Muscular Investing

Which ETFs Will Outperform This Month? Here's the List.

Brian Livingston

Brian Livingston


The S&P 500 crashes more than 30% every 10 years, on average. Another such destruction of your wealth is on the way. • Can a simple formula keep your life savings from being shredded while still delivering market-like returns across bear-bull cycles? The answer is ‘Yes.’ Best all of, it’s free of charge. The steps are fully disclosed and supported by years of actual use.


Figure 1. Users of Muscular Portfolios check a website once a month to make sure they hold the three asset classes with the best statistical odds of rising in the 30 days to come. Source: MuscularPortfolios.com.

• More than 100 million households in the US, Canada, and other countries hold 401(k), IRA, and similar savings accounts. The vast majority of 401(k) participants cannot buy individual stocks — only index funds — and can make no more than one or two portfolio changes per month. Despite restrictions like these, you can use 21st-century financial breakthroughs to enjoy market-like returns and more, with no fear of crashes. See my Muscular Portfolios summary.

The search for investing strategies that produce market-like returns with only bond-like volatility is often called the quest for the Holy Grail. I call the process of finding these strategies “Goldilocks investing.”

Astronomers probe the universe for “Goldilocks planets” — ones that are not too broiling hot nor too icy cold to support life, but have a temperature that’s just right, like Earth. After six years of intensive research as an investigative journalist — and 32 years as an investor — I’ve found three Goldilocks investing strategies that stand out.

Remarkably, each one of these simple models prevents your life savings from crashing while returning as much as the S&P 500 or more. This is not impossible at all. In fact, you can match the index, without crashes, using the very simplest of the strategies — perfect if you’re in a restrictive plan that doesn’t allow even monthly adjustments.

I’m not going to discuss this topic in every column, but January is the only month in which the 1st is always a trading holiday. That makes Jan. 1 a perfect day for me to reveal the three formulas before the market opens on Jan. 2. In addition, given fall 2018’s sharp correction, everyone wants to know how to deal with downtrends.

I’m sticking my neck out, as well as other body parts, by claiming that the ETFs shown above will perform well in the coming month. But I’ll support this fully in the discussion below.

How to determine the assets with the best odds

Figure 1 shows the holdings of users who reallocate their portfolios on the last trading day of the month, as explained in the book Muscular Portfolios. You can make portfolio changes on any day of the month that’s convenient for you — your payday, your birthday, or whatever — but reallocating in the first two or last seven trading days of the month produced slightly better results in the most recent 12-year period (see Chapter 5).

As you can tell from Figure 1, the odds now favor bonds and gold. Over the past three months, the portfolios gradually rotated away from their previous holdings of equities. Bonds are currently rallying, while gold — after trending down for seven years — has been rewarding investors since Aug. 16. (Note: The numbers in Figure 1 are provided by ETFScreen.com, based on the Xignite data service.)

In keeping with the Goldilocks story — but updated with 21st-century economic science — the three primary investing formulas that work for long-term savers are as follows:

  • The Papa Bear Portfolio is a “clone” of a basic asset-rotation strategy first published by Mebane Faber in his book The Ivy Portfolio. Cloning means translating a financial expert’s methods into a fully disclosed formula that anyone can use free of charge. His book, based on a paper published in the Spring 2007 issue of the prestigious Journal of Wealth Management, used only five classes of assets. After Faber’s method saved its users from the 2008 crash, he expanded his analysis from 5 to 13 asset classes in a February 2013 whitepaper, which received less notice than his journal article or book. The 13 exchange-traded funds (ETFs) that match Faber’s whitepaper are the basis of the Papa Bear. This strategy is designed never to lose more than 25%, even when the S&P 500 is crashing more than 50%.
  • The Mama Bear Portfolio is a fully disclosed strategy that’s been tracked in real time since 2006 by Steve LeCompte, CEO of the CXO Advisory Group. CXO’s method is slightly simpler than Faber’s, using only 9 instead of 13 asset classes. Its formula is also designed to subject investors to even smaller losses than Faber’s — no more than an 18% drawdown in the most severe bears. (All drawdowns are measured as the worst loss between any two month-ends.) The Mama Bear delivered a smaller rate of return than the Papa Bear in 43-year simulations of asset-class behavior, 14.3% vs. 16.2%. But the less-variable Mama Bear suits people who truly want the smallest risk possible that is consistent with market-beating gains.
  • The Baby Bear Portfolio (not shown in the image above) is a clone of a strategy that’s been advocated for more than two decades by Jack Bogle, founder of the Vanguard Group. It’s ideal for people in college savings plans (called “529 programs” in the US) that restrict owners to no more than one or two portfolio changes per year. Bogle’s formula is simplicity itself. At all times, you hold a balance of 50% US stocks and 50% US bonds using low-cost index funds. No trades are necessary, except a rebalance back to 50/50 near the end of the year. Remarkably, the 50/50 portfolio statistically matched the S&P 500 (including dividends and current ETF expenses) in the 43 years from 1973 through 2015: 9.8% vs. 10.0% annualized. The Baby Bear lost only 29% in the 2007–2009 financial crisis, while the S&P 500 crashed more than 50%. The Baby Bear is living proof that market-like returns with only bond-like volatility can be achieved with simple formulas.

The Papa Bear and Mama Bear are Muscular Portfolios. This term differentiates them from old, 1990s–style Lazy Portfolios. Lazy Portfolios never change their proportions of different asset classes. A Muscular Portfolio, by contrast, is not static — it requires up to 15 minutes of work each month. Users check a free website, where tables like the ones shown above are updated every 10 minutes during market hours.

Only in 9 out of every 12 months, on average, is a portfolio change needed. Users of Muscular Portfolios find this to be well worth the effort, in return for happily sailing through crashes while enjoying market-like returns or better over complete bear-bull market cycles. (The Baby Bear Portfolio is not a Muscular Portfolio but a “starter portfolio” to keep trading costs to a minimum for people with less than $10,000 to invest. A fourth portfolio in the book, the End Game, is for wealthy retired householders who desire income and capital preservation.)

Keeping losses small makes your gains large

 


Figure 2. Muscular Portfolios underperform the S&P 500 during bull markets, but far outperform the index during corrections and bear markets. The math causes Muscular Portfolios to outperform in complete bear-bull market cycles. Source: FolioInvesting.com.

Few investors realize how badly the heart-stopping losses of the S&P 500 hurt one’s long-term performance. It’s well-known that a 50% loss requires a 100% gain to get back to even. A mere 25% loss requires a gain of only 33.3%. But few people know that Warren Buffett, an acknowledged financial genius, doesn’t beat the S&P 500 during bull markets. Buffett’s exceptional returns since 2000 have come entirely from keeping his losses smaller than the index during bear markets. The combination beats the pants off the benchmark over full bear-bull market cycles.

No politician or economist will ever “solve” manias and panics — they’re baked into human behavior. Muscular Portfolios make rallies and crashes work in your favor, using gradual asset rotation rather than market timing that attempts to switch from 100% equities to 100% cash.

Figure 2 uses the Oct. 1 through Dec. 31 collapse as an example. In a real-money account — not a simulation — the Mama Bear Portfolio lost only 9.77%, not even a correction, while the S&P 500 (including dividends but not subtracting ETF expenses) lost a harrowing 13.83%. If the downturn in the S&P 500 that began on Sept. 20 turns into a full-blown bear market — closing down more than 20% — the Mama Bear Portfolio will have an even bigger head start in the new bull market that will inevitably follow.

The Muscular Portfolios website is the first totally free service that reveals the three portfolios’ exact signals, so individual investors can liberate themselves from the fees charged by financial advisers. Wealth managers are in the process of disappearing, the same way most travel agents went out of business as soon as reservations could be made for free on the Web. High-priced advisers won’t vanish overnight, but investors will increasingly dump them and eliminate the haircut that fees take out of their portfolio returns. (Advisers will shift toward estate planning, trusts, and other skills that still require personal consultation, leaving stock-picking to the free sites.)

Thousands of finance professors (academics) and professional traders (practitioners) have spent millions of computer hours analyzing stock-market behavior to death. Studies by these parties claim to have “discovered” more than 300 factors that make some securities rise more than others. Most of this “factor zoo” relies on nothing but statistically insignificant differences, according to “Finding Smart Beta in the Factor Zoo” (Hsu and Kalesnik, 2014).

The simple “four-factor model” that’s been described since 1997 by Mark Carhart, Kenneth French, and Eugene Fama (the latter of whom won the 2013 Nobel Prize in Economics) is still relevant today. It explains that securities do better if they are: (1) exposed to the equity market, as opposed to cash, (2) are small-cap rather than large-cap stocks, (3) are a good value, or (4) or have strong momentum, i.e., a rising price. 

However, some of the four factors work better than others. The small-cap factor “has not been observed in the United States since the early 1980s,” according to Hsu and Kalesnik. They say small caps probably impressed early researchers only due to an error in the databases that were available at that time. Inconsistency also afflicts the value factor. In the 25 years ending Dec. 31, 2017, US value stocks produced no greater return than growth stocks. (The returns were approximately 9.6% annualized in both cases.)

This leaves momentum as the most significant factor — and one that individual investors who understand it can easily use to pump up their gains. “All models that do not include a momentum factor fare poorly,” wrote Fama and French in a 2014 academic paper.

Figure 1 shows how simple the asset-rotation rules are. Muscular Portfolios gradually tilt your holdings toward funds with good momentum and away from funds with bad momentum:

  • The Mama Bear Portfolio holds each month the three index funds with the highest total return (including dividends) over the past five months.
  • The Papa Bear Portfolio is only slightly more complicated, holding the three index funds with the highest returns over the average of the past 3, 6, and 12 months.

The two different formulas make the Mama Bear have smaller gains and losses and the Papa Bear have slightly higher gains and losses. All of the numbers are calculated for you absolutely free at the Muscular Portfolios website. However, if you’d prefer to use StockCharts.com, the book’s appendix provides everything you need to calculate each month the best three index funds for yourself.

How do the formulas “know” that the funds in Figure 1 will perform well in the month to come? The 2016 book Adaptive Asset Allocation reported on 10 asset classes that are very similar to the Mama Bear’s. The authors found that assets in the top half of the six-month performance rankings had a 54% chance of performing in the top half in the following month. Holding just the top three assets rather than the top half improves the probability even more. That may not sound like great odds, but a 54% edge on a roulette wheel would let you bankrupt any casino that would let you keep winning.

In the stock market, unlike Las Vegas, no one can prevent you from playing the odds over and over again, no matter how many times you win. If it’s 54% likely that the assets in Figure 1 will outperform, it’s also possible they may not. We make our money as investors by putting the probabilities in our favor, not obsessing over periods as short as one month or one year. Let the chips fall where they may!

The four strategies in the book — two Muscular Portfolios, one starter portfolio, and one wealth-preservation portfolio — were subjected in the book to extensive 43-year simulations using actual asset-class price data. (I consider the histories to be simulations and not backtests, because the modeling software includes no prices on any tradable securities, only asset classes. Index funds didn’t exist until two decades after 1973.)

It’s my personal opinion that the Papa Bear Portfolio will outperform any other investing strategy that could actually by used by 401(k)-type investors in the next bear-bull market cycle:

  1. The formula is fully disclosed (no secret formulas allowed)
  2. It requires no more than one change (under 15 minutes of work) per month
  3. It’s supported by a free website revealing the picks with no registration required
  4. It’s designed to never lose more than 20% to 25%, even in 50% market crashes

The simulations in the book end on Dec. 31, 2015. But live results have been tracked for the past three years by the brokerage firm FolioInvesting.com. These are real-money accounts, not Folio’s Ready-to-Go tracking funds. I selected Folio to host these accounts specifically because its performance figures and graphs cannot be faked.

This month, I plan to post spreadsheets that will reveal the month-by-month returns of the simulations. And in the next three parts of this column, I’ll extend the 43-year histories to 46 years, using the latest real-money returns.

• Parts 2, 3, and 4 appear on Jan. 3, 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