Muscular Investing

Which ETFs Will Outperform This Month? Here's the List - part 2

Brian Livingston

Brian Livingston


The secret to long-term performance is not letting your portfolio skyrocket during bulls. Instead, keeping your losses small in bears is the key. • A clone of a strategy by Steve LeCompte delivers on both counts using simple rules. Surprisingly, it has similarities to the way Warren Buffett racks up his huge winnings in the market - and it’s easy for you to do the same.


• Part 1 of this column appeared on Jan. 1, 2019. •

I mentioned in Part 1 of this column that Warren Buffett’s portfolio, which trades under the symbol BRK/A, doesn’t beat the S&P 500 during bull markets. The outstanding outperformance that Buffett is famous for is entirely due to his portfolio losing less than the S&P 500 during bear markets.

This fact is an important part of why Muscular Portfolios work so well over long periods (complete bear-bull market cycles). The secrets of long-term investing — for people who can’t or don’t wish to rapidly trade individual stocks — can be summed up in two principles. Unfortunately, they go against every instinct we have about money:

  1. Virtually every market-beating financial strategy underperforms for years. Mark Hulbert, the founder of the Hulbert Financial Digest, studied 36 advisory newsletters that had continuous, 34-year publication histories. Only 8% of the advisers outperformed the S&P 500, and even that success might or might not repeat. The amazing trait that all the winning newsletters shared is that they badly underperformed the S&P 500 in more than half of the five-year periods during the study. “It’s the rare investor,” Hulbert says, “who is willing to stick with a strategy after five years of market-lagging performance.” But that’s exactly the dogged conviction that investors must have to follow a superior investing plan. The Vanguard Group did a separate study of 1,540 equity mutual funds. Only 18% outperformed the S&P 500. Practically every one of them (97%) underperformed their benchmark in at least 5 years of the 15-year study period, confirming Hulbert’s findings but on a much larger scale.
  2. It doesn’t bother Buffett that he lags in bull markets. Figure 1, shown below, illustrates the fact that Buffett’s diversified portfolio falls far behind the S&P 500 during bull phases. For example, in the 2002–2007 bull market that followed the dot-com collapse, the S&P 500 rose 90%, but BRK/A went up only 56%. That’s less than two-thirds of the index’s gain. But Buffett’s asset selection performs much better than the S&P 500 during bear markets, easily making up the difference. Buffett’s portfolio actually rose during the 2000–2002 dot-com crisis. This is the same lagging-to-leading behavior that virtually all market-beating advisors and fund managers exhibited in Hulbert’s and Vanguard’s studies.

To our detriment, human nature works against patience. We live minute by minute and don’t allow a successful formula to work its magic over the years. Fortunately, you can overcome this destructive trait.

Even a genius like Buffett lags during bull markets

 


Figure 1. In total, Buffett’s portfolio gained an amazing 169% from March 2000 to June 2015 — two bear-bull market cycles — whle the S&P rose only 28% in the same period. The outstanding performance was entirely caused by the BRK/A portfolio keeping its losses small or nonexistent during the two crashes.

The financial strategies that are revealed in the book Muscular Portfolios don’t require you to have patience. Instead, users of the portfolios are told right up front: “A Muscular Portfolio will lag the S&P 500 in every bull market — get over it.” In truth, Muscular Portfolios sometimes enjoy a few months of outperformance during a bull phase. But you can treat those periods as rare treats. You can’t expect a diversified portfolio to magically outdo the bull run of one of the strongest economies on the planet.

I’d like to clear up right now any illusion that I personally developed any of the portfolios in the book. Instead, through years of research, I identified strategies that were fully disclosed, free of charge, required no more than one position change per month, had years of real-money experience, and were developed by financial experts such as Jack Bogle, founder of the Vanguard Group, and Mebane Faber, co-author of The Ivy Portfolio. We’ll examine their strategies in later parts of this column.

Today, the focus is on Steve LeCompte, CEO of the CXO Advisory Group. He developed and revealed to the world the strategy he calls the Simple Asset Class ETF Momentum Strategy. The free, cloned version in the book is known to us as the Mama Bear Portfolio (which specifies a few newer ETFs that have lower fees than LeCompte’s original lineup). The strategy has been tracked with real money since at least 2006. And while outperforming the S&P 500 over complete market cycles, the Mama Bear also pulls off the remarkable trick of never losing more than 18%, even when the S&P 500 is down over 50%. (All drawdowns are measured as the greatest loss between any two month-ends.)

In my research, I use 43 years of asset-class price histories to simulate what would have happened if investors as far back as 1973 (1) could buy low-cost index ETFs and (2) enjoyed today’s very cheap trades or even commission-free ETFs. The historical data was available through Dec. 31, 2015. I’m glad to say that I’ve maintained real-money accounts at FolioInvesting.com to demonstrate the actual percentage gains of the Mama Bear, Papa Bear, and Baby Bear in 2016, 2017, and 2018. These accounts are fully subjected to the free market’s expenses, bid-ask spreads, price slippage, and all the other ills we investors fall prey to.

The Mama Bear illustrates the power of long-termism

Figure 2 adds the latest three calendar years to the 43 years of simulated performance. This forms an unbroken picture of 46 consecutive years. In the graph, the diamond markers represent the month-end drawdowns that the Mama Bear and the S&P 500 (including dividends) suffered. The two circular markers at the beginning of 2016 and the end of 2108 denote the track record of the real-money accounts.


Figure 2. Despite lagging during the 2009–2018 bull market — which is by design — the Mama Bear Portfolio greatly outperforms the S&P 500 when both the bear and bull phases are counted together, which many pundits fail to do.

From the peak of the market at the end of October 2007 through the volatile ending of 2018, the Mama Bear Portfolio handily beat the S&P 500’s total return. The Mama Bear rose 128%, delivering an annualized rate of return of 7.67% during the 11 years and 2 months. The S&P 500 gained just 104%, a return of only 6.58%. Notice the following facts:

  1. The Mama Bear underperformed the S&P 500 in the simulation from Feb. 28, 2009, through Dec. 31, 2015, with a gain of only 125% vs the index’s 409%. The Mama ’s $14,203 turned into only $31,905. The S&P 500 turned $1,881 into $6,010.
  2. The Mama Bear also underperformed the benchmark in the three years of real-money tracking. The diversified portfolio gained slightly less than 15.5% compared with the S&P 500’s 30.1%. That translates into a three-year return of 4.9% vs. 9.2% annualized.
  3. Despite lagging during the bull, the Muscular Portfolio vastly enriched its users across the entire 11+ year period. From Oct. 31, 2007, through Feb. 28, 2009, the Mama Bear lost only 12% while the S&P 500 crashed 51%. Bear markets seize control seemingly out of nowhere, with no 100% accurate method to predict crashes. Muscular Portfolios users don’t time the market. They don’t have to! Instead, they use gradual asset rotation, moving each month into ETFs that are in uptrends and out of ETFs that are not. (Using different start and end dates, the Mama Bear was actually down a still-tolerable 18% at one point during the financial crisis. This drawdown is shown in Figure 5-1 of the book. But to remain consistent here, Figure 2 uses the same start and end dates for both the S&P 500 and the Mama Bear. The 18% drawdown is still fully reflected in the performance numbers graphed in Figure 2.)

Can you accept a diversified portfolio that is expected to never outperform the S&P 500 during bull markets? Can you focus on the important things in life while a Muscular Portfolio proves itself across the next bear-bull market cycle? (A bear market occurs every eight years, on average.) If you’re ready to leave short-termism behind, you can free yourself from scrutinizing the wiggles of the market every day. You can stop paying fees to advisers who can’t deliver better results than you can achieve by yourself.

In Parts 3 and 4 of this column, we’ll see how the cloned portfolios of Bogle and Faber manage in different ways to deliver on their own promises: market-like returns with less than bond-like volatility.

• Parts 3 and 4 appear on Jan. 8 and 10, 2019.


With great knowledge comes great responsibility.

—Brian Livingston

CEO, MuscularPortfolios.com

Send story ideas to MaxGaines “at” BrianLivingston.com

 

Brian Livingston
About the author: is a successful dot-com entrepreneur, an award-winning business and financial journalist, and the author of Muscular Portfolios: The Investing Revolution for Superior Returns with Lower Risk. He has more than two decades of experience and is now turning his attention directly on the investment industry. Based in Seattle, Livingston is now the CEO of MuscularPortfolios.com, the first website to reveal Wall Street's secret buy-and-sell signals, absolutely free. He first learned computer programming on an IBM 360 in 1968 at age 15. Learn More