Market leadership change and momentum investing

Investopedia defines momentum investing as:

“Momentum investing is an investment strategy that aims to capitalize on the continuance of existing trends in the market. The momentum investor believes that large increases in the price of a security will be followed by additional gains and vice versa for declining values.”

One of the key pieces of data needed to implement a momentum strategy is knowing which sector is outpacing the pack. The good news is once leadership is established they often stay leaders for a fairly good stretch of time. For example, biotech and healthcare had been consistent leaders over the past several years. The bad news is momentum investing can be, shall we say, frustrating when there is a change in leadership.   It is a waiting game where unbiased data analysis is intensive but action is slow.  It is a period where the proverbial “head fake” is common and you have to count on being wrong some of the time which is often frustrating for investors that do not have a well thought out, written investment strategy.

Closely related to momentum investing is trend analysis. A trend is really nothing more than the general direction in which a security or market is headed. That direction can be one of three directions – up, down or sideways.  During a leadership change, trend lines for various sectors are often sideways  until one or more of the sectors break out of that trend and establish new leadership.

Momentum investing predictably goes through a period of underperformance during these changes in leadership or sideways trends.  However, over time, momentum strategies executed with discipline often outperform their buy-and-hold strategy counterparts during periods of growth as well as decline.

So where are we now? Although there are some promising signs for new leaders, by most definitions, we are still in a fairly sideways trend in the equities markets. We are watching for the next leaders to emerge and settle in, knowing there will be some “head fakes” along the way.

Read more: Momentum Investing Definition | Investopedia http://www.investopedia.com/terms/m/momentum_investing.asp#ixzz44D0N96CL
Read more: Technical Analysis: The Use Of Trend | Investopedia http://www.investopedia.com/university/technical/techanalysis3.asp#ixzz44D62NF7C
 

Easter

Easter is a time for gathering with family and friends. In our families it is usually a ham or lamb dinner. We all have different traditions for this holiday; one of the most common traditions is the decorating of eggs.

Historically, eggs have been thought of as symbolic of the sun, new life, and new birth. Because of this perception, they became a natural fit to be included in spring festivals of new growth and new beginnings. It’s uncertain where the tradition of decorating eggs began, but what is certain is that this tradition took a strong hold in Eastern European culture. This tradition led to the creation of the famed Fabergé eggs.

Peter Carl Fabergé, born in St. Petersburg, Russia in 1846, was named the goldsmith and jeweler to the Russian court in the 1880s. Czar Alexander III had him create an elaborate Easter egg for the Czarina Alexandra in 1885. The Czar made these eggs an Easter tradition throughout his reign, and that of his son and successor, Nicholas II. Fifty such imperial eggs were created before the fall of the house of Romanov in 1917. In 1918 Fabergé’s firm was closed by the Bolsheviks, causing him to flee to Switzerland, where he died in 1920. The Fabergé eggs are some of the most valuable pieces of art in the world.

The lesson we can learn from Czar Alexander is that he gave the best that he had to his friends and family. Our hope is that we are able to do the same with those who are closest to us. Please enjoy this spring season and especially this Easter holiday.

St. Patrick’s Day

In 1736, a young man named George Taylor emigrated from Ireland to Philadelphia.  With almost no money, Taylor had little choice but to indenture himself to an ironsmith in order to pay for his passage.  In those days, working as an indentured servant meant years of hard labor and little freedom, but it was a course thousands of Irish men and women were forced to take in order to live in the New World.

Forty years later, Taylor signed the Declaration of Independence.

There were 56 signers of the Declaration, but Taylor was one of only eight who had been born in a foreign land.  The fact that a poor Irish immigrant could rise to such a stage might seem incredible, but American history is filled with contributions made by Irish immigrants.

This month we celebrate St. Patrick’s Day.  As you probably know, St. Patrick’s Day can mean many things to many different people.  At its heart, the day is to honor the death of Saint Patrick, one of the most important figures in Irish history.  Children, of course, see it as a chance to wear green.  More recently, though, we’ve come to associate the holiday with a celebration of Irish culture in general.  To us, that’s a good thing—because Irish culture has had a profound influence on American culture, too!  For that reason, St. Patrick’s Day gives us the opportunity to acknowledge the contributions made by thousands of Irish Americans over the centuries.

Irish immigrants began settling in what would become the United States during the 17^th century.  By the time of the American Revolution, over 250,000 Irish people had settled here.  From the start, many of these brave men and women adopted the cause of Independence and went on to serve under George Washington during the Revolutionary War.  In fact, one British general stated that “half the Rebel Continental Army were from Ireland.”

The second great wave of Irish immigrants came during the 1840s during the Great Famine.  When a disease struck Ireland’s potato crop, a million people left the island to get away from the mass starvation taking place.  Thousands of them came to the United States, where they settled in cities such as Boston, New York, and Philadelphia.  When the Civil War broke out a decade later, many Irishmen formed their own units, such as the famous Irish Brigade, one of the most celebrated units in Army history.  Some historians estimate that more than 140,000 soldiers were from Ireland, while many thousands more were of Irish descent.

But Irish immigrants didn’t just distinguish themselves on the battlefield.  From religion to music, from law enforcement to literature, and from food and drink to sports, Irish culture has influenced many of the traditions, customs, symbols, and sayings we know so well today.

Perhaps the biggest influence the Irish have had on American history is in the halls of government.  Besides George Taylor, two other Declaration-signers were Irish, while five were sons of Irish immigrants.  Most significantly, President Andrew Jackson was born to Irish parents, and twenty one other presidents have had Irish blood in their veins.

So as you wear green, count the leaves on a clover, or take in your local parade this St. Patrick’s Day, remember that it’s not just the Emerald Isle we’re celebrating—but the link between those green shores and ours.

From all of us here at MinichMacGregor Wealth Management, we wish you a happy St. Patrick’s Day!

Siri®, is my route clear?

From our earlier articles, you know that tactical asset allocation involves having a well thought out system which allows you to change your mix of stocks bonds cash, etc. based on current market conditions. One of our data partners recently published an article which draws an interesting parallel between tactical asset allocation and taking a road trip. We think the analogy is amazingly close!

Here is an excerpt from their article:

We’ve all been on a road trip that starts out smooth sailing.  Maybe it’s a clear, sunny day. There’s no traffic, the gas tank is full, and you’re well-rested; so you flip cruise control on and you’re on your way.  Then, up ahead you begin to see more and more break lights illuminate as traffic slows and the road becomes more congested.  At this point, what do you do?  Leave your foot on the gas, and brace for impact? Of course not!  You adjust to avoid catastrophe and reevaluate.  If you cannot clearly identify the cause of the traffic ahead, how far it will last, or how long you will be delayed, you might even begin to search for alternate routes.  Perhaps the alternate route is on a slower speed road with traffic lights along the way.  Perhaps it adds an extra 30 minutes to your original travel time.  At that point, you have a decision to make. Will you do nothing, and hope the traffic clears without too long of a delay; or will you adapt, and take a clearer route knowing it might take a little longer than your original plan?  Each driver may have a slightly different answer here based on certain variables.  For instance, how much gas do you have?  When did you last eat? How many times will you have to hear, “are we there yet?”  Some drivers may choose to change their path immediately, some may be okay just waiting it out, and others may take the opportunity to pull off at an exit, stretch their legs, and grab a bite to eat.  

This example is analogous to the type of market we are in now.  We aren’t at a complete standstill, but we also can’t see up ahead to know if the worst is over or if there’s miles of traffic to come.  All we can do is take the information we have at hand and make the best decision possible.          

We all encounter “traffic jams” at some point.  How do we deal with them?  Do we find an alternate route or do we sit and wait it out?  In our investor analogy there is no question of what to do with a static allocation approach.  You wait and sit in traffic, no matter what.  Just sit.

However, as is the case in the market, there is typically a point at which most drivers get fed up with waiting.  When they have reached this point, they can’t take it anymore and in many cases a rash, emotional decision is made.  In an effort to deal with the traffic jam, they zig and zag or change their route, only to look back and see the original route is now clear.  They made the mistake of either waiting too long to make a decision or they made a uniformed decision. They didn’t have enough data or a calculated plan before they encountered the traffic.  Allowing “road rage”, or an emotional reaction to influence your decisions does not often end well. Most people only have to make this mistake a few times before they start to believe doing nothing is the only way – and they sit.

However, with some technology, a little planning and the right data, making a well thought out, non-emotional decision is possible. In traffic, iPhone users might say: “Hey Siri® – Is there a faster way to my destination?”

Though there is no magic “Siri®” for executing a tactical allocation strategy for your investments, the traffic analogy can be applied to how we handle the market’s volatility.  The cars are equities; the buses are bonds and the car carriers can be mutual funds.  If you have a plan in place to follow when things become uncertain, you will be better equipped to handle it than the person to the left that decides to blindly buy and hold and the person on the right that reacts based on emotion.  We all want to be the motorist…or investor…that makes good time…or money…and arrives safely at our destination.

Risk Management:

Tactical Asset Allocation and Sector Rotation

Risk management is a broad term used for any steps taken to protect a portfolio from loss. However, there are different types of loss and different risk management strategies for hedging against each.

Diversification

Diversification, better known as the “don’t put all your eggs in one basket” strategy, helps protect against absolute loss.  For instance, if you own two stocks equally and one of them goes out of business, then your portfolio takes a 50% hit.  If instead, you own 100 stocks equally and one of them goes out of business you would only take a 1% hit in your portfolio.  Mutual funds and ETF’s are a common way to manage the risk of absolute loss through diversification because by design they are comprised of many different securities for a specific investment objective. For example, assume you own an S&P 500 index fund.  In reality, you own a small portion of 500 different companies. If one of those companies were to go out of business and its stock price went to zero, the fund may go down in value but you would be protected from absolute loss.

However, simply diversifying your portfolio does not protect you against market losses. For example, owning an S&P 500 index fund does not protect you against the market for US large company stocks going down as a whole. That risk needs to be managed with different strategies.

Asset Allocation

We want to take the “don’t put all your eggs in one basket” diversification strategy one-step further. If large company US stocks as a class are down 25%, and you own that broad asset class investment, you can expect that asset class in your portfolio to be down around 25%. There is no inherent risk management being applied to this type of market risk simply by owning mutual funds or ETFs. To help offset some asset class risk, investors typically construct a portfolio where a certain percentage of their portfolio is represented by different broad asset classes like stocks, bonds, cash, real estate, etc. This helps manage the risk of having all of your money in one asset class.  If one class is down, it is less likely that all of the classes will be down – you are managing some risk.

Setting the appropriate allocation percentages is a challenge because the optimal allocation at any given time for your specific situation changes based on the current market conditions. For this reason, a static allocation strategy, which commonly is only reviewed on an annual basis, may not allow enough flexibility to effectively manage asset risk at the broad asset class level.

For example, assume you have a static allocation of 60% stocks and 40% bonds and you rebalanced your portfolio on January 1st. However, by the end of the first quarter, stocks were down 20% and bonds were up 5%. Intuitively it makes sense that a better allocation at that point might be 50% stocks and 50% bonds, but your allocation is static so you ride it out.  By the end of the third quarter, stocks are down 30% and bonds are up 10%.  Your original allocation of 60/40 now seems far off given the market conditions.

Tactical Asset Allocation

A tactical asset allocation strategy requires more frequent monitoring and a good bit of unbiased data, but puts in place a set of rules that help to change your allocation mix based on specific metrics in each asset class.  In the example above, during the first quarter it is highly unlikely that stocks dropped 20% in a day or two. It is more likely that the decline happened over several weeks.  A tactical allocation approach may have shifted a percentage of the stocks to bonds or even cash after the first “x”% decline. Fast forward to the third quarter and a tactical allocation strategy may have shifted a sizable percentage of the stocks to bonds before it got to that point – helping to have avoided some of the large loss. The process and metrics are of course more complex than this.  The important concept here is that having an adaptable process can help manage broad asset class risk.

Sector Rotation

Another risk management strategy is sector rotation.  Owning securities representing different sectors within an asset class further diversifies a portfolio and allows the implementation of a sector rotation strategy. It is important to understand that within any broad asset class, there can be a significant difference between the best performing sectors of that class and the worst performers – in good times and in bad. For example, for the large company US stock market asset class, the difference between the worst performing sector and the best performing sector often is more than seventy percent in any given year. That means that although the average for that asset class might have been 10%, there were likely sectors within that class that were up as much as 45% and other down as much as 25%.

From a risk management standpoint, a sector rotation strategy may give you the ability to sell sectors that are showing signs of weakness and buy sectors showing signs of strength. Over the past couple of years for example, the biotechnology and healthcare sectors significantly outperformed the basic materials and precious metals sectors. However, over the past few months, precious metals have outranked both biotechnology and healthcare, while basic materials has stayed near the bottom. Utilizing a sector rotation strategy may have allowed for the rotation away from biotechnology and healthcare while looking for other sectors on the rise.

Risk management is such a broad term it is easy to be confused as to which risk you are managing, or are having managed.  There are many risks in the capital markets that, with some effort and data, may be managed through a variety of strategies. Knowing which strategy to use, the data you will need, and how to implement it is a complex problem. Asking a professional is a good first step in solving it, but be sure you know which risks they are willing to actively manage – often times the answers vary more than people think.

Combining asset allocation strategies, tactical management and sector rotation is not a panacea to market risks.  However, remaining adaptable, process driven and willing and able to make changes when necessary is a great start.

Check out these links on Investopedia for more reading:

Diversification: http://www.investopedia.com/terms/d/diversification.asp

Sector Rotation: http://www.investopedia.com/terms/s/sectorrotation.asp

Tactical Asset Allocation: http://www.investopedia.com/terms/t/tacticalassetallocation.asp