significant. If the markets are vulnerable and news turns out to be good or neutral, the declines may not occur. We err on the side of being conservative and moving out of vulnerable markets, even if negative events and losses do not occur.
Thus, Focused 15 Investing model portfolios are not influenced by the emotions and news of the day. They are driven by quantitative and systematic metrics that have been tested over many years. A by-product of this approach is that the Focused 15 Investing publications have little traditional market news in them.
While conventional wisdom says, “be a long-term buy-and-hold investor,” the Focused 15 Investing wisdom says that trading is cheap and easy, and that we can and should avoid periods of vulnerability that could turn into larger scale declines. Being responsive during periods of low resilience is an important part of getting higher returns over a 10- to 15-year horizon.
Of course, losses will occur. During these times, we will follow the disciplines that have worked in the past for rapid recovery.
The target weights for the Focused 15 Investing model portfolios are based on proprietary measures of market resilience that we call the Market Resilience Index® for each market (MRIs). These are the Macro, Exceptional Macro, and Micro MRIs. In general, we trade the cycles of resilience, not market prices.
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