Dow Jones, Shiller And Momentum Approaches Compared
While the disaster is Japan will take many years to be put right, there is a very important lesson that can easily be overlooked in the rush to stop radioactive leaks and repair the damage. Like New Orleans where the leveeswere known to be a problem area, Japan’s nuclear reactors were living on borrowed time, having had their life extended — just another year. The temptation to delay until next time is very seductive until disaster strikes and the cost to repair, dwarfs the cost to prevent.
Retirement investing is a “hair on fire” problem — especially for baby boomers for whom retirement is a near and present danger. Retirement investing cannot be left — just a little longer.
We are looking at a variety of trigger mechanisms to signal when to make a change in your portfolio.
1. Dow Theory
2. Shiller’s CAPE
3. Momentum Based Asset Allocation
The Dow Theory — the grand-daddy of all portfolio strategies can be compared with more modern approaches. We will look at Shiller, a long term but newer approach and then modern portfolio theory which is based on asset allocation.
The Dow Theory is one of the most venerable strategies. It uses the price trends of the Dow Jones Industrial index (^DJI) and the Dow Jones Transportation Index (^DJT) to decide whether to invest in the stock market.
The Dow Theory has been around for almost 100 years, yet even in today’s volatile and technology-driven markets, the basic components of Dow theory still remain valid. Developed by Charles Dow, refined by William Hamilton and articulated by Robert Rhea, the Dow Theory addresses not only technical analysis and price action, but also market philosophy. Many of the ideas and comments put forth by Dow and Hamilton became axioms of Wall Street.
Today, there are a variety of strategies.
There are multiple interpretations of the original Dow Theory. This strategy represents a typical version: all the buy and sell signals are confirmed by both the Dow Jones Industrial Average and Dow Jones Transportation Average.
The Dow Jones Transportation Average is used to triangulate the Dow Jones Industrial Average to ensure that an upward or downward trend is not just a localized phenomenon.
The buy signal
- A primary low is established
- A secondary bounce
- A pullback of around 3% but above previous lows
- Both averages hold above the prior lows
- Both averages exceed the secondary bounce
The sell signal
- A primary high is established
- A secondary drop
- A rally of over 3% but falls short of the previous high
- A drop of both averages below the previous drop
The funds in the portfolio are (ETF alternatives):
- Wilshire 5000 total return index ^DWC (NYSE:VTI), (NYSE:SPY), (NYSE:IWM)
- Cash (NYSE:BND)
Yale Professor Robert Shiller devised and maintained a ‘Cyclically Adjusted Price Earning’ ratio (CAPE10) as an alternative to the popular PE ratio to value the US stock market. CAPE10 is defined as the ratio of price to the average of last 10 year trailing S&P 500 annual earnings. We capture this strategy called Shiller Cyclically Adjusted PE 10 Stock Market Timing Strategy. This strategy characterizes the stock market valuation into the following five categories based on the ratio of the current CAPE10 to the long term average CAPE10:
- Significantly Overvalued (SO): such as if the ratio >= 150%
- Modestly Overvalued (MO): such as if 117% <= ratio < 150%
- Fairly Valued (FV): such as if 83% <= ratio < 117%
- Modestly Undervalued (MU): such as if 67% <= ratio < 83%
- Significantly Undervalued (SU): such as if ratio < 67%
We implement a simple strategy that makes a switch to cash once the market is significantly overvalued and back to equities when the market is modestly undervalued.
The funds in the portfolio are (ETF alternatives):
Finally we take the tactical asset allocation which uses a 200 day rolling average.
Historical Returns for Dow Theory, Shiller and 6SIB TAA
|Portfolio/Fund Name||1Yr AR||1Yr Sharpe||3Yr AR||3Yr Sharpe||5Yr AR||5Yr Sharpe|
|P Shiller Cyclically Adjusted PE 10 Stock Market Timing Strategy Monthly||5%||94%||4%||30%||3%||23%|
|Six Core Asset ETF Benchmark Tactical Asset Allocation Moderate||11%||83%||9%||79%||13%||91%|
|P Dow Theory DJI||0%||20%||-0%||-7%||2%||9%|
The Dow Theory has not been effective in the last ten years given the prevailing market conditions. It is possible that a different investment portfolio would perform better but given that Shiller is using similar funds, Shiller appears to be a better choice.
- Both the Dow Theory and Shiller are based on long term indices and both of them outperform the market
- Shiller performs better as we recover from the nightmare of the last few years — it is bipolar in terms of volatility — depending whether it is in cash or equities.
- Modern portfolio theory based on diversification and tactical asset allocation has good returns and reasonable volatility – within the measurement timeframe
Disclosure: MyPlanIQ does not have any business relationship with the company or companies mentioned in this article. It does not set up their retirement plans. The performance data of portfolios mentioned
LTI Systems, Inc. is the operator of MyPlanIQ.com and ValidFi.com. The founders of LTI Systems have extensive technology and business background in computer and semiconductor industries. They have been using the strategies provided by MyPlanIQ for their own personal retirement and taxable investments. The mission of LTI Systems is to make wealth management investment strategies that are used to be only accessible to institutions and high net worth individuals available to private investors with a fraction of flat cost and ease of use. The founders of LTI Systems, investors themselves, take pride in creating such a system and service for investors by taking the perspective from the investor side. They are using the system and the strategies for their own investment and align their interests with their customers.
MyPlanIQ’s blog provides periodical articles to discuss issues related to retirement plans (401(k), 403(b) and IRAs), deferred compensation plans (457), college savings plans (529), taxable brokerage investment accounts, variable annuities and universal life insurance plans. It also covers investment strategies, specifically strategic and tactical asset allocation and investment products such as ETFs and mutual funds. In addition, it syndicates daily articles that are related to retirement planning, personal finance, investment strategies, annuities, insurance, college savings and market/economic outlooks. It provides a comment and discussion community for readers.