My Journey Continues

September 26 ,2014

When I discovered ” SPY ” , I thought my investment journey was at an end.  All I had to do was  trade  VTI /  SPY  trends  and  be assured  of controlled losses and unlimited gains.  And , last year,  I did,  in fact, cover almost  all  of my household expenses.

This year is a different story.  I am ahead, but I had  better come up with an improved method  to reach my annual financial goal.

For instance, year to date,  SPY has appreciated 7.7%.  That is $77,700 on a 1 million dollar investment, $38,500 on $500,000 invested,  $19,250 on $250,000 and $7,700 on a $100,000 investment.  The Real Estate taxes on my house are almost  $36,000 so there is a need either  to build a better mouse trap or burn savings to cover living expenses.  Of course, another alternative would be to reduce living expenses.  But, this journey is not about austerity budgets. Its about moving on up,  instead of moving down and out. .  Its about  what keeps the blood circulating in my brain.

Because there have been no opportunities to trade SPY this year , ( VTI hasn’t ended a month lower than its 200 day moving average ), and, because I intend to leave expenses at their current level, I have no choice  other than taking on more risk  than the market timing risk that accompanies “SPY ” via my market canary VTI.

I am going to review my alternatives out loud.  And, I’m not going to make any significant moves until this is thought through…in the open, in this and subsequent posts.

SPY is the performance benchmark that all analysts, advisors, hedge funds etc are measured against .  And, according to John Bogle, Founder  of Vanguard, the majority of paid professionals don’t measure up to the results achieved  by VTI or  SPY.  And, his opinion is shared by Warren Buffett  It just so happens that I intend to invest most ( at least 51% ) of my liquid net assets in SPY or VTI or IWB or IWM  based on which of these indexes is leading the market.

On the other hand, its just been reported that the YALE endowment returned something north of 20% this year.  The middle ground between the  SPY  result and the Yale result,  (+/- 13.5%  ) is where I want to be.

I know that endowments are usually  involved in alternative investments,  supposedly giving them an advantage over  traditionally assembled equity  portfolios.   The closest I can come to that, on my own, is to  invest in the Blackstone Group, symbol BX, which has investments in residential real estate mortgages and consumer paper.  Blackstone has $270 billion in assets under management, yields 5.40% per annum and,  at $31  is almost all the way  back from its visit to below $5 per share in 2007.  Clearly, I can’t wait eight years for an investment to re-emerge from the watery depths.  But, I will invest in Blackstone, purchasing  just a few shares. They are supposed to be the best of their breed and whatever small investment I make should yield information about the  alternative investment universe.

One step down from SPY, ( but up one step  in risk ), are  ETF  sector funds.  Investors Business Daily organizes the stock market  market into 33 broad sectors containing  197 sub-industry groups. IBD estimates that 12% of a stock’s performance depends on the broad sector in which it operates and 37% of a stocks performance is dependent on its sub-industry group.  I suppose that means the balance of its performance ( 51% ) relates to the specific issues a company confronts.

For  my convenience , I’m going to reduce the broad sector head count from IBD’s 33  sectors to a more manageable State Street Global Investor’s 9 SPDR -ETFs.  They are listed with their 2014 year to date results as follows;

XLP ( Consumer Staples ) 4.5% , XLY ( Consumer Discretionary ) 0.2%, XLI ( Industrial ) 1.1%,  XLB (  Materials)  8.0%,  XLK ( Technology ) 10.6%,  XLU ( Utilities ) 10.3%, XLE ( Energy ) 2.6%,  XLF ( Financial ) 5.9%,  XLV ( Health Care )  16.2%..

Unless, a sector ETF or sub-Industry Group ETF  is outperforming SPY there is no reason to be invested in it….because of the extra risk involved….and, because our goal is to beat the benchmark’s 7.7% return.

Broad sectors and sub-industry groups are more risky than SPY because of  ” rotation risk”.  Sectors and industry groups come into favor and go out of favor at different times and for different reasons and at different speeds.  Here is where charts come in handy.

I want to be on the lookout, not just  for chart trend line crossovers of the ETF’s price,  but the crossover of one trend line above or below another.    Just last week there was a lot of buzz about the 50 day trend line of IWM ( Russell 2000 index  ) crossing below its 200 day trend line….an ominous  ” death cross ”  for the entire stock market.  I want to  check to make certain money is flowing into the subject ETF and not leaving.  I also want to determine whether or not volume ( in relation to 90 days average  volume ) is above the 90 day average on increases in price ( conviction ).  Finally, I want to select and sort, top down,  what I consider are the healthiest looking charts and then ask the question ….why?

If I’m not comfortable with the answer to the question ….Why?,  then no investment.  If I am comfortable I will invest.  The amount of money for investment in sector and sub sector ETFs is yet to be determined.  An initial run through the list of ETFs I follow shows very few have outperformed SPY ( 7.7% YTD ).  A sprinkling of those who have are FBT ( Biotech 13% ) RPG ( Fastest growing third of S&P 500 index )  11%,  QQQ ( Nasdaq 100) 12.1%, INP ( India ) 25.6%,  XLV ( Healthcare )16.2%, and XLK ( Technology ) 11.1%.   At some point,  soon, I’ll publish a list of the Charts I follow.

And then, there is the recent development of ” smart ” ETFs whose component stocks have been handpicked for a reason.  Stocks selected for inclusion can come from any ETF sector.  These stocks are included because they share  predetermined business operating  and performance criteria.

For instance, stocks selected for the PKW and SYLD baskets are based on the propensity of the included companies  to buy back shares from shareholders at lower than fair market prices,  to the benefit of the remaining shareholders.  And, ( my criteria ),  these repurchases must not be financed by debt.  These component companies share revenue growth, healthy operating margins, and free cash flow that is not required for capital reinvestment and / or acquisitions .  Companies in the VIG basket  operate the same way but focus on increasing dividends rather than share re-purchases. The level of dividends isn’t as important as the record of increases…demonstrating continually improving operating performance.  And, then, there is ” MOAT” , an ETF containing 20 companies who have demonstrated they enjoy a sustainable advantage over their competition by virtue of product patents, scale,  systems that are not easily transferrable etc..

What I especially like about these four ETFs is that their portfolio components represent the ” cream” of a ton of research to arrive at what I consider to be the safest possible investment in stocks, and well diversified, as follows ; PKW   (175 holdings ) , SYLD ( 102 holdings ), VIG (163 holdings ), MOAT ( 20 holdings ).  These are real businesses which subscribe to practices which result in the creation of long term value.  You don’t date these stocks, you marry them.. except for temporary separation during severe market downturns.  This is as close to “buy and hold ” as I will ever get.

All that’s left here,  is for  me to refine this ” cream ” by gradually analyzing all 460 of the above components ( I’m positive there are quite a few duplications because of redundancy of selection criteria ).  The result will be 20 entrants into the RMG personal ETF portfolio.

Want returns north of 25%. ?   This is where you really take on risk unless you manage the risk by the size of the investment in relation to the balance of your financial investments  and the number of names in the portfolio.

Everybody gets excited about names like Facebook, Twitter, Baidu,  Stratasys, Tesla,  Sales Force .com, Apple, Ali Baba, Netflix and Amazon.  All great businesses except I’m not 100% comfortable with what the management wants versus what I want.  An illustration would be Jeff Bezos vision of how he sees Amazon.  I believe many of these entrepreneurs see their creations as a reflection of themselves, and I don’t trust that.  I’d rather they thought that the growth rate of their free cash flow is a better, more flattering reflection.  That doesn’t mean I don’t admire  what these entrepreneurs  are accomplishing.  It just means I see my money more as a hostage than as an investment and that makes me nervous.  My goal is to create an RMG 20 stock  momentum portfolio with the riskiest  5% of my liquid assets and accept the risk that goes with it.  Who knows how this will track ? !  It will be subject to my rules for selling VTI.

SUMMARY of Risk /  Return progression

1 )  Index ETFs……. VTI ,SPY,  only market risk.

2) Additional Index ETFs with a bit more risk / reward baked in….QQQ, IWM, IWB.  Contents of these baskets already  in VTI.  If VTI wins, these win.

3 ) Smart ETFs ….PKW, SYLD, VIG, MOAT ..Stocks can come from any sector based using the fruits of high performance to  enhance shareholder value

4 ) More Risk / More Reward ….” rotational risk ”  Sectors such as Energy  / VDE,  Transportation / IYT,  Biotech / IBB,  Defense / ITA  etcetera

5 ) Start to add specific risk by screening  individual stocks from Smart ETFs pool with an eye toward marriage. ( suggestion: 20 positions of 5% )

6 ) Add specific risk plus mania risk to Stocks that ( for me ) are difficult to value for the long term…I call these ” dating stocks “. SSYS, TSLA, FB,  TWTR, YHOO etc.

So that is it for now – just  preliminary thinking to make my journey more rewarding and fun without exposing myself too much.

Stay tuned

Richard Maurice Gore





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