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Peter F. Way, Blockdesk (691 clicks)
ETF investing, CFA, portfolio strategy, long/short equity
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If you really want to get depressed, you might sit down in front of your computer and get drawn into a half-hour promotion by an investment letter-writer/would-be investment manager, telling just how despicable a democracy we have become. Because "they" lie to us, and we must believe them, since we don't do anything about the coming catastrophe crisis ready to consume us all.

I get depressed because the marketing mavens have done such a slick job of presentation in modern electronic costume that folks may waste a lot of otherwise potentially productive time being drawn into the "woe is me" web.

The pitch is, of course that the vendor has a common-sense set of solutions that he will sell you for a pittance, but you better hurry up because he can only save 5,000 folks a month, and you sure don't want to be writhing outside when the "bunker" door of opportunity slams shut - (until the next month's opportunity comes?)

It got me to thinking. Amos Tversky and Daniel Kahneman, professors at Stanford over 50 years ago, made it clear that fear was a stronger motivator for investors than greed. So maybe writers might make out better by scaring the bejesus out of investors than by simply trolling for them with the candy of profits.

But what has been happening in the real world of investments during the past 5 years while our country has been steadily(?) going to a hot hereafter? Could a strongly defensive portfolio outperform an aggressively optimistic one?

How to compare opposite extremes?

We are behavioral investment analysts, and differentiate ourselves from the academic crowd who strives to find some exploitable advantage from focusing on the mistakes that humans make. Our insight is more optimistic in that we look to see how successful folks in the investment community operate, and find benefits in their intelligent behavior. So be warned, we may come at this question with a built-in bias. (Disclosure is where you find it.)

Looking at the way market-making traders hedge their firm's at-risk capital, often required to complete a "fill" of big-volume trade orders, we have the advantage of a standard and systematized analysis of what future securities prices are implied by what will be paid for such protection, and the way the defenses are structured. It is employed every market day, as it has since the turn of this century, on over 2,000 stocks, ETFs, REITs, and indexes.

The resulting price range forecasts have a great advantage of being directly comparable with one another across the whole array of investable alternatives. Potential price change is no different for Intel, Krispy Kreme Donuts, or Las Vegas Sands. A bet is a bet, even when dressed up in the formal attire of an investment proposal.

We can, and do, put each alternative to a common ex-ante test of how well a bet made at any level of balance between upside and downside prospects has worked out in every case during the past 5 years. Both as to the ODDS of success, and the size of the average net PAYOFFS, measured in the TIME required for their typical achievements - compound annual rates of return.

This is not a history lesson of how much better one group of stocks did than another during a past time period that is known, and could be selected just to make or "prove" a point. Instead, it is a comparison of what we might obtain in the future if investors behave in times ahead like they have before, when they had the same expectations then as they do now. A look back this way provides more meaning about the future than just wishful thinking and hoping.

Onslaught-proofing your portfolio

So here is a comparison of what a defensive holder of stocks oriented to Guns and Gold would have encountered, had he/she invested every time in the past when those stocks and ETFs appeared to the market-making pros as they do today.

(click to enlarge)

To explain the table's column heads: Sell targets are the % rise from Price Now to top of the forecast range. Drawdowns average the worst end-of-day price comparison with forecast day price during each position holding, among all similar Range Index experiences in the sample. The Range Index measures that % of the forecast range lying below the current price. Win Odds are the % of forecasts reaching targets, plus those that don't but, 3 months later, are at a higher price than at time of forecast. Payoffs are the average % price changes from all similar prior forecasts. Market Days Held reflects early closeouts of achieved sell targets. Annual rates recognize 252-market-day years. Sample size counts number of all forecast days available in the past 5 years, and the number of days therein with similar Range Indexes.

When using any past data as a clue to the future, the scope of that sample is crucial to its credibility, both in number of observations and their presence over a time span. We have segregated the table's data into those investment candidates with at least 3 years of forecasts available, and those with less. Within each segment, the candidates are ranked by their past ODDS for profitable results. Justification for the ranking is elaborated in this article, and suggested by the blue summary data below the first few stock detail lines of the table.

Within the 3+ year group those with strong past odds for profit experiences show attractive annual rates of return, +52%, while the average for that entire sub-set is zero. Further, the average CAGR for all Guns and Gold stocks and ETFs becomes negative when the less than 3 year candidates are included. Selection is clearly a significant contributor to investment performance here on the return side.

Looking to the risk side, maximum price drawdowns encountered rise substantially as selections become less restrictive.

There is no guarantee that future prices will be similar to the past, but humans often formulate habits that are repetitive where surroundings seem familiar, and it is humans that move market prices.

Well, if markets behave in the future as they have in the past, those four top-ranking candidates offer an attractive return-versus-risk prospect. They include Esterline Technologies (ESL), General Dynamics (GD), Powershares Precious Metals ETF (DBP), and Randgold Resources (GOLD). Maybe there is something to this bunker mentality. Let's see what the wild-eyed optimists have to offer.

And in this corner, wearing blue lab coats . . .

Medical technology is a wide-open frontier of science currently with DNA, genetics, and the assistance of nanotechnology. Under the umbrella label of Biotechnology hundreds of new companies are emerging, and their huge appetite for research & development working capital makes public ownership a practical necessity. For many demonstrated reasons, the public has been, and continues to be, receptive to the proposition.

Using the same screening approach taken with the radical conservatives, here is what is to be found among the biotech offerings:

(click to enlarge)

Well, we see more high-odds winners (8) out of the 35 Biotechs than the 4 we found among the 40 G&Gs. And they outscore on the CAGR front significantly with an average of +74%, compared to "only" +52%. In each set there is only one ETF, and they both are the "least" productive with performances of +25% and +22%. Granted, they minimize the drawdown exposures, but at a considerable tradeoff in comparison to the other candidates' upside achievements. Maybe this is not the best place for ETFs?

The strong biotech candidates, Gilead Sciences (GILD), Biogen Idec (BIIB), Perrigo (PRGO), Regeneron Pharmaceuticals (REGN), Celgene (CELG), Vertex Pharmaceuticals (VRTX), and Medivation (MDVN) all have average holding periods of less than 8 weeks (two months) to achieve sell targets. That leaves lots of opportunity to compound gains from alternative biotech investments in this fast-developing arena.

Speaking of fast developments, our screening process tends to minimize the opportunities that may be (have been) present among newcomer investment candidates, simply because of their newness. When included, their presence pushes up the average simple gains for the whole group from the "best ranked" at 8+% to nearly +12% on all 35 stocks. With their even shorter average holding periods to reach sell targets, an average CAGR of +148% appears.

But these newcomers have little market maturity. Who knows how their futures will develop? Buying them is a little like a lottery.

There is an ancient piece of ethnic humor that tells of a devout, suddenly impoverished practitioner whose daily at temple prayer of "Dear God, please let me win the lottery" is finally met with a thunderous invisible response of "So, Sol, buy a ticket!"

Here are some biotech tickets: NPS Pharmaceuticals (NPSP), Osiris Therapeutics (OSIR), and Celldex Therapeutics (CLDX).

Conclusion

One of the strongest, pervasive investment guidelines is diversification. Another is the avoidance of extremism. Chauncey, the "gardener" in Peter Sellers' best movie, "Being There", observed that "as long as the roots are intact, there will be growth." The roots of medical technology and energy technology, along with other technologies, will help grow the US economy despite the disruptive efforts of parts of society. Optimism and pessimism, in moderation, can play a constructive part in investment portfolios, as I hope this exercise illustrates. The opportunities are there, always changing, if you will seek them out.

Additional Disclosure: The author has an investment interest in the website blockdesk.com which, while not yet open to the public, is in conversion from being a delivery medium of information to institutional investors to a new life of providing similar help to do-it-yourself investors. Both brief and extended-time subscriptions for single or multiple issue inquiries should be at quite reasonable and manageable costs for individuals. Announcement of its opening is hoped for in the 4th quarter of this year.

Source: U.S.: Half-Empty Or Half-Full? Investing In Guns And Gold Vs. Biotech