Market Map update 09/15/2014

As the Market Map model’s current allocation is longer dated U.S. bonds ( TLT ), we again look ahead to the predefined allocation schedule and to the model’s components in preparing for the next tactical allocation action. On 09/29/14, component 4, “4th quarters characteristically showing statistically significant probability of profitability”, will come into play.  The allocation will shift from TLT, to the SPY or QQQ  etfs, with the QQQ achieving higher alpha historically.

Allocation 4th Q  2014

This table and graph show  the previous instances and performances of component 4.

4  quarters  table

4th quarters graph

We examine the performance of the above table and graph and the historical performance table here: http://stockmarketmap.wordpress.com/2013/11/04/market-map-model-2-enhancing-returns-with-bonds/ for the purposeful reminder of staying with the model for a long term, multi year asset accumulation process through time diversification and compounding, and not for the purposes of developing pride and arrogance and the turning of quick profits.

The next predetermined asset allocation date will be: 01/16/2015

Review of Allocation Dates ( Objective 3 )

One of the pitfalls of active investment management is the inability to follow the rules of one’s investment discipline. This could be because the investor / manager uses subjective means to determine asset allocation ( thereby “anchoring” off of the “purchase prices” of assets) or because the signals produced by their process’s algorithm occur in a random fashion and can’t be “anticipated” with precision. These biases, along with a lack of robust historical testing and trustworthy empirical results, ultimately lead to cognitive dissonance and uncertainty in many investors’ asset allocation decisions. 

The Market Map model was designed to alleviate these pitfalls with the application of “predefined” dates used in asset allocation decisions, which we spell out as “objective 3″ in our list of model objectives. In this way, instead of letting ambiguity and purchase price control our decision process, we let “date” control it.   In previous posts, we have charted the course of the model’s asset allocation process in real time and have published actionable reminders ahead of the actual allocation dates. The tables below show the definity of the method. The first table shows the historical Equity allocation dates and the second table shows the cash and bond allocation dates. In a perfect world, it would be nice to predefine 100% of the equity allocation dates yet, as shown in the first table, the model comes up with 77% predefined.

  .   
Equity Allocation predefined dates

Cash Bond Allocation Predefined dates

…. Model remains in TLT until 9/29/2014

“Start small and disrupt to make something useful to people”

Market Map Allocates To Long Bond

As another predefined date for asset allocation action as defined * by the Market Map model has been reached, at this time the model is indicating an allocation from cash (position allocated on 01/24/2014) to a 75% allocation in the iShares 20+ Year Treasury Bond ETF (TLT). The model identified 15 previous instances of allocation to long bonds in the investment timeline since 1924.

BOND record

ScreenHunter_174 Jul. 07 21.27

The long bond allocations within the full record of model allocation changes can be seen here http://stockmarketmap.wordpress.com/2013/11/04/market-map-model-2-enhancing-returns-with-bonds/.

* Objective # 3. To make infrequent asset allocation changes occurring on fixed, predefined dates during the course of market cycles. See objectives http://stockmarketmap.wordpress.com/2013/08/29/market-map-basic-version/.

Market Map: Style Diversification With Dividend Growth Portfolio – Retirement Withdrawal Rates study

In this article we examine withdrawal rates from a portfolio style blend as constructed in previous articles using the Market Map model. It is instructional to read the previous MM articles to get up to speed on the topic at hand.

As each individual has their own investment needs and goals, we find the Market Map model useful as a multi purpose tool for application towards tax deferred retirement portfolios during different periods in an individual investors’ life cycle. For example, in the post http://stockmarketmap.wordpress.com/2014/03/05/market-map-portfolio-diversification-with-dividend-growth-and-small-cap-value/, the model is presented as a possible solution towards accelerating the “accumulation” phase pertaining to investors who may be “slow starters” towards their retirement asset accumulation.

For those who qualify for the withdrawal process from their retirement funding, their asset base may not be large enough on which to generate sufficient income from the conventional offerings often cited in the financial literature that are either reliant on staying fully invested and riding out the cycles of the market and/or on the “ceiling” of dividend yields. These offerings include buy and hold of index funds that mimic the S&P500 index, blends of “low expense” international, domestic, and bond funds (target date products), dividend growth portfolios, etc. The Map model can conceivably be used to provide an income stream that is sourced from a higher annual portfolio total return (because of the exposure to the “growth” universe of mid/large cap stocks included in the Powershares QQQ Trust ETF (QQQ)) and simultaneously grow the account balance.

In order to ascertain the rate(s) of income withdrawal that could be expected from the Map model and portfolio blend, we subjected the portfolios to a fixed, inflation adjusted withdrawal during two of the most difficult 14 year investment periods in the last 45 years. We did the same with data for 14 of the most recent bull market run years of 1983-1990. Hence, we adjusted the withdrawal amounts according to the market environment: less withdrawal in difficult “cyclical sideways” periods and more withdrawal in a secular uptrend.

Our choice of withdrawal process in this analysis was that of “selling shares” for income as opposed to “taking the dividends”. We realize that a “selling shares” process is a controversial topic, yet with combination of the outsized portfolio growth, conservative annual withdrawal amounts shown, and personal experience, deemed it to be the best choice for this study. In the future, we will explore an analysis using a process combination in generating the income stream by “selling shares” from the growth allocation of the blend and “taking the dividends” from the dividend growth allocation of the blend. At present we chose the former.

Charts 1,2, & 4 depict fixed withdrawals from three different portfolios with starting balances of $1M over the two most recent “cyclical sideways market periods and the most recent “secular uptrend” market environment. These portfolios were introduced in the previous article and include: 1) the “growth” portfolio (the QQQ ETF) utilizing the tactical allocation of the Market Map model and 2) a “buy and hold”/ dividends reinvested portfolio of popular dividend growth stocks*. The 40% 60% “style” blend performance analysis and logic that we use for this study was presented in “Style Diversification With Dividend Growth Portfolio”, charts 13 & 14.

Chart 1
$ withdrawal1970 -1983

Chart 2
$ withdrawal 2000 - 2013

Chart 3 shows the fixed annual $ withdrawal amounts adjusted for 2% inflation growth applied to the portfolios during “cyclical sideways” market periods in charts 1 & 2.

Chart 3
withdrawal 1970 - 1983

Chart 4
$ withdrawal 1983 - 1996

Chart 5 shows the fixed annual $ withdrawal amounts adjusted for 2% inflation growth applied to the portfolios during the secular uptrend market period in chart 4 .

Chart 5
Withdrawal 1983 - 1996

As we can see above, when subjected to fixed withdrawal processes, the “individual” style portfolios’ growth during the different market environments were affected in a vastly dichotomous fashion, and the “combined” portfolio (in black) provided sufficient income streams accompanied by stable growing portfolio values and diversification throughout the 3 different diverse market environments.

Conclusion

Investment literature may lead us to believe that as an investor gets near the retirement withdrawal stage, they should gravitate away from the growth stock universe and concentrate largely on a portfolio leaning towards the quality large cap arena with consistent dividend growth universe and yield based products for their income needs. Yet as shown in this (and previous articles), with innovative, sound tactical asset management applied towards a growth stock universe, an investor can generate a decent income using a combination of two universes. And hopefully, in the not too distant future (if not already), there will be ETFs (exchange traded funds) that can cost efficiently replicate the performance and dividend payouts of a portfolio of quality mid and large cap companies with consistent dividend growth and thus alleviate and replace the tasks of managing a multiple individual stock portfolio.

* comprised of: 3M (MMM), Exxon (XOM), Merck (MRK), Johnson & Johnson (JNJ), McDonald’s (MCD), Procter & Gamble (PG), ConEdison (ED), General Electric (GE), Altria (MO), Coca-Cola (KO) (with a switch of Wal-Mart (WMT) for GE on 01/02/08 for performance optimization)

Market Map: Staying the Course for the Long Term

As the stock market performs it’s weekly and monthly gymnastics, we can wait patiently for the next tactical allocation shift, and thus, do other things with our time. In order to not become distracted with the market’s behavior and stay focussed on long term asset allocation, we can review 90 years of Market Map model data to discipline our reflexive brain circuitry. We have no need for technical “chart pattern” analysis, economists’/analysts’/TV personalities’ opinions, the Wall Street Journal, etc. We just rely on the body of evidence from our statistical analysis thereby using reliable components and prepare ourselves beforehand with predetermined dates on which to take action.

In chart 1 of the previous article http://stockmarketmap.wordpress.com/2014/03/05/market-map-portfolio-diversification-with-dividend-growth-and-small-cap-value/?preview=true&preview_id=734&preview_nonce=83a93e2bec&post_format=standard, were presented the statistcal outcomes of various investing time frames using buy & hold. In viewing four 20 year periods and the most recent 10 year period of the Market Map model (below), we can see that the model did indeed provide positive outcomes.

Chart 1

1924 – 1943

Model vs. SP500 1924 -1943

Chart 2

1944 – 1963

Model vs. SP500  1944 - 1963

Chart 3

1964 – 1983

$1 growth  Model vs.  Buy Hold  SP500

Chart 4

1984 – 2003

Model vs. SP500 1983 - 2003

Chart 5

2004 – 2013

Model vs. SP500  2004 - 2013

Chart 6

Model using Nasdaq 100/QQQ and S&P500

Model NDX  SPX  25 yrs  1989 - 2013

Viewing returns from a different perspective, chart 7 below shows rolling 20 year returns of the 3 data series. The 20 year CGRs of Nasdaq 100 and S&P500 using the model have been trending up:

Chart 7

20 yr GAGR

Neutral Risk Profile study

As 2014 was identified as a “neutral risk profile” year in the January 22nd post http://stockmarketmap.wordpress.com/2014/01/22/market-map-model-allocates-to-cash/, in order to get a sense of the signature of past neutral risk years, the chart below reveals the historical neutral years return distribution for the S&P500 buy&hold with the corresponding model returns included. The distribution is relatively even (there are equally large gains on the left compared to the losses on the right). The cumulative return for the Model outperformed the S&P500 as the model tends to capture profitable points during the year when applicable. Over the long term, the allocation may have been in cash when the market was going up and, conversely, going down. We just go with the flow.

Chart 8

Neutral trend years

Asset allocation since 1/17/14 = cash
Probability of allocation to TLT (iShares 20+ Year Treasury Bond ETF) on 7/O9/14 = 5O%
Probability of allocation to QQQ / SPY on 1O/O3/14 = 1OO%

a

Market Map: Portfolio Diversification with Dividend Growth and Small Cap Value

In past articles, we have favored the use of the Powershares QQQ Trust ETF (QQQ) over small cap value weighted methodology http://seekingalpha.com/article/1915041-market-map-model-2-using-small-cap-value-weighted-portfolio for use with the Market Map model because of QQQ’s ultra low expense ratios, tax ratios, and accompanying comparable performance. The model and QQQ has also held a performance advantage, historically, over the SPDR Trust ETF (SPY), and Vanguard Total market ETF (VTI).
In this article, we explore portfolio “diversification” using: 1) a portfolio of popular dividend growth stocks 2) the “growth” universe (the QQQ etf) and 3) a “small cap value” universe (the Vanguard Small Cap value ETF (VBR)). As many investors find psychological comfort and safety by the “mere exposure effect” of owning a portfolio of “great” U.S. company names with growing dividend streams, they tend to shy away from exposure to the growth stock and small cap value universes because of perceived risk. Yet, for the population of middle and upper aged investors that have gotten a late start in their retirement asset accumulation phase http://www.fool.com/investing/general/2013/05/02/the-biggest-retirement-myth-ever-told.aspx, a compound “total return” from a strict dividend growth portfolio or the buy and hold of low cost total market fund(s) or S&P500 index fund(s) may be too little, too late in helping them meet their goals. Portfolios consisting of growth and small cap value etfs combined with the Market Map asset allocation models diversified with a buy & hold/annually rebalanced portfolio of quality dividend growth stocks (with the possible eventual goal of, as preferred by many, a total dividend paying/income producing portfolio), is a reasonable approach in alleviating the reluctance of investing in the growth and small cap equity universes while exposure to those universes can serve as the “faster turtles” in the “long term” accumulation phase of the assets.

In order to build a resolute belief in the “long term” view, we rely on data driven methods as defense against the “noise” of the financial markets and the anecdotal information presented by the media. Chart 1, prepared by Robert Shiller, reveals total market return statistics for varying time frames. We can see that, over the last 140 years, 20 year investment periods have had 100% probability of success, 15 year have had 95%, and then lower probabilities of success as the data moves left. Since the Market Map model was designed towards the long term investing time frame, we have used the 20 year time frame in our diversification study.

Chart 1

Shiller chart

Additionally as described in the beginning of the article, with the increasing longevity of the population http://www.fool.com/investing/general/2013/11/29/everything-is-great-and-nobody-is-happy.aspx , investors who are “slow starters” on their retirement asset accumulation plan and have missed the conventional 30 to 40 year asset accumulation “glide path” window (with a retirement age commencing at 65 ) typical of a more stable work, salary, and 401K contribution history, may still be afforded a chance in accumulating sufficient assets for a financially satisfying “late” retirement in a 15 plus year accumulation phase window.

The Quality Dividend Growth portfolio

The Dividend Growth portfolio applied to the diversification study* comprised of MMM, XOM, MRK, JNJ, MCD, PG, ED, GE, MO, KO (with a switch of GE for WMT on 01/02/08 for performance optimisation). The stocks are useful because they possess 40 plus year price history and have been stalwarts of consistent dividend payment increases.
Additionally, an analysis was conducted on the effect of different rebalancing frequencies on this portfolio over two different 20 year time frames and we found that, as Chart 2 and Chart 3 reflect, an annual rebalancing frequency was sufficient, did add value to the returns, and was implemented into the management of the 2 and 3 style allocation blends represented below.

Chart 2

Quality div growth 1970 - 1994

Chart 3

Quality div growth 1994 - 2013

Portfolio Diversification Using 3 Style Universes

Charts 4, 5, 6, and7 illustrate the types of returns achieved over the past 20 year period in terms of $ accrual using different percentage “blends” of asset allocations of the 3 style universes.

Chart 4 represents the first example of diversification “blend”. The Quality Dividend Growth portfolio was assigned a 60% allocation and the Growth** and Small Cap Value portions were each assigned a 20% allocation. The total portfolio was rebalanced every 5 years:

Chart 4

Pie chart 1

Chart 5 $ growth of each separate portfolio allocation and the combined total return of the 20-20-60% blend since 1994:

perf chart 1

Chart 6 represents the second example of diversification “blend” using a 20-20-60% configuration.
Quality Dividend Growth was again (initially) assigned a 60% allocation and the Growth and Small Cap Value portions were assigned each 20%. However, after a 5 year period, the allocation percentages were switched so that the Quality Dividend portion received 40% allocation and the Growth and Small Cap portions each increased to 30% allocation, or at total of 60% for both. Also, during this switch, the total portfolio was rebalanced.

Chart 6

Pie chart 2

Chart 7

perf chart 2

3 Portfolios and Volatility

Chart 8

DrawdD 1

Chart 9

DrawdD 2

Chart 10

DrawdD 3

Diversification Using 2 style Universes

In the previous charts 8, 9, and 10, we can see that the volatility, as measured by peak to trough drawdowns, was highest with the Small Cap value universe. In consideration of those investors who may have concern about having portfolio exposure to the greater volatility as represented by the small cap universe, we can utilize a 2 portfolio blend of the lesser 2 volatility universes by excluding the Small Cap Value style from the allocation mix (and consequently forgoing style diversification). These results are seen in charts 11, 12, 13, and 14 below:

Chart 11

Pie chart 2

Chart 12 $ growth of each separate portfolio allocation and the combined total return of the 40-60% blend since 1994:

Chart 12

perf chart 3

Chart 13 represents the second example of diversification “blend” using just the QDG and Growth portfolios.
Similar to the 3 style diversification blend, Quality Dividend Growth was again assigned a 60% allocation and the Growth portion was assigned 40%. After each 5 year period, the allocation percentages were switched so that the Quality Dividend portion received 40% allocation and the Growth portion increased to 60% allocation (and vice versa), accompanied with a rebalance:

Chart 13

Pie chart 4

Chart 14

perf chart 4

As with the value that the annual rebalancing provided the 10 stock Quality Dividend Growth portfolio over the non rebalanced version in charts 2 and 3, so did the 5 year 60% allocation “switch” between Quality DG and Growth/Small Cap value styles provide value versus the non “switched” versions.

Performance Comparisons and Vanguard Target Retirement

The charts shown below present an overview of the $ returns and compound growth rates of select items that have been covered in the article. We can see that the rate of growth for Quality Dividend portfolio slowed dramatically from 1994 – 2013 vesus the 1970-1989 period and that the performance of the combined diversified blends took the lead in the latter. As the data used for the Growth portfolio calculation in the 1970 – 1989 period was taken from the Nasdaq OTC composite and that the Nasdaq 100 outperformed the Nasdaq Composite from 1985 – 1989 (and beyond), we can assume that the performance for the blends would have been improved if the Nasdaq 100 was a viable option for use in a portfolio in that period.
An additional item included for comparison in charts 16, 17, and 18 is a mix of Vanguard funds that is part of their “Target Retirement” series (as with many other investment companies’ “Target date” offerings) and is a popular choice with the disciples of the John Bogle investment approach ***. The portfolio shown was constructed using a diversified equal weighted mix of three Vanguard funds: 1) Total Stock Market 2) Total International and 3) Total Bond Market. In the calculation, the mix was rebalanced every 5 years in order to maintain consistency with the calculation of the other portfolios in this article.

Chart 15

Growth Traject 2

Chart 16

Growth Traject 1

Chart 17

Perf compariasons

Chart 18

DrawdD 4

As we can see in chart 16, the compound returns and $ accrual of the Quality Dividend Growth and the Vanguard Target portfolios were admirable. The returns for most retirement plans constructed using Exchange Traded Funds **** seem to fall somewhere in between that of the Quality Dividend Growth and Vanguard “Target retirement” trajectories shown. Of course, there are many disparate factors that could affect contribution regularity applied towards a plan in “later” years and terminal asset accrual could vary from a strict extrapolated target.
Surprisingly, focusing on volatility concerns, the largest peak/trough drawdown for the Vanguard portfolio fared slightly better than the buy & hold of the Small Cap value (VBR) etf. Granted, the sample size used in the volatility calculation for the Vanguard portfolio is smaller than the other universes’ volatility charts in the study, yet the results still seem to run counter to the premise that holding a broadly diversified portfolio of funds (including the incorporation of a Total bond fund) provides “less risk”.

A Long Term Look at Compound Growth

A look at chart 19 shows 20 year compounded growth rates for various combined portfolio blends and universes over a 25 year span. Some observations include:1) The Quality Dividend Growth portfolio (yellow line) appeared to have a 6 year, 20 year Compound Growth Rate performance run of 3000% – 5000% from 1996 to 2002 and has since slowed to a sub 1000% 20 year CGR performance 2) the Small Cap Value universe (blue line) stayed in the 1000% CGR range until around 2004 and has since trended upward 3) the Growth universe CGR (green line) has consistently trended upward and 4) the combined 20-20-60% diversification blend (black line) tracked the performance run of the Quality DG portfolio until 2003 and appears to have stabilized between the 2000% – 3000% range, reflecting the strength of the Small Cap Value and Growth universes.
The reason to review this visual information, along with chart 1 and 16, is that it can further help solidify our conviction in “staying the course” for 20 year period(s). Knowing, for example, that the 20-20-60% blend is the product of the calculation of the 3 diversified universes with varying cyclical natures (at this moment, upward trending Growth universe, lower trending Quality DG, and awakening ? Small Cap Value) gives us an idea, along with historical volatility information, of the 20 year potential performance percentage and behavior of this blend. Obviously, an investor can invest in just the QQQ or the SPY with the Market Map model exclusively if they so choose, but this study provides some food for thought towards a diversified retirement asset accumulation plan.

Chart 19
20 year CGR

Conclusion

In the broad world of retirement plan investment choices, there are many different schools of thought and somewhat confusing misconceptions. As shown in this study with additional input from the previous articles:

a) tactical asset allocation models that have produced repeatable and consistent outcomes when applied to a Small Cap value and Growth stock universe, and combined with a buy & hold of a Dividend growth stock portfolio, have produced steeper asset accumulation trajectories over a 20 year investment period versus an exclusive buy & hold portfolio of Dividend growth, further providing style diversification albeit with more volatility.

b) tactical asset allocation models ( in “a)” ) when applied to a Growth stock universe and combined with a buy & hold of a Dividend growth stock portfolio, have produced steeper asset accumulation trajectories over a 20 year investment period versus an exclusive buy & hold portfolio of Dividend growth, providing less style diversification albeit with only slightly more volatility.

c) the use of the term “less risk” in literature regarding a broadly diversified portfolio of Vanguard funds targeted towards retirement is a misconception see here https://investor.vanguard.com/mutual-funds/target-retirement/#/mini/holdings/0304

Last but not least are the questions asked such as:

40 years ago, the dividend “stalwarts” were younger, mid to large cap size companies and have since turned into “mega” cap companies … If the slowing of the 20 year CGR shown in chart 19 has been a a reflection of a cap size growth effect and in order to achieve the types of returns produced from 1970 – 2002, which mid to large cap companies would represent the “new” era of dividend growers as replacements for the mature companies?

Or … will the expansion of the sales of products and services into developing markets give the mega cap dividend payers a cyclical move up in the portfolio’s 20 year CGR moving forward ?

To alleviate the management of annual rebalancing of a 10 stock dividend growth portfolio, would a dividend ETF used in it’s place be a reasonable option?

Unfortunately, the above questions are the very ones that turn us into stock selection portfolio managers (with all of the latent obsessional behavioral tendencies and performance drift accompanied therein) and pull us slightly away from the non-subjective rule based simplicity of using a data driven tactical model. Yet for the comfort that “brand” stocks provide an investor, it is an uncomfortable reality in this particular form of style diversification.

* http://www.buyupside.com/calculators/dividendreinvestmentbackportfoliocalculatorinputbookmark.php?symbol=mrk,jnj,mcd,ko,pg,ed,mo,ge,xom,mmm
** Growth as represented by Nasdaq 100 index/QQQ using the Market Map model. Small Cap value as represented by the French small cap value weighted 2 factor model/Vanguard Small Cap Value ETF using the Market Map model.
*** http://www.forbes.com/sites/thebogleheadsview/2011/01/28/three-funds-to-own-now/
**** http://www.sharebuilder401k.com/portfolios.aspx

instead of settling for the conventional, we frequently remind ourselves that “there’s gotta be a better way” and “we can take it to the next level“.