Hoeing The Garden (More Of The Process), Dividend Stock Update, And More

Last month, we thought it was a good time to remind everyone of the building blocks of our Process—that is, how we go about making allocation decisions. We promised a follow up on how we go about determining what to own (selection), as the allocation portion is more about how much to own.

That’s the focus this month—what to own, and why. We also have an update on TABR’s Dividend Stock Strategy, now in its 3rd full year. There’s also a reminder on why it’s important to create your own personal account with the Social Security Administration, whether your 32 or 68. Read on.

Our Selection Process—Relative Strength

Back in 1997, money manager James O’Shaughnessy, wrote a book titled “What Works On Wall Street:  The Classic Guide to the Best-Performing Investment Strategies of All Time.”  The book today is in its Fourth Edition.  With access to the Compustat database, probably the most complete in the industry, he tested dozens of variables over a 47-year period from 1951 to 1996.  Today, these variables are known as factors, or smart beta.

They include measurements such as market capitalization, P/E ratios, price-to-book ratios, price-to-sales ratios, price-to-cash flow ratios, dividend yields, profit margins, and relative strength.  He tested these variables both independently, and in combination with others, and in recent editions, has added additional factors, such as EBIDTA (earnings before interest, depreciation, taxes and amortization) and Enterprise Value.

O’Shaughnessy found that there was only ONE factor that was included in all of the top 10 performing strategies over time.  That factor was relative strength.  Relative strength is the price trend of a stock or other financial instrument, compared to another stock, instrument or industry.  It is calculated by taking the price of one asset, and dividing by another.  The number is given context when compared with previous levels of relative strength.

Another term for relative strength is price momentum.  The whole point of the process is to own what is performing well, and to avoid what is not.  It is adaptive and dynamic, and not necessarily complex.  A great question is—does it work?  That was answered above, but below is a graph from the 4th edition of the book.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

It shows the average annual compound return of stocks, broken down by decile, using 6-month price momentum, or relative strength.  During the period from 1926 to 2009, all stocks compounded at 10.50% per year, while the strongest stocks (1st decile) earned 14.1% and the weakest (10th decile) earned 4.20%.

Hoeing The Garden

If you planted a garden, and left it alone for a year, what do you think it would look like when you went back to visit it?  Chances are, there would be weeds and a lot of dead flowers and vegetable plants.  There would be some work to do.  In some ways, I could argue that sounds a lot like passive investing.  Do nothing, look at things maybe once per year, and all will be fine.  Truthfully, in some cases, that does work.

But, in comparison to tending to one’s garden, getting rid of the weeds when necessary and making sure there’s plenty of water and nurturing, it’s an inferior approach.  In the summer of 2015, we created a matrix of 22 ETF tickers which represent broad parts of the stock market.  Each month, all of the indexes are ranked against one another using relative strength.  Below are the top and bottom portions of the matrix, first for the month ending December 29, 2017 and then for the month ending June 30, 2018, so one can see some of the changes that have taken place.

Rank	Ticker	Name	Technical Score
1	QQQ	Invesco QQQ Trust	5.59
2	IEMG	IShares Core MSCI Emerging Markets	5.43
3	RSP	Invesco S&P 500 Equal Weight	5.05
4	IJR	IShares S&P SmallCap 600 Index	4.92
5	IJJ	IShares S&P MidCap 400 Value	4.91
6	IJT	IShares S&P SmallCap 600 Growth	4.90
19	ITOT	IShares Core S&P Total U.S. Stock Market	3.44
20	IVV	IShares S&P 500 Index	3.40
21	IUSV	IShares Core S&P U.S. Value	3.21
22	IVE	IShares S&P 500 Value	3.10

At year-end, the four ETFs we owned in client portfolios for our broad equity exposure included QQQ, IEMG, IJT and RSP, having owned the latter two since November 2015, and the QQQ since March 2017.  On June 1, 2018, though, we sold two of the four positions because of deteriorating relative strength (RSP and IEMG), and replaced them with the two highest ranked ETFs that we didn’t already own (IVW and IJR).  Look at how the ranks looked on June 29, 2018, below.

Rank	Ticker	Name	Technical Score
1	IJT	IShares S&P SmallCap 600 Growth	5.77
2	IJR	IShares S&P SmallCap 600 Index	5.75
3	QQQ	Invesco QQQ Trust	5.74
4	IVW	IShares S&P 500 Growth	5.64
5	IJS	IShares S&P SmallCap 600 Value	5.50
6	IJJ	IShares S&P Midcap 400 Value	5.18
8	RSP	Invesco S&P 500 Equal Weight	5.06
17	IEMG	IShares Core MSCI Emerging Markets	2.52
19	IXUS	IShares Core MSCI Total International Stock	2.38
20	IEFA	IShares Core MSCI EAFE	1.87
21	VXUS	Vanguard Total International Stock	1.81
22	IEV	IShares Europe	1.69

At present, five of the bottom six indexes in the matrix are international related stocks.  Though we did own IEMG entering this year, having purchased it on September 1, 2017, we recently sold it because its price momentum was deteriorating (yes, we have a rules-based process to determine WHEN to sell).

Some context.  Many advisers and brokerage firms recommend that one should always have an allocation to international stocks, typically ranging from 25% to 50% of one’s stock market allocation.  In TABR’s Passive Index portfolio, we do in fact follow this process, but for our main portfolios, we strictly follow the monthly rankings, and that means often we will have no international exposure, and at other times, we may have a substantial allocation, even at 75% to 100%.  It is all about owning what is doing the best.

How Is It Doing?

Thus far, 2018 has been an excellent year to demonstrate the power of relative strength.  Had you owned the top four tickers in the rankings entering the year (QQQ, IEMG, RSP and IJR) and held them through the first six months, the average gain was 5.33%, which included a near -7% loss in IEMG.  In contrast, had you owned the bottom four tickers (ITOT, IVV, IUSV and IVE), the average gain was 0.32%.

Since implementing our selection process using this methodology in late 2015, the strategy has more than held its own against the equity benchmark we use, which is 75% Vanguard Total Stock Index (VTSMX) and 25% Vanguard Total International Stock Index (VGTSX).  See below.

	TABR RS Matrix	VTSMX	VGTSX	75/25 Blend
2016	16.13%	12.53%	4.65%	10.55%
2017	17.00%	21.05%	27.40%	22.63%
2018(to 6-30-18)	6.36%	3.23%	-3.61%	1.52%

The above data assumes a fully invested allocation to each index/matrix and includes reinvested dividends.

Granted, two and half years is not a long time, but it is encouraging that our work is “working.”  Remember, though, every investment strategy will have laggard periods where it underperforms, and relative strength is no exception.  The key is implementing the model consistently through good and bad times.  That’s how you get success.

Right now, growth stocks are leading the market, and they have been for several years.  There is a big performance gap between growth stocks and value stocks.  At some point, this is going to change, but we don’t know when.  Often times at turning points in the stock market, the stocks that have been doing the best will perform the worst, and the ones at the bottom will perform the best.  That is all part of the process, knowing that relative strength will adapt.

Above we showed the total results of our process the past 2 1/2 years, but in digging into the data, we thought we’d share some other tidbits.  First, there’s not been a lot of turnover, which is good.  Since November 2015, a total of 31 months through July 1, 2018, we’ve only had a total of 8 trades.  We held two of our original positions (RSP and IJT) for over 2 1/2 years, and still own IJT.  In evaluating past trades, we don’t just compare them to the benchmark, but we also look back at what happened to the position that we sold.  This can be very instructive.

For instance, in 2017, international stocks ended up beating domestic equities by a decent margin, but our portfolios didn’t have any exposure until September, when we bought IEMG and sold IJJ (IShares S&P 400 Midcap Value).  Though IEMG lost nearly -7% this year through June 30, we actually made money on the trade with it, earning just over 5% since 9-1-17.  Yet, had we held onto IJJ, it earned 11.73% during the same period.  We made money, but relative performance suffered.

But, in another example, what we aim for is exactly what has happened.  On March 1, 2017, our process told us to sell IJH (IShares S&P Midcap 400 Index) and buy the QQQ.  As of this writing, we still own the QQQ.  During the 15 months ended June 1, 2018, the QQQ has gained 32.83% vs only a 13.54% gain for IJH.  This also handily outpaced the 75/25 benchmark described above, which was up 17.45%.

In sum, we are using a process which past evidence suggests has an edge over time.  Not every trade will add value, but we are confident that over time, the cumulative effect of this edge will continue to manifest itself.  Having discipline and a proven process will prove especially important in the next few years, as the tailwind that markets have enjoyed for 9 years will eventually cease.

The Power Of Dividends

In August 2014, we unveiled research on a new strategy we were about to roll out which focused on S&P 500 companies with a combination of high dividend yields and high earnings yields.  We were able to take the study back to the beginning of 1973, with the help of Ned Davis Research.

We were motivated by a few things.  First, the evidence below that dividend payers over time are superior to non-dividend payers.  Second, we wanted to present something that was easy to understand and that could be used to deliver cash flow that would likely be superior to other alternatives.  An investment strategy that results in a growing, spendable cash stream provides investors with a better understanding of the relationship between their portfolio and future income goals.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The chart above, courtesy of Ned Davis Research, plots the return of S&P 500 stocks by Dividend Yield, going back to March 1972.  You can see that in this approximate 46-year period, the highest yielders (Quartile 4) compounded at 13.43% per annum, while the S&P 500 Equal Weight Index earned 12.33% and non-dividend paying stocks were down at 10.93%.  So, just by owning the top 25% of the highest yielding stocks, you had a nice edge.  When this factor was combined with high earnings yield, the edge expanded to over 400 basis points annually, net of fees, in comparison to buying and holding the S&P 500 Index.

Dividend investing is often a trade-off between yield and growth.  The higher the yield, the slower the growth, and vice versa.  In addition, a portfolio of dividend stocks is different from a broad market portfolio or benchmark, and it will perform differently for any given period.  I should point out the myth that dividend stock investing is conservative, or perhaps “safer” than other strategies.  Just look at the Maximum Drawdown in the table above.  It was over -62%.  This was no better in our back-test which combined the factors, and every client we showed the work to told us they liked the concept, but the worst case losses were just too much to handle.

Keep in mind the strategy as initially tested assumes that one is fully invested in the stocks that pass the screen each quarter, at all times.  To deal with this very real and valid objection of clients, we modified the approach, but only from an allocation standpoint, not wanting to mess with the integrity of the data.  To manage downside risk, we’ve over-laid four of our stock market risk models onto the process, giving them each a 15% weight.

When any one of them turns negative, we reduce stock exposure by 15%, simply by selling some of each position (there are usually 26 or 27 stocks we hold at all times) and re-balancing.  If all four risk models are in a negative mode (as they are now), equity exposure would be reduced to 40%, the minimum floor we will maintain.  The cash is kept in the PIMCO Short Term Fund.

Now, we have over 3 1/2 years of data to look back on, and see how things are progressing.

	S&P 500 (VFINX)	TABR Dividend Stock	Annual Income
2015	1.25%	-9.09%	$3,688
2016	11.82%	13.34%	$3,478
2017	21.63%	12.8%	$4,049
39 months	11.1%*	6.7%*

*compound annual returns

Our original investment of $102,000 is now worth just over $131,000, and income has increased by 9.78% from the first full calendar year, providing a yield on initial capital of 3.96%.  Currently, the average yield on the stocks held is over 4.5%, but overall portfolio yield is lower with nearly 60% sitting in cash and the PIMCO fund, which is yielding about 2.4%.

Obviously, just owing the S&P 500 during this period has provided a better total return (with less income), but there will be more valid comparisons over time once we’ve experienced a full market cycle with a significant decline.  Meanwhile, the strategy is providing growing cash flow in excess of inflation and total returns better than most bond strategies, which we’ll touch on in a future monthly update.

Every factor, whether it be relative strength, dividend yield, or others, goes in and out of favor.  Below is a five-year look back at the ratio of S&P 500 Dividend High Yielders to Low Yielders.  The chart is also courtesy of Ned Davis Research.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The ratio has been trending down, in favor of low-yielding stocks, since December 2016.  Value stocks in general, which high yielding stocks tend to be, have been out of favor versus growth stocks for a number of years.  At some point, this will revert, though.

We’ve used a real estate analogy in the past to describe how to think about this strategy.  With rental real estate, you own a home, get rental income and typically don’t fret over the value of the house year to year.  For this discussion, we’ll ignore depreciation (which has its pluses and minuses) and assume one owns the home outright, since carrying a mortgage would substantially reduce net income.

With dividend stocks, they are the home, but in this case, are real, growing established companies, which typically are increasing their dividends each year (rental income).  The difference is, each month, you will get a statement showing the value of your stocks.  It is best to ignore it, but hey, we’re all human.  We look.  But, you certainly don’t get a statement each month showing the value of your house.

From a liquidity standpoint, there is no comparison.  To buy or sell a rental property will take 30 to 60 days, minimum, and when you sell, you’ll likely pay at least 4-5% of the sale price to a real estate broker.  In contrast, I can initiate or liquidate a $3 million or $700,000 dividend stock portfolio for virtually nothing.  It’s all about what one is comfortable with.  We have many clients who do both, but I’m not one of them.  I’m very comfortable with what I know, so I’ll leave the nightmare tenant stories and on-going home maintenance issues to other brave souls.

Make Sure To Establish Your Own Digital Social Security Account

Last fall, we wrote about the Equifax data breach, where some 145 million Americans had their personal data stolen, including Social Security numbers.  There was guidance on what to do about freezing your credit, and also a recommendation to make sure you establish an online account with the Social Security Administration (SSA), if you hadn’t already.

The latter process was to prevent someone else from doing this, acting as if they were you, and possibly attempting to redirect your Social Security payments to a different bank.  Don’t think this can’t happen to you.  It can.  It recently happened to one of our clients.

The way they found out is that, fortunately, he received a letter from SSA wanting to confirm that he was in fact changing the bank to which his monthly check was to be deposited.  But, in fact, he was doing no such thing, which means someone had used his personal data to initiate this.  So, whether you are 32 and at the beginning of your career or you’re 68 and receiving benefits, it’s quite advisable to create your own personal account.  For those still working, it is also helpful to check your yearly earnings record for accuracy.

The Value Of Your Personal Portal

A few years ago, we transitioned to private personal portals for clients, so we could eliminate paper mailings of quarterly statements and performance summaries, among other things.  But, that is not the only benefit, for those who choose to utilize them on a regular basis.  I just wanted to remind you that we also store a variety of documents in these password protected and encrypted portals for the benefit of our clients, such as tax returns, estate planning documents and a variety of statements.

When necessary, this makes it quite easy when communicating with other professionals who are serving our clients, where with permission, we can grab relevant documents and send them out, protected with passwords and such.

Recently, the portal was a life saver for one of our clients.  They were traveling in Southern California, having just sold their house in Northern California, and were in the process of closing escrow.  Since their home was registered in the name of their Trust, the escrow company needed a copy of the Trust.  Fortunately, we had a copy of their Trust, and were able to send it to the escrow company within two hours of our client calling, and all turned out well.

So, while there are risks inherent in today’s digital age, there are huge convenience factors.  Prior to the digital age, at best in this scenario, the client would have either called us or the estate attorney who drafted it, have a photocopy made, and then mail it to escrow by FedEx.  That would have been a best case.  It’s helpful to have all this information for clients at our fingertips.

Material Of A Less Serious Nature

4-year-old Hunter was staying with his grandfather for a few days.  He’d been playing outside with the other kids, when he came into the house breathless and asked, “Grandpa, what’s that called when two people sleep in the same bedroom and one is on top of the other?”

His Grandpa was a little taken aback, but he decided to tell him the truth.

“Well, Hunter, it’s called ‘sexual intercourse.'”

‘Oh,’ little Hunter said, ‘OK,’ and went back outside to play with the other kids.

A few minutes later he came back in and said angrily,

“Grandpa, it isn’t called ‘sexual intercourse’……It’s called ‘Bunk Beds’…..and Jimmy’s mom wants to talk to you.”

 

Just about six weeks before school starts (depending on the school), which also means pro and college football are just around the corner.  Spoken like a true baseball fan whose teams (Angels and Giants) are struggling.  So, if not them, why not Oakland?  The stadium challenged, low payroll juggernaut being led by two former Fullerton Titans that I know, Khris Davis and Matt Chapman.  Keep it up guys!

Sincerely,

Bob Kargenian, CMT
President

TABR Capital Management, LLC (“TABR”) is an SEC registered investment advisor with its principal place of business in the state of California.  TABR and its representatives are in compliance with the current notice filing and registration requirements imposed upon registered investment advisors by those states in which TABR maintains clients.  TABR may only transact business in those states in which it is notice filed, or qualifies for an exemption or exclusion from notice filing requirements.

This newsletter is limited to the dissemination of general information pertaining to our investment advisory/management services.  Any subsequent, direct communication by TABR with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides.  For information pertaining to the registration status of TABR, please contact TABR or refer to the Investment Advisor Disclosure web site (www.adviserinfo.sec.gov).

The TABR Model Portfolios are allocated in a range of investments according to TABR’s proprietary investment strategies. TABR’s proprietary investment strategies are allocated amongst individual stocks, bonds, mutual funds, ETFs and other instruments with a view towards income and/or capital appreciation depending on the specific allocation employed by each Model Portfolio. TABR tracks the performance of each Model Portfolio in an actual account that is charged TABR’s investment management fees in the exact manner as would an actual client account. Therefore the performance shown is net of TABR’s investment management fees, and also reflect the deduction of transaction and custodial charges, if any.

Comparison of the TABR Model Portfolios to the Vanguard Total Stock Index Fund, the Vanguard Total International Stock Fund and the Vanguard Total Bond Index Fund is for illustrative purposes only and the volatility of the indices used for comparison may be materially different from the volatility of the TABR Model Portfolios due to varying degrees of diversification and/or other factors.

Past performance of the TABR Model Portfolios may not be indicative of future results and the performance of a specific individual client account may vary substantially from the composite results above in part because client accounts may be allocated among several portfolios. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable.

The TABR Dividend Strategy presented herein represents back-tested performance results. TABR did not offer the Dividend Strategy as an investment strategy for actual client accounts until September/October 2014. Back-tested performance results are provided solely for informational purposes and are not to be considered investment advice. These figures are hypothetical, prepared with the benefit of hindsight, and have inherent limitations as to their use and relevance. For example, they ignore certain factors such as trade timing, security liquidity, and the fact that economic and market conditions in the future may differ significantly from those in the past. Back-tested performance results reflect prices that are fully adjusted for dividends and other such distributions. The strategy may involve above average portfolio turnover which could negatively impact upon the net after-tax gain experienced by an individual client. Past performance is no indication or guarantee of future results and there can be no assurance the strategy will achieve results similar to those depicted herein.

Inverse ETFs
An investment in an Inverse ETF involves risk, including loss of investment. Inverse ETFs or “short funds” track an index or benchmark and seek to deliver returns that are the opposite of the returns of the index or benchmark. If an index goes up, then the inverse ETF goes down, and vice versa. Inverse ETFs are a means to profit from and hedge exposure to a downward moving market.

Inverse ETF shareholders are subject to the risks stemming from an upward market, as inverse ETFs are designed to benefit from a downward market. Most inverse ETFs reset daily and are designed to achieve their stated objectives on a daily basis. The performance over longer periods of time, including weeks or months, can differ significantly from the underlying benchmark or index. Therefore, inverse ETFs may pose a risk of loss for buy-and-hold investors with intermediate or long-term horizons and significant losses are possible even if the long-term performance of an index or benchmark shows a loss or gain. Inverse ETFs may be less tax-efficient than traditional ETFs because daily resets can cause the inverse ETF to realize significant short-term capital gains that may not be offset by a loss.

For additional information about TABR, including fees and services, send for our disclosure statement as set forth on Form ADV from us using the contact information herein.  Please read the disclosure statement carefully before you invest or send money.

A list of all recommendations made by TABR within the immediately preceding one year is available upon request at no charge. The sample client experiences described herein are included for illustrative purposes and there can be no assurance that TABR will be able to achieve similar results in comparable situations. No portion of this writing is to be interpreted as a testimonial or endorsement of TABR’s investment advisory services and it is not known whether the clients referenced approve of TABR or its services.