Technical Thoughts: Going Beyond Fundamentals, 3 Attractive Ideas

Written by Jeff Miller, A Dash of Insight

— this post authored by Mark Hines

Our previous article asked if it was time to get contrarian. If you missed it, a glance at your news feed will show that the key points remain relevant.

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This Week: Going Beyond Fundamentals, 3 Attractive Ideas

This week we review three attractive trading strategies that go beyond fundamentals, and then our cast of trading characters offers three specific trading opportunities that are currently attractive.

Our first attractive trading strategy is “time series momentum,” also called “trend momentum.” Larry Swedroe does a good job of describing this strategy (investing in winners, and avoiding losers) and explaining “Why Trend Following Works” in this article. Swedroe also mentions multiple times that trend momentum not only offers attractive expected returns, but it also has a lower correlation with other strategies, thereby making it a powerful risk-adjusted addition to multiple trading strategies. As we’ll see more later, several of our trading models (e.g. Felix, Oscar and Athena) utilize trend momentum strategies.

Our second attractive trading idea is a multi-strategy “team-based” approach. According to Dr. Brett Steenbarger, successful traders find multiple ways to make money. With regard to successful traders, Steenbarger writes:

“They aren’t limited to one strategy or pattern to trade. That allows them to succeed when markets become slower or when trends are not dominant… A great way to not succeed is to be isolated and locked into a single style of trading.”

This multi-strategy approach is also relevant to the non-correlated benefits of trend momentum as mentioned earlier. Further, we find that blending multiple trading strategies helps us to lower risks while also keeping returns strong (we share our trading model performance later in this report).

Our third attractive trading strategy involves behavioral economics. According to the 2017 Nobel Prize winner for economics, Richard Thaler, behavioral economics will eventually disappear as a distinct part of economics, instead becoming essentially ubiquitous with the term. And according to AQR (the creator of much of the academic trend momentum work cited by Larry Swedroe, earlier in this report):

“a large body of research has shown that price trends exist in part due to long-standing behavioral biases exhibited by investors, such as anchoring and herding, as well as the trading activity of non-profit-seeking participants, such as central banks and corporate hedging programs.”

We’ve been having success taking advantage of said behavioral biases using our momentum models (e.g. Felix and Athena), as described in the following trading model performance table.

Trading Model Performance:

Per reader feedback, we’ve recently started including a table summarizing the performance results for our trading models. The table (below) shows actual client results after commissions and fees (I watch this every day, and now readers can see it as well). We’ll share additional information, including test data, with those interested in investing. For our weekly updates, we use only real-time results.

For reference, the results in the table above include all of the positions (10 for Road Runner and Athena, 16 for Holmes, and 20 for Felix), not just the specific stock examples we discuss in the Stock Exchange every week (and sorry Oscar, you have too many individual stocks and trades to be part of this approach). We’ve included six months of data since that is the shortest real-time record we have. All of the models are expected to perform well over longer time periods. Holmes, for example, has returned over 20% in the last eighteen months.

Also very importantly, our models (especially our “Blended” approach) tend to have a low correlation with the overall stock market, which can be extremely valuable for diversification and risk management purposes (this is essentially the multi-strategy team-based approach Dr. Steenbarger described, and the low correlation benefits that Larry Swedroe described.

Expert Picks From The Models:

This week’s Stock Exchange is being edited by Blue Harbinger (aka Mark Hines). Blue Harbinger is a source for independent investment ideas. The three stocks selected by our “trading team” this week are based on multiple strategies (e.g. trend momentum and dip-buying). We also share lists ranking securities from Felix and Oscar.

Road Runner: This week I like Southwestern Energy Company (SWN). Have you heard of it?

Blue Harbinger: Yes, it’s an energy company; oil and natural gas exploration and production. It’s relatively small ($2.8 billion market cap), and based out of Spring, Texas. Why do you like this stock, Road Runner?

RR: As you know, I like to buy stocks that are at the bottom of a rising channel. And based on the following chart, you can see why I like Southwestern Energy Company.

BH: Interesting pick. Are aware this company has generated a large net loss (i.e. negative net income) in 2015 and 2016, and it has a lot of debt relative to its assets. Higher energy prices could help this company, but the price of oil has fallen since we wrote about it two weeks ago: Will Oil Hit $70 Soon?Here is a look at Chuck Carnivale’s FastGraph for more fundamental information.

Road Runner: I am a trading model, not a person, so I am not “afraid” of the data points you mentioned. Besides, my typical holding period is about 4-weeks. I’ll be in and out of this stock before the company’s fundamental story plays out.

BH: Suit yourself, Road Runner. Personally, I like to dive deeply into the fundamentals before I invest in any company, but I suppose you’re trying to move beyond the fundamentals. I’ll check back with you on this one in about 4-weeks. Anyway, how about you, Holmes – what have you got this week?

Holmes: This week I bought Proofpoint (PFPT). This stock’s dip over the last month is the sort of setup I like to see. From the chart below, you can see it is well below its 50-day and 200-day moving averages. However, it has attractive upside over the next six weeks.

BH: Proofpoint provides cloud-based solutions to prtect people from attacs on their email, social media and mobile aps. It sounds like there could be a large total addressable market for this company given the explosive growth in cloud-based applications. And even though this company is not yet profitable, its revenue has been growing very rapidly. Here is a look at the FastGraph.

Holmes: It’s nice that your FastGraph showns the company will experience strong growth in 2018 and 2019, but I’m typically in and out of my trades in about six weeks.

BH: Based on your dip-buying strategy, I suppose your trying to move beyond the fundamentals, but this long-term growth story is interesting to me. I’m going to take a closer look at this one. Thanks for bringing it to my attention. How about you, Athena – any ideas for us this week?

Athena: I like Vertex Pharmaceuticals (VRTX).

BH: Interesting. Vertex is engaged in discovering, developing, manufacturing and commercializing medicines for serious diseases. For example, Vertex is focused on developing and commercializing therapies for the treatment of cystic fibrosis (CF). Why do you like this stock, Athena?

Athena: As you know, I am a momentum trader, and my typical holding period is about 17-weeks. Based on the following chart, Vertex has a lot of upside price potential.

BH: Honestly, I don’t know enough about this company to have a strong opinion. I don’t know if I’m impressed or disturbed that you and the other models can pick stocks so quickly, and then own them for only a few weeks at a time. Vertex, for example, has barely been profitable so far this year, and the market has very high hopes for the company based on its valuation multiples. Here is a look at the FastGraph.

Athena: Thanks for that information, but I’m a trader, not an investor, and Vertex looks attractive right now.

BH: Well, at the very least I can say I am impressed with your performance in recent months, as shown in the earlier performance table. How about you, Felix – what have you got this week?

Felix: This week I am sharing my ranking of the top stocks in the Dow 30. I’m showing my top 20 in the following list. Also, as you know, I am a momentum trader, but I typically hold my positions for about 66 weeks – which is much longer than the other models. I exit when my price target is hit, and I use stops and macro considerations to control risks.

BH: Thanks for that list, Felix. I see a lot of the usual suspect (i.e. stocks that have been performing well this year) which makes sense considering you’re a momentum trader. DowDuPont (DWDP) is an interesting one. I think it’s still not on the radar of many investors as much as it should be following its creation through the relatively recent merger of Dow and DuPont. I suspect their actually are some synergies there that the market isn’t yet fully recognizing, plus I like Basic Materials (Chemicals) companies at this point in the cycle. Thanks for sharing. And what about you Oscar – any picks this week?

Oscar: This week I’m sharing my top ranked ETFs among “high volume” ETFs. The following table includes my top 20.

BH: Thanks Oscar. I see gold miners (DUST) and oil (USO) are still at the top of your list (the were last week too). Its also encouraging to see you have the S&P 500 (SPY) ranked highly too because it suggests to me you think this market can still go higher, at least over the next six weeks, which is your typical holding period.

Conclusion:

As we often mention in this Stock Exchange series, trading and investing are very different. However with both (and particularly with trading) it’s important to move beyond just the typical fundamental analysis, and to also include other factors (such as momentum) via a blended approach in order to take advantage of market opportunities such as those created by behavioral biases. Our blended model approach has been performing well, but more data and analysis is always important.

Background On The Stock Exchange:

Each week, Felix and Oscar host a poker game for some of their friends. Since they are all traders, they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” (Check out Background on the Stock Exchange for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am usually the only human present and the only one using any fundamental analysis.

The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities.

Stock Exchange Character Guide:

Getting Updates:

Readers are welcome to suggest individual stocks and/or ETFs to be added to our model lists. We keep a running list of all securities our readers recommend, and we share the results within this weekly “Stock Exchange” series when feasible. Send your ideas to “etf at newarc dot com.” Also, we will share additional information about the models, including test data, with those interested in investing. Suggestions and comments about this weekly “Stock Exchange” report are welcome.