ETF Update: Back to the Sideline

Sometimes great minds think alike, but often they do not.  In the financial world the leading experts often disagree, especially on specific trades.

Method Matters

Regular readers know that I like to use the sports world for examples, particularly the realm of handicapping.  Let us imagine that we have four different football experts:

• The fundamental football analyst looks at team strengths and weaknesses, injuries, and the matchups he sees on tape;
• The "smart money" analyst looks at the line moves in the market;
• The psychological analyst looks at the schedule to see if this is a "must game" or a possible let down;
• The modeler runs power ratings and makes his own independent prediction.

The very best practitioners of these methods may all be winners.  On a specific forecast, they may disagree.

So it is with investments.  There are many successful investment methods, including a close parallel for each of the football handicappers.

My Favorite Methods

I described my favorite approaches in this article.  To summarize, I have a long-term perspective that plays upon market themes.  It is a long-only program, but it is not "buy and hold."  I also use short-term trading methods.  Finally, I recommend a dynamic asset allocation program that protects investors against big moves.

Each investor is different, but some combination of the methods works well for most people.

Not surprisingly, the methods sometimes disagree.  Let me look more carefully at the trading approach.

Background

Traders all seek rewards but they have differing appetites for risk.  It is important to find a method that suits your personality and needs.  Our short-term trading systems are basically Trend-following, but also include recognition of Cycles and a touch of Anticipation.  Since we apply the method to ETFs, we call it the TCA-ETF system.  We follow two versions of this method, designed for two clients (Oscar and Felix) with different needs and risk appetite.  [New readers can find more information about the models at the end of this article.]  For convenience, we have named the models based upon the intended clients.

This Week's Results

Felix, the cautious approach, has moved to the sideline.  This does not mean a prediction for a lower market.  If Felix had that forecast (briefly in place last week), the inverse ETFs would be in the buy range.  Instead, everything is in the penalty box.  Felix just sees the world as too unpredictable right now.

Oscar, the more aggressive approach, is always looking for a way to win.  Oscar is unafraid of the volatility and recommends the short side, holding all three inverse ETFs.  (We do not endorse or use leveraged ETFs).

Individual Stock Analysis

With encouragement from Vince (our modeling expert) I have been looking at individual stocks to see if Felix approves.  The results this week are interesting.

The Dow

Felix is not ready to move on my Dow 20K concept!  Felix has every member of the Dow in the penalty box, although two stocks have positive ratings.  I plan to provide regular updates on this analysis if there is reader interest.  I often use Felix to assist when starting a new position, so this could be a useful assist to those considering dipping a toe in the Dow waters.

The NASDAQ 100

The fussy Felix has assigned 99 of the 100 stocks to the penalty box.  The sole survivor is O'Reilly Automotive (ORLY).  Here is the chart.

Now here is the fun part.  Tonight on his popular Mad Money program Jim Cramer cited ORLY as a top choice.  Catch this:

First on the list were auto parts makers Advance Auto Parts (AAP), O'Reilly Automotive (ORLY) and AutoZone (AZO). Cramer said this trend makes sense, when things get bad, people keep their cars longer and fix them up.

Felix was operating on official closing data, without knowledge of the Cramer pick.  This will be fun to watch.  Will Felix and Cramer agree in the future?

Weekly TCA-ETF Rankings

We are currently out of the market in our Felix ETF program and short for those following Oscar.  (We are happy to report and discuss performance with interested investors.  We also offer a report on how we use the models, and a free weekly email update.  Write to etf at newarc dot com.  Our actual trading is a combination of both models and some weekly timing).

As recently noted, I am changing the timing schedule for this weekly article.  It will now appear mid-week, with a one-day delay in the ratings.  The ratings below are from Tuesday's close.

Please note that these are not recommendations.  Investor needs and risk tolerance varies.  We hope everyone finds the ratings to be a useful supplement to their own work.  The recommendations can change quite rapidly in this environment.

Here are the current rankings for both Oscar and Felix.

Note for New Readers

Our weekly ETF Update is designed to assist both investors and traders interested in ETF's and Sector Rotation.  We also have free reports, available upon request to etf at newarc dot com.  These reports describe how we use the system, compare results from Oscar and Felix, and contrast the method with our long-term trading approach.

Our Method.  In this past article, we described our basic methodology and why we believe the rankings are useful for fundamental traders and technical traders alike.  While we urge readers to check out the entire article, the key point is that ETF's pose challenges and opportunities different from investment in individual stocks.  The fundamentals may be more difficult to assess.  Even with a good grasp on fundamental trends, there is a lot of technically-based trading in ETF's.  This means that those trading with a fundamental approach (and we do this as well) want to monitor the "hot money" moves.  Here is an article on that point.

The system synopsis. We look at Trending sectors, Cyclical Sectors, and build in an element of Anticipation for both entry and exit -- thus the name of the model, TCA-ETF.  While we do not reveal the exact methodology for spotting trends and cycles, the system is not a "black box."  The basic elements are used by many, and widely reported.  We even discuss the need for human analysis as opposed to black box trading.

We report the rankings each week, now on the weekend with a one-day delay, using the Thursday output from the model.  We monitor and trade this daily, and offer a free report (request via the email address on the top left of the site) for those interested in our weekly trading program.

Oscar and Felix. We follow two versions of this method, designed for two clients with different needs.

• Oscar believes in the long-term strength of the economy and the stock market.  He has a lovable and irrepressible enthusiasm.  When things go wrong, he steps back for a bit, but soon tries again.  He expects to do better than others during good times.  Oscar understands that this approach involves more risk.  Oscar is opportunistic.

• Felix also has a positive long-term outlook, but he is something of a fussbudget.  He is much more cautious, with an emphasis on capital preservation.  He is perfectly willing to step aside from the market when there are signs of danger.  He knows that he will miss some moves, but that is OK.  He scores big gains when the market moves lower and he escapes the loss.

There is more detail on Oscar and Felix in this article.  There is more about the Penalty Box here.

Comments

[Mike C]

There is only so much I can do to distinguish between the two models. There are specific parameters.

You ask a good question, but that is about all that I can tell you.

Just to be clear then, the specifics are proprietary? No prob, I can certainly respect not giving away the store for free. For those of us who do this professionally, there is always the question of how much to share for free versus what to keep for paying clients.

Just curious, and maybe we take this offline to private e-mail, but has the blog been helpful in getting new clients. Many OPM managers seem to write blogs, you, Random Roger, David Merkel, Humble Student, Toro. I've been thinking about starting one, but with my current schedule I'm not sure I can commit to the regularity guys like you and Roger do. We often disagree, but I respect the effort you put into this blog!

[derek]

This is outstanding, love both the content and parallel with sports handicapping

[oldprof]

Mike C -- There is only so much I can do to distinguish between the two models. There are specific parameters. Felix is much more sensitive to volatility, outside days, unexplained high volume, and other factors. We carefully identify circumstances where we have less confidence, and step aside.

You ask a good question, but that is about all that I can tell you.

Jeff

[Mike C]

There is more detail on Oscar and Felix in this article.

I must have missed this original post, but I did read it now. Is there another post that describes more of the criteria that Oscar uses to make his decisions?

We are currently out of the market in our Felix ETF program and short for those following Oscar.

I am interested in Oscar's criteria because I actually have the exact opposite short-term position which is mostly long.

I've actually gone from very little equity exposure to roughly 50 to 80% (my own personal 401(k) is the only one with 80). Of course, I've got a stop out where I go right back down to little to no equity exposure, and that is the 1040 level. I suspect if 1040 breaks, then all h*ll will break loose, and you and I will be in agreement that valuations are cheap given how far they might fall if that happens.