TODAY’S PARADOX: SUCCESS WITH LESS MONEY

Last week Dow Jones announced that Apple will replace battered telecom giant AT&T in the Industrial Average. The change will take place on March 19, 2015, and while most theories regarding the change point to the impending 4-to-1 stock-split of another Dow component (Visa), I suggest a very different motive: Poor Performance. See below.

There is only one reason a 500 stock portfolio consistently outperforms a 30 stock portfolio for three consecutive years – inferior construction and/or components. And no one knows this better than the members of the Dow Jones selection committee.

People who have read my book know how much respect I have for those responsible for the Dow Jones Industrial Average. It really is a brilliant piece of work. But to be fair they’ve had a tough time solidifying the portfolio since the ’08 meltdown.  This Apple move will represent the tenth change to the Industrial Average since trading began in the ’08 year. While I’m sure they didn’t want to make another move so soon – they had to.

Despite all the hype and hoopla surrounding the Dow’s recent streak of new record highs, its performance has been weak as comapred to the S&P 500. In the three year trend shown above the S&P 500 outgained the Dow Average 65% to 46%, respectively. That’s too much, for too long. The Dow needed a change to improve its performance.

So not the case with the 15-51 strength indicator.

As you know, the objective of that portfolio is to indicate how stock market strength is performing. It should produce above-average market returns on a consistent basis, which it reliably does. See below.

The 15-51 Indicator produced an index-leading 77% gain in this three year period while also moving in a “market-like” way. That’s what it is supposed to do. And while I believe it will continue to produce above-average returns in its current form, I’m not so sure it will continue to move in a market-like way.

The Dow Jones Industrial Average is replacing AT&T with Apple, a stock that produced a 31% gain in the last five years with one that added 291% in the same time. Needless to say, the move will significantly change the trajectory of the Dow Average. That dynamic, all by itself, might cause the 15-51 Indicator to move in an “un-market-like” way. So after much thought and analysis, I decided to again modify the 15-51 Indicator.

The last time the Indicator was altered was year-end 2011; it was the first change in its history. (See: Re-defining Strength) I took some heat over that move because it was announced in arrears. Some thought the after the fact announcement was intended to enhance or protect the 15-51 indicator’s performance trend, which is silly. The original and unchanged 15-51 portfolio detailed on page 162 of my book continues to outperform all others; it was up 92% in the same period shown above. A comparison of the portfolios is below.

As you can see, the original 15-51 portfolio wasn’t moving in a market-like way – and Apple was the reason for that. Its performance was too strong, too volatile, and too contrary to market movements. It constantly pushed the portfolio’s performance and allocations far beyond market boundaries — so much so it was making it impossible for the portfolio to meet its objectives.

Performance – and market movement – are key objectives for the 15-51 Indicator. It must produce above-average returns and move in a market-like way. If it fails in either of these cases it must be changed. That’s why Apple was removed in 2011.

And that’s why it will return.

15-51 component IBM has a similar five year return as AT&T (24% versus 31% respectively) which is way below the market average during the time. IBM also has some significant operating issues to face; it no longer has a dominant position in the marketplace, suffers from an identity crisis, and seriously needs to reinvent itself. It really doesn’t deserve a place in a strength-oriented portfolio.

As a result, Apple will replace IBM in the 15-51 indicator at the IS: 2-2 position. The portfolio will also be rebalanced at the same time. The change will take effect at the close of trading on March 18, 2015, one day after Visa splits 4-for-1 and one day before Apple appears in Dow trading. The move will elevate the 15-51’s technology allocation similar to that of “the market,” and should keep it on the same trajectory as the Dow.

Success is about achieving goals – and comfort-level is a key component.

Movement is a key objective for me because I take comfort in knowing exactly how my portfolio will act under any condition. Prior to making the changes to the 15-51 portfolio in 2011, its movement became more about Apple and less about “the market.” I’m not comfortable with that dynamic, so I made the change.—And I wasn’t scared about losing the powerful performance of Apple because I knew I could get robust performance with a less volatile, less risky, 15-51 portfolio. Proof of that can be seen in the table of three-year returns shown below.

  ROI Pts Off % Off
o15-51  (original, static) 92%  
 15-51si (strength) 77% -15% -16%
S&P 500 (average+) 65% -27% -30%
DJIA (average) 46% -46% -50%

Apple more than doubled during this time (132%) and the stock I replaced it with only grew 76%, which is better than the market average but half of what Apple produced.

There is no such thing as a free lunch with investment.

There was a cost to achieving my desired pattern of movement. However, by earning less return the portfolio went from failure (not achieving objectives) to success (achieving objectives). Success, therefore, was obtained by earning less money and gaining more comfort. That’s a trade I was more than willing to make – and it was made easier by my 15-51 method.

The 15-51 method has a lot of good traits; it’s simple, stable, and flexible. But perhaps its best feature is the long-term profit power it produces. The method allows investors to be more cautious while still earning great rewards. See below.

Since inception in 1996, stock market strength via the 15-51 Indicator has produced an amazing 1,606% return – despite my efforts to produce less. The market average added just 243% in the same time – despite their efforts to produce more.

That’s today’s paradox.

Stay tuned…

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