Home Wealth Management Tornadoes in Tulsa: Utilizing Relative Rotation Graphs (RRGs) in Portfolio Administration

Tornadoes in Tulsa: Utilizing Relative Rotation Graphs (RRGs) in Portfolio Administration

Tornadoes in Tulsa: Utilizing Relative Rotation Graphs (RRGs) in Portfolio Administration


Let me preface this piece with a warning: This isn’t a broad market replace, an earnings season knowledge regurgitation, or a Federal Reserve assembly autopsy. It’s meant to be a glance below the hood at how we handle our mannequin portfolios. As Daniel Ocean stated, “If that doesn’t sound like your specific model of vodka, secure journey (till subsequent publish!) and no exhausting emotions!” 

Relative Rotation Graphs, or RRGs, are an incredible device that our group makes use of to evaluate the relative power of particular person shares, sectors and asset courses.

As we’ve written earlier than, relative power is an investing idea that has been closely researched and is without doubt one of the main refutations of the Environment friendly Market Speculation. For those who needed to distill relative power right down to a tagline, it’s this: do extra of what’s working, and fewer of what’s not.

However simply studying about relative power may cause glazed eyes in even the steeliest of funding professionals.

With RRGs, we’re capable of visually dissect these relationships in a short time, and over any timeframe of our selecting.

To assemble an RRG, an asset is “comped” (in contrast) in opposition to a benchmark and is assessed into certainly one of 4 classes, or quadrants, primarily based on the relative power relationship and—this is essential—the momentum of that relationship. Moreover: the additional away from the origin (lifeless heart) of the RRG plot, the stronger the connection (i.e. you may lag by somewhat or lead by quite a bit).

As you learn on, do not forget that relative power, by definition, doesn’t indicate something about absolute funding efficiency. If inventory A goes down 20% in a month and inventory B goes down 10%, the latter is claimed to have constructive relative power, although absolute efficiency is destructive.

  • BLUE: Enhancing (Damaging relative power, with constructive relative power momentum);
  • GREEN: Main (Constructive relative power, with constructive relative power momentum);
  • YELLOW: Weakening (Constructive relative power, with destructive relative power momentum);
  • RED: Lagging (Damaging relative power, with destructive relative power momentum);

As knowledge factors are accrued and plotted (every day, weekly, month-to-month, yearly relative returns), you’ll be able to see how relationships transfer over time. Additional, these relative power calculations needn’t be seen as static knowledge factors. We are able to additionally view the trajectory of an asset, and thru some primary visible rendering, we are able to additionally witness its evolution by time. The timeframe chosen will vastly influence the visible rendering of the connection. Which means, the motion of an asset will look very completely different utilizing a every day timeframe versus a yearly timeframe. A day dealer would use this device very in a different way than a place dealer. (Clearly, you’d classify Monument into the latter.) 

For those who take a look at sufficient of those interactive plots – particularly with particular person S&P sectors on shorter (every day) time frames – you’ll discover that they have a tendency to maneuver in a clockwise method by the assorted quadrants. Although there are at all times exceptions. A meteorological comparability may be the trail of thunderstorms within the Midwest. Rising up, I at all times anticipated storms in Tulsa to strategy us from southwest to northeast. However we at all times knew that storms may hit us from the northwest, and on a uncommon event, we’d get them from a totally sudden route (the uncommon southeast to northwest path).

Bringing it again into funding parlance, you may argue that RRGs visually plot cycles, that are at all times and in all places current over a number of time frames. I’ve really simply laid out the bottom case for why lecturers and practitioners are so all in favour of cycle principle: they’re pervasive in each nature and in markets. For those who actually wish to get “wonkish,” take a look at Fibonacci retracement.

In the long run, I actually benefit from the RRG device as a result of it’s one other method to visually synthesize and examine elements of different mannequin portfolios we use at Monument. Particularly, our Versatile Asset Allocation (FAA) technique, which is closely reliant on stock-to-bond relative power, and our Core ETF mannequin, which employs a sector rotation sleeve.

Let’s hit on the Versatile Asset Allocation (FAA) angle first.

The animation beneath illustrates the relative power of world shares (as represented by the $ACWI ETF) to the bond market (as represented by the $AGG ETF). We’re weekly relative returns, going again over the past yr, with the RRG tail representing the final ten knowledge factors. You may clearly see international shares very clearly residing within the purple Lagging quadrant as we hovered close to the lows in October of 2022, however very decisively altering trajectory close to the flip of the yr. We’ve spent most of 2023 with shares residing within the Enhancing and Main quadrants, with some early-year zig zagging between the Main and Weakening zones.

As a reminder, this doesn’t essentially say something explicitly about absolute returns, solely how shares are performing compared to bonds.

This more-or-less suits with the relative power knowledge within the Versatile Asset Allocation mannequin, which appears to be like at a longer-term transferring common of the stock-to-bond relative power relationship. The $ACWI RRG plot may at the moment sit (albeit shallowly) within the Weakening quadrant, however the period of time spent within the Main quadrant, in addition to the magnitude of the relative power relationship whereas residing in that zone, at the moment mimics our risk-on FAA sign. The place we go for the upcoming October rebalance is anyone’s guess, however except we see a big trajectory shift between now and the tip of the month (bonds considerably outperforming shares), I’d wager we keep the course with the present sign.

stock-to-bond relative strength relationship

Now, let’s check out Core ETF

Now, let’s view this by the lens of the Core ETF Mannequin, which makes use of a “dynamic” sector rotation sleeve to enhance the low value “buy-and-hold” core.

What we’re beneath are the 11 S&P 500 sectors, in contrast to not bonds as within the earlier instance, however to cap-weighted S&P 500. That is the place I’d say this piece is related for passive buyers holding a broad-based S&P 500 fund. You may know the market is up or down, however are you aware why? Which pistons are at the moment transferring the automotive ahead or a minimum of protecting it in gear?

S&P 500 sectors, compared to cap-weighted S&P 500.

Some observations from the sector rotation RRG embrace the next:

  • The prolonged, demonstrable power of each Expertise ($XLK) and Communications ($XLC), which actually picked up steam coincident with the regional banking disaster in February of this yr. That is what has brought about some to invest that Tech has develop into a de facto “flight to security” sector.
  • As we all know, Expertise is a big part within the cap-weighted S&P 500, so any power in that sector will amplify the returns of the group.
  • The more moderen emergence of Power ($XLE) since July/August, which lately displaced Client Staples ($XLP) in our sector rotation sleeve of the Core ETF Mannequin.
  • Taking a look at different particular person inventory fashions we handle, the Power theme has been pervasive, paving the way in which for some current entrants into each the Dividend ($PSX, Phillips 66) and Progress ($APA, APA Corp) fashions.

We hope this publish was instructive. When you’ve got any questions, please be happy to succeed in out. In any other case, have a beautiful weekend.

~ Erin

*For those who’re all in favour of studying extra about RRGs, take a look at this hyperlink.
*We entry RRGs by Optuma.



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