Portfolio Performance Enhancement
Relative strength, long-term cycles, and short-term cycles are utilized as describe below.
1. Following are the benefits from relative strength screening:
- Stocks that advance in one six-month period tend to have above-average price appreciation in the following six-month period.
- This was the conclusion of research by Dr. R. Levy (PhD dissertation, American University, 1966) and Dr. R. Hagin (PhD dissertation, University of California, 1966) show that Professors P. Brown and R. Ball (Journal of Accounting Research, August 1968). They found that when a company’s reported earnings were better than forecasted, the share price rose in the 12 months prior to the announcement and tended to fall in the 6 months after the announcement. Dr. M. Kisor and V. Messner studied trends in earnings in the Financial Analysts Journal in January of 1969. They did not find predictability in earnings trends. Instead, they found that stocks that advance in price substantially ahead of the market for 6 months tend to have above average appreciation potential in the following 6 months. Thus, share price appreciation tends to precede favorable earnings, and stocks that perform well over 6 months tend to do so in the ensuing 6 months.
- Research by CR demonstrates that 500 bp can be added in a narrow market and 300 bp added in a broad market.
- Research by Merrill Lynch shows that 670 bp was added annually over the last 19 years by investing only in the top 50 strongest stocks in the S&P (re-balanced monthly) as depicted on the following slide.
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Source: Quantitative Analysis Department, Merrill Lynch
S&P Return = +9.0%
Relative Strength Ranks as One of the Top Two Selection Methods
| Stock Selection Method | Annualized Return 1987-2007 |
|---|---|
| Enterprise Value/EBITA | +16.5% |
| Relative Strength | +15.7% |
| PE/Growth Rate | +15.5% |
| Price/Free Cash Flow | +14.9% |
| Most Active | +13.8% |
S&P 500 Return=9.0%
Cycles Research LLC
2. Following are the benefits from monthly cycles analysis:
- Spectral analysis extracts mathematically valid cycles from price data.
- Bartels test measures the fit of the extracted cycle to the actual price data. A low Bartels score is best.
- The algorithms were developed over 50 years.
- My testing (from 1980-2006) demonstrates that the method works especially well with equities on a monthly basis. See the following table:
This test was run on the 30 stocks in the DJIA. The monthly rising cycles were calculated for each stock. It was assumed that the stocks were bought at the commencement of the up cycle and were sold when the cycles peaked. The results are below.
3. Following are the benefits from short-term cycles:
Below we see that annual seasonal cycle for Archer Daniels Midland.
The combination of these three has added 500 to 800 bp annually to equity portfolios.