Notice: New Feature Added To Backtesting

Feb 25, 2011 in Backtest | Relative Strength

Last summer, we added a feature to the portfolio relative strength backtest application. We added a line that showed what the 'provisional picks' would be if the update period had just ended. The provisional picks listed are the exact same as if you ran the ETF screener using the same list of ETFs and same parameters. We added this feature just as a convenience so it wouldn't be necessary to open another tab and check what was strongest now -- rather than at the last update period.

Depending on the list you use, it is of course possible that the 'provisional pick' is not the final pick (hence the term 'provisional'). But what if we just looked up the provisional pick on the next-to-last day of a given month and bought that ETF the next day on the close and held it for the subsequent period? What would the performance look like assuming we did that? Would it be similar?

Let's look at a simple example just to discuss the mechanics of what we mean. We will compare using the 'next-to-last day picks' with the 'last day picks.' The holding periods will be the exact same, we are just reading the picks of the ETF screener with a one day offset. Of course, for many periods the picks (and therefore performance) will be the exact same.

In this example, we will use one of the Ivy Portfolio lists of 5 basic ETFs and a semi-monthly update period. We are choosing the top 1 of 5 and holding it on 2-week intervals. The settings are the exact same except we are checking the box "Invest in next to last day pick(s) near the top of images below.



Using Regular 'Last Day' Picks:



Using Next To Last Day Picks:



We can see that the returns follow similar paths but that there was a difference -- even for this list of just 5 ETFs. In this case, the next-to-last day picks actually performed better -- which means very little in and of itself. We simply are pointing out the mechanics of how it works. Users should test this using their lists across various other settings and draw their own conclusions. Our view is that this doesn't change anything -- if your backtest is well thought-out, then this extra analysis will very likely show a result that is in the same ballpark as the original method.

Final note is that today is Friday, February 25th -- so the next-to-last days picks will be locked in and known after todays close. The final picks will update using Monday's (Feb 28) closing price. In both cases, the backtests will assume the cost-basis for March performance is the closing price as of Feb 28.

 

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Summary of ETF Performance Since Just Before Fed Embarked on QE2

Feb 15, 2011

 

Back in beginning of November,  the Fed began QE2 --- though it was extremely well telegraphed in advance as yields had already dropped substantially.   Since that time, here is quick snapshot of how various indexes have performed:

 

 

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The Outperformance of Economically Sensitive Groups in Developed Markets

Feb 10, 2011

 

Divergences have developed in the marketplace.    There will be rotations ahead at some point but real-time relative strength analysis has greatly aided portfolio positioning.   These themes have been ongoing for months now:  Economically sensitive segments in developed markets (ie U.S. Industrials and U.S Energy) outperforming.   Inflation fears have caused India (INP, EPI) Brazil (EWZ,BRF) and other emerging markets to roll over.  The money flows show up in relative strength.   

 

 

 

 

 

Snapshot From Our Relative Strength Reader Application ( RS Reader Tools Page)

 

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ETF Movement as Research For Understanding Bigger Themes

Feb 03, 2011 in Strategy

"I measure what’s going on, and I adapt to it.” - Martin Zweig

ETFs represent well-defined baskets of securities --- indexes --- and we can use these index movements to better understand money flows and trends. The following list is a blend of ETFs that was based on the most popular securities at ETFreplay. This list of 15 ETFs represent a good sampling of bonds, stocks, commodities etc... Some editing to avoid duplicate indexes from different providers was used.

First lets take a look at what happened if we just held all 15 in equal-weight for the entire year 2010 using the Backtest Portfolio Allocations App (you can hand-input up to 10 symbols in the free version of the page).

Auto-Load Symbols From An Existing Portfolio:

 

Press 'Test Strategy' Button on Right To Run Chart Of Portfolio:

Scan Supporting Statistics:

Note that the correlation of this equal-weight portfolio is 0.97 to the S&P 500 (see SPY correlation figure in the top-middle of the 3rd chart image above) . This reading actually isn't that big of a surprise. Most buy & hold ETF allocations that contain a large allocation to equities will result in high correlation to an equity index like the S&P 500.   

Now let's take a look a little deeper at how one particular tactical asset allocation (TAA) strategy found leadership in 2010. We will study 2010 by creating a model and then observing which ETFs were held the most during the year within that model. Whatever was held most might be considered a 'theme' for the time period under discussion.

What relative strength does is tries to understand what is strongest and hopefully thereby find ETFs that are beginning to trend. Every leading ETF starts out with relative strength and then either trends or mean-reverts. Judgment based on experience will be necessary ultimately -- but having a quantitative process locate the strongest ETFs will give you thematic ideas as they develop to consider.

We used a monthly rebalance schedule and a basic 3-factor model to choose among the 15 ETFs. We set the backtest to include the top 3 at the end of each month and hold until they fall out of the top 3, at which point they are replaced with the new top 3.

The next table summarizes which ETFs were held using this strategy for 2010:

As this model correctly identified at the time, U.S. Tech stocks (QQQQ) U.S. Midcaps (MDY) were themes. Bonds had strong relative strength bull move into the summer and Treasuries (IEF) and U.S Corporate Bonds (LQD) both show significant days of being held. Using this strategy, Europe (VGK) was NOT held for even a single day during 2010. Below is a chart of a comparison of these 3 ETFs (QQQQ, MDY, IEF). You can easily visualize what the model was picking up.


Forwarding to more recent action, emerging markets have moved down the relative strength rankings while agricultural commodities remain highly ranked. Underweighting emerging markets equities and overweighting agriculture have been recent themes. Will this continue? It is to be determined --- but this is where a quantitative backtest would say to be --- but there will be future rotations in 2011 so we will just have to continue to...measure what is going on and adapt to it.

 

 

 

 

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