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Stock Market Analysts Are Useless

In this video, I’ll provide more evidence that stock market analysts are useless, with help from Sarah Gordon at the Financial Times, who recently summarized today’s installments.

I call analysts “z-vals” for their 50% mistake rate. It’s a shorthand of the term “zero-validity environment” used by Daniel Kahneman in his book Thinking, Fast and Slow when discussing stock pickers and political scientists whose “failures reflect the basic unpredictability of the events that they try to forecast.”

A 2002 academic paper found that analysts merely follow glamour stocks.

[Paper abstract shown in the video, at 1:20.]

They’re just stock cheerleaders, with far more buy recommendations than sell. A waste of time.

In April 2013, the personal finance website Nerdwallet reported that 49% of analysts’ ratings on the 30 components of the Dow in 2012 were wrong. Have a look:

[Key findings shown in the video, at 2:39.]

Of course they’re better at identifying winners — the stock market rises twice as often as it falls!

If you have to guess, guess that a stock will rise because up is where the market usually goes.

A stock market analyst guessing a stock will rise and then bragging when it does is about as sophisticated as somebody guessing that the sun will rise and then jumping for joy when it does.

Useless!

The strong odds of the market rising is why almost no analyst ratings are “sell.” In February 2015, Bespoke Investment Group put a finer point on it, as reported by CNBC. Take a look:

[Article excerpt shown in the video, at 4:45.]

In this round-up of evidence, we see analysts chasing the same glamour stocks everybody sees in the news, and almost never advising to sell.

This is completely unnecessary to you because you can already accomplish the results of this advice by just owning index funds, which go up with the market two thirds of the time.

Stick with a system of rational price reaction, the way I do. Analyst ratings are useless.


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Do Investors Need News?

In this video, I’ll consider whether investors should see any difference between fake news and useless news.

Since Donald Trump was elected, there’s been an obsession with fake news. This story from Politico shows Facebook in the fray:

[Story shown in the video, at 0:25.]

Factually incorrect news is obviously useless, but what about factually correct and still useless news? For investors, this type has been damaging for longer and remains so.

A pundit’s honestly held belief about the future of markets is not fake, but it is useless because it’s unreliable. Ditto information about, say, interest rates or the price of oil or another war.

These are unhelpful for purposes of portfolio management because you don’t know the impact of the news, if any.

Consider this May 19, 2016 installment from The Economist’s Free Exchange blog:

[Story shown in the video, at 2:06.]

What shall we do? Sell stocks to avoid higher rates? It doesn’t seem good, what with the “ruins summer” quip.

Yet, here’s the Huffington Post on June 15, 2016, just one month later:

[Story shown in the video, at 3:40.]

There was nothing fake about reporting of the Federal Reserve’s key interest rate last May and June, but it was useless to investors.

You should not be guessing how to respond to news. You should run a proven portfolio system of price reaction only, like mine.

For rational investors, all news is pointless. We could say, “Don’t sweat the useless news, and it’s all useless!”


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How to Use Leveraged ETFs

In this video, I’ll show you the right way to use leveraged ETFs.

Their high volatility requires a set of defined reactions.

Leveraged funds were first offered to investors in the early 1990s. The first leveraged ETFs appeared in 2006.

The idea behind leveraged funds is to increase an investor’s performance by magnifying the movement of an index.

For example, the SSO ETF seeks to provide twice the daily movement of the S&P 500. If the S&P 500 rises 1% on Tuesday, SSO should rise 2% on Tuesday. If the S&P 500 falls 2% on Friday, SSO should fall 4% on Friday.

Other ETFs provide 3x leverage. There’s also inverse 2x and 3x leverage, where the ETFs move twice and three times farther than the index in the opposite direction, thus rising when it falls and falling when it rises.

In all cases, the leverage is applied daily.

Eager investors drew the hasty conclusion that this doubling and tripling of performance could be applied to longer time periods. “If the market rises 10% this year, I could make 20% by just owning a 2x ETF,” they thought.

But it’s not that simple.

Because the daily performances of the index are magnified, the difference in the leveraged ETF’s performance over time will not be exactly 2x or 3x the index’s.

It’s easy to demonstrate why.

If an index starts at 100, and drops by 20% one day and 20% the next day, it’s down to 64. Would rising 20% each of the next two days take it back to 100?

No. It would take it back to just 92. Why? Because 20% of 64 is not as much as 20% of the initial 100.

Starting from the smaller place it ended up after falling, the index needs a greater percentage gain than the decline that preceded it, in order to return to its pre-decline value.

In total, the index needs to rise 56% from 64 in order to regain 100.

If this is the case, wouldn’t leverage magnify the problem? Sure it would, because all numbers are magnified, specifically by 2x and 3x on a daily basis.

Instead of falling 20% one day and 20% the next, a 2x leveraged ETF of this index would fall 40% one day and 40% the next. From a starting level at 100, this would take it down to 36.

To recover from 36 back to 100 would require a 178% gain, more than twice the 56% needed by the index.

Seeing this situation, the financial media made a different hasty conclusion about leveraged ETFs. They boldly declared that “Leveraged ETFs decay over time. They are not suitable for buy-and-hold investors.”

For example, look at this story in the Wall Street Journal on May 11, 2012: “Beware ‘Leveraged’ ETFs.”

[Story screen capture in the video, at 3:40.]

Here’s another, this one from Business Insider on September 21, 2016 titled: “Buyers Should Beware of This $3 Trillion Market.”

[Story screen capture in the video, at 4:05.]

These articles and many others like them warn that due to the daily tracking issue I just explained, investors should avoid leveraged ETFs.

While it’s true that leveraged ETFs are not for everybody and must be managed with care, the daily tracking issue is not a flaw that makes them unusable. There are two reasons why.

First, even though buying and holding leveraged ETFs is not the preferred way to use them, it actually does work out in most long-term time frames.

The market rises more often than it falls, and big crashes are rare, so while it’s possible to find time frames where the leveraged ETFs trailed their indexes, they usually come out ahead.

For proof, look at this shot from my website’s Strategies page, at jasonkelly.com/resources/strategies:

[Performance table in the video, at 5:05.]

The table shows the growth of $10,000 without dividends, just price change, from the end of 2002. This screen capture picks up at the end of 2004.

The first column shows the $10K’s growth in the plain Dow without leverage.

The third, titled “Double The Dow,” shows it in a Dow 2x fund. The fourth, “Maximum Midcap,” shows it in a Midcap 2x fund.

All of these are just buy-and-hold.

Were the Dow 2x and Midcap 2x funds a disaster, something to beware of? Not at all. After they were crushed along with everything else in the subprime mortgage crash of 2008, they roared back.

By the end of 2016, look how much farther ahead they were than the Dow:

[Performance table top row in the video, at 5:56.]

The Dow ended 2016 having grown $10,000 to just $23,472. Double the Dow, or Dow 2x, grew it to $39,394. Maximum Midcap, or Midcap 2x, grew it to $60,984.

Dow 2x didn’t perfectly double the Dow’s balance, but it delivered a much bigger performance than the Dow’s and that’s good enough, certainly within the spirit of what the leverage is supposed to do.

So, while it’s a fact that setbacks become magnified in the leveraged funds, it is not true that they are certified disasters over time periods longer than a day.

The second reason why media warnings against leveraged ETFs need to be understood in context, is this: If the ETFs are used the right way, the daily tracking issue becomes a strength, not a weakness.

Leveraged funds are simply more volatile than non-leveraged. They follow the index’s same directional moves, but rise more and fall more.

That’s all. If you react appropriately to these rises and falls, then they work for you, not against.

I use a 2x and a 3x ETF in The Kelly Letter within a predefined framework of reaction to their magnified moves.

On a quarterly basis, so just four times per year, I look at their prices in relation to a growth target line.

If they’ve delivered surplus profits above the target, I sell the excess and put it in a safe bond fund. If they’ve fallen short of the target, I buy the shortfall with money from the bond fund.

This process works with both leveraged and non-leveraged funds, but the higher highs and lower lows of leveraged ETFs can make it work better. The reason is straightforward: they present bigger profits and bigger bargains due to their wider zones of fluctuation.

This is the right way to use leveraged ETFs.

To sum up, while the media are right to warn investors about the dangers of higher volatility in leveraged ETFs, they are wrong to state that the ETFs cannot work over the long term due to “performance decay.”

In fact, they can work even in a buy-and-hold approach spanning years.

But a much better way to use them is with an automated system of extracting excess profits and buying excess bargains, both of which are delivered by leverage.

I hope you found this to be helpful. If you did, please like and subscribe.

You can learn more about the way I use leveraged ETFs in The Kelly Letter at jasonkelly.com.


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Why My Signal System Uses Bonds

In this video, I’ll show you why my Signal system uses bonds for safety.

Each permutation of my Sig system uses just one stock fund for growth and one bond fund for safety. For background on how the Sig system works, please see my video, How My Signal System Works.

In recent years, and again now, pundits have warned about a bond market crash. For an example of this, see my video, Should You Avoid Bonds, which defuses the latest warning from Bill Gross at Janus.

These bond warnings have led some investors to abandon bond funds in favor of riskier assets or dead cash.

But bonds have been around a long time, and have served their main purpose as income-providing, safe alternatives to stocks for many decades.

Let’s take a look at the history of stock bear markets and the bond market, with help from Ben Carlson, the director of institutional asset management at Ritholtz Wealth Management.

In a February 6, 2017 article on Bloomberg View, Carlson provided this table listing the 15 bear markets in the S&P 500 since World War II:

[Chart shown in the video, at 2:18.]

Would bonds have helped you through these bear markets? Absolutely.

Carlson provided this table listing the performance of 5-Year Treasuries through those same 15 bear markets:

[Chart shown in the video, at 4:05.]

This historical relationship between stocks and bonds is why they are the only asset classes I use in my Signal systems, and it will keep working.

Do not sell your bonds. Use them the way I do, to keep buying power ready for deployment into stocks during the next stock-market bear. It will greatly improve returns.


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The Effectiveness Of My Signal System

SUMMARY:

In this video, you’ll see the effectiveness of my Signal system.

Starting with $10,000 in 2001 and making employee contributions to a 401(k) account, The 3% Signal system (3Sig) returned far more than dollar-cost averaging into the S&P 500 (SPY), and dollar-cost averaging into a portfolio of Morningstar medalist actively-managed funds, as follows by year-end 2016 balance:

$332,091 in 3Sig
$263,874 in DCA SPY
$209,070 in DCA Medalists

This shows 3Sig beating both the unmanaged stock market and top-quality managed funds.

Even more impressive, the example pits an imperfectly run version of 3Sig against perfectly executed dollar-cost averaging plans, but 3Sig won anyway. In real life, 3Sig does even better against the mess that is most people’s portfolios.

Get your financial future on the Signal system ASAP!

TRANSCRIPT:

Hello, I’m Jason Kelly. Thank you for joining me.

In this video, I’ll present the effectiveness of my Signal system in the stock market.

For background on how the system works, please see the video “How My Signal System Works.”

In The 3% Signal, I showed how an investor named Mark used the plan to greatly outperform two of his colleagues earning the same income and directing the same percentage of their income to 401(k) accounts.

On page 291 in the book, you’ll find this chart:

[Chart shown in the video, at 0:34.]

This chart shows in the y-axis on the left the balances of their accounts over time. The three investors are named Garrett, Selma, and Mark. Mark is the main one we care about. He’s the one running The 3% Signal.

It starts back in 2001 and ends in June of 2013. Notice there, “The 3Sig Advantage.” That stands for 3% Signal. We can see that at the end of this run Mark’s plan greatly outpaced the balances of his colleagues, Garrett and Selma.

Notice also that the comparison in the book ends in June 2013. What happened after that? Let’s have a look.

At my website, jasonkelly.com, click on Resources and then Compare Investing Strategies to see the comparison extended to the present.

To jump straight to the page, visit:

jasonkelly.com/resources/strategies/

On the Strategies page, I compare Mark’s 3Sig plan with two others: DCA SPY and DCA Medalists. I’ll explain each of the three plans:

Mark’s 3Sig
This is Mark’s plan run with IJR and VFIIX (Vanguard GNMA bond fund) as shown in the book, beginning at the end of the fourth quarter of 2000 with $10,000 and the salary history shown in the book, then his salary increasing 3% annually in the years after 2013 (where tracking ends in the book).

His quarterly contribution to VFIIX in 2013 was $1,815; in 2014, $1,871; in 2015, $1,927; and in 2016, $1,983. Mark also contributed $13,860 in new cash during the subprime mortgage crash, per the signal’s guidance. Notice the low expense ratios: IJR 0.14%, VFIIX 0.21%

DCA SPY
This plan runs the same $10,000 invested at the end of 2000 and with Mark’s same salary history shown in the book, with the same quarterly contributions after 2013.

The only difference is that all capital goes into the S&P 500 as represented by the SPY ETF. This is dollar-cost averaging into SPY with Mark’s quarterly contributions. Mark’s $13,860 in new cash is distributed evenly across the first 50 quarterly contributions (Q101-Q213). Notice the low expense ratio here, too: SPY 0.09%

DCA Medalists
This plan is the same as DCA SPY, but using a portfolio of Morningstar medalist actively-managed funds, initially allocated as follows: 30% Longleaf Partners (LLPFX) large-company stock fund, 20% Wasatch Small-Cap Growth (WAAEX) small-company stock fund, 20% Artisan International (ARTIX) international stock fund, and 30% PIMCO Total Return (PTTDX) bond fund.

All are featured in the book, and all are still highly-rated. Contributions are divided by the initial allocation percentages; holdings are not rebalanced back to target allocations. Notice the high expense ratios: LLPFX 0.92%, WAAEX 1.21%, ARTIX 1.17%, PTTDX 0.75%

So, how did the three plans fare? Have a look:

Chart at 5:20 in the video, showing that at the end of 2016 Mark’s 3Sig plan had amassed a balance of $332,091 compared with $263,874 in DCA SPY and $209,070 in DCA Medalists.

Keep in mind: Mark’s 3Sig plan was not run perfectly because he skipped one buy signal, but the DCA plans are shown here being run perfectly.

In real life, almost nobody runs a perfectly executed DCA plan or restricts their portfolio to just medal-winning mutual funds!

Yet, in this table we see an imperfectly run 3Sig plan performing much better than two perfectly run dollar-cost averaging plans.

Compared with the real-life mess that most people’s portfolios turn into over time, the Signal system does even better than it’s shown doing against these perfect DCA plans.

The numbers don’t lie, folks. The Signal system works, and this is just one version of it. In addition to 3Sig, I also run 6Sig with 2x leverage and 9Sig with 3x leverage.

This boosts profit potential even more while using the same trusted Signal framework.

There’s just no better way to go! Get your financial future on the Signal system ASAP. That’s my recommendation to you.

Thanks for watching.


To review the performance of Mark’s 3Sig plan, please visit my Strategies page.

Want more videos like this? Subscribe to The Kelly Letter YouTube channel.

Thank you for watching!

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