A new tool will be provided with the January momentum-volatility ranking. I am excited about its potential. It is still preliminary in nature, but offers the promise of significant risk reduction without corresponding reductions in return. It may provide the investor the ability to both eat well and sleep well. It should make sleeping easier at least.
This indicator is an important step toward making the ETF rankings system, which is already pretty good, a better and safer approach to markets.
The Pelerin Protection Indicator
All indicators need names and all pseudonymous authors should have at least one indicator named after them. Hence, this indicator shall be known as the Pelerin Protection Indicator or PPI (not to be confused in any way with the purchasing price index). The PPI is a composite index of trend measures and long term oscillators. It performs like an oscillator, ranging in value from 0 to 10. It measures market strength and provides a means for determining how strong a financial commitment should be made.
The motivation behind this effort was to provide a front-end screen for the ETF rankings. Selecting from a large pool of ETFs invariably catches some fish, even when markets are weak. Rarely do no ETFs not pass their individual screens. A front-end screen to modify the overall commitment was needed. It is difficult to make money in weak markets, especially on the long side. If markets appear weak, that information should be reflected in investment decisions.
To test the efficacy of this indicator, it was applied to the ranking selections of the ETF system. The test was a fairly simple one. What would happen if the PPI was used to alter the weight of money committed? The ETF ranking system was not changed. Only the amount of funds committed to the selections in a particular month were were changed.
Here are some early testing results of combining the indicator with the ETF selections.
Initial Results
Only the amount of funds to be committed to the ETF selections was affected by the PPI in this test. The results are discussed and shown below.
The monthly returns were used from the ETF backtesting. When the PPI indicated strong markets 100% of the funds were committed to the ETF system. Otherwise, a lesser percentage was committed. Premium members know that ETF selections often include cash. That was not altered; only the funds applied in any particular month changed.
For testing purposes hypothetical conservative, normal and aggressive investors were created. Each of these could invest 100% of their funds according to a formula based on PPI. It was harder for the conservative and normal investors to remain fully invested than the aggressive one. The aggressive one did not remain fully invested for all months. A formula based on the PPI value determined the percentage invested for each investor each month. The conservative investor could go to as low as 20% committed to the ETF selections. That meant 80% might be in cash (in addition to whatever cash might have been selected in the ETF rankings).
The period covered 84 months of returns. All three investors performed in line or better than the ETF system alone. All three did so with less money at risk. Total returns over a seven year period remained virtually the same although the volatility (risk) was greatly reduced.
Below are two tables, both dealing with extreme monthly market outcomes. The first one represents the three worst months in terms of the ETF ranking performance. The composite line is merely the summation of these three months. Even in these bad months, the ETF system outperformed the S&P by 4.07%.
These same three months, adjusted for the PPI screen and portfolio allocation adjustments, are shown under the New Port. columns. Depending upon which type of investor you were, the PPI improved your performance over the ETF rankings for this period from 11 – 16%! That is how you sleep and eat better!
| Original | New Port. | Improvement | |||||||
|---|---|---|---|---|---|---|---|---|---|
| Month | Rankings | Market | Better/Worse | Cons. | Norm. | Aggressive | Cons. | Norm. | Aggressive |
| 5/1/10 | -8.89% | -7.95% | -0.94% | -4.4% | -5.3% | -6.2% | 4.4% | 3.6% | 2.7% |
| 9/1/08 | -8.80% | -9.44% | 0.63% | -2.6% | -3.5% | -4.4% | 6.2% | 5.3% | 4.4% |
| 2/1/09 | -6.37% | -10.74% | 4.37% | -1.3% | -1.9% | -2.5% | 5.1% | 4.5% | 3.8% |
| Composite | -24.06% | -28.13% | 4.07% | -8.36% | -10.77% | -13.17% | 15.70% | 13.30% | 10.89% |
This next table shows the three best monthly ETF outcomes:
| Original | New Port. | Improvement | |||||||
|---|---|---|---|---|---|---|---|---|---|
| Month | Rankings | Market | Cons. | Norm. | Aggressive | Cons. | Norm. | Aggressive | |
| 4/1/09 | 15.4% | 9.9% | 5.5% | 10.8% | 12.3% | 13.9% | -4.6% | -3.1% | -1.5% |
| 3/1/10 | 9.6% | 6.1% | 3.5% | 9.6% | 9.6% | 9.6% | 0.0% | 0.0% | 0.0% |
| 7/1/13 | 7.7% | 5.2% | 2.5% | 7.7% | 7.7% | 7.7% | 0.0% | 0.0% | 0.0% |
| Composite | 32.72% | 21.19% | 11.53% | 28.09% | 29.63% | 31.18% | -4.63% | -3.09% | -1.54% |
Improvements are not possible in the best months. Anything less than 100% commitment in these periods reduces returns. The PPI’s market assessment was pretty accurate, leaving these portfolios almost fully invested during these months.
The PPI indicator will be discussed fully with Premium Members. It will be incorporated with the January ETF rankings.
This indicator or the principles on which it is based may be useful in major market allocation decisions. An example would be the percentage of a portfolio devoted to US versus International.
