2018 First Half: Active Investment Wins 3x The Capital Gains Of Passive Indexing

Jul. 10, 2018 9:17 PM ET66 Comments5 Likes
Peter F. Way, CFA profile picture
Peter F. Way, CFA


  • Conventional investors with long-term goals using long-term passive investing strategies just threw away another half-year of their most precious resource: Time. It can’t be recovered.
  • Will their retirements be put off 6 months? Will the kids’ college entrance choices get downgraded, forcing that generation’s graduate careers into competition against peers with Ivy-League connections?
  • Will those kids be faced with providing the parents assisted living elder care instead of it being contracted out (by the parents themselves)?
  • Investing strategies suited to 20th century investment markets don’t work in 21st century investment technology surroundings. Stop playing yesterday’s game, and now play today’s players who are pushing ahead.
  • Ahead of you? Probably, and ahead of many others. We see it happening.

What is yesterday’s game?

Try to find investments you can buy & hold until you retire. Ones that will pay quarterly dividends which (after income taxes) fatten up your bank account or can only drip-buy additional shares in your hoped-for winners. Like Eastman Kodak, Xerox (XRX), General Electric (GE), General Motors (GM) (before 2010, when its stock met bankruptcy.)

Or just buy “the market” like SPDR S&P 500 Trust ETF (SPY) and see it go up 7 ½% a year (for its 24 ½ years of existence) - except in those years that it dropped -44% or -52%. Hope you didn’t need the tuition cash in either of those years.

But if you were lucky and dodged those bullets, you still know it could happen again, especially now, after a big multi-year market rise. All a buy & holder can do about market timing is worry. The “strategy” traps you. “Everybody” knows “the market” can’t be timed. Yet, all can still worry.

What fun! Misery loves company. Since the market can’t be timed, and the market is made up of stocks, then stocks must not be able to be timed. Know anyone who has tried? What luck did they have? Honestly? Consistently?

What is the 21st century game?

Were those who tried to time stocks hired to do it? A community of hired market professionals have been paid well to do just that, for at least a couple of centuries. In the 19th-20th century, they were the “establishment” brokers of the exchanges, the “market-makers” or “specialists” handling trading on the exchange “floor” in specific assigned stocks, charged with making “an orderly market”.

The definition of an orderly market was one where price changes from one trade to the next were typically fractions of a “point” or dollar. When transaction cost minimums were tens to hundreds of dollars per trade, and were scaled to the capital values involved, such disciplines were obtainable under competitive practices of the time.

Since then, advances in electronic communications, coupled with information technology evolution and reductions in securities unit trade price regulations, fostered sharper competitive practices among transaction aid providers (brokers). Closer integration between markets for derivative securities fostered arbitrage which lacks regulatory understanding.

The result is commonplace intra-year price swings which typically are 3 to 5 times the stated earnings growth of the corporation’s shares. Some important part of each stock’s year is spent in the negative retracement of those excesses. That part of the year which an investor should want to avoid. Risk aversion.

Its complement, the remainder of the year where price recovery gains outpace underlying establishment of worth, is what big money fund portfolio managers are constantly on the lookout for as “value investors”. They are on the prowl to outdo their competition and justify big salaries, big reputations.

They, and the market-making brokers, are building their own retirement resources, where a career might take as little as five years, ten at most.

Playing the players

These are the players you need to watch. You can’t beat ‘em at their own game. It takes lots of resources you don’t have and can’t assemble.

But they can be watched, and closely followed, where their tailwinds provide amazing advantages over the bulk of individual investors and over their sleepy institutional investing peers.

Their alert, informed actions leave tracks in the market’s sand. Tracks which we understand and have been revealing on a day by day basis for well over a decade. Tracks which provide odds-on advantages of selecting investments from the most timely few out of thousands and provide knowledgably set departure targets.

In a serious game where securities’ price actions are the product of players’ perceptions and expectations, market dynamics deny any perfect strategies. Where and when price drawdown risks will occur is perfectly known only after the fact - too late. But experience can suggest when those odds are high and exposures may be minimized.

Aim at the most favorable balance of odds for reward and against risk by constant active selection of investment securities. The net result of appropriately diversified positions thus held likely will be a net balance between gains and losses strongly favoring the winners. This is far better than accepting the meager payoffs and massive uncertainties of the market averages.

Active Investing results 2018 to-date

At Peter Way Associates, after every market day’s NYC close of Exchange trading, we select 20 stocks or ETFs judged to be the most likely to accumulate capital value from their purchase and subsequent sale. Score is kept on those choices by a pre-determined set of subsequent investment management actions applied in the same way to all selected securities.

During the period from January 2, 2018, to June 30, 2018, capital values of securities selected this way and closed out by sale gained 163%, or an average of more than +8%, while parallel-timed positions in the SPDR S&P 500 Trust ETF gained 1.7% (less than 2%). Please see Figure 1.

Figure 1

Since 12/31/2015, similar measurements for the selections are 86% and SPY 33%. Nearly 8 out of 10 of the 687 positions in 2018 were profitable.

The cumulative multi-year record indicated by these averages does not adequately reflect the positive leverage effect of sequential applications of capital (compounding) by the use of this information. The post-2015 record is about 6 wins out of every 8 of the over 11,500 before-the-fact selections. Please see Figure 2.

Figure 2

Twenty-First Century market mechanics

The intent of this discussion is to present the availability of a stream of active investment alternatives attractive to investors with personal financial objectives subject to time deadlines difficult or impossible to change. That urges them to build portfolio values as reliably and promptly as is possible.

Advances in communications, information technology, and competitive practices have made current-day investing markets enormously different from their last-century ancestors. Transaction costs have become so automated and streamlined that transaction facilitators (brokers) now pay one another to have knowledge of changing volume pressures on transactions in specific securities. Commissions charged investors for single-ticket trades approaching a quarter of a million dollars in market value can be as little as only $1.

The bulk of daily equity transaction share volumes (not the number of individual trades) are conducted by off-exchange negotiations among major “institutional” investors managing multi-billion-dollar portfolios. These “block trades” are completed typically between one initiator (buyer or seller) and a number of momentarily assembled other big-money funds for “the other side of the trade”. All such participants get the same transaction price, which is posted on an exchange or other public site to maintain market transparency of current share values.

In over 95% of such trades, the Market-Maker [MM] conducing the negotiation needs to become a principal in the trade (instead of just an agent) to balance buyers with sellers and complete the transaction. But the MM will only put the firm’s capital at risk when a hedge protecting it against price changes in the trade subject can be arranged. The trade initiator bears its cost in the trade spread paid.

That is done in derivative securities’ markets with their operating leverages, where the buyer and seller of the protection compete openly, based on their then-current expectations for the trade subject’s coming prices. What must be paid, and the structure of the derivative contracts involved, tell what those well-informed professionals think can happen.

One major benefit of knowing this is that price, and expectation of its credible limits, is a value-defining input common to all securities. That makes it possible to directly compare the prospects for securities across widely different underlying circumstances.

And with a history of such expectations, security by security, it becomes possible to determine how well the appraisers have done this job in the past. That makes it possible to qualitatively grade the credibility of the expectations.

Combining expectation quantity and quality

Risk and reward are the principal factors of concern for the investor. For over half a century, the primary “acceptable” description of investment risk has been offered as a statistical measure of past uncertainty about price changes, or “volatility”. The problem with that is the measure, standard deviation of price change, contains both price variances to the upside (rewards to the “long” position holders) and deviations to the downside.

Typically, no effort has been made to separate the two types of variances. And the assumption has been made that their proportions are equal (deviations from the mean) and are static through time. All determined from analysis of the past, not from expectations of the future.

These are failures of analysis fatal to the application of this statistical measure as a credible definition of investment risk. Fatal failures despite the apparent elegance of many complex uses of the definition as “theory” of securities valuation.

Now, after at least a couple of decades of failure to produce any credible and meaningful evidences of return of capital advantage (and avoidance of loss of capital disadvantage), the professional investing management establishment is seriously contemplating a more effective way to deal with the risk-reward trade-off. Exploration of the behavior of investors is being considered as one approach.

The same academic community which put forward the fatally flawed notions of price risk have actively offered up elegant discussions of the errors which occur in investor behavior, but ignore behaviors which are evidence of productive investing results. That group deserves to be ignored by serious investment practitioners.

Contrary evidence of a productive alternative

The self-protective actions of the market-making community provide one means of illustrating the potential for desired gain advantages and loss avoidances. The price range limits inferred by their actions avoid confusions publicly promoted for purposes of marketing their small-volume transaction services. In comparison with each forecast’s current price, they separate upside and downside price change prospects.

The existence of a standardized analysis of this data over more than a decade of daily derivations makes possible comparisons of the current state of affairs possible, not only among widely different securities at this point in time but also a comparison of each security’s present outlook with its own prior forecasts. Since those forecasts have been made day-by-day across an array of circumstances, it is possible to further refine the comparisons of today with prior forecasts where upside-to-downside prospects were like today’s.

A publicly auditable record of such daily forecasts and the priors on which they were scored was begun at the end of 2015. Since then, over 11,500 forecasts have been held to a standard portfolio management discipline which forces their outcomes to be realized in no longer than 3-month holding periods. That discipline is known as TERMD and is detailed here.

Over a hundred previously unknown and unrelated subscribers to these forecasts have live experiences resulting from their investment choices from lists of 20 best-ranked stocks or ETFs made available daily. One clear example of a specific equity investment is our recent article on the Direxion Daily Semiconductor 3X Bull Shares ETF (SOXL). In just the first six months of this year, SOXL has made five transits across its price range, including two full cycles. The price moves have been forecast by MM ranges which alerted observers to the approach and arrival of changing price directions.

Another look at the effectiveness of the Market-Maker daily Intelligence Lists of 20 best odds-on equities is presented in Figure 3. It shows the Intelligence List of 4/6/2018, which met its 3-month holding period time limit under TERMD just this past Friday, July 6th.

Figure 3

Of these 20 stocks, seen at the earlier date to offer prime wealth-building advantage, 17 came to price-positive closeouts, 14 of them in 40 days or less of a 91-day limit. Only 3 produced losses, although one was cut almost in half.

The scorekeeping here was held to an arbitrary publication standard, set over a decade ago to maintain comparability of results as time evolved. Users of the information are at personal liberty to set their own standards of what limits they will tolerate.

The averages row of Figure 3 shows these stocks were expected to rise in price during the coming 3 months by an average of +12%, and those ending with a gain did so by 11.1%. The geometric mean price change of all 20 was +5 ¼% - during the period that a market index proxy of SPDR S&P 500 Trust ETF rose by +7.3%, as shown in the next-to-last column to the right.

Prices of the 20 stocks on the date of the forecast averaged $150.03, and at the close of the next market day, their average entry position cost was $150.85. They were all ultimately sold at an average price of $167.02.

Now that you have had the description which many in the investment industry establishment would like you to focus on, we will look at what really happens to portfolios which pursued the discipline of TERMD. Please see Figure 4.

Figure 4

The buy & hold (perhaps never sell) mentality insists on score-keeping everything in a portfolio on a single time-duration holding period. That was being suggested in the review discussion of Figure 3. But what actually could occur is seen here in Figure 4.

The left-hand half of the two figures are the same up to and including the Closeout 1+Gain column. The far-right column of Figure 4 flags the mental flaw of the buy & holders. When a holding has reached its target and is sold, capital cash (as expanded from a presumed initial 5%-each commitment) is available to be reinvested. The more Sell targets that are reached, the larger is the idle cash hoard.

At the 40-day (out of 91 days) mark, that idle capital could have reached 78% of the initial commitments to these 20 stocks. And under buy & holding thinking, it would stay idle for the next 51 days. But under active investment strategy discipline, it would be reinvested in new prospective gain candidates and put back to work.

That discipline, and its score-keeping, calls for a more sophisticated performance measurement. In the financial community, that unit of measurement is the amount the capital’s value grows in the average day. Since those growths each day are usually pretty small, the unit is referred to as a “basis point”, or 1/100th of 1%. The descriptive shorthand is bp/d, or basis point(s) per day.

Figure 4 uses bp/d to calibrate the power of each investment for both good and bad results. For reference, a bp/d of 19+, when sustained for 365 days, doubles the capital involved, or a CAGR of +100%. All of the 14 stocks reaching their forecast-specified Sell targets bested +19 bp/d. Only two of the gainers failed to beat SPY’s cumulative bp/d at the 91-day point.

In comparison with the bp/d progress of SPY, the portfolio remains ahead by more than the 100% CAGR bogey, up to the inclusion of that worst loss of GGAL. But even then, the portfolio has an average bp/d of +14, nearly double that of SPY’s +7.8. Put in CAGR terms, the portfolio’s wealth-building “speed” averaged +67%, compared to SPY’s CAGR of +33%.

And in coming weeks or months, SPY is likely to have some negative bp/d to rationalize its recent +33% CAGR with an historic CAGR of under +8%. But the cash being invested in the portfolio - as it was liberated - had its typically more generous (and historically justified) next selected candidate’s expectations to work from. Those choices may have already come to liquidation and further capital compounding in the 50+ days since their new commitments.


If your situation is comfortable (meaning “well-to-do” or rich), your apprehension over doing anything out of the ordinary with your capital may prevent any future-year distress situations. Alas, for most of us investors, that may not become the case as medical science pushes us closer to “perpetual” lifetimes.

So, what’s the alternative? Learn how to become an active investment strategy player in this 21st century set of markets.

The widely prevailing notion that timing stock prices cannot be done is a falsehood promoted by those who do it daily, to their own considerable benefit. Evidence of the value of being able to approximate their advantages is apparent, and far exceeds the wealth-building gains available under conventional passive portfolio management of market index buy & hold strategies. There is evidence of results even superior to those from complex strategies built on existing fatally flawed investing theories.

Individual investors who have the advantage of monitoring the actions of huge institutional investors (which tend to contribute to security price volatility) also have the advantage of easy entry and exit in relatively small (to the market, perhaps large to the individual) transactions in a timely manner.

This article was written by

Peter F. Way, CFA profile picture
Peter Way Associates provides daily updated, near-term (3-month) price range forecasts for over 2,500 widely-held and actively-traded stocks, ETFs and market Indexes. Comprehensive results are available on the SA blog of my name.__These forecasts are derived from the way market professionals protect their own capital placed at risk while helping big-money portfolio managers adjust their holdings in multi-million-dollar "block" transactions.__ They cannot be found elsewhere.__Having these price-change prospects available on a continuous basis encourages individual investors to actively and economically build up the values of their own smaller portfolios. PWA only provides information for individual investors; it no longer manages investments for others.__Rates of portfolio capital growth being achieved by subscribers are at MULTIPLES of the growth in market averages, due to the efficient use of holding period time and the compounding of gains a number of times each year.__Risks of capital loss are protected against by insightful selection guidance and holding-period-limit disciplines. The advantages of good selection and careful timing amply cover a much smaller portion of unavoidable losses.__These Market-maker forecasts have several decades of demonstrated productivity. Earlier in the 20th century they were used by large institutional portfolios, and now in the 21st century they are available only to individual investor wealth-building portfolios. Thousands of day-by-day identifications of specific securities having consistent, odds-on profitable results rule out any likelihood of their exceptional outcomes being due to chance. Peter F. Way is a veteran Chartered Financial Analyst, having taken and passed the CFA Institute’s required 3 examinations in the first years they were given, 50+ years ago. Armed with BS in Economics from the Wharton School and an MBA degree from Harvard Business School, he has managed staffs of dozens of Investment Researchers and Quantitative Analysts for the nation’s largest bank, arbitraged index options for NYSE Specialists, and managed portfolios of hundred-million-dollar equity investments for Fortune 100 corporate pension funds and non-profit endowments. He has been elected President of professional Investment Analyst Societies in San Diego and New York City and has served on the editorial boards of the Financial Analysts Journal and the CFA Digest.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Peter Way and generations of the Way Family are long-term providers of perspective information, earlier helping professional investors and now individual investors, discriminate between wealth-building opportunities in individual stocks and ETFs. We do not manage money for others outside of the family, but do provide pro bono consulting for a limited number of not-for-profit organizations.

We firmly believe investors need to maintain skin in their game by actively initiating commitment choices of capital and time investments in their personal portfolios. So, our information presents for D-I-Y investor guidance what the arguably best-informed professional investors are thinking. Their insights, revealed through their own self-protective hedging actions, tell what they actually believe is most likely to happen to the prices of specific issues in coming weeks and months. Evidences of how such prior forecasts have worked out are routinely provided, both in SA articles and on the website.

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