I’m Creating a New Stock Strategy
Thursday, June 25, 2015

I’ve been working on a new stock strategy. I’m focusing on the screen first—the method for identifying potential candidates—with plans to establish the sell rules afterward. This is the first time I’ve created a new personal strategy, as opposed to revising an existing one, in several years. Though I’m not creating it entirely from scratch, it is a new strategy as opposed to simply a revision. As such, the process is offering insights in and of itself.

Before going any further, I’ll answer the question many of you likely already have: What is the strategy? It will be a value and momentum approach to investing in fundamentally sound stocks. I don’t have details to share because they are not finalized yet. I’m still in the middle of the process and anticipate making various tweaks and changes before I’m done.

The premise for the strategy is based on both research and personal preference. Much has been written about how value stocks outperform growth stocks over the long term. Momentum has also been shown to be a driver of stock prices, and it is uncorrelated with value. I like combining the two factors because, although I am a value investor, I like seeing evidence of other investors viewing the stock as a bargain as confirmation of my ideas. My reasons are not about going with the herd or doing what’s popular (games that don’t give me any advantage), but rather ensuring that my opinion about a stock is not too far out in left field.

Having a preference for how to invest is one thing, but it’s another to have the data to back up one’s ideas. Or as our president John Bajkowski asked me when we were discussing the strategy, “Can you rationalize the criteria you are using?” The answer is “yes,” because there is research I can point to—beyond what I’ve learned over the course of my career—that supports my ideas, particularly for the core part of the strategy.

One of those sources is AAII.com. We have over 60 stock screens based on the ideas and works of many investing gurus. In putting together a list of criteria to consider, I looked at our value-oriented screens to see what parameters were being used and what limiting criteria was included. I’ve also looked through our extensive archives on AAII.com for data, research and ideas. (You can do the same by using the search box located near the upper right-hand corner of any page.)

I then went beyond our website, often following references from articles published in the AAII Journal. For example, I’ve looked at James O’Shaughnessy’s “What Works on Wall Street” (McGraw-Hill, 4th Edition, 2011) more times than I can count. At the same time, I’ve hunted down research papers mentioned in various articles to see exactly what the source said. At times, the citations in these papers have led me to read other papers. (I find the SSRN website to also be a good source for doing this, as well as simply typing the title of a study into Google.)

Since I had a good idea of what I wanted the core of the strategy to be, one of the surprising challenges of the process is selecting the limiting criteria. For example, what should I set as the minimum stock price? Do I exclude financial stocks? These choices affect how many and the type of stocks that pass my eventual screen. (I’ve decided on a minimum share price of $4 because that is the minimum share price to be listed on the NYSE and the NASDAQ. I’m excluding financial stocks because of their unique financial structure and because famous studies on value—most notably the ones conducted by Eugene Fama and Kenneth French—exclude the sector.)

I’m testing the core of my strategy by running preliminary versions of the screen with older data from AAII's Stock Investor Pro fundamental stock screening and research database program to get return and other related statistics. (Stock Investor Pro subscribers have access to our historical data.) As part of this process, I will be “flipping” the strategy to see what happens when I seek stocks with the opposite characteristics—high valuation and weak momentum. Based on my research, the core screen should perform well and the “flipped” screen should perform poorly. I’ll be surprised if this not the case, but I would rather find out for sure before I make an investment decision based on it.

If things do work out as planned, you’ll hear more about the strategy in the future. For now, I’ll simply say that it’s not yet ready for prime time.

More on AAII.com

The Week Ahead

The U.S. financial markets will be closed next Friday in observance of Independence Day. Our offices will be closed as well. Have a happy Fourth of July!

A handful of S&P 500 member companies will report quarterly results next week: ConAgra Foods (CAG) on Tuesday and Constellation Brands (STZ), General Mills (GM), McCormick & Co. (MKC) and Paychex (PAYX) on Wednesday.

The first economic report of note will be the National Association of Realtors’ May pending home sales index, released on Monday. Tuesday will feature the April S&P Case-Shiller home price index, the Conference Board’s June consumer confidence survey and the June Chicago PMI. The June ISM manufacturing index, June ADP employment report, June PMI manufacturing index and May construction spending will be released on Wednesday. Thursday will feature the Labor Department’s June employment report (released a day early because of the holiday) and May factory orders.

St. Louis Federal Reserve president James Bullard will speak on Tuesday.

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AAII Sentiment Survey

Optimism surged to a three-month high as pessimism plunged to a four-month low in the latest AAII Sentiment Survey. Neutral sentiment continues to stay at an unusually high level.

Bullish sentiment, expectations that stock prices will rise over the next six months, jumped 10.1 percentage points to 35.6%. Optimism was last higher on March 26, 2015 (38.4%). Even with the big increase, bullish sentiment remains below its historical average of 39% for the 16th consecutive week—the first such occurrence since a 20-week streak between April 5 and August 16, 2012.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, rebounded by 2.5 percentage points to 42.8%. The rise keeps neutral sentiment above its historical average of 31.0% for the 25th consecutive week and at an unusually high level for a 12th consecutive week.

Bearish sentiment, expectations that stock prices will fall over the next six months, plunged 12.6 percentage points to 21.7%. The drop follows what had been a 10-month high and puts pessimism at its lowest level since February 26, 2015 (20.3%). The historical average is 30%.

The big rebound in optimism and large drop in pessimism comes as the major indexes have bounced off of their recent lows. It also follows a period of seven consecutive weeks with bullish sentiment staying below 30%, the longest such streak since early 2003.

This week’s reading puts pessimism below its historical average for the 20th time this year, or 20 out of the past 26 weeks. Bearish sentiment is near the lower level of its typical range, but is not currently at an unusually low level.

This week’s special question asked AAII members what impact the first interest rate hike will have on stock prices. Just under 35% of respondents said it will have little to no impact, with many reasoning that the first rate hike is well anticipated. A nearly equal number said there will be a short-term negative reaction, though the majority of these respondents anticipate stocks rebounding fairly quickly. Slightly more than 19% think stocks will fall, with some anticipating a decline of 10% or more. A small group of optimists (7%) expect to stocks react positively.

Here is a sampling of the responses:

  • “Very little. I think the anticipation of a rate hike is already priced in.”
  • “Minimal effect. It is already baked into the market.”
  • “Some investors will freak out and there will be a pullback in stock prices across the board.”
  • “A swift 5% drop after the announcement, followed by a recovery 2-3 months later.”
  • “A short-term downward blip, but recovering within 30 days.”
  • “If the market hasn’t factored a rate hike in all this time, it never will.”


This week’s Sentiment Survey results:

Bullish: 35.6%, up 10.1 points
Neutral: 42.8%, up 2.5 points
Bearish: 21.7%, down 12.6 points

Historical averages:

Bullish: 39.0%
Neutral: 31.0%
Bearish: 30.0%
Take the Sentiment Survey.

Local Chapter Meetings
AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!