Reviewing the ITA Risk Reduction Model

Readers not familiar with the ITA Risk Reduction model would do well to review this blog post.  Of the eleven portfolios tracked here at ITA Wealth Management, five are undergoing testing of the ITARR model and they are: Maxwell, Euclid, Madison, Gauss, and Kenilworth.  Of these five, Platinum members have access to the trades for the Gauss and Kenilworth, but not the other three.

Within these portfolio we concentrate on eight critical ETFs and the are:  Large-Cap Blend (VTI), Small-Cap Value (IWN), Developed International (VEU), Emerging Markets (VWO), Domestic Real Estate (VNQ), International REITs (RWX), Commodities (DBC), and International Bonds (PCY).  Of these eight ETF, only VNQ and PCY are currently priced above their 195-Exponential Moving Average.  Even VTI moved from above to below the EMA yesterday.

It appears as if the best selling points are now history, considering the huge market drop this week.  As the different portfolios come up for review this month we will examine each carefully in an attempt to make the right decisions.  As mentioned in another post, we will wait for the Bullish Percent Indicator (BPI) for the NYSE to turn positive.  I suspect when the BPI is updated tomorrow we will see far fewer than 50% of the stocks showing bullish signals.

This is a time to be patient and wait for the demand to come back into vogue, as it will, and then be ready to put available cash to work when we see potential buying opportunities.  For investors who are adding money to their portfolios each month and do not need to withdraw for living, this market is a blessing as one can purchase more shares at a lower price.

What Happens When We Substitute VYM For Individual Stocks

The question was raised in a comment – What if one uses VYM instead of the six individual stocks as recommended in the Seeking Alpha article?  Using the same 60 months of historical data for the analysis and the same projections for the S&P 500, below is the QPP analysis where 18% is allocated to VYM as a substitute for the six individual stocks.

The projections are not as strong when one moves to VYM.  The projected return drops from 8.02% down to 7.8%, not a huge loss.  The standard deviation or portfolio volatility is elevated from 13.39% to 14.16% so that value is also moving in the wrong direction.  Diversification Metric moves from 49% down to 32% with the VYM change.  That move is also in the wrong direction.  Last, and of least importance, is Portfolio Autocorrelation (PA).  Here too, the move is from 13.63% with individual stocks up to 17.18% with VYM.  We want PA to be as low as possible.

In almost all cases, I find adding in a few highly selected yield oriented stocks will move these four metrics in favor of the investor.  If one does not feel competent to select or simply wishes not to be bothered with the effort, it is possible to come up with a combination of ETFs that will rival the numbers produced when individual stocks are worked into the mix of ETFs.

Bullish Percent Indicator Update

In the Bullish Percent Indicator data table below, I want to draw your attention to several features.  1) Look at the latest data in the 06/01/12 row.  The left-hand number, 46.62, is the most important as that indicates the percent of stocks in the NYSE that are generating a bullish PnF graph. [Next time I will include the headers or titles in the screen shot.]  That percent indicator is showing major declines since last April.

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Portfolio Performance: 2 June 2012

The good news is that every portfolio improve with respect to the ITA Index, our customized index, and every portfolio with exception of the Schrodinger outperformed the VTSMX index fund.  The Schrodinger held even when compared to VTSMX.  On the downside, all portfolios with the exception of Gauss saw a decline in their IRR value.  This was not unexpected considering the lousy week in the market.  Frankly, I was surprised the Gauss was up for the week.

In nearly every case, the portfolios will have higher IRR values than shown in the table below as the May dividends are missing in a number of portfolios.  When the May statements are available this weekend, I will update all eleven portfolios and enter the dividends and any monthly interest.  Results this week show that the ITARR is doing its work.

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