|
|
The Muscular Portfolios Newsletter — No. 23 — Jan. 31, 2020
|
|
|
Performance results for the year
By Brian Livingston
One-year performance numbers are completely meaningless when evaluating investing strategies. But so many people want to know how a strategy did this year or that year that I produce annually a month-by-month breakdown of three different portfolios around the end of January — as soon as possible after I’ve recovered from my New Year’s hangover.
Anyone who’s been tracking a Muscular Portfolio with real money lately knows that 2019 was a phenomenal year for the S&P 500 and a weak year for well-diversified portfolios. Fortunately, we’re don’t expect to beat the market every year. A diversified portfolio always holds at least three different asset classes to protect against crashes. Figure 5-4 in the book Muscular Portfolios shows that holding the three strongest assets at all times can easily beat holding only the top one — and you suffer much smaller losses along the way.
Although the market tugs at our emotional heart strings, long-term investing requires patience. If one asset class is skyrocketing upward, it’s mathematically impossible for the average of the top three assets in any given month to beat whichever asset happens to be the performance leader. We know that going in.
As readers of Muscular Portfolios understand, asset-rotation strategies are specifically designed to underperform the S&P 500 in every bull market. A Muscular Portfolio only surpasses the index during bear markets. Remarkably, that lag-then-lead pattern is enough to make a diversified portfolio outstrip the S&P 500 in most bear-bull market cycles.
Figure 1 shows the math behind the lag-then-lead principle. If you keep your losses down to half of the losses of the S&P 500 in down months, you only need to achieve two-thirds of the index's gains in up months to end the cycle with market-beating returns.
|
|
Figure 1. Lose only half as much as the S&P 500’s declines in down months and gain only two-thirds of the index in up months, and you can beat the pants off the index. Source: Total returns of the S&P 500 and a theoretical portfolio.
__________________________________________________________
|
|
The most surprising finding in Muscular Portfolios is that’s it’s easy to keep your losses down to only half of the S&P 500’s. Simply hold each month a diversified portfolio of the three ETFs with the greatest relative strength (i.e., momentum).
What’s hard is making a portfolio that holds three very different assets generate two-thirds of the S&P 500’s gains during up periods. As of today, the 2009–2020 bull market has run for more than 10 years. That’s one of the longest and strongest upmoves in a century.
Faced with how thrilling the large-caps have been, it’s easy for us to fall victim to “investor’s remorse.” That’s defined in Muscular Portfolios as follows: “Any investing strategy that you start following with serious money will disappoint you for the first two years or so.” The reason for this is that you very likely chose to follow a strategy that had done well recently. Any formula that just finished a hot streak is likely to start a cold streak next. (This is a principle called “reversion to average.”) Staying the course during the inevitable reversion is the only way to achieve the maximum long-term return from any market-beating strategy.
Here, without further ado, are the results of each strategy in 2019 — one of the worst years of underperformance for diversified portfolios since simulations going back to 1973. The following numbers are from FolioInvesting.com, where I maintain three real-money accounts. Being actual, not theoretical, the account balances are nickel and dimed each month by bid-ask spreads, SEC trading service fees, order slippage, inability to trade exactly at the close of the last trading day of the month, and other frictions (hey, just like life):
2019 gains
——————
31.49% — S&P 500 including dividends
19.49% — Baby Bear Portfolio
10.53% — Mama Bear Portfolio
7.90% — Papa Bear Portfolio
The portfolios certainly look weak, but that’s only one year. How do we overcome our behavioral bias toward short-termism and our fascination with 12-month results? Fortunately, ETFScreen.com — which powers the ranking tables at our website — has a feature I’ve recently harnessed to show the long-term returns of Muscular Portfolios in real time, updated daily. The Mama Bear’s performance in the current bear-bull market cycle (often called the primary cycle) is shown in Figure 2.
|
|
Mama still leads this cycle, despite a super-long bull market
|
|
Figure 2. Even after the S&P 500’s spectacular 10-year bull run, the Mama Bear Portfolio remains slightly ahead of the total return of the index in the current bear-bull market cycle. (Shown: Jan. 1, 2007, the year the global bear market began, through Jan. 29, 2020.) Source: ETFScreen.com.
__________________________________________________________
|
|
The S&P 500 has zoomed ahead of many other asset classes for a nearly unprecedented 10+ years. So it’s remarkable that the dollars in a Mama Bear account are still a bit ahead of a buy-and-hold S&P 500 account.
In 2007, almost all of the ETFs used by the Mama Bear and Papa Bear were available for purchase. The exception is PDBC. This is a commodity ETF that’s been used in Muscular Portfolios since PDBC’s inception in 2014. To start the series with 2007, I configured ETFScreen’s graph to use as a substitute DBC, the first-ever commodity ETF, which opened in 2006.
Muscular Portfolios now specify PDBC because it has more a straightforward tax structure and a lower expense ratio than DBC. Notably, both DBC and PDBC are managed by the same sponsor, Invesco; they track the same Deutsche Bank Commodity Index, according to an ETFdb article; and they have virtually identical returns, according to StockCharts data. That makes DBC a suitable stand-in for PDBC.
Graphing publicly traded ETFs automatically subtracts each fund’s annual fees, whatever they were each year. That’s a more realistic simulation than simply backtesting a set of theoretical asset classes with no adjustments for trading friction. (Note: The graphs in the book Muscular Portfolios do subtract a reasonable estimate of each fund’s fees and friction.)
As you can see from Figure 2 above, the Mama Bear had great outperformance in 2008 and 2009, the years of the financial crisis. In addition, the diversified portfolio roughly tracked the S&P 500 in most other years. But the Mama Bear significantly underperformed in 2015, 2018, and 2019. That’s just the luck of the draw. To defend against crashes, a diversified portfolio will usually lag the index in every year of a bull market. In some years, it underperforms a lot. There are no guarantees in investing, only probabilities.
If my money is going to grow from $1,000 to $3,000 in 13 years, I like the Mama Bear ’s relatively smooth ride. It’s not worth it to put up with the S&P 500’s gut-wrenching collapses in years like 2000 and 2008 — and its crash in the coming bear market, which is certain to hit us when we least expect it.
One big caveat: ETFScreen graphs a portfolio’s “typical” performance. That’s an average of 21 different time series, each of which started on a different day in January 2007. My experience indicates that reallocating a Muscular Portfolio near the last trading day of each month adds about 1 percentage point of annualized return over the “typical” performance. An analysis of a Mama Bear–like portfolio by the CXO Advisory Group, which is reported in Chapter 5 of the book, shows that reallocating on the first and last few trading days of the month produces the best returns and the smallest drawdowns. However, ETFScreen cannot at this time produce a simulation that reallocates on, say, the first or last trading day of each month.
I reported in a StockCharts column in January 2019 that the Mama Bear had succeeded in outperforming the S&P 500’s total return in the current primary cycle. From Oct. 31, 2007, through Dec. 31, 2018 — using real money in the last three years — Mama’s annualized return was 7.67%, well over the S&P 500’s 6.58%. ETFScreen rounds its calculations to one decimal place. From Jan. 1, 2007, through Jan. 29, 2020, ETFScreen reports that both Mama and S&P had annualized returns of 8.8%. (Without the rounding, the Mama is still a smidge ahead — but who knows how long that will last!)
In a StockCharts follow-up, also in January 2019, I reported that the Papa Bear Portfolio had not surpassed the S&P 500 in the current primary cycle. That’s still the case, as of the end of 2019. These strategies are not magical elixers, they’re just the best economic science that the 21st century happens to offer to people who want to avoid the 30%, 40%, and 50% crashes that the S&P 500 subjects investors to every 10 years, on average.
The January 2007–January 2020 performances of the three portfolios are documented at the following ETFScreen pages (viewing the graphs requires a paid subscription to ETFScreen, which currently costs $15.95 per month, cancellable at any time):
Mama Bear Portfolio / Papa Bear Portfolio / Baby Bear Portfolio
In my February 2020 newsletter, approximately four weeks from now, I’ll publish links to my month-by-month breakdown of each portfolio’s estimated and real-money performances back to 1973.
|
|
Lots of people want something that can’t possibly exist
As human beings, we are driven by the gambler’s dream: “There must be a formula that beats the S&P 500 in every good month but loses only half as much as the market in every bad month.”
Unfortunately, that’s a fantasy. In Chapter 1 of Muscular Portfolios, the dream is called a “yeti portfolio,” as shown in Figure 3 below. “Up we win, down we also win” is an investing myth that can’t exist in reality.
Around the world, thousands of traders with high-speed computers test and retest every imaginable strategy. Anything that initially works won’t continue working for long. When enough traders use the same formula, it gets “overgrazed” and disappears (like a blurry yeti sighting). The book provides numerous examples in Chapter 15.
|
|
Figure 3. Any strategy that consistently outperforms the S&P 500 in good years and minimizes the index’s losses in down years is almost immediately eliminated by traders with high-speed computers. Instead of beating the market every year, lagging the index during bull markets is a trait of virtually every long-term market-beating strategy. Illustration by Pieter Tandjung.
__________________________________________________________
|
|
As a journalist, my goal when researching and writing Muscular Portfolios was not to include any strategies unless they were (1) tested for years with actual money and (2) unlikely to turn into wildly popular fads that would become overgrazed and stop working as soon as they were revealed.
The answer was provided by two studies that identify why true market-beating strategies are tough disciplines that most people would hate, hate, hate:
- Mark Hulbert, founder of the Hulbert Financial Digest, found that only a handful (8%) of advisory newsletters over a 34-year period (1980–2014) had outperformed the S&P 500. All of the superior long-term strategies “lagged behind the S&P 500 in more than half of the five-year periods since 1980.” He wrote that it’s “a rare investor who is willing to stick with a strategy after five years of market-lagging performance.”
- The Vanguard Group, in a separate report, found that only 18% of 1,540 US equity funds had beaten their benchmarks from 1998 through 2012. Virtually all (98%) of the winning funds had underperformed their benchmarks in at least 5 of the 15 years. Not a single top performer had disappointed investors during merely one or two years.
If you can accept underperformance during bull markets and let go of S&P 500 envy, you can enjoy long-term, market-like growth with no fear of crashes.
But, due to human nature, most investors will never give up on the gambler’s dream. They will continue to jump from one strategy to another. After sinking their money into each new formula, they’ll give up on it as soon as the usual two-year investor’s remorse discourages them.
From 1926 through 2019, bear-bull cycles — top to top — have averaged approximately eight years in length, according to a one-page PDF by First Trust. Do you plan to live for another eight years? If so, your money can survive the next bear market and grow steadily through the next bull market, while you ignore all the noise. You can spend 100% of your time doing more important things in life than staring at computer screens and facing constant uncertainty.
I’m well aware of high-frequency traders (“freeqs”) who make money outracing institutional trades in less than 10 millionths of a second. This can be quite profitable. But they aren’t trading, they’re front-running. Quietly siphoning pretty pennies out of high-value transactions is as old as markets. Each new front-running technique is eventually uncovered and banned; then another one emerges, and the cat-and-mouse game continues. Fortunately for us, a new report by the Financial Conduct Authority of the United Kingdom finds that “ordinary households need not worry.” (You should be concerned only if you’re buying and selling huge blocks of shares.)
Investigative journalism shows that many of the most outstanding stock-market investments over the past 30 years have lost 65% or worse at some point along the way. Periodic underperformance is a proven trait of virtually all market-beating strategies. A Muscular Portfolio, thankfully, saves you from heart-stopping losses greater than 25%. But the bull-market underperformance principle is something we can learn from and take advantage of, as I reveal in the lead article of today’s paid newsletter.
|
|
Get the book that frees you from Wall Street
Muscular Portfolios has received rave reviews from experts of all kinds:
“I know of no book for a general investment audience that is more thoroughly researched and backed up by hard data.” —MARK HULBERT, founder of the Hulbert Financial Digest
To order the book, visit Amazon, Barnes & Noble, or any bookseller.
|
|
You’re reading the FREE newsletter
Please donate to receive the longer, paid version of the newsletter. We accept ANY DONATION of ANY AMOUNT. We want as many people as possible to have the information.
You get the following extra articles in the paid version of today’s issue:
• Exposing the features of all market-beating strategies
• Would a higher minimum wage “trickle up” to you?
Please don't forward your newsletter to others. This subjects us to spam complaints and harms our deliverability.
Instead, ask your friends to visit the Muscular Portfolios home page and get a subscription that’s all their own.
|
|
|
|
|
|