Monthly Market Update, Part I

Improve your equity trading performance using proven performance management techniques

3 Mar 2019


In this series we will go through a monthly review and establish our forward plan for next month.

Current Portfolio

Using our proprietary HPI process for establishing A Diversified Portfolio, our portfolio currently has the following attributes.

Segment Review

Some things worth noting:
  • We are not constrained to conventionally defined Sectors. Our proprietary Trader Performance Coach©(TPC) software enables us to define Sectors in a way that makes sense to us.

    For example, BA is in the Industrials Sector but the Aerospace /Defense Industry performs much differently than the Industrial Sector in general. AMZN is in Services but performs more like Consumer Discretionary. We can create a pseudo-sector to accommodate this or simply move a given equity to another Sector.

  • We are not constrained to the weightings of the DJIA or the S&P 500 or any other index. Our goal is to define weightings across our sectors that will deliver performance that exceeds index performance (delivering Alpha) by more than 10% (our 10alpha© program).

  • Our proxies are focused ETFs or ETNs that cover the sector of interest.

  • Target Weighting: Red indicates the target is below the S&P 500; Green indicates the target is above the S&P 500; our choices are based on a view of the market and its segments for the next quarter.

  • Current Weighting: Red indicates the current weighting is below the target; Green indicates the current weighting is above the target. There are a variety of reasons for being off-target:

    • Lack of reasonable entry points;
    • Value of holdings increased;
    • Lack of sufficient equities in the stable.
  • General Direction: This is a subjective view from a technical perspective.

  • Performance Relative To S&P: This comes from a Relative Strength Indicator comparison to the S&P.

  • Best Bets: These are equities from our stable that are performing well.

Relative to S&P Discussion

Caution is recommended in using the DOW or S&P 500 to determine whether a given equity should be in the portfolio.

The Dow Jones Industrial Average is price weighted meaning higher priced stocks have a greater weight and influence in the index calculation. It only has 30 stocks in it and excludes Utilities and Transports as those were separately indexed when the DJIA was created.

In a nod to random rules, the selection committee keeps the ratio of the highest stock price to the lowest at less than 10 to 1. This excludes companies like Alphabet, Amazon and Berkshire Hathaway from being considered.

Currently, the 5 most expensive stocks account for nearly 20% of the index: BA, UNH, MMM, GS, HD.

The S&P 500 is market capitalization weighted. This means larger companies have more influence in the index calculation. While size is an important consideration, overweighting solely on this measure seems off the mark.

Currently, the 10 largest companies account for more than 21% of the index: AAPL, MSFT, AMZN, FB, BRK.B, JPM, XOM, GOOGL, GOOG, JNJ. That is a strong weighting to technology driven firms. Such a focus can drive up the Risk without materially impacting the Expected Value of a given portfolio.

Why it is important

Judging a given equity's performance against an index may not always be helpful. For the DJIA, what does price, absent any other information, really say about a given equity? Similarly for the S&P 500, larger market capitalization does not guarantee better performance.

Unless a given equity is part of top 5-10 equities that influence an index, the comparison may not be complimentary and certainly is not helpful in delivering improved performance. This can lead to poor decisions.

Our goal is to increase our Expected Return at our chosen level of Risk. That may or may not lead to beating an index during some time periods.

Our interests might be better served to compare each equity to its Sector and look for the higher performing stocks in each. With a rational diversification plan across the sectors coupled with the higher performers from those sectors, our performance may be materially better (meaning improved Expected Value at a given level of Risk) than a focus on individual equity performance against an index might be.

We may find that a Sector level index based on equal weight, price to earnings ratio, growth, P/E to Growth (PEG), ROI, Cash Flow ROI, Discounted Cash Flow, Return on Assets, or intangible elements such as leadership team tenure yields a better rationale for choosing individual equities.

And, it is entirely possible that none of these independently provides an effective answer. Clearly, price weighted, capitalization weighted or equal weighted are entirely too simplistic to deliver improved performance.

Finally, keep in mind that to buy low and sell high, entering sectors and equities that are out of favor is not a bad thing. Some of the largest annual gains will come from positions entered when the equity was in disfavor yet had a good forward story. Patience is paramount as is selecting options with sufficient time to expiration for the thesis to play out.

Don't mistake activity with achievement John Wooden