This week I want to give you a peek at one of my favorite TradeSmith tools.
I’m referring to Pure Quant, our proprietary portfolio-building software.
We designed Pure Quant to make building a professional-quality portfolio as easy as possible.
With just a few clicks of a mouse, Pure Quant can take whatever sources you choose — from entire indexes to newsletter recommendations to your favorite individual stocks — and deliver you a complete, diversified, risk-balanced portfolio in seconds.
If you’re anything like me, and often feel overwhelmed by the sheer number of compelling investment opportunities available at any time, it can be a game-changer.
But Pure Quant isn’t only useful for building traditional long-term investment portfolios. It’s also a powerful tool for building “tactical” portfolios.
These are generally smaller portfolios — either held separately or as a small allocation within a larger, long-term portfolio — meant to profit from short- to intermediate-term market trends.
And today, I’ll show you just how easy it is to build a tactical portfolio with Pure Quant.
Of course, because this is Money Talks, I’ll also share the complete portfolio at the end, so you can take advantage of this opportunity whether you’re a TradeSmith subscriber or not.
Sound good? All right, let’s get started.
For this example, we’re going to focus on the energy sector.
Why energy? Well, there are a couple of big reasons.
The first is the health of the overall sector.
Energy commodities like crude oil, natural gas, and gasoline are solidly in the TradeSmith Health Indicator Green Zone. And as you can see below, our S&P Sector health tool shows energy is the healthiest of all 12 market sectors today.
Specifically, the sector’s Health Distribution (circled in blue) currently shows 100% of the stocks in the sector are in the Green Zone.
Only one other sector (Financials) currently has more than 90% of its stocks in the Green Zone. Most have less than 80%.
And we’re seeing similar strength in the price action of many individual energy stocks — particularly those in the oil and gas industry — which broke out to new recovery highs this week.
Second, as our Chief Research Officer Justice Clark Litle noted in this morning’s edition of TradeSmith Daily, the fundamental drivers of higher energy prices are likely to continue well into next year at least.
On one side, energy demand has been rising as the global economy slowly begins to recover.
On the other, ongoing pandemic-related supply chain disruptions and worker shortages have dramatically reduced energy production. And the global push toward “green energy” has slashed new investments in traditional energy sources before reliable replacements are widely available.
This combination has created something of a perfect storm for higher energy prices that could quickly become a full-blown crisis in the months ahead.
After deciding to make our tactical investment in energy, we would traditionally consider two investment strategies.
We could find a few of the best individual energy stocks we believe are likely to do well. Or we could keep it simple and buy an energy-focused exchange-traded fund (ETF).
Each of these options has advantages and drawbacks.
Buying individual stocks can produce better returns if you choose the right companies. But it can also introduce unexpected company-specific risks you aren’t aware of.
Buying an ETF is an easy way to diversify your risk among several companies. That’s why they’ve become so popular. However, this convenience can come at a cost.
ETFs often charge hefty fees. They can also hold plenty of unhealthy and poorly performing stocks that can weigh on your performance.
Fortunately, with Pure Quant, we can essentially get the best of both approaches.
We can get the diversification benefits of an ETF while holding only the healthiest, best-performing stocks. And if we take advantage of the commission-free trading offered at many brokers today, we won’t have to pay a penny to do so.
Here’s how it works…
First, I’ll open the Pure Quant tool under the “Invest” tab in TradeSmith Finance. I’ll then click the green “Build New Pure Quant Portfolio” button below.
Next, I’ll choose my sources under “Step 1.”
For this example, I’m keeping things simple. I’m using only two sources: stocks in the energy sector and stocks that trade on a U.S. exchange. (Note: I’ve selected to use “All” sources at the top so that Pure Quant will include only stocks that meet both of these criteria.)
However, Pure Quant can accommodate just about any source you’d like to include.
For example, if you subscribe to any energy- or resource-focused newsletters, Pure Quant can draw from those recommendations as well. Likewise, you can easily include any favorite individual stocks or funds as a source.
Once I’m happy with my chosen sources, I’ll click “Step 2.”
Step 2 is where you can adjust the settings Pure Quant uses to identify only the healthiest stocks from the sources you added in Step 1.
We settled on these specific settings after extensive backtesting, so we generally don’t recommend making changes to most of them unless you have a good reason to do so.
However, I will click to turn off our proprietary “Maximize Diversification” algorithm in this case.
This algorithm can dramatically reduce the overall risk of a traditional diversified portfolio. But when building a tactical portfolio — which by definition tends to hold correlated assets — this feature will limit your results.
Finally, I’ll click “Step 3” to customize the size of the portfolio.
First, I’ll tell Pure Quant that I would like to invest a total of $5,000 in this energy portfolio.
If you decide to invest in this portfolio, your preferred investment size may differ. The critical point is you don’t want to bet the farm on a relatively concentrated portfolio like this.
A good rule of thumb is to think of the whole portfolio as a single position and allocate roughly what you would to any other single position.
For this example, I’ll spread my risk across 10 different stocks.
Again, you may prefer a different number, but our usual recommendation of 10 to 20 total positions still applies. This is generally a large enough number to limit company-specific risk, but not so large that the portfolio becomes difficult to manage.
Then I’ll click the green “Build Portfolio” button at the bottom, and a few moments later, Pure Quant will deliver the portfolio.
I could stop here, but I want to make one final adjustment.
You see, most of the stocks on this list have a relatively high VQ of 30% or more.
I also see two stocks — Equitrans Midstream (ETRN) and Genesis Energy (GEL) — that are primarily focused on energy transportation and storage, rather than exploration and production.
So, I’m going to swap those two stocks with two other highly ranked stocks on the list: Chevron (CVX) and Exxon Mobil (XOM).
These companies are well-established producers that should more directly benefit from higher energy prices. And their relatively low VQs will also reduce the overall volatility of the portfolio.
After making that change, I’ll simply save these results as a new portfolio, and I’ll be ready to invest.
This portfolio shows precisely how many shares of each position I should buy and what percentage of the overall portfolio is allocated to each of them. If you would like to download a CSV file of the portfolio, click here.
Again, if you decide to invest in this portfolio, your position sizes may vary depending on your total investment amount.
But if you’re not a TradeSmith subscriber, don’t worry. You can easily customize your position sizes for yourself using the “Portfolio %” column above.
As always, I’d love to hear what you think at [email protected]. I can’t personally respond to every email, but I read them all.