Episode #119: Tom Dorsey, Dorsey, Wright & Associates, “Fundamentals Answer the First Question ‘What Should I Buy?’ The Technical Side Answers the Question ‘When?’”

Episode #119: Tom Dorsey, Dorsey, Wright & Associates, “Fundamentals Answer the First Question ‘What Should I Buy?’ The Technical Side Answers the Question ‘When?’”


Guest: Tom Dorsey co-founded Dorsey, Wright & Associates in 1987 and joined Nasdaq Global Information Services with Nasdaq’s acquisition of his company in 2015. Tom is the author of Point & Figure Charting: The Essential Application for Forecasting and Tracking Market Prices, Thriving as a Broker in the 21st Century and Tom Dorsey’s Trading Tips: A Playbook for Stock Market Success.

Date Recorded: 8/14/18     |     Run-Time: 51:56

Summary: Meb begins by asking about a book which Tom claims had a tremendous influence on his entire life. From this, Tom tells us the story of being a young broker, eventually introduced to a book called The Three Point Reversal Method of Point & Figure Stock Market Trading by A.W. Cohen. After reading just the first paragraph, the clouds on Wall Street parted and he saw clearly. In the end, it’s the irrefutable laws of supply and demand that cause prices to change.

Meb asks for more details, so Tom tells us how Point & Figure charting was created in the early 1900s. You’re watching the up and down movements of an asset – those movements represented by Xs and Os. You’re looking for patterns in these up and down movements. Meb asks how one goes from charting these Xs and Os into building an actual strategy. Tom gives us an example using just two stocks, Coke and Pepsi. He walks us through how we would analyze the price movements relative to one another to determine which one might be the best investment at that moment. It’s a discussion of relative strength investing.

Meb asks if this approach means an investor can totally ignore fundamentals and value. Tom tells us that fundamentals answer the first question – what should I buy? But relative strength answers the question, when should I buy? You can be a value investor, but you may not want to be the typical value investor who buys a value play, sits back, and waits for a long time before other people see that he’s right. Tom would rather get the stocks that are ready to move now. So, he tells us to take the fundamentals and work from there.

Next, the guys get into a discussion that bounces around a bit: smart indexing… the beginnings of ETFs at the Philadelphia Stock Exchange (Tom was in the middle of it from basically the beginning)… and how 92% of active managers never outperform the S&P. But this last point dovetails into a broader conversation of whether “the S&P” can beat “the S&P”. The topic touches on the difference between cap and equal weighting, as well as myriad other indexes that might exist within the broader S&P universe. One of the takeaways is that index investing can be harder than you might think. He suggests looking at all the indexes, then using relative strength to narrow it down.

Meb asks what the world looks like to Tom today. What areas are showing the most strength? Tom tells us the strength has been in small caps for a few years now. Value has been hurt, which points toward the problem with value – the asset can be down and out, but still not move north as you want it to.

There’s plenty more: the various ways to implement a relative strength strategy… Tom’s affinity for selling covered calls… the benefits of automated investing… how Tom’s team is beginning to apply their strategies to crypto… and an upcoming investing forum Tom will be a part of consisting of five market veterans with a collective two-hundred years of market experience.

Comments or suggestions? Email us Feedback@TheMebFaberShow.com or call us to leave a voicemail at 323 834 9159

Interested in sponsoring an episode? Email Jeff at jr@cambriainvestments.com

Links from the Episode:

Transcript of Episode 119:

Welcome Message: Welcome to “The Meb Faber Show,” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.

Disclaimer: Meb Faber is the cofounder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.

Meb: Welcome, podcast listeners. It’s getting down to the end of summer, but today, we have a fantastic show for you. Our guest launched his investment advisory service back in the 1980s and just sold it a few years ago to NASDAQ. He’s an author, he’s written books. On top of that, he’s been a regular guest on TV. He has something like 600 podcasts, OG podcast host. Frequently speaks to audiences worldwide on topics related to stock market, technical analysis, relative strength and momentum investing. We’re excited he’s joining us today. Welcome to the show, Tom Dorsey.

Tom: Well, thank you so much. It’s a pleasure to be here.

Meb: So Tom, you’re in Richmond, Virginia. I feel a little sorry for you, because I remember the summers on the East Coast were hot and sweaty and gross. And so, I’m here in the AC in Los Angeles. But I want to talk about a lot today, but I thought we would take it back–kind of like the Allman Brothers, back where it all began–go back to some of your origins. And as you started your career, I thought it was really interesting, because in a number of your interviews and publications, you’ve said before that almost all of it dates back to you reading a book. Could you give us a little insight into what this book was and how it changed your trajectory forever?

Tom: Well, the interesting thing about that is the way life is. You think back a number of years, different roads that you came across, did you take them, did you not take them? Another road you may have taken would…you know, maybe you’d own a restaurant today. You never know. There are ships passing in the night all the time and this is one of those things. Such a low probability that happened, it dates back to when I was a stockbroker at Merrill Lynch back in the mid-1970s. Long story short, after my first year as a broker, I realized that I needed to be an expert at something in this business if I was going to succeed. And options were new.

They had debuted a couple years earlier, they were a new product for us as stockbrokers. That’s what we were called back then. We weren’t advisors, we were stockbrokers. And I chose options and I learned options on weekends with a legal pad and a pencil. And I’m leading up to where this all happened. Later, at the end of 1970s, [inaudible 00:03:12] Securities offered me an opportunity to come over to their company and develop and manage their first Options Strategy department. So I did that. Well, the first person that I hired…what’s the probability of this? The first person I hired brought with him a book written by A.W. Cohen in 1947 called “The Three Point Reversal Method of Point & Figure Stock Market Trading.”

And he said, “Tom, I’d like you to read this paperback. You’ll understand how I think, you’ll understand the operating system in my mind when I come to you with a stock or sector of the market.” And I said, “Fine, I’ll be happy to do that.” So I took the book to Virginia Beach that weekend, with my wife. And I remember laying in bed and opening it up and reading the first paragraph of the introduction, and my life profoundly changed. Meb, if you’ve ever had an epiphany in your life, you’ll know what I mean, because that second, I knew why I was here on Earth and what I had to do the rest of my life. And that was to teach this methodology to my brothers and sisters.

Now, here’s what happened. I hadn’t even learned it yet, but that first paragraph of the introduction brought me back to the most important course that I had in the university, was Econ 101. And I never once thought that that had anything to do with the stock market, because all we did was sell research. We sold fundamental research. If the research department had a ranked number one on it, then you went ahead and sold it, because that was supposed to be a good company and that was indicative of the stock that was likely to rise. Well, that wasn’t the case. And when I read that first paragraph, that brought me back to Econ 101 and in particular, the irrefutable law of supply and demand.

And I thought to myself, “By God, I have arrived.” If there’s a Holy Grail of investing, this was it, because in the end, no matter how you look at it, it’s the irrefutable law of supply and demand that causes all price change. If there are more buyers than sellers willing to sell, price must rise. If there are more sellers than buyers willing to buy, price must decline. If buying and selling is equal, price must remain the same. There’s nothing else. You can send that to MIT and have it macerated put a square root over the top of it, but that’s the end of it, the irrefutable law of supply and demand.

And all of a sudden that night, the clouds on Wall Street cleared, I understood Wall Street for exactly what it was. I understood also, all my friends and all the people I work with did not have this piece of the equation that they used in their investment process. And I knew that I had to embark and spend my life doing it and I’ve done exactly that, Meb, since that night. That’s exactly what I have done since then and that led to Dorsey, Wright & Associates.

Meb: So you famously have talked about educating seventh-graders on some of the processes involved and you said that they could understand in about 30 minutes to an hour. Maybe walk us through…I think a lot of our listeners may not be so familiar with…they’ve probably heard “momentum” before, or trend-following, or… Why don’t you tell us a little bit about relative strengths/point and figure charting? What does this mean? Give us the overview.

Tom: Well, point and figure charting was created in the early 1900s. Charles Dow created this methodology in the late 1800s and it was called figuring back then. And what he did is, as a stock rose in price–let’s say from $30 to $35–he would write in the text on chart paper. He would write it in a box, “$30,” “$31,” “$32,” “$33,” “$34,” “$35.” And then, when the stock pulled back…because they go and down. They move up, they pull back, they move up, they pull back. When it would pull back, he would shift columns and reverse the order. So at $35, let’s say the stock fell back to $31, he would shift columns and then write, “$34,” “$33,” “$32,” “$31” and so forth. As the stock rose again, he would shift columns and write the figures or the price of the stock in the box.

Well, early 1900s, they looked at this and said, “You know, it’s a little difficult to see the up and down parts of this chart. Let’s make X’s represent the stock rising, let’s make O’s represent the stock declining.” And it hasn’t changed one iota to this day and all it is is a compilation of X’s and O’s. As the stock rises in price, you put X’s in the chart. When the stock stops rises in price and supply takes over and starts moving downward, you change columns and write O’s. Well, what happened was, Charles Dow realized there were some patterns that had a tendency to repeat themselves.

So when you think about physics, things in motion tend to stay in motion until acted upon by an opposite force. Plain and simple, basic physics. Well, what happens with stocks? Stocks are in motion, when demand is in control, stocks stay in motion. Stocks rise in price until, at some point, supply begins to take over where they’re acted upon by an opposite force. So supply begins to come in, it overtakes the demand level and the stock begins to fall back in price. So what point and figure is, simply a logical, organized way of recording this imbalance between supply and demand, nothing else. Nothing more, nothing less.

That’s why the kids that I…at Gates Elementary School here in Richmond learned it in 40 minutes. They could pick out good and bad charts in 40 minutes. That’s all it took, seventh-graders. That’s how simple this is. When you think about relative strength, that’s something that we knew was very important early on. Now, back in the early days, we used to take chart crafts books and we would get monthly books, hundreds of thousands of stocks in there. And the second you got the book, it was outdated, so you had to update the charts by hand. Relative strength charts, we were able to do maybe 200 in a week, because the way you do a relative strength chart is divide one thing by another.

So if I want to compare the price of Coca-Cola to the price of Pepsi-Cola, Coca-Cola is the numerator, Pepsi-Cola’s the denominator, or reverse those if you wish. But let’s leave it at Coke-Pepsi. And you draw that little horizontal line and you put a dot over the top and you put a dot underneath at the line. And any fourth-grader would say that’s division. So I’m going to take the price of Pepsi and I’m going to divide it into the price of Coke and that yields a number. So let’s say Coke was at $100 and Pepsi was at $50, Pepsi goes into Coke two times, that number is two. We would then just add another zero to it to make it easier to chart and that’s how you get your relative strength chart.

So the X’s and O’s, then, represent that relative change, not the price of the stock. The chart looks the exact same, but it’s long-tem in nature, signals can last two to two and a half years. So relative strength for us was extremely important and we could do, by hand, maybe 200 in a week. Today, we do 15 million overnight. We compare everything in the world, from Indonesia to Malaysia to IBM to everything you can think of.

Meb: You know, it’s funny… And one of the things I love about you finding this book, Warren Buffet talks a lot about value investing, which is totally separate, but where you’re either inoculated or you’re not. And hearing you talk about this, I’ve always been a momentum and trend guy. But it’s funny, because the academics in my world, I read all these academic papers and they talk about momentum and relative strength and they always reference an academic paper by [inaudible 00:10:51] and Tedman, as if that was the first time people ever talked about momentum. And I always laugh, because there was books by Levy on relative strength investing in the 1960s…

Tom: One of the greatest.

Meb: …and you’re talking about stuff in 1900. But all the academics acted like this literally just got invented in 1990 or something and as if you’re not a historian. And the same thing for value investing, a lot of stuff’s been around forever. So talk to me a little bit about…all right, so I think people understand the theory. And I’ve loved your references, I’ve stolen them, where you talk about relative strength either being arm wrestling or a race car. And I think those were really good examples. But tell me how you go from the X’s and O’s to actually implementing that into concepts. Maybe give me an example of how you may build either a portfolio or a strategy that would be based…and you could even take us back to the early days at Dorsey, Wright. How did you guys start to implement some of these ideas?

Tom: Well, here’s the way we do it. Take, for instance, if there were only two stocks in your life, Meb, and you were only allowed to buy one of those stocks at any given time. And let’s say it’s Pepsi and Coke. First thing I would put you through is the Pepsi challenge. I will want to blindfold you and see if you can tell which one was Pepsi and which one was Coke.

Meb: I can tell, I love Coke. I’m a believer. I hate Pepsi.

Tom: Everybody says that. And I say that, too. And I was at the Jefferson Hotel one night and I ordered a Coca-Cola. And she brought the Coke and told the lady…I said, “This is Pepsi.” And she said, “No, we only buy Coke products.” So I failed the Pepsi test. And I think most people think they can tell the difference, but when you get the two together and they’re unmarked, very difficult. But let’s go one step further and say in this Pepsi and Coke example, I want to look at the fundamentals, well, because value investors say, “Hey, the fundamentals should be strong.” And if I went to Merrill Lynch and I looked at the fundamental report of Coke, it’s probably a rank number one. And if I went to–let’s say–Wells Fargo and I said, “Let’s look…give me your take on Pepsi-Cola,” probably ranked number one.

Two great companies in America, these represent America. So which one do you buy? Who knows? Either one. Both are fundamentally sound. Well, then, we need to take this one step further. If I wanted a long-term play here, I’m going to create a relative strength chart. And I’m going to do it…the computer will do it automatically in one second. But I’m going to divide the price of Coke by the price of Pepsi, I get a number and then, I put that on the point and figure chart. If it’s in a sell signal, i.e., a column of O’s exceeding a previous column of O’s, it’s saying, “Own the denominator.” If it’s in a column of X’s on a buy signal where a column of X’s exceeds a previous column of X’s, it’s saying, “Own the numerator.”

So I’m going to go with that. I have two fundamentally sound companies, I’m now going to look at the relative strength chart on it. The relative strength chart on it is on a sell signal saying, “Own Pepsi,” and that would have been the case for the last three or four years, to own Pepsi. The returns on that were significant. You definitely would have wanted to own Pepsi over Coca-Cola. Now, that will change at some point. Recently, that relative strength chart has reversed into a column of X’s, suggesting that at least short-term, you should own Coke now over Pepsi.

So that’s how we begin with that. If I’m looking at two things, then you might say, “Hey, I’m also interested in the whole beverage sector, not just Pepsi and Coke.” Well, then, that’s fine. There are 70 different stocks in the beverage sector and we would have to do that arm-wrestling contest, i.e., create a relative strength chart, one versus every other one. So I’m going to create 1,400 relative strength charts. And by looking at that, I can automatically see who has the most buy signals, who has the most sell signals. And in that beverage sector, I can look at the top five or the top 10, top 20. I can see them right there after doing that basic children’s arithmetic. So I go through the sector like that.

Then a person might say, “You know what? I’m interested in the U.S. market, everything that trades in America.” We can punch a button and the relative strength chart will come up with a list of the best relative strength there. So that’s how we do it. It took us to get on the Internet before we could actually do a lot of charts. I mean, we started with a Tandy 3000 back in 1987. I think that’s in the Smithsonian Institute now, it doesn’t run anything. And now, we’re state-of-the-art, so we can compare and contrast anything and it automatically happens overnight. So on our system, if you pulled up IBM and you said, “Well, I’d like to see the whole sector’s relative strength. Show me a matrix of them all,” you just press a button and it happens automatically.

Meb: I love it. So as you developed Dorsey over the years, I think you famously said that you and your wife would…in the very beginning days, would be happy…your goal was to get to $10,000 in your retirement account. And then, you grew Dorsey to a manager with many employees, all sorts of indexes and funds that Dorsey ideas have been based of that are multi-billion dollars now. Talk to me a little bit about…I know there’s some questions that listeners would immediately pop into their head.

And the first one that I always get and I would love to hear your perspective of, “Okay, Tom, I get it, this makes sense. Are you going to tell me that you’re totally going to ignore fundamentals? Where does valuation come into play? How does all this impact?” So I’d love to hear your response.

Tom: No, I think that’s beautiful, because fundamentals answer the first question, “What should I buy?” That answers “What?” The technical side answers the question, “When?” So as Warren Buffet is a value investor, fantastic. “Mr. Buffet, please give me a list of all the value stock that you think are of value. And I’ll put them in our relative strength matrix and I’ll pick out the ones that are ready to move now.” So I can be a value investor, but the last thing I’m going to do is be the typical value investor, where I buy a stock that’s of value, it fits in with that definition and I sit back and wait for other people to see that I’m right. And that might be five or ten years from now.

I would rather take the list and find out those stocks that are ready and where demand is beginning to control them now. Again, stocks in motion or things in motion will tend to be in motion until acted upon by an opposite force. Stocks going down that are value stock, they’re fundamentally sound but they’re going down in price, eventually, something will happen if they stay in business where demand will take control. Well, if I’m watching that…and Yogi Berra once said this. He said, “You can observe a lot just by watching.” If you keep watching and you set your systems today to watch for you, then you’ll see these value stocks begin to change.

So I can take any list of anything–from Indonesia to Malaysia to Malta to France, it doesn’t make any difference to me–you give me the list of the greatest things that you think might spread, I’ll put them into a matrix and we’ll find out which ones are the best. So that’s the way you want to do it, is take the fundamentals and then work from there.

Meb: And so, as you guys started developing ideas and growing the company and as ETFs came on the scene, maybe start to walk us through a couple of your concepts behind some of what I think you call smart indexing. And so, whether…your thoughts about applying these ideas to the portfolios. So for a really long time, y’all’s wheelhouse was educating advisors and providing tools for advisors. But now, you also have the ability to say, “Hey, we’ll partner with the various firms like First Trust or NASDAQ, etc.,” where you’ll say, “We can launch products actually, based on these.” So maybe walk us through some of the ideas and/or the evolution of Dorsey’s business, as well.

Tom: When we talk about exchange-traded funds, Meb, we’re the first ones to be involved in it. The Philadelphia Stock Exchange and one Joseph Rizzello put together the first exchange-traded fund that was called the CIP, the cash index participation unit. And what it was, it was on the Dow-Jones industrial average and Standard & Poor’s 500. This was the first time that we could actually buy an index, make a trade on an index itself. And I travelled with the Philadelphia Stock Exchange to untold number of venues and this was so well-received it was unbelievable.

They ended up losing it to the Chicago Futures Exchange, because what Philadelphia did is, they backed this ETF with futures contracts, Dow futures and S&P futures. So the Futures Exchange won in court and took that product. It actually traded on the Philadelphia Exchange under symbol “BIG” for Dow-Jones and “S&P” for Standard & Poor’s. Well, that was the beginning of the exchange-traded fund and we were there from the beginning. Once the funds began to really gain some strength, that was when Barclays Bank came in with the iShares, put money behind it. Another bank–I think it was State Street Bank–put a lot of money behind it. That’s when it had the staying power.

And with the exchange-traded funds, that put Dorsey, Wright & Associates right in the middle, right at the beginning. iShares came to us and we rolled out the iShares product throughout the United States. Here’s my point, is that we were very early in the exchange-traded funds world. And that was a natural for us, to come out with exchange-traded funds, because we were already well-versed in it. Our first one that we came out with was the Dorsey Wright technical leaders and again, we used relative strength. And all we did was…if you could do this by hand…is take 1000 stocks and out of those 1000, pick the 100 that have the best relative strength. And then, we over-weighted some of the top ones, a very minute amount. And that’s it, plain and simple. Every quarter, we do the same thing.

The interesting thing that you can do with relative strength and momentum, too, that many people listening here with 401Ks is, when you talk about momentum…and I’m going to get back on track in a second…is, if you look at your 401K each quarter and you rank them… Because in your 401Ks, they give you a certain number of funds that they allow you to have. Rank them as to performance, best performance and last performance, take the top five performance and carry them forward to the next quarter. That’s momentum and you’ll see that you’ll probably outperform. It’s the same kind of concept that we’re doing here, except we use relative strength.

Once a quarter, we’re going to re-evaluate the positions, put the best 100 in that PDP and we go forward to the next quarter. And ETFs are totally transparent, so you can see everything that we have in there, there’s no sleight of hand, nothing that you can’t see. It’s all right there. So we have come out with numerous ETFs, all kinds of things that could be mixed and matched and put into a portfolio. So let me let you get me back on track again. I don’t want to go too far down on you.

Meb: No, that’s good, because a lot of people, they get so confused with this topic: active versus passive and indexing and smart beta and all these topics. And these probably fall under what category? How would you describe these?

Tom: Well, smart beta is what they attach the name to and I don’t know anything smart about any of this stuff. It’s all mathematical, computational, physics, basic…just basic types of things, but they call it smart beta. But you know, what’s interesting is, you mentioned, Meb, that people are beginning to do…get indexing. One of the things that we do is smart indexing. And you can read any number of articles today where it shows you statistically that 92% of active managers never outperform the S&P 500. And that’s the S&P 500 cap weight. And an investor might sit back and say, “Wait a minute. So what you’re saying then, is if I want to be in the top eight percent of all investors, I just buy the index?” And the answer’s yes, absolutely.

However, if the index goes down by 20% next year and you have outperformed it by one percent, you still lost in your portfolio. You were down 19%. So there’s more to indexing than you might think. And the first question I would ask a person is, do they think that the S&P 500 can outperform the S&P 500? And that might be a question they think, “Well, that’s a trick question. Can the S&P 500 outperform the S&P 500?” And the answer’s absolutely, yes. There are two different S&P 500s. One is capitalization-weighted, which is like Congress.

The largest states have the most congressmen–California, for one–against Rhode Island, which is a small state, has few congressmen. So there is more voice in California than there is in Rhode Island. However, we have the Senate too, which is equal weight. Every state gets two senators. Well, we have an S&P 500, the exact same 500 stocks that are equal weighted. So the smallest stock in the S&P 500 has just as much voice as the largest. Well, if you look back to the year 2000 and if I were to ask you, “What do you think the performance was of the Standard & Poor’s 500 for the last 18 years?” This is the S&P 500. Dividends aren’t reinvested, it’s just price. It’s up 92% since 1999, December 31st.

But if I say, “What’s the equal-weighted S&P,” the same 500 stocks that are like the Senate is up 268%. Which one of those would you have preferred to select in your indexing process? So indexing’s not so easy. And if you look at that and you said, “Well, are there indexes that I could consider?” Yes. As a matter of fact, there is. In that same S&P complex, there’s the Standard & Poor’s 600, which is considered small cap. But these are billion-dollar companies–they’re not little companies, these are big companies–up 433% during the same period. If I look at the mid-cap stocks that are bigger than the small cap but smaller than the Standard & Poor’s 500 like IBM and Exxon, that’s up 346%.

So if you look at it like that, then my next question would be, “Which index would you prefer to own?” I mean, you want to be involved in indexing, but there’s a lot of different indexes out there. And with these types of returns, I haven’t even gone to a sector, I haven’t picked the stock, none of those types of things. So if Mr. Jones is looking at indexing and there are a number of different indexes that he could select, there’s even the Standard & Poor’s 500 growth, Standard & Poor’s 500 value. There’s the mid-cap value, mi-cap growth, small cap value, small cap growth. I mean, there’s all kinds of indexes within the S&P world that he could select some.

So it’s not so easy. You really would need an advisor who was well-versed in being able to search these out. So what we do is, we simply take all of the items that you can find, the different type of Standard & Poor’s or NASDAQ type–because many exchanges have their own versions of the S&P 500–and put those together, put the QQQs in, which is the NASDAQ index and you’ve got a heck of a program there. Put it into a matrix and look at the relative strength and you calculate relative strength the same way we talked about before. And here, you’d have…might have 11, 12, 13 different items. And you’d want to take the top five and then, once every six months, look back, because this is long-term. This is not overnight types of things.

So indexing can be a very interesting way to invest–what I call smart indexing–by taking all of the indexes that are available to you and then, using relative strength to determine which ones you’re going to be investing in. It’s pretty simple, straightforward.

Meb: And do you guys think…? I’m sure there are some investors and advisors listening to this who say, “Okay, I get this. This works with stocks, this works with sectors and styles.” Does this apply also to multi-assets? So could I put together a portfolio of, say, U.S. stocks and gold and bonds and commodities and foreign stocks? Do you think it works cross-asset, as well?

Tom: Absolutely. Absolutely, because I did that, Meb. I did a portfolio or a model and I call it “One-Stop Shop.” In other words, I put all those things together, just like you mentioned. Just like you mentioned, you’ve got the gold in there, you’ve got the merging market, low-volatility, high-volatility, you’ve got developed markets, all those together–the types of things that you would want–and it just stays there. Once a year, you rebalance it, some things may have done really well and you bring things back to normal once a year. And that’s it, there’s no changes. So, yes. To answer your question, you’re dead right, Meb. You can do that.

Meb: And so, one of the things that I would surprise a lot of listeners is, a lot of these models are actually not all that high-frequency trading. I mean, some of these, I think you’ve mentioned they don’t have a whole lot of signals, which for most people, is a good thing. And so, what’s the world look like to you today? Any areas in particular, as we look around the landscape, that show the most strength?

Tom: Well, I’ll tell you what. When you look at the market itself and you say, “Where’s the strength,” the strength’s been in small caps. And that’s been for a few years now. In fact, if you even look at the numbers I just gave you and you go back 18 years and you look at the SML–which is your small caps, Standard & Poor’s 600 small cap–it’s up the most in the last 18 years. So small cap really has been the play over that long period of time. Have there been times in between there where periodically, you should be long…the larger cap or the mid-cap? Yes, there are periods there.

But as far as not trading is concerned and saying, “What’s the long-term picture,” small caps have been it, mid-caps have been next. And growth over the last few years, growth has been the play, not value. You have been penalized if you’re a value player over the last few years. And that’s the problem with value. You can be a value layer and you’ve got value stocks and they look great, they’re fundamentally sound, they’re down and out, but they don’t move. They don’t move relative. But there’ll be a time when value comes in. As a matter of fact, if you go back to the year 2000–in fact, it was October of the year 2000–we saw something amazing take place when we looked at our relative strength charts.

All of a sudden, after years of being the place to be, large cap gave way to small cap. This is October of 2000. I remember this distinctly, we wrote it up in our report. Value became the play over growth. Growth was the play for years before that, October of year 2000, the play went to value and equal weight from cap weight. It had been capitalization-weighted, i.e., Congress to equal-weight Senate. So all you and to do at that point in time in 2000–October 2000–is buy a fund that was equal-weighted value and small cap and do nothing for the next 13 years and you out-performed. So these things will change periodically, but they’re long-term in nature. And to answer your question, small cap is still the play and has been for 18 years.

Meb: So let’s say you’ve been chatting with advisors for decades now and this podcast has a lot of institutional and professional investors, what is your message to them? And even individuals as well, they probably said, “Look, okay, I get it. I understand it now, I believe this message you’re preaching.” How do most people put it into practice? Do some people just go full, all-in, cannonball into the pool, “I’m going to go relative strength on everything?” Do most people say, “You know what? I’m going to have my core buy-and-hold and then, I’m going to do the satellite relative strength?” What’s the advice that…? What do most people…? How do they apply all the various Dorsey Wright approaches?

Tom: Well, just like you just mentioned, Meb, there’s all kinds of different ways to go about doing it. One of the things is, I am a covered writer and…in other words, I buy stock and sell calls. One-third of my net worth is in covered writing and it’s in covered writing because it’s the right strategy 68% of the time. When you think about a normal distribution, anything you’re evaluating–if it’s men’s heights, women’s blood pressures, whatever it is–it’s going to fall…68% will fall within one standard deviation above or below trend.

Therefore, what it’s saying is, most things in the market are middle-end. They go up, they come back, they go down, they come up, but they hang around the centre. Therefore, covered writing is the right strategy 68% of the time, that’s why I do it with one third of my portfolio. But what stocks do I use? They go through the filter of relative strength, as do their sectors go through the filter of relative strength. We want favoured sectors, we want stocks in there that are also favoured on a relative strength basis. So I want to put my ducks in a row for stocks that I feel are going to rise in price, all understanding that 68% of the time, they don’t, they hang around the middle.

So covered writing is a way of doing that, but you’re using these relative strength matrixes and whatnot to determine what your inventory’s going to be with that. Others do just like you said, take a core position, “Here are the core stocks that I own, they’re fundamentally sound. I want to own these in the portfolio and will trade around those.” There’s so many different ways of doing it, but the end result has to be the irrefutable law of supply and demand. Somehow, that has to be worked in there. Let’s say you took a funnel and you stuffed that funnel full of all the research on Wall Street, all the talking heads on television. And you stuffed it down that and all fundamental work and you get down to the tip of the funnel. That’s price.

That’s where price changes. You can take all the fundamental work and stuff it in there, but price has to change at the tip. So why not go directly to the tip? And that’s what I have done and that’s what the real smart people, 100 and some years ago, have done, which would be Charles Dow in the late 1800s and others along the way, from A.W. Cohen to all kinds of different people. Nothing’s new under the sun, they pretty much created it themselves back then.

Meb: We should just have…you launched the Tom ETF, which is the covered call writing version of the Dorsey Wright strategies. That’ll be next up in the queue. That way, you don’t have to trade it on your own.

Tom: Well, that’s where we are today, Meb. Where we are today is electronics, is it actually can run a program. You should be able to run a billion-dollar portfolio from a cruise ship with an iPhone, plain and simple.

Meb: Yeah, that’s true.

Tom: Because the systems will automatically do it. When we put together a model–let’s say it’s a smart indexing model–I don’t have to do anything until the system emails me and says, “Tom, small cap growth has been replaced by small cap value,” let’s say. Okay, when I go into the portfolio, I make those changes. But the system automatically told me. What would be one step further is, the system should automatically do that. When a change takes place, it will do it.

Meb: I was just going to say, from someone who’s implemented automated investing personally and for clients as well, I don’t know why anyone would ever go back to the shooting from the hip, just discretionarily running a portfolio. It seems like such a nightmare.

Tom: It really is. But the thing about it, when you think in terms of electronics and technology running a portfolio, I don’t mean that it’s AI, artificial intelligence that’s become brilliant and is going to run the portfolio and decide what to do. We saw that with…who was it that had the Russian bonds collapse on them?

Meb: Long Term Capital Management.

Tom: Yeah, Long T, exactly. We’ve seen that type of thing happen before. What this is saying…what we’re saying is, take what we would do by hand and that hasn’t changed in 30 years. What we do every year, you could do by hand. And we did do it by hand. We used to update 2500 charts a day by hand. All we do now is let the computer do it. The computer just brings the speed. To do what we do that we would have done by hand, the computer does it.

So if we would have said, “By hand, take out the Standard & Poor’s growth and put it in the Standard & Poor’s value,” that would automatically happen by the computer. That’s something that we would have set ourselves by hand, the computer just does it automatically. That’s where we are today. So it doesn’t have to be AI. It can be the same things that we would do automatically ourselves by hand and just tell the computer to do it. It’s just like telling the computer now…let’s say I had a portfolio of stocks and I took every one of those portfolios and I set an alert.

And I told the computer, “I want you to alert me if this stock gives a sell signal on this point on the figure chart. I want you to alert me if this stocks even reverses down into a column of O’s on its point figure chart. I want you to alert me if this stock goes below the price of $51. I want you to alert me if the relative strength turns negative versus its sector.” And you can put all those in there and the system will notify you. So you don’t have to watch it, you can go about your business. You can take your son and daughter to the soccer practice and play golf and do what you have to do and let the computer watch your system. You told the computer what to do. You’re not just sitting back, letting the computer just figure it out themselves.

Meb: Interesting. You know, it’s funny, I know you guys have an offering on Folio as well, which is funny to hear about a lot of these automated services in Folio. Man, they’ve probably been around since the 90s at this point, one of the first automated platforms, brokerage platforms. Is that something you guys see a lot of adoption there, as well, people running models on Folio?

Tom: Yeah, Meb. As a matter of fact, I have. I’ve been with Folio for probably 16 years and they don’t do options. So at Folio Investments, that’s where I do my modelling. So it remains relatively–let’s say–stable, where at Charles Schwab, I have to watch it every day. I look at my options, I look at the deltas and the changes and the different things. I enjoy that, it keeps me sharp. Over on Folio is where I put a model and the model’s going to run itself. And I’ll be notified when there’s a change in that model and then, I go make the change.

So I may go months at a time with models that are in my portfolio, but I do nothing with. But that’s the beauty of Folio, of…well, it used to be called Folio FM…Folio Investments, is, you can have things broken up into pieces in the portfolio. Rather than most brokerages where you have to put it all together–mishmash, put everything together–here, you have it broken up into pieces and you can see each model itself and how it’s trading. It’s beautiful. It’s absolutely beautiful.

Meb: Talk to me real quick about the behavioural challenges of relative strength investing. We often say that the challenge for a lot of people that do buy-and-hold is the big bear markets, where they’re just not doing anything and they watch 10%, 20%, 40%, 50-plus percent of their money go away. Are there some unique challenges to relative strength investing and doing the approaches?

Tom: Yeah, Meb. That is a difficult thing and that’s something that we all are guilty of, let’s say, because it’s human nature. It’s fear and greed. If I have a $10-million portfolio, let’s say, and that’s what I have accumulated all of my life and I’m looking at retirement five years down the road and I go through a 2008…and I’ve been told, “Don’t worry, be happy, because we’re diversified.” And 2008, everything went down together, nothing was diversified. The margin clerk sold everything and you found yourself down 40% in your portfolio. That’s $4 million gone from your $10 million. That’s going to change the way you look at things.

That’s why, in our exchange trader funds now, we’ve taken it one step further. Take, for instance, our First Trust 5. The “FV” is the symbol. That went to $5 billion. Now, we had $5 billion in that ETF. We now have gone to FVC. The “C” means cash. Well, when you think in terms of a matrix…and we’re going to do that relative strength calculation arm-wrestling contest with X numbers of sectors in the First Trust Five. They’ve already been…the sectors have been selected by First Trust in their AlphaDEX way of looking at fundamentals. And we put cash in there.

Now, to us, cash is the symbol “MNY MKT,” “money market.” “MNY MKT” is a symbol to us just like IBM, Coca-Cola, Pepsi, anything. And we put that in the mix. So if MNY MKT, which is “money market,” begins to rise in that portfolio, once it gets to a certain point within the rules, portfolio begins to go to cash. So it automatically happens. So this is the kind of thing that I think investors are going to want to look at. We’re now coming out with our ETFs that we have with cash in them, so that it can automatically begin to be defensive when it needs to be.

Meb: Yeah, I think when you have that sort of 2008/2009 environment, which is sort of a deflationary bear market where everything’s going down, really except for bonds and cash, that’s a really useful feature that I think is pretty important. Talk to me a little bit about…you’ve been in the business 20, 30, 40 years.

Tom: Forty-five years.

Meb: Forty-five years? My goodness. And you’re still at it. What’s gotten you excited? What are you guys…? Y’all have…some of my favourite people in the world are at Dorsey Wright on the research side. What are you guys working on these days? Anything in particular that’s got you excited? Maybe you guys have started publishing relative strength on the cryptocurrencies. Well, what’s in the labs over there?

Tom: Well, in the laboratory–you’re right–is crypto. We began to make a move into crypto. We have programmers here and one in particular that I think is the premier in crypto, it’s a natural. We’re putting the charts in the system right now–we’re getting all the charts up–and we’re going to become experts in crypto, as best you can in that area. If you ask me today, “What’s crypto and what coin should I be in,” and I couldn’t tell you. But once we have the charts in, that’s where we’re going to be able to watch and see which ones are doing well and which ones aren’t.

And this is going to be a work in progress, because crypto reminds me of back in the 70s, when I first began to become well-versed in options. Options was so brand-new in the 1970s, none of us knew anything about them. There were no books written on the subject and options were like crypto now, we had to learn them and we had to learn them by hand. Now, options are so mainstream, if you just go to tastytrade.com, you can learn everything you want to know about options. And that’s on YouTube. So crypto is the same way. You’re beginning to get crypto management companies, crypto advisory companies and I think the subject is here to stay, no question about it. So we’re going to become experts at it, in what we do.

Meb: You know, it’s funny because…is there…? I can’t think of an area that would be more uniquely suited to relative strength than currencies that have literally no fundamentals, it’s just driven by price. So there’s probably no better application for your relative strength algorithms than applying them to crypto. Sadly, though, year to date–and this week is a great example–there’s going to be a lot of relative strength to the downside. A lot of these things have been going straight down. But who knows? It’ll be fun to watch.

Tom: Yeah. It’s not for the faint of heart, Meb, I’ll tell you. And people that get into it, you want to put a small amount into it. And I mean a small amount, not something where you put $100,000, $200,000 into it, unless you’ve got $1 billion. But you want to put a small amount, get your feet wet. And better get your feet wet once we get our charts up and we’re able to begin doing some advising on it, but it’s a new frontier. It’s a new frontier, lots of risks and not unlike the option business back in the 70s. But now, the option business has become fully realized.

Meb: You know, it’s funny that we often say the same thing. I say, “Look, if you want to put a portion of the global market portfolio,” let’s call it $200 trillion, “that crypto represents, that means it’s 0.1%.” So if you’ve got $1 million, you’re allowed to put in $1000. And I have…

Tom: [Inaudible 00:44:34]

Meb: …no problem with that, if you want to reflect the global market portfolio. If you had $10 million, fine, you could put in $10,000. Other than that, I’m not really sure…really high net worth, it’s probably a little too risky. Put your glasses on to the future. All right, so we’ve talked about crypto, a little about automated. I mean, the world’s changing so fast. We essentially have many platforms now that have zero-fee commissions, like Robin Hood and others, Folio. You have others. We just got notice of our first market cap-weighted zero-fee fund. As you look out to the horizon of the future of investment management, of product development, anything in our world, is there anything that you are thinking about in general, or predict the way things are going to change? Or is it just more of the same? What’s on your brain?

Tom: Well, for us, we’re always trying to take that step forward to automation. And I don’t…again, I need to preface that. Is automation doing what we would do by hand, what we already do? It’s just that the computer allows us to do it faster and allows us to do it while we’re asleep and that type of thing. I’m a part owner of DIF Brokerage in Portugal, dif.pt, Papa Thomas. And that’s a white-label Saxo-bank. Well, I do all my developed market models at DIF. And the way we do them is, I’ll simply tell them…I’ll email them and say, “I want to own…” Let’s just take this out of the air. “I want to own France, I want to own Germany, I want to own Switzerland.

I want to own Sweden in Swedish coronas, I want to own London in British pounds, Switzerland in Swiss francs, Germany in euros, France in euros and buy my models.” Okay, so we’ll split up your money and we’ll buy those models. Now, the models automatically run them. They have access to our system here and our system then alerts them whenever there’s a change in a model. So the only thing that happens to me is, I get an email from them at DIF saying, “This took place. This particular stock fell too low on the matrix and was replaced by this one.” They automatically do it for me. Then they notify me, because we always have money market in their cash.

If cash overtakes the model…on that arm-wrestling contest, then cash wins. We only have two symbols, the model and cash. If cash wins, I automatically go to cash. That simple. But they notify me. So I could be on a cruise ship and my portfolios are automatically running. My international portfolios are running and I just simply get notified when a change takes place. Now, if you took the traders out or notify me and let a computer do it, then I’m totally automated. So that’s coming.

Meb: I love it. So as we think about…I think I saw you mention that you’re going to get together with our common friend, Ralph Acampora, potentially and some other of these old-school guys to talk markets. What are you guys going to be talking about? What’s the plans there?

Tom: Yeah, it’s going to be the Richmond Forum, here in Richmond. And there are five of us that we have over 200 years’ experience in the markets. Ralph Acampora is one, one of the great technicians. He’s considered the godfather of technical analysis, great friend of mine. He speaks at our broker institute, should be up here in November, myself, Tony Fadell [SP], who is the head of Federated Marketing & Distribution and development of the funds they have. Skip Morton, he actually runs my municipal bond portfolio. This is the guy. He’s my age, so he’s got some age to him, but he’s been around this business 45 years. He’s a specialist in bonds.

And also, Joseph Rizzello, who’s the past CEO of the National Stock Exchange. Joseph is the person who brought the first exchange-traded fund to market and Joseph is going to explain that, how they came about that process, how the first ETF came. The Philadelphia Stock Exchange is the one that brought that. Now it’s owned by…the NASDAQ has bought the Philly exchange. In fact, Joseph is the first person to bring foreign currency option trading to the Philadelphia Exchange. That was considered never being able to be done, he did that. But he’ll be able to talk about flash crash and what happens with the flash crashes and how the exchanges came about, changing the way they look at things. It’s going to be interesting. So it’ll be an evening of five of us giving you 200 years’ experience in the markets.

Meb: I love it. I love it. That’s awesome. Last question, we’ve kept you long enough. As you look back into all the thousands, probably tens of thousands, of trades you’ve made investments, is there one that stands out as the most memorable? It could be positive, it could be negative. Is there anything that just burns, seared in your memory as the most memorable investment or trade?

Tom: Boy, that’s a tough question, because you’ve brought me back now. All of a sudden, 45 years of business is running through my mind. I can think of one that is so memorable to me and it was important that this happened. It was Genentech. When Genentech first came public, I had a friend who was in desperate need of money. He and his family had fallen on difficult times. And Genentech was coming and I was able to get 10 shares of Genentech.

And I gave it to him and I said, “Somehow, I need you to come up with the cost of these 10 shares, because legally, you have to do that. You have to pay for it, but by the end of day, I’ll be selling these shares and sending you the difference.” And Genentech came and I can’t remember how much it went up, but went up significantly and I was able to significantly help this family who was in desperate need.

Meb: I love it. Genentech, one of the classic biotech success stories of the past handful of decades.

Tom: I’ll never forget that.

Meb: All right, that’s awesome. Tom, it’s been an absolute pleasure today. Where do people find more info? If they want to follow you, want to follow everything that Dorsey Wright does, what’s the best places?

Tom: Well, one place that you can get a lot of information is just go on YouTube or Google and type in “Tom Dorsey, Dorsey, Wright & Associates,” or just, “Dorsey, Wright & Associates” and you’ll see a lot of things. Otherwise, on our web page, we’re at www.dorseywright.com. We do a podcast every Wednesday that’s free to anyone, so I would alert anyone to listen to that podcast, because we give a lot of information in that. Podcast, we’re at number… We’re one of the oldest podcasters around. We’re about 666 podcasts, weekly podcasts. We’ve been doing this a long time. So tune in and listen to that, but anyone that wants to take a free trial of our service can do that. We’re pretty visible people. We hide in the open.

Meb: I love it. Tom Dorsey, thank you so much for taking the time today.

Tom: Meb, thank you very much, buddy.

Meb: Listeners, it’s been a blast. We’ll put all the show notes in mebfaber.com/podcast, links to Tom’s books, YouTube, podcasts, all sorts of good stuff, funds, everything else. Subscribe to the show on iTunes, Stitcher, Breaker–my new favourite–Overcast, anywhere podcasts are found. Thanks for listening, friends, and good investing.