This report will discuss the results of the investment strategy that we recommended in our market comments for the week ending March 13, 2020.
At that time, we made an extremely valuable call on the market, when we advised buying triple leveraged exchange traded funds (ETFs). Since then, these ETFs have produced dramatic gains as the market has recovered, as seen in the chart below.
Figure 1 Triple Leveraged Nasdaq 100 ETF (ticker symbol TQQQ)
In our market comments for the week ending 3-13-20, we wrote: “Large percentage gains can be made by buying at very oversold levels, especially using double or triple leveraged ETFs … This is not just for short-term trading purposes. We may want to hold these stocks or ETFs for years, and buying them at very oversold levels can make a major contribution to performance. Thus it would make sense to place buy limit orders on a variety of stocks and ETFs, such as TQQQ in the $35 – $45 range.“
(Note: in general, a buy limit order is an order to buy at a specified price, which is below the current price. This order stays in effect for 30 days or more, and will be executed only if the market price drops to this limit price.)
The Invesco QQQ Trust (ticker symbol QQQ) is an ETF that holds 100 large stocks in the Nasdaq 100 index, including Apple, Amazon, Microsoft, Facebook, etc. QQQ is one of the oldest and most widely traded ETFs in the stock market, with average daily trading volume of over 40 million shares.
In recent years many triple leveraged ETFs have been introduced, which are designed to move three times as much as the underlying index. We recommended buying the ETF with ticker symbol TQQQ, which is the triple leveraged version of QQQ. So if QQQ rises by 10%, TQQQ rises by 30% (there is some tracking error over time).
When we wrote our comments in mid-March 2020, the stock market was plunging amid the coronavirus outbreak, and on March 13th, TQQQ closed at $57. Note that we did not recommend buying TQQQ at that point, as that would have been like “trying to catch a falling knife.” Instead, our strategy was to place buy limit orders at very low prices, so that if the market kept falling and reached those prices, we would be buying at extremely oversold levels.
Over the following six trading days, the market continued its sharp decline, and TQQQ hit an intra-day low near $33 on March 18th. This meant that all of our buy limit orders were filled, resulting in a TQQQ position with an average cost of $40.
The market then turned up in April and has been rising steadily for the past five months (as seen in the chart above). By 7-31-20, the price of TQQQ had risen to $119, an increase of almost 200%.
Thus our strategy of buying triple leveraged ETFs near the market lows in March has made a major contribution to our investment performance this year, and has far outperformed a buy-and-hold strategy.
The exact contribution to performance would depend on a variety of factors, such as what percentage of an account was invested in ETFs such as TQQQ, and when they were sold.
After buying the ETFs, we can manage the position in a number of ways, such as selling all or part of the shares, placing sell limit orders, placing stop-loss orders, holding part of the position as a long term investment, etc.
With this in mind, we will look at several scenarios to assess the impact of buying triple leveraged ETFs when the market was near its lows in March.
Base Case Scenario: 30% Cash and 70% S&P 500, with no ETFs
With the large V-shaped move in the market this year, the year-to-date price change of the S&P 500 through July was a gain of 1.2% (for simplicity we will not include dividends, and assume that cash had a return of zero).
A basic investment strategy would be an asset allocation of 30% cash and 70% stocks, with the stock portion invested in the S&P 500. For a portfolio valued at $1.0 million at year-end 2019, this strategy produces a year-to-date return of 0.9% as of 7-31-20, and the value of the portfolio rises to $1.009 million.
Scenario #2: Investing 10% in TQQQ in March and selling the position in April
This scenario is shown in Figure 2 below. A $1.0 million dollar portfolio starts the year with an asset allocation of 30% cash and 70% S&P 500, but in mid-March we place buy limit orders on TQQQ, as recommended in our blog post, moving 10% from cash into TQQQ. As mentioned above, these orders were all filled by March 18th.
In mid-April, when the price of TQQQ reached $60, we recommended taking profits to lock in a 50% gain. By this time the $100,000 position in TQQQ has risen to $150,000. We sell the TQQQ position and move the proceeds into the S&P 500.
By July 31st the S&P 500 rises by another 14.9%. This means that as of 7-31-20, the value of the total portfolio has risen to $1.081 million, for a year-to-date return of 8.1%. This is 7.2% above the return of 0.9% from the basic buy-and-hold approach.
Figure 2 Investing 10% in TQQQ in March and selling it in April
Scenario #3: Investing 30% in TQQQ in March and selling the position in April
Buying TQQQ in late March 2020 was actually a very low risk proposition, for two reasons:
- TQQQ is a diversified portfolio, containing 100 stocks.
- The entire stock market had already plunged and was very oversold. In fact it was reaching an extremely oversold condition which occurs only very rarely, based on a number of indicators (these indicators are shown in more detail in our blog post entitled Key Indicators Showed a Buying Opportunity in March 2020).
Therefore, it was not unreasonable to move more than 10% of a portfolio into TQQQ when the market reached its extremely oversold condition in March. Perhaps 20% or 30% of a portfolio could have been placed into triple leveraged ETFs, in which case the strategy would have a greater impact on the returns of the overall portfolio.
Figure 3 shows what happens if we move 30% of a $1 million portfolio, or $300,000, from cash to TQQQ in March and sell it in April after a 50% gain, moving the proceeds into the S&P 500.
In this case the value of the $1.0 million portfolio rises to $1.226 million, for a profit of $226,000. This is a year-to-date gain of 22.6%, or 21.7% above the 0.9% return from the basic buy-and-hold approach.
Figure 3 Investing 30% in TQQQ in March, and selling it in April
Scenario #4: Investing 10% in TQQQ in March, selling half the position in April, and holding the other half as a longer-term investment
In our March 13th comments regarding buying triple leveraged ETFs, we stated: “This is not just for short-term trading purposes. We may want to hold these stocks or ETFs for years.”
Therefore, a likely scenario is that after establishing a position in TQQQ at $40 in March, we discuss the situation with the client in April, and decide to sell half of the position at $60 to lock in a profit, while continuing to hold the other half as a longer-term investment.
This situation is shown in Figure 4 below. To summarize this data, a $1 million account starts with 30% in cash and 70% in the S&P 500. In March we move $100,000 into TQQQ. By mid-April, this TQQQ position has a gain of 50% and has risen to $150,000.
At that point we sell half the TQQQ position for $75,000 and move the proceeds into the S&P 500. We continue to hold the other half of the TQQQ position as a longer-term investment.
From mid-April to the end of July, the S&P 500 rises by 14.9%. But in the meantime TQQQ rises by 99%, from $60 to $119.38, bringing the TQQQ holding from $75,000 up to $149,225.
This means that as of 7-31-20, the portfolio now holds $200,000 in cash, $794,942 in the S&P 500, and $149,225 in TQQQ, for a total value of $1.144 million. This means the year-to-date return is 14.4%. This is 13.5% above the buy-and-hold return of 0.9%, as mentioned above.
Figure 4 Investing 10% in TQQQ in March, selling half in April, and holding the other half
Last scenario: Investing 30% in TQQQ in March, selling half the position in April, and holding the other half as a longer-term investment
As mentioned above, buying TQQQ in late March 2020 had a good reward-to-risk ratio, because TQQQ is a diversified portfolio, and the entire stock market had become extremely oversold. Therefore, we could place at least 20% or 30% of a portfolio into TQQQ at that time.
The scenario of placing 30% into TQQQ is shown in Figure 5 below. To summarize this data, a $1.0 million account starts 2020 with 30% in cash and 70% in the S&P 500. In March we move $300,000 from cash into TQQQ. By mid-April, this TQQQ position has a gain of 50% and has risen to $450,000.
At that point we sell half the TQQQ for $225,000 and move the proceeds into the S&P 500. We continue to hold the other half of the TQQQ position as a longer-term investment. Because this means holding a fairly large leveraged position, we could use a trailing stop-loss order to limit the downside risk. But the market remained in a solid uptrend through July (as seen in Figure 1), so the position would not be stopped out.
From mid-April to the end of July, the S&P 500 rises by 14.9%. But in the meantime TQQQ rises by 99%, bringing the TQQQ holding from $225,000 up to $447,675.
This means that as of 7-31-20, the $1.0 million portfolio has now risen to a value of $1.415 million, for a year-to-date return of 41.5%. This is 40.6% above the buy-and-hold return of 0.9%, as mentioned above.
Figure 5 Investing 30% in TQQQ in March, selling half in April, and holding the other half
For a $1 million account, this strategy produces a gain of $415,000 in seven months.
For a $10 million account, this strategy produces a gain of over $4 million. The account would rise from $10 million to over $14 million in seven months.
For an ultra high net worth client with a $100 million account, this strategy produces a gain of over $40 million. The account would rise from $100 million to over $140 million in seven months.
In each case, the key investment decision was to buy a position in leveraged ETFs when the market became extremely oversold in late March 2000. This is exactly what we specified in our mid-March blog post.
Instead of selling when the market was plunging, we recognized that the situation was shaping up as a major buying opportunity, and we placed a series of buy limit orders to build a position in these ETFs, if and when they reached extremely oversold levels.
The strategy worked perfectly and enabled us to buy near the market lows, thereby producing large gains when the market recovered.
Note: this analysis is not a matter of “would have, could have” done something in the market, with the benefit of 20-20 hindsight. This is simply showing the results of executing a strategy that we specified on our blog, in writing, in mid-March 2020 – in advance, BEFORE the market reached its lows and then turned up sharply. (Click to see the complete blog post).
Based on our investment knowledge and years of experience, we recognized what was going on in the market and made the correct call.
Note: additional information is provided in our comments entitled Key Indicators Showed a Buying Opportunity in March 2020.
Conclusion
This follow-up report to our mid-March blog post provides an example of the idea, outlined in various articles on our blog, that successful investment strategy is not a matter of having a Ph.D. in economics and being able to make perfect forecasts of the economy and the market.
Instead, it involves consistently monitoring the mosaic of economic and market activity as events unfold, and recognizing opportunities when they occur.
The strategy that we recommended in March provides an example of how it is possible to add value beyond the traditional investment approach used by most money managers, which is to buy and hold high quality stocks for the long term. Note: we are not criticizing this approach.
However when I served for 16 years as the strategist for an investment firm for high net worth clients, some of our clients wanted us to go beyond a basic buy-and-hold approach. They wanted us to invest a portion of their assets in ways that could produce higher returns.
We believe that sometimes it is possible to identify situations in which the risk / reward ratio from buying or selling an asset is highly tilted in one direction or the other. When such situations occur, sometimes it is possible to take advantage of them with leveraged ETFs or other investment vehicles. This can be an important factor in creating good investment performance.
Please contact us for more information, and to discuss how we can put this professional investment process to work for you.
Jonathan Strauss, CFA
513 – 379 – 2792 (cell / text)
jon@straussresearch.com