Don't Let the 'Naysaying Empire' Pull the Wool Over Your Eyes

Editor's note: This Weekend Edition, we're taking a break from our usual fare to discuss why you should be the captain of your investment strategy. In this essay, Marc Gerstein of our corporate affiliate Chaikin Analytics explains how a "naysaying empire" created a group of folks who shied away from individualizing their investment decisions... and how you can beat them at their own game.

John Bogle built a naysaying empire...

In 1975, Bogle launched Vanguard. As the decades passed, the company grew into a financial-management titan. And its pioneering approach to investing – called "indexing" – buoyed its success.

Put simply, indexers don't think investors can consistently make good choices with their own money. They don't believe folks can keep choosing the right stocks over the long run.

So Vanguard convinced large numbers of investors to stop trying... and just buy everything.

In Bogle's mind, that meant "buy the market." Or more specifically, it meant "buy index funds." That way, investors could buy into the S&P 500 Index with one trade instead of 500.

Using this approach, Vanguard became one of the world's largest financial-management firms. An entire empire of indexers told investors not to think for themselves.

However, that brings us to this approach's major flaw...

Suppose you want to consider economic weakness and high fuel prices, two of today's biggest problems. So maybe you don't want to own automaker Ford Motor (F) or shipping giant FedEx (FDX).

"That's too bad," the indexers would say. "People like you can't decide such things. Just pipe down and own those stocks along with the rest of the S&P 500."

Folks... that's wrong. As an investor, thinking is good. You can – and should – avoid stocks that are likely to perform poorly.

And as I'll explain today, it's easy to beat Bogle's naysaying empire on its own turf...

It all starts with a sensible stock-selection method...

Don't let the naysaying empire pull the wool over your eyes. And don't just flip coins, read tea leaves, act on gossip from around the water cooler, or follow any hunches, either.

As regular readers know, our 20-factor Power Gauge system ranks thousands of stocks using objective data. It combines metrics like quality, sentiment, and technical analysis.

In short, you can use a system like the Power Gauge to make sensible, profitable investment choices. But there's more...

The Power Gauge also ranks exchange-traded funds ("ETFs"). These ratings combine the overall rankings of the stocks held within them with a specially designed technical ranking.

Importantly, this is how we can gain an edge over Bogle's naysaying empire. We don't need to just blindly buy into the SPDR S&P 500 Fund (SPY). We can do better...

We can eliminate the bad parts.

You see, the broad market is made up of 11 different sectors. And investors like us can easily invest in each sector using ETFs. So to eliminate the bad parts, we just need to buy the sector-focused ETFs with "neutral" or better rankings in the Power Gauge.

And after we've done that, we can re-examine the ETF rankings and adjust our portfolio as needed once per quarter.

Take a look at the table below to see how this approach would have worked over the past four and a half years. You'll notice that our analysis started on June 22, 2018. That's how long the S&P 500 has had 11 consistent sector-focused ETFs (without changing up the categories). So it's a good "line in the sand" for tracking returns.

By just avoiding the weakest sectors every quarter since then, our annualized performance would have beaten the indexers in SPY by one percentage point.

That might not seem like much at first. But keep two things in mind...

First, Vanguard made big bucks by convincing folks that nobody could beat the market. Also, remember that this period included the old "everything bull market," which was generated by decades of easy money and little to no inflation. That era is now over.

The new era will likely feature "rolling" booms and busts. As a result, we should expect much larger differences between strong and weak sectors in the months and years ahead.

To that point, here are the returns for this approach over the past year...

As you can see, this approach still would have lost money during this tough period. But it significantly outperformed the indexers. It beat SPY by more than 13 percentage points.

In the end, I hope my message is clear...

It doesn't take much effort to beat Bogle's naysaying empire. You can beat the market. And you can do that on its own turf – using the sector-focused ETFs with the most favorable Power Gauge rankings.

With this tool at your disposal, you can build a smarter version of the overall market with just a few trades every quarter.

Good investing,

Marc Gerstein

Editor's note: As this brutal year wraps up, everyone is scrambling to predict what's next for the market. But according to Wall Street legend Marc Chaikin, most of those predictions are dead wrong. That's why on Thursday, December 15, he revealed the only Wall Street indicator with a 100% success rate of predicting where the Federal Reserve will send stocks next... and what to do with your money before January 1. Click here for the full details.