Dan Shaffer has amassed more than $20 million in assets from high-net-worth clients despite an investment strategy that would send most people running for the hills: He buys only stocks that are at or near their 52-week highs. BusinessWeek's Tara Kalwarski asked Shaffer how his stock investment program (which he runs as separately managed accounts) managed to return an average 7.43% a year since inception, vs. the S&P 500's 1.11%.
Your strategy sounds crazy. How does it work?
The trend is our friend. The markets tell us where we want to go. We buy stocks at new highs to sell higher, and we sell at new lows to buy back lower, at a later time. We can be 100% in cash at any time. It depends on the Commitments of Traders (COT) reports, which are published by the government each Friday. (They can be found at cftc.gov.) The COT reports tell us whether commodities traders are on the long or short side of the market [whether traders expect the stock market to rise or fall], and they are our overriding indicator telling us how much exposure we should have. This strategy worked out well in a very bad environment.
How so?
In the early summer of 2000, the report indicated that traders were expecting the market to move 25% to 30% lower. I said, 'Uh oh, we're in trouble. There's gonna be a major sell-off.' By September, I implemented the strategy I'm using now and had taken my investors out of the market and into cash. [In the second half of 2000, Shaffer's method returned more than 25% while the S&P suffered nearly a 10% drop.]
Are you often all in cash?
We've been 100% cash all the way to 100% invested. In the past 12 months, we've been 100% cash twice, for two to four weeks at a time. When stocks are moving at $10 a pop, up or down, like they were this past August and December, that's too much for us. Most managers look to buy stocks based on value. We have found that buying stocks while they are coming down is extremely dangerous.
And when you're invested in equities?
We only buy and sell equities traded on U.S. exchanges. And two months ago, I added exchange-traded funds, through which we have currency and bond positions. But it's a lot more technical than just looking at the 52-week highs. We'll look for high relative strength to the overall market and mutual-fund ownership. We don't want to be the only ones who own the stock. And we want to make sure that the company is growing earnings. We look very carefully at the ratio of a stock's price to the previous 12 months' earnings. If a stock is making a new 52-week high and its valuation is trading below the Standard & Poor's 500-stock index, that's a positive attribute. When we've put all this—and more—together, there's been a high probability of success.
Do you pick many losers?
I would say that it's pretty much split 50-50. We have as many winners as we have losers. But our winners are bigger. Our biggest loss would be about a 50% decline in price. On the flip side, we've had stocks that more than doubled in value.
What looks good now?
Two stocks that look very attractive are Wal-Mart (WMT) and IBM, (IBM) both of which meet a lot of the criteria. [Shaffer stresses he is not giving a buy or sell recommendation on the stocks.] They've both recently hit new 52-week highs. Wal-Mart is currently trading at 18 times earnings, and IBM at 16 times vs. the S&P 500's 22.
What's your market outlook?
We're looking at a pattern right now that is very similar to the COT reports that we saw in 2000. Right now, our indicator is flashing a major signal in the Russell 2000. The traders are at their highest net short position since 2001. We believe that the Russell 2000 will lead the market lower. We are targeting a low of 1060 for the S&P 500 within the next two years. I have 18% in cash.