U.S. Stocks Continued To Outperform The Rest Of The World In The Second Quarter. What’s Next?
Monday, July 08, 2013 10:47

Tags: active management | Economic Outlook | momentum investing | stocks | style classification

The second quarter brought more good news for investors in U.S. stocks, which continued to dominate the global investment scene. No other asset class even comes close to the lofty 14% return on U.S. stocks so far this year. Will this dominance continue? Read on for my views on that question and for a review of second-quarter results.


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U.S. stocks earned 2.5% in the second quarter, bringing the year-to-date return up to 14%. By contrast, the EAFE index lost 1% in the quarter, bringing the year-to-date return down to 4%. Since U.S. stocks earned 16% last year, the 18-month return through June was 32%.
Small cap growth stocks led the way in the first half, earning more than 19%. By contrast, large cap core companies earned only 7.5%. Other than these extremes, style returns clustered around 14%. (See Surz Style Pure® classifications.) On the sector front, consumer discretionary and health care fared best, earning 20%. By contrast, materials lost 7.5%.
When you cross styles with sectors you can exploit momentum effects. In Searching for Alpha in Heat Maps I showed how heat maps can be used to forecast winners and losers, based on momentum.
The following table shows the forecast I made in April (check me out) and the actual results. As you can see, momentum “worked” in the second quarter, with my picks to outperform doubling the market with a 4.8% return while my forecast underperformers lost big time, decreasing by 8.4% on average.

U.S. Market  in 2nd Quarter of 2013 Earned 2.4%

High Momentum Earned 4.8%

Low Momentum Lost 8.4%

Mid-cap Core Consumer Staples


Small-cap Core Telephones & Utilities


Small-cap Growth Financials


Small-cap Growth Materials


Small-cap Core Consumer Staples


Small-cap Growth Energy


Using the same method, I have forecast winning and losing sectors for the third quarter. For my picks, go to the full version of my Quarter 2 Commentary.
Foreign markets earned 2%, lagging both the U.S. stock market’s 14% return and EAFE’s 4.5% return. All countries outside Europe and Japan suffered losses.
I also forecast winning and losing segments in foreign markets for this quarter, and my foreign forecasts did not turn out as well as my U.S. forecasts. The “Low” momentum underperformed as predicted, but so did the “High” momentum. My full Quarter 2 Commentary includes my sector forecasts for the third quarter in world markets.
Remember, momentum doesn’t always work. My full commentary includes an analysis of the June slide, along with my predictions on quantitative easing, gold and bonds.
My goal is to give you some places to look for opportunities. Good luck!
So What's Next?

Quantitative easing will end, along with its distorting effects. Markets will adjust to an un-manipulated reality: higher interest rates, inflation and the pain of controlling our crazy spending, especially government spending. It won't be easy, but it is inevitable. U.S. markets will not be the best place to be during the transition.


A Good Week For The Keynesians: A Day After Lawrence Summers Tells Congress To Boost Deficit Spending, IMF Report Says Greek Crisis Was Worsened By IMF’s Austerity Measures
Thursday, June 06, 2013 10:36

Tags: economy


A day Lawrence Summers, a top economic advisor to two presidents, warned Congress against economic austerity in the U.S., the IMF said in a report that it had underestimated the “multiplier effect” of cutting government spending on the Greek economy, exacerbating the Greek financial crisis.

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“The (IMF) report said that the fund miscalculated the so-called multiplier, or the effect that adding or subtracting a dollar of government spending would have on the broader economy during the downturn,” according to The New York Times. “It underestimated the scale of what has proved to be a devastating Greek depression, fueled in part by sharp government spending cuts and tax increases.”
A day earlier, Summers, a former Secretary of the Treasury in the Clinton Administration and head of the National Economic Council for President Barack Obama until November 2010, offered testimony before Congress against cutting government deficit spending in the U.S.
Borrowing to support spending, either by the government or the private sector, raises demand and therefore increases output and employment above the level they otherwise would have reached. Unlike in normal times, these gains will not be offset by reduced private spending because there is substantial excess capacity in the economy, and cannot easily be achieved via monetary policies because base interest rates have already been reduced to zero. Multiplier effects operate far more strongly during financial crisis economic downturns than in other times.
It would not be desirable to undertake further measures to rapidly reduce deficits in the short run. Excessively rapid fiscal consolidation in an economy that is still constrained by lack of demand, and where space for monetary policy action is limited, risks slowing economic expansion at best and halting recovery at worst. Indeed, there is no compelling macroeconomic case for the deficit reduction now being achieved through sequestration, as the adverse impacts of spending cuts on GDP more or less offset their direct impacts in reducing debt.
Attention should be devoted to measures that reduce future deficits by pulling expenditures forward to the present when they have the additional benefit of increasing demand. It is important to recognize that just as increasing debt burdens future generations, so also does a failure to repair decaying infrastructure, or to invest adequately in funding pensions, or in educating the next generation burdens future generations. Wherever it is possible to reduce future public obligations by spending money today, we should take advantage of this opportunity especially given the very low level of interest rates. In particular, a major effort to upgrade the nation’s infrastructure has the potential to spur economic growth, raise future productive capacity and reduce future deficits. It should be a high priority.



ERISA Attorneys Confirm That Fiduciaries Must Vet Target Date Fund Selections
Friday, May 10, 2013 14:48

In a detailed new analysis, two ERISA attorneys make the case that fiduciaries are “responsible for the prudent selection and monitoring of” target date funds (TDFs) within defined contribution plans.

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Safe harbor provisions for Qualified Default Investment Alternatives (QDIAs) do not relieve fiduciaries of their obligation to vet TDFs, according to this in-depth analysis by attorneys Bernard T. King and Michael R. Daum of Blitman & King, published by Bloomberg Law.
Fiduciaries generally believe they are protected from litigation by two safe harbors in their selection of TDFs: Properly structured TDFs are Qualified Default Investment Alternatives (QDIAs) under the Pension Protection Act of 2006, and as long as they choose among the most popular TDF providers they should be OK.
However, relying on these two factors can lead to breaches of fiduciary duty that will bring lawsuits after the next economic downturn, as I explained last year in this article about the Safe Harbor minefield.
The U.S. Department of Labor released a guide for fiduciaries concerning TDFs in February that agreed with my analysis, and now two prominent ERISA attorneys have done the same. Here is a summary passage from the Bloomberg Law article:
“Regardless of whether the plan fiduciaries responsible for setting the plan’s investment lineup comply with Section 404(c)(5), or whether the mutual fund platform provider would qualify as a fiduciary, the responsible fiduciaries must understand the underlying details about the TDFs they are selecting as the plan’s QDIA. Although the fiduciaries can receive some protection from the QDIA safe harbor, they remain responsible for the prudent selection and monitoring of the TDF. Thus, at a minimum, the responsible fiduciaries should understand the TDF’s glide path, fees, and underlying assumptions. Then, having a general idea about the projected actions and attributes of the plan’s participants and beneficiaries, the fiduciaries should confirm that these characteristics are appropriate for the plan participants.”

For more guidance on selecting TDFs, see my Fiduciary Guide.


Looking For Love In All The Right Places: Using Heat Maps To Generate Alpha Signals
Wednesday, May 01, 2013 15:00

Tags: investing | investor behavior | stocks | style classification

Momentum investing works, and it works best in an opportunity-rich environment. You just need to know where to look.

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A just-published report in Reuters Hedgeworld, which I happened to have authored, demonstrates the power of using heat maps that incorporate sector, style, and country to generate alpha. The report provides heat maps for investors that have proven effective.


The standard disclaimer, “past performance is not an indicator of future results” might not be true, if momentum investing works. Studies have shown that investing in yesterday’s winners can indeed generate alpha over time. Investor behavior is the probable cause of momentum, believing we can buy past performance.


Heat maps are good visuals for finding yesterday’s winners and losers. A heat map shows shades of green for “good,” which in this case is good performance, and shades of red for “bad,” indicating underperformance. Yellow is neutral. The idea is to focus on the dark greens and dark reds for clues on momentum and reversals. The opposite approach to momentum is “regression to the mean,” which seeks reversals – winners switch to losers and vice versa.


Presented below are charts showing back-tested performance results using a very simple rule. “High” takes the three winners in the previous 12 months and invests equally in them for the next quarter. “Low” takes the three worst performers. Results are for the 9.25 years ending March 31, 2013.






United States




Good Start To 2013 As Domestic Stocks Earn 11% In First Quarter Performance
Monday, April 08, 2013 15:12

Tags: international equities | stocks | style classification | US investing

2013 stock markets started like 2012 stock markets – with a bang. U.S. stock markets kicked off 2013 with a very good 10.7% return. Also like 2012’s first quarter, foreign markets didn’t fare as well, earning only 3.5%. If we merely hold onto these gains for the remainder of the year we’ll do fine.


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In the following I examine the details of what has been working in global stocks, providing quick insights into market segments that have succeeded and failed.
U.S. Stocks
Smaller value stocks led the way in the quarter, earning more than 13%. By contrast, large core companies earned only 7.5% and large value earned 9.5%. Other than these extremes, style returns clustered around 12%. This has been one of those unusual periods where the “stuff in the middle” (core) has not performed in line with the “stuff on the ends.” I use Surz Style Pure® classification throughout this commentary.
On the sector front, health care and consumer staple stocks fared best, earning 15% and 14% respectively. By contrast, materials earned only 1%, and infotech gained only 6%.
Foreign Stocks
Looking outside the United States, foreign markets earned 3.5%, lagging both the U.S. stock market’s 10.7% return and EAFE’s 5.3% return. Japan was the big story, earning 12.8% in $U.S. The return in Japanese yen was an even more impressive 23%. The Japanese stock market soared in the quarter as the yen was weakening against the dollar. By contrast, emerging markets suffered a setback, losing 2%.
On the style front, core surprised, as it did in the United States, but core led rather than lagged.

For more details please visit

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