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Last week I wrote about how much things have changed in the financial markets in the past quarter century (see Kaeppel’s Corner: Be of One Mind… or Two, or Maybe More). Below, I include again the table from last week that lists 16 ETFs, four from each of the following categories:

• U.S. Stock Market Indexes
• International Stock Market Indexes
• Bond funds
• Commodity related funds

Table 1 – ETFs in different categories

So what is the purpose of this list? In part, it is to illustrate the fact that there is a very wide range of opportunities available in the markets these days. As I discussed last week, investors no longer have to choose between being a “stock guy” or a “bond guy,” or a “growth guy” or a “value guy.” In fact, you don’t have to be a guy at all. Just one other major change over the past several decades is the number of women who make their own financial decisions. So how can an investor use this list specifically? Well, there are several choices.

On a somewhat subjective basis, you can watch the various categories and note which one or ones seem to be performing the best at the moment. At the very least this can give stock market investors a heads up to times when it might make sense to “lighten up” a bit – i.e., if bonds and/or commodities are leading the way. Likewise, investors who typically only invest in stocks of U.S. domestic companies – or mutual funds that do the same – can peruse these various vehicles and consider “branching out a bit rather than simply “riding out” a bear market.

At the other end of the spectrum lies a completely mechanical approach. Consider this strategy:

• At the end of each month, buy and hold the five ETFs from Table 1 that have shown the greatest gain over the previous year.

This strategy would have garnered a profit of about +28% in 2007 and a further gain of about +3.3% so far this year. This performance compares quite favorably with the +3.5% gain and the –8.1% loss registered by the S&P 500. This works out to a gain of +32.1% over the past 13.5 months for this simple timing method versus a loss of –4.8% for the S&P 500 during the same time.

Table 2 displays the five funds held each month, the gain for the month and the cumulative total.

Table 2 - Month-by-Month (Top previous 12-month performers)
*  Through 2/15/08
*  ETFs in bold are new additions for that month

There are a few things to note in Table 2 beside the pretty decent performance.

1. First off, there is not a lot of turnover. New additions are bolded in the “Funds Held” column. As you can see, this is not a “high frequency trading program” by any means.
2. You can also see the “rotation” evolving as the year 2007 progressed. The large cap domestic and foreign stock indexes led the way through most of last year, then in recent months the commodities markets (gold, oil, ags, etc) have moved to the fore. This is called “going with the flow,” or “taking what the market gives you,” or “there’s always a bull market somewhere,” or, well, you get the idea.
3. The last thing to note is that the results were quite consistent over this short test period, despite a great deal of volatility within the financial and commodity markets.
4. The only real problem with this method is the extremely short test period. Some of the foreign and commodity ETFs have not been around very long so it is simply not possible to run a multi-year test on them. Nevertheless, my guess is that it will hold up pretty well over the long haul. I’ve done a pretty similar thing with Fidelity sector funds for many years and the long-term results have been excellent.

Chart 1: Powershares, Weekly Chart #1

Chart 2: Powershares, Weekly Chart #2

Summary

So should everybody rush out and start investing money using this method? That’s not exactly the point I am trying to make. The main purpose is to highlight the fact that:

• There is life out there beyond individual U.S. stocks,
• It is possible to utilize a mechanical method and beat the market (okay, at least for the past 13.5 months anyway).

The obvious question is “how well will this method perform in the future.” And here I have to go with my stock answer:

As always, time will tell.

To search for previous articles written by Jay Kaeppel, please click here.


Jay Kaeppel
Staff Writer and Trading Strategist
Optionetics.com ~ Your Options Education Site

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