Seasoned analyst Grant Wasylik presents a duo of ETFs that when used in tandem can offer market-beating gains — without increased risk versus the S&P 500 index.
2016 may go down in history as one of the toughest years for active equity managers.
One of my mutual fund industry contacts recently sent me a research report that shows how tough a year it’s been for stock-pickers.
Bank of America (BAC) has been tracking the performance of active managers for 14 years. And it says 2016 has been the most difficult year on record for active managers.
Just how tough? Only 18% of large-cap managers outperformed the Russell 1000 Index through June 30, 2016.
The Russell 1000 was up 2.6% for the year as of June 30. It’s up about 4.8% as of Oct. 11.
Now, beating the market is a difficult task in any given year …
Last year, 80% of active equity managers underperformed their benchmarks.
And it’s also tough for professional investors to outperform over longer time periods, too …
For the 10-year period through 2014, 75% of active managers failed to beat their benchmarks.
This month, my colleagues at The Leuthold Group found a simple way to bypass the poor prospects of active management and beat the S&P 500.
[For those of you who haven’t heard of The Leuthold Group, they’re one of the top institutional research firms in the world (I’m honored to have access to their information). Leuthold uses proprietary data to do extensive research on financial markets. Individual investors, financial advisers and institutions can view the firm’s product offerings — mutual funds and separately managed accounts — here.]
Leuthold’s method is tied to the “Sell in May and Go Away” phenomenon. But with a twist, which I’ll tell you about in just a moment.
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The time-honored “Sell in May” trading adage warns investors to liquidate their stock holdings in the month of May to avoid a seasonal drop in equity prices. Then, it urges them to get back into stocks in November.
The goal is to skip the worst six months for stocks (May-October), but be fully invested during the market’s strongest six months (November-April).
Historical data supports this old adage …
Over the last 25 years, the S&P 500 gained 548% in the six-month period from November to April. That is more than eight times the 66% return achieved during the six months from May to October over that time.
But, while the May-October stretch has been inferior return-wise, it still posted positive returns.
And in turn, Leuthold has found a market-beating strategy connected to this pattern.
Instead of “Sell in May,” it’s “Switch in May.”
In their October write-up, Leuthold said:
“We tested a hypothetical portfolio which held the equal-weighted S&P 500 during the traditionally strong seasonal months, while hiding out in the relative “safety” of the cap-weighted S&P 500 during the seasonal period of weakness (May to October). The strategy has topped the cap-weighted benchmark by almost 3% since 1990.”
Here’s the chart showing the outperformance of the S&P tag team (S&P 500 Cap-Weighted Index and S&P 500 Equal-Weighted Index):
Source: The Leuthold Group — October 2016
As you can see, even the S&P 500 Equal-Weighted Index has outperformed the S&P 500 Cap-Weighted Index. (11% to 9.3% since 1990.)
Naturally, as market historians, Leuthold examined returns on a calendar basis, as well …
Source: The Leuthold Group — October 2016
The green arrows (S&P 500 Switching Strategy) far outnumber the black arrows (S&P 500).
The consistency of outperformance here is impressive.
Leuthold went on to say:
“It’s clear the track record is not merely the result of one or two “home run” trades: last year broke a string of 15 consecutive years in which the seasonal-switching strategy bested the capitalization-weighted S&P 500 benchmark. In all, barring a violent reversal in the fourth quarter, this simple strategy will have beaten the benchmark in 22 of the 27 years for which we have data.
The strategy “alpha” of 2.9% per annum is remarkable considering the holdings of both portfolios are identical 100% of the time, and the weighting of the holdings are identical 50% of the time.”
Not only is this strategy easy to understand, it’s also easy to execute.
Thanks to ETFs, the SPDR S&P 500 ETF (SPY) and the Guggenheim S&P 500 Equal Weight ETF (RSP) will do the trick.
Next time you’re ready to “Sell in May and Go Away,” consider “Switch in May and Stay” as an alternative.
This article is brought to you courtesy of Uncommon Wisdom Daily.
About the Author: Grant Wasylik
Grant Wasylik is an analyst and editor for Uncommon Wisdom Daily — a division of Weiss Research.
Before joining the investment newsletter business, Grant worked as a portfolio manager, lead research analyst and head trader for a billion-dollar wealth management firm for 10 years. He also spent a few years working in a specialized risk-trading department at Charles Schwab — where he was the first-ever, external hire into this elite department. In his first stint in the securities business (after passing Series 7, 64 and 24 exams), Grant ran a margin department and supervised a trade desk for a discount brokerage firm.
Prior to coming to Uncommon Wisdom Daily, Grant was co-editor and chief analyst of The Palm Beach Letter for two years. This monthly publication — with over 70,000 subscribers — focused on safe, income-oriented investments.
Due to his vast investment experience, Grant has a deep contact list comprised of 300-plus mutual fund, ETF, index, hedge fund and other top-notch financial professionals. In addition, he receives special invitations to — and attends — several of the world’s top investment conferences each year.
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