By: Tim Fortier — November 18, 2020
Invest with Style and Make More Money
Would you like a simple way to bank more profits from your portfolio?
No problem! It can be done if you pay attention to your investing... style.
In last week's article, I discussed how the U.S. stock market was exhibiting a rotation. We saw that Technology stocks were being sold, and money was moving into sectors like: Energy, Steel, and Banks in hopes of a bounce-back in economic activity should a vaccine become widely distributed.
Large value outperformance days continue to pile up, and in my view, this speaks to a major long-term change in sector allocation.
Monday last week was value’s best day ever versus growth, as seen by the green spike at the far right of the chart, below. For the week, value beat growth by nearly 7%
(Click any image to enlarge)
Now we have seen trends like this emerge before. Sometimes they last for short spans of time, similar to earlier in the year when globally, value stocks rallied.
But these short-term rotations can sometimes turn into long-term meaningful trends and if you get it right, it can mean a lot of extra profit for your portfolio.
I will show you why in a moment.
But first, what exactly do we mean by "style"?
For years, academics and practitioners have tried to identify persistent, systematic sources of stock market returns.
We call these sources "factors", and they can be defined as "a method of investing that produces unique returns across markets and asset classes".
Style investing is one example of "factor investing".
Now since "size" is also a factor, we end up with a classification system for stocks that orders them by size. You're familiar with large-cap growth, large cap value, mid-cap growth, mid-cap value, small-cap growth, and small-cap value.
This analysis is typically applied to the equity markets and is often identified as "value" and "momentum" (also known as "growth").
Here's why this is important. The following graphic displays the annual performance ranking of style factors.
What is readily apparent is that a single style factor has never dominated the top spot for more than two consecutive years. In other words, the best style factors rotate on a regular basis.
On a cumulative basis, large-cap growth (represented by IWF) has returned the most. For the period 12/31/2007 -10/31/2020, large growth has returned more than 3x small-cap value (represented by IWN).
But, what if we could take advantage of rotation. Could we do even better?
To demonstrate, I set up a simple study that started with a basket of ETFs that represented the dominant investment styles.
All total, the basket included six ETFs representing both size and growth or value. I included QQQ to represent a pure technology play, and DVY to represent dividend-paying stocks.
The rules of this game were simple.
On the last day of every month, I ranked the basket of ETFs based on their performance over the past three, and past six months.
The two ETFs with the best score and the lowest volatility were held for the upcoming month. That process was then repeated.
If none of the ETFs had produced a return greater than T-Bills, then cash was held. (This protects the portfolio from large losses)
Here are the results.
My rules-based Style Rotation strategy (the green line) grew from $100,000 to $555,297. Much better than the $338,587 for SPY, and the $314,020 for IWF, the best performing style ETF for the period.
(Just so you know, this is more than theory. I manage real money portfolios using this exact methodology and I get similar results.)
My point in sharing this with you is to emphasize why it is important to pay attention when the market signals important shifts in sentiment. Timely shifts in investment style within your portfolio can amplify your wealth.
So you ask, what are the ETFs that my system is suggesting right now?
Well, not surprising the two ETFs are:
(1) IWN - Russell 2000 Value
(2) IWS - Russell MidCap Value
Thanks for reading, and I'll see you next week.
Guest Editor, True Market Insider