“Helping others is the secret sauce to a happy life.” – Todd Stocker
In last week’s post we looked at the merits of the trend following investment discipline as an elegant answer to The Great Lie that it is always a good time to buy and hold stocks. At its core, trend following is a reactionary discipline that doesn’t try to predict the future based on some sort of gut conviction or analysis of the macroeconomic tea leaves. Instead it interprets the price movement of an asset through the lens of an unbiased, mathematical formula to dictate buy and sell signals with the ultimate goal of participating in an uptrend and side-stepping the bulk of a large downtrend. Trend following can encompass a wide range of strategies ranging from a short-term trading tool to a long-term investment discipline. In this week’s post we will unpack Season Investments’ own secret sauce of trend following coined MarketVANE, which we apply as a long-term investment discipline to both stocks and hard assets.
The first defining characteristic of MarketVANE is that it is a long-term trend following discipline. It was not designed to be a trading tool, but rather a risk management tool which measures major trends in the market. Looking at the theoretical chart in last week’s post, MarketVANE is trying to identify and measure the shaded circles rather than reacting to every intermediate price reversal.
MarketVANE’s second defining characteristic is that it is a relative strength model, which means it is measuring the performance of a particular asset relative to other similar assets. As an example, MarketVANE STOCKS looks at 15 different ETFs which represent different sectors, countries, or regions that make up the global stock market. It measures the performance of each of these ETFs relative to one another and invests in ETFs with the best relative strength (upper third or top 5 performers). A buy signal is established when an ETF 1) establishes an uptrend and 2) ranks in the top 5 of the model’s 15 components. In the case of a global sell-off in stocks, similar to the financial crisis of 2008-09, none of the components will be in an uptrend and MarketVANE will move entirely to cash.
Let’s look at some real life examples over the past year. The first example we will look at is the US Healthcare sector. As some may already know, healthcare has been the best performing sector in the US over the past year due to a heavy amount of M&A (mergers and acquisitions) in the space. As such, MarketVANE STOCKS has remained invested in the Healthcare ETF through every wiggle and waggle over past 12 months.
The next example we will look at is the US Consumer Staples sector. Staples are typically considered a defensive investment due to the low growth and somewhat stable/predictable earnings of the underlying companies (e.g. P&G, Colgate Palmolive, etc.). Towards the end of last year, Staples moved into the top 5 performers as market participants braced for the end of the Federal Reserve’s QE program. But then as investors became more comfortable with a post-QE world, other parts of the global stock market moved past US Consumer Staples. As such, MarketVANE rotated out of the sector after riding a nice little eight month uptrend.
A third example we will look at is the European region. When investing outside the US, currency movements can have a significant impact on the performance of the underlying asset. Such has been the case in Europe where the Euro has weakened against the US Dollar by more the 17% over the past 12 months. This has been a major headwind for all US based investors putting money into non-currency hedged European investments. As the chart below shows, this has culminated in a down-to-flat trend for the European ETF, which MarketVANE STOCKS has avoided entirely over this period.
The last example we will look at is the US Energy sector. This chart is a great example of why we are such staunch supporters of the trend following investment discipline. Although not shown in the chart below, the US Energy sector was in a strong, two year uptrend heading into the summer of last year, earning a spot in our MarketVANE STOCKS strategy. Shortly thereafter, crude prices took a precipitous plunge when OPEC decided not to cut back production to support oil prices. By the end of September, energy stocks had fallen out of the top 5 on their way to establishing a negative trend, so MarketVANE STOCKS rotated out of the position. After that point, the sell-off continued until a bottom (at least for the time being) was reached toward the end of last year. The energy sector is currently trending sideways at a price close to 20% below the point at which MarketVANE STOCKS sold out of the position. The same logic that moved MarketVANE out of energy stocks will also move it back in once an uptrend is established and the relative strength of the sector moves back into the top 5.
At the end of June 2014 we began tracking performance for both MarketVANE STOCKS and MarketVANE HARD ASSETS via live client account composites. The last 12 months have been a fairly good stretch for each strategy on a relative basis as MaketVANE STOCKS has outperformed its benchmark in an up trending market while MarketVANE HARD ASSETS has preserved capital in a down trending market.
To wrap up the past three weeks, a trend following investment discipline is an elegant, yet simple solution to the glaring mismatch between The Great Lie and the Cost of Being Human. Our own flavor of trend following concentrates on long-term trends with the dual mandate of preserving capital in a downward trending market while capturing a good chunk of the gains during an upward trending market. We are constantly testing and refining MarketVANE to create the most effective balance between those two objectives for our clients. As the opening quote states, “helping others is the secret sauce to life.” By utilizing a well-defined trend following discipline like MarketVANE, our goal is to take some of the stress out of investing to help empower our clients with the freedom to pursue what makes life truly rich.
Author Elliott Orsillo, CFA is a founding member of Season Investments and serves on the investment committee overseeing the management of client assets. He spent nearly ten years as a financial analyst and portfolio manager working primarily with institutional clients prior to co-founding Season Investments. Elliott earned a bachelor's degree in Engineering from Oral Roberts University and a master's degree from Stanford University in Management Science & Engineering with an emphasis in Finance. Elliott and his wife Gigi have three children and like to spend their time outdoors enjoying everything the great state of Colorado has to offer.
Transparency is one of the defining characteristics of our firm. As such, it is our goal to communicate with our clients frequently and in a straightforward way about what we are doing in their portfolios and why. This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities. It represents only the opinions of Season Investments. Any views expressed are provided for informational purposes only and should not be construed as an offer, an endorsement, or inducement to invest.