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World Stockmarket Rotation Strategy

ETFI've been asked my opinion on people trying to avoid paying capital gains tax by not buying and selling within a 12-month window.

My personal view is twofold.

Firstly, tax can be minimised to some degree using company structures, family trusts or investing through a SMSF.

Secondly, I liken tax to advertising. If advertising adds value to the bottom line then it's beneficial to the business. If it doesn't, then don't advertise

Active investing should be viewed in the same.

If you have the capability to generate outperformance after tax, then why wouldn't you?

World Rotation Strategy

We've previously investigated buying a portfolio of weak vs buying strong stocks on an annual basis, specifically buying the strongest (weakest) for the year, holding for the following year, then repeating.

What we found is a lot can go wrong with an already struggling company in the space of a year.

What about a country ETFs?

In this exercise we'll measure the momentum of 42 country ETFs for the prior year then rank from strongest to weakest.We'll then buy the strongest (weakest), hold for 1-year, then repeat^.

This first chart, extending back to 1997, shows the return if we invested 100% into the strongest country ETF.

ETF buy strength

And this next chart shows the return the following year if we bought the weakest country ETF from the prior year.

ETF buy weakness

But what happens when we put each return profile together?

The following chart offers some interesting insights. Buying the strongest country ETF worked extremely well until the financial crisis. The strategy caught 5-years of  large upside moves culminating in a 50% gain in China through 2007.

That China gain was promptly crushed through 2008. Since then buying the prior winner has failed to hold itself together. Indeed there are several instances where the prior best performer becomes the worst performer the following year.

For the contrarians, buying the prior worst performer has actually been a reasonably steady strategy and has outperformed the S&P 500 by about 50%.

ETF combined

Regardless of the S&P 500 outperformance it's been a very lumpy ride and not one I'd personally undertake. As stated above, this exercise corroborates the theory that a lot can go wrong in the space of a year.

I'll stick to being an active investor.

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