In this research paper, we highlight how you can significantly boost the returns of the SUPERModel Market timing system by using appropriately selected Cyclical stocks on the JSE. We also show at the end how you can use simple and cost effective Exchange Traded Funds (ETF's) to participate in the benefits of Market Timing.

Modern research indicates that Sector Rotation over various stages of the Business Cycle can produce superior returns. The idea is that various sectors of stocks perform better during various stages of the business cycle as shown below:


In a July 2007 paper titled "Sector Rotation over Business-Cycles", Ben Jacobson, Jeffrey Stangl  and Nuttawat Visaltanachoti tested the sector rotation theory described by Stan Stovell’s book "Standard & Poor's Guide to Sector Investing 1995." They compared the performance of a market buy-and-hold strategy versus two perfect hindsight strategies that used Sector Rotation over Business Cycles and Market Timing. The Sector Rotation strategy buys and sells stocks in sector portfolios in equal weights during the business cycle stage according to the Sector Rotation model whilst the Market Timing strategy holds the market portfolio during "Market Bottom", "Bull Market" and "Market Top" phases.

They concluded in their research that significantly superior returns could be achieved with both sector rotation and market timing methods but that the Market Timing method would be far less effort and cost far less in brokerage fees to implement.

In another recent study published in the Journal of Investing and titled "Sector Rotation and Monetary Conditions”  Robert Johnson, C. Mitchell Conover, Gerald R. Jensen, and Jeffrey M. Mercer, showed that U.S. Federal Reserve interest rate policy changes are associated with strong patterns in equity returns. The article,  indicates that a sector rotation strategy based on the Federal Reserve rate changes could substantially improve a portfolios performance over the past 33 years.

According to the study, investors could outperform the market using a more aggressive strategy when the discount rate is decreasing and a more defensive strategy when the Fed is raising rates.  We have already tested and confirmed this spectacularly on the JSE with the SARB Repo Rate Timing Model, so nothing new here but they concluded that :

1.The average return for cyclical stocks (cyclical consumer goods, cyclical services, general industrials, information technology, financials, and basic industries) was 20.3 percent during expansive monetary periods and 2.3 percent during restrictive monetary periods.

2.The average return for non-cyclical stocks (resources, non-cyclical consumer goods, non-cyclical services, and utilities) was 14.7 percent during expansive monetary periods and 10.2 percent during restrictive monetary periods.

So this got us wondering which stocks or sectors performed the best during periods in which the PowerStocks SUPERModel Market Timing strategy was vested in the JSE? The SA Economy is resource driven and very different to the US so we cannot naturally conclude that what works in the US will work on the JSE. If we could answer this question, then investors could potentially significantly enhance the portfolio returns of their market timing strategies, hopefully by simply investing in an ETF that tracks various sectors, as opposed to investing in a broad market index.

The SUPERModel timing system is unique in that it gets you in the JSE during:

(a) Expansive monetary policy periods (MPI timing);
(b) Periods of strong recovery and upward momentum (Trendex Timing) and
(c) Market Bottom, Bull and Top business cycle phases (Econometric Timing).

It may well be that certain sectors on the JSE perform best when any of the above three conditions exist.

We only had JSE Index data going back to 1998, so we compiled 11 year backtests on the SUPERModel using the JSE Resources, Consumer, Industrial, Financial and Platinum indexes (we have problems with the Mining Index data hence the choice of Platinum until we can resolve the issues) The results are shown below:

We see that any sector that generally out-performs the ALSH index will "super out-perform" when the SUPERModel Timing Strategy is used. We also note that timing does not help the Industrial and Financial sectors, which under-perform the JSE in both the buy-and-hold (left chart) and the timed strategy (right chart).

The Resources and Consumer sectors respond well to market timing whilst the Platinum sector went to dizzy heights with market timing. The Platinum sector is an "uber-cyclical" that is very tied to world economic conditions and swings
 wildly between boom and bust cycles in the world economy, and it is this volatility that lends itself so well to the SUPERModel, since the SUPERModel is in at the bottom, rides the market to almost the top and then gets out before the bust. We suspect the general mining index will display similar (but not as good) performance once we have resolved the database integrity issues.

We show the performance of SUPERModel on our RiskCurves BLUECHIP portfolio as well. This is a specially selected diversified set of 5-shares taken from among the largest shares on the JSE that have displayed historically "investor friendly" statistics as defined in our RiskCurves Theory. You can see that BLUECHIP buy-and-hold slightly out-performed that of the JSE Platinum Index (left chart), but its "investor friendly" characteristics remove that ugly volatility that investors hate and of course that means it does not quite reach the heights of the Platinum strategy when it comes to market-timed returns.

Yearly investment performance (March-to-March) of each of the "best" strategies are displayed below:

Just look at the miracle of market timing. The SUPERModel timed ALSH strategy (ALSH SMODEL) delivered over 3 times the performance of the ALSH buy-and-hold with one third the risk! Will you ever buy-and-hold again after that sinks in?

We note that only the ALSH and BLUECHIP timed strategies showed 100% positive year growth (no negative years). The ALSH timed method shows the best Return-to-Risk ratio (average yearly growth divided by deviation of growth) whilst the ALSH buy-and-hold strategy shows the worst.

The BLUECHIP timed strategy shows a very respectable Reward-to-Risk of 1.15 given it is the 2nd best performing strategy in overall returns.

Although the PLAT model showed outstanding performance it came at the cost of volatility as shown with the 0.98 reward-to-risk ratio. However at 2,728% growth not many people will give a damn!

The best strategies only manage to beat the ALSH index 63.6% of the time (7 out of 11 years) but they never sink to the depths that the ALSH can sometimes do (as they avoid crashes) and this is what makes them out-perform on a grand scale from both a returns and risk basis. They sell near the top, sit safely earning high interest rates during the lacklustre and down years and buy again for peanuts on the bottom, producing a grand compounding effect on returns.

So market timing is definitely the way to go, but with which shares?

If you are prepared to build your own BLUECHIP portfolio of 5 shares as recommended by our RiskCurves research then this is obviously the route to go from a risk-to-reward basis. Your minimum investment to make this worth your while from a brokerage perspective is R40,000.

If you have more of a stomach for volatility, then you can build your own PLATINUM index by purchasing IMP, LON, AMS, AQP and NHM which should serve to pretty much mirror the index.

If you have less than R40,000 you want to spend on a timed strategy then just purchase a SATRIX40 (less risk) or a SATRIX RESI (slightly more risk but much better returns than SATRIX). These ETF's offer a cost effective and painless way to participate in market timing strategies.

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