Value bears vs. momentum bulls

If you ask value investors for a market prediction, you might not get one. But if you do, it’ll probably be less than bullish due to the market’s lofty valuation. For instance, the S&P 500 trades at a cyclically-adjusted price-to-earnings ratio of 27. It was higher only in the bull markets that peaked in 1929 and 2000. Similarly, the index’s Q ratio (price to replacement value) is also very high, which doesn’t bode well.

Problem is, while these indicators do a fairly job of gauging the attractiveness of the market over the very long-term, they’re poor short-term predictors. Momentum investors, on the other hand, can offer some short-term guidance.

I recently had the pleasure of reading Gary Antonacci’s book Dual Momentum Investing, which provides a primer on momentum investing. If you’re interested in the topic, it’s a good place to start.

Half of his “dual” strategy relies on what he calls absolute momentum, which tells investors when to jump into, or out of, the market. The idea is to compare the returns of the S&P 500 to those of U.S. treasury bills, over the last 12 months.  When the S&P 500 comes out on top, investors should move to stocks. When T-Bills reign supreme, it’s time to hide out in bonds.

Mr. Antonacci figures that his absolute momentum strategy returned 14.4% per year on average from 1974 to 2013. By way of comparison, the S&P 500 advanced 12.3% annually over the same period. In addition, momentum investors benefited from a less volatile ride than investors who held the S&P 500.

It is important to point out that absolute momentum did not protect investors from each and every downturn. For instance, it failed during a sudden collapse in 1987. In addition, it didn’t get investors out at the very top of the market in 2000 or 2007. But it did shield them from a good deal of the pain caused by both downturns.

These days absolute momentum investors are pretty bullish.

Over the last 12 months the S&P 500 has outpaced U.S. T-Bills by about 13 percentage points. As a result, momentum investors favour stocks stateside.

In Canada, the S&P/TSX 60 has outpaced Canadian T-Bills by about 6 percentage points over the last 12 months. As a result, momentum investors hold stocks north of the border.

Are North American stocks guaranteed to gain ground over the next year? No. After all, momentum investors regularly check the numbers and are willing to change course quickly. But, for the moment, stocks look good because they have positive momentum.

Just watch out because, with value investors firmly on the sidelines, prices might fall a great deal when momentum investors decide its time to sell.

Safer Canadian Dogs

Investors following the Dogs of the Dow strategy want to buy the 10 highest yielding stocks in the Dow Jones Industrial Average (DJIA), hold them for a year, and then move into the new list of top yielders.

The Dogs of the TSX works the same way but swaps the DJIA for the S&P/TSX 60, which contains 60 of the largest stocks in Canada.

My safer variant of the Dogs of the TSX tracks the 10 stocks in the index with the highest dividend yields provided they also pass a series of safety tests, such as having positive earnings. The idea is to weed out companies that might cut their dividends in the near term. Just be warned, it’s a task that’s easier said than done.

Here’s the updated Safer Dogs of the TSX, representing the top yielders as of May 26. The list is a good starting point for those who want to put some money to work this week. Just keep in mind, the idea is to hold the stocks for at least a year after purchase–barring some calamity.

Notes

Source: Bloomberg, May 26, 2015

Price: Closing price per share

P/B: Price to Book Value Ratio

P/E: Price to Earnings Ratio

Earnings Yield: Earnings divided by Price, expressed as a percentage

Dividend Yield: Expected-Annual-Dividend divided by Price, expressed as a percentage

As always, do your due diligence before buying any stock, including those featured here. Make sure its situation hasn’t changed in some important way, read the latest press releases and regulatory filings and take special care with stocks that trade infrequently. Remember, stocks can be risky. So, be careful out there. (Norm may own shares of some, or all, of the stocks mentioned here.)

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