The Portfolio Barometer
Using an inductive portfolio model approach that goes where the types of returns in the market are strongest, I monitor different fundamental, value, momentum, forensic, and anomaly portfolios from financial research to create a portfolio barometer. This article continues the weekly update on the conditions I see in the market based on the types of portfolios that are outperforming or absent from the list of top stocks. This approach is based on the premise that different categories of investment strategies have some staying power under different market conditions. Much like the behavior of individual momentum stock characteristics with autocorrelation that sustains strong price movements, portfolio strategies may also experience similar sustaining effects.
I also use this inductive portfolio approach to select the 20 stocks in the Premium Portfolio from my membership service that draws from a wide range of different models in the financial literature.
The gains in the Premium Portfolio for January appear to be primarily based on the strength of momentum and forensic negative stock selections that have been dominating the standard value and fundamental models since last year. This article also expands on last week's results as to what these signals may mean for short-term trading.
Not only are these some of my top performing stocks from this week, but the concentrations of portfolio type also may provide meaningful support to future return behavior. This list forms a type of market barometer you can use that may signal what selection strategies are working best.
Of the 27 stocks listed above from different active portfolios that delivered better than 8% this past week (through the writing of this article), only seven stocks, Sea Ltd (SE), Energy Fuels (UUUU), Cellectis, Ring Energy (REI), Skyline Champion Corp. (SKY), Hecla Mining (HL), and Daqo New Energy did not come from either a Forensic Negative or Momentum-based stock portfolio. This tells me that the market is continuing to discount or disregard top emphasis toward fundamentals-based selection models and is much more attracted to price momentum behavior. Though these conditions do not have to be mutually exclusive, the small cap momentum selections are still outperforming portfolios based exclusively on strong fundamental and value characteristics.
This may reflect the condition of market health that has not yet returned to a focus on fundamentals and value where outperforming returns have been more highly correlated in the past. My ongoing barometer, based on the chi-square statistical tests conducted on 2018 key performance variables, continues to show that alternative selection models are more dominant under current conditions. Detailed descriptions of each of the portfolio types are available in the links in the table and in the explanation of the table in the section below.
Some additional measures appear to support the strong performance of momentum and negative forensic stocks in a market less focused on fundamental and value conditions at the present time. For example, according to the latest BofA Fund Managers Survey, which took place between Jan 4-10 and polled a total of 234 panelists with $645bn AUM, investors’ expectations for global GDP growth continue to fall, as 60% of those surveyed think global growth will weaken over the next 12 months, the worst outlook on the global economy since July 2008 and below the trough in Jan. 2001.
For the first time since 2009, corporate leverage is the chief concern among surveyed fund managers, with half of those surveyed preferring corporations use cash to improve balance sheets, as opposed to increase capex (39%) or return cash to shareholders (13%) (Source: Zero Hedge)
The current disconnect between the S&P 500 index and the forward EPS for stocks in the S&P 500 illustrated above also suggests a certain degree of frothy momentum type behavior. This supports the portfolio barometer showing momentum and adverse forensic stocks continuing to outperform since December.
Using the Bernstein analysis chart below, I show some theoretical ranges of stock selection models that I am continuing to test. The possibility exists that momentum stock selection is the most effective strategy during high volatility "frothy market" periods where standard fundamental and value models are unable to differentiate from market indexes.
This is a working theory that I continue to test with my stock portfolio barometer across the different models from the financial literature to see what develops. The overly generalized organization of stock portfolio performance into 3 categories (frothy, stable, oversold) serves mainly to help explain my observation that fundamental selection models increasingly failed to deliver differentiated market returns throughout 2018: Funds And Fundamentals Breaking Down: What Are Your Best Alternatives For 2019?
This supports the Bernstein analysis charted above of high vs. low momentum stocks by sector P/E levels and the possibility we are nearing a correction back toward fundamental strategies. We know that fundamental models work very well during stable markets with rational valuations and a lack of central bank external effects to alter market liquidity conditions.
Explaining the Table of Stocks by Portfolio
First, the stocks from portfolios highlighted in yellow are classified as momentum-based stock selections. These are stocks that have strong characteristics of high volatility, money flow, strong positive technical signals, and an increasing level of positive sentiment building for momentum gains. They are not necessarily good value or fundamentals-based stocks, but ones expected to deliver quick short-term gains over regular periods as their technical parameters move through optimal trading ranges.
Second, the stocks from portfolios highlighted in green come from the Forensic Negative portfolios with generally accepted negative fundamental characteristics. These stocks score poorly on three academic forensic models covering 22 different financial ratios and criteria.
My working theory is that stocks that achieve high adverse scores on all three forensic algorithms may be much more dependent on momentum and investor sentiment for price performance than on fundamental financial performance. This dependency on weaker fundamental financial data makes the firms more susceptible to larger price fluctuations and potentially lower annual returns.
Third, the stocks from portfolios highlighted in red come from the different Russell Index Anomaly portfolios that try to exploit the annual index reconstitution effects documented in the literature. These stocks by design are small- to mid-cap stocks with potential for high momentum volatility, but not necessarily selected for momentum characteristics over fundamental and value-based criteria.
Fourth, the Piotroski-Graham enhanced portfolios in gray leverage one of the top value portfolios known to outperform many other value portfolios in published studies. The Graham enhancement and other modifications make this a top performing portfolio for long-term buy/hold stock portfolios.
Lastly, the Forensic Positive portfolios shown in blue represent the best fundamental scores from three different forensic algorithms that apply 22 different financial tests. Potentially these strong financial characteristics produce strong long-term value returns in buy/hold models that I am testing.
This list is not the entirely comprehensive list from my top stock tracking board but represents the top stocks through this point in time today.
These results following on last week's article support the continuation of momentum and technical models to generate more positive returns in the short term. Also Seeking Alpha recently released a new feature that lets you monitor your own stock's momentum here.
What condition is the market in?
If these stocks and portfolios can serve as sort of weekly barometer of market conditions, what condition is the market in?
I submit based on my ongoing research into the Fed QT activity, VIX anomaly, and patterns of the FANG+ stocks, that investors are currently keying on different variables like money flow, liquidity, and volatility for market decisions. The latest announcement from the Federal Reserve to move cautiously with the quantitative tightening activity provided a large positive relief reaction that has seen the market breaking out through today.
Monitoring the $3.6 trillion proxy of the markets known as the NYSE FANG+ Index comprising 10 stocks provides strong indicators of where the market is headed. The 10 stocks that comprise the NYSE FANG+ Index: Apple (AAPL), Alibaba (BABA), Amazon (AMZN), Baidu (BIDU), Facebook (FB), Google (GOOG) (GOOGL), Netflix (NFLX), Nvidia (NVDA), Tesla (TSLA), and Twitter (TWTR).
The latest update is as follows:
(Source: FinViz) MicroSectors FANG+ -3X Invrs Lvrgd ETN (FNGD)
(Source: FinViz) BMO REX MicroSector FANG+ Index 3X Leveraged ETN (FNGU)
Based on these FANG+ stocks as a market proxy we are seeing significant breakout conditions above the negative price channel for the first time since last July on the FNGU chart. The bearish inverse chart FNGD is confirming a breakdown in the bearish trend for these mega cap stocks that comprise large positions in market indexes.
I will reiterate the good outlook from last week. Go where the momentum takes you. Currently, we are seeing very positive conditions of the January Effect extending through the month and recovery from December lows that have not yet abated.
I will provide another update on this barometer later next week to see what changes in top-performing stocks and portfolio types are delivering gains into a very volatile market.
All the best!
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.