Quant Concepts: Fundamental or technical?

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Emily Halverson-Duncan: Welcome to Quant Concepts. There's an age-old debate over what sort of company analysis is most effective, fundamental or technical. Fundamental analysis is a method used to evaluate how much a company is worth by focusing on firm-specific factors, like earnings or revenue, and how they relate to macroeconomic conditions. On the other hand, technical analysis focuses on forecasting the direction of stock prices by looking for trends in historical market data such as price and trading volume. But why do we have to choose one or the other?

Today's strategy is built based on fundamental momentum variables but is overlaid with the technical screen to help determine the appropriate timing as to when to buy and sell securities. The aim of this strategy is to still achieve the upward momentum of a momentum strategy while timing appropriate entrances and exits for the underlying holdings and without taking an excessive amount of risk or trading too frequently. So, let's take a look at how to build that.

First off, we're going to rank our universe of stocks which is all the Canadian stocks in the CPMS database, today that's 697 names. Our screens that we're going to look at or the ranking factors, we're going to look at are quarterly earnings momentum. So, again, we're looking at how much a company is growing their earnings quarter-over-quarter. We want a higher value for that. Quarterly earnings surprise, so whether or not a company is beating or missing on expected earnings. And five-year price beta versus the TSX Composite. That's a measure of sensitivity. You want to see that on the lower side.

From there, we'll move into our screens. So, our screens we're going to apply – quarterly earnings momentum, we want that to be greater than or equal to zero. So, we want them to at least be maintaining the same level of earnings or growing them. Quarterly earnings surprise greater than or equal to zero is at least meeting expected earnings or again, beating them. Five-year price beta versus the TSX Composite. We want that to be less than or equal to 0.7. So, again, trying to be much less sensitive than the actual indexes. Latest total debt to equity, we want that to be less than or equal to 1.1. It's just a measure of control and a measure of risk. So, not trying to have too much debt per unit of equity. And lastly, our technical screen, which is a price relative to 200-day moving average. So, what that's looking at is a stock's price compared to its 200-day moving average price. We want that to be greater than or equal to 3%. On the sell side, we're going to sell if that value falls below minus 10%. So, that's going to be our timing for when to get into a security and then when to exit it subsequently.

Of course, we want to see how that does and whether or not it works over the long term. So, here, we're going to run a back test. I'm going to use 15 securities at most and I'm going to run from November 2001 until end of February 2020.

Overall, the performance did really well. The annualized return was 22.1% across that timeframe, which is an outperformance of 14.9%, almost 15%, over the TSX. So, very, very high outperformance. Turnover though with something that high, you'd typically expect it to be a high turnover or high trading. But here we can see it's only 53%. So, on average, what that means is on a portfolio 15 stocks, you're probably only flipping about seven or eight of them in a year.

Metrics that I always like to look at in terms of risk – downside deviation. So, what are the volatility of negative returns for the strategy was 7.3%; for the benchmark was 8.6%. So, there is an improvement on the downside deviation. And then, of course, my favorite green and blue chart down here. In up markets, this strategy outperformed 56% of the time, but in down markets, it outperformed 79% of the time. So, despite the fact that it's a momentum-tilted strategy and again has that technical overlay, that actually helped with the timing of the strategy and you can see how that's compounded into better downside performance and then overall very strong returns.

For Morningstar, I'm Emily Halverson-Duncan.