The Future of Investing: A NEW Diversification Approach
A self-proclaimed investing "newbie" expressed appreciation for Friday's missive and the introduction of some long-term indicators that can indeed help just about anyone "time" the market successfully. This particular reader decided to start following the "golden cross" in an effort to be better prepared the next time the bears come out of hibernation.
While the "golden cross" approach (be in stocks when the S&P 500's 50-day moving average is above its 200-day moving average and be in cash when the 50-day is below the 200-day) isn't the best indicator on the planet and can cause some heartache when in whipsaw mode, it will keep investors out of harm's way during periods such as the Tech Bubble Bear of 2000-02 or Credit Crisis Bear of 2008.
In addition, this incredibly simple indicator is available free to just about anyone with an internet connection.
S&P 500 and the "Golden Cross"
View Larger Image
Another great comment came from a Seeking Alpha contributor, who happens to be a full-time investor. The reader suggested that combining some of the indicators mentioned might be good idea.
"Thanks for one of the best articles I've ever read tellingly refuting the commonly accepted myth of 'time not timing'... If one were to combine the 2 indicators you mention with all the other important back-tested leading indicators the evidence one can outperform the general market with astute timing is overwhelming. Too bad all those 'buy and hold until you die' sheeple in mutual funds will never read this article."
While it is always nice to see folks appreciate the work we do, the reader actually brings up a VERY important point regarding what is likely the future of investing in general and diversification in particular: Creating multiple strategy portfolios.
The Old Way to Diversify a Portfolio
Traditionally, a diversified portfolio has spread assets across multiple classes. Modern Portfolio Theory (which, by the way, was developed between 1950 and 1970) has split portfolios among U.S. stocks, foreign stocks, bonds, and cash. And then more recently, the concept has been expanded to include additional asset classes such as real estate, gold, commodities, emerging markets, currencies, alternatives, hedge funds, and foreign bonds.
According to Wikipedia, "MPT models an asset's return as a normally distributed function (or more generally as an elliptically distributed random variable), defines risk as the standard deviation of return, and models a portfolio as a weighted combination of assets, so that the return of a portfolio is the weighted combination of the assets' returns."
In recent years however, the MPT approach has come under fire as evidence has surfaced that financial returns do not actually follow the prescribed distribution curve and that correlations between asset classes are far from fixed and can vary widely - especially in times of crisis.
Speaking of crises, investors learned (the hard way) that traditional diversification strategies did little to protect them from the two brutal bear markets that occurred in 2000-02 and again in 2008.
There are Ways To Avoid the Bears
On Friday, a single, long-term indicator was highlighted that has done a stellar job at keeping investors on the right side of the really big, really important trends. The idea is to review the technical health of the more than 100 sub-industry groups and use the weight of the evidence to determine when to be invested and when to be on the sidelines. It was suggested that if one was stranded on a desert island, THIS would be the indicator to have in your backpack.
Looking at the historical data, the system would have been right 88% of the time since 1980 and produced hypothetical compound returns of +18.2% per year (before fees, commissions, and taxes) when using a Long/Short approach versus +8.7% for the overall market.
But here's the thing... Even this indicator stumbles at times. It is vital to understand that NO INDICATOR IS PERFECT! Sorry folks, there is no such thing as the Holy Grail of stock market indicators.
So what's the answer then? How does one run with the bulls and still avoid being mauled by the bears? By diversifying your portfolio, of course. But PLEASE keep reading because today's markets demand a new approach to this age-old concept.
The NEW Diversification Approach
Again, we are not talking about diversifying by asset class here. No, the trick to creating an "all weather" type of portfolio that makes hay while the sun shines and seeks shelter when a financial storm hits is to implement what we'll call the NEW diversification.
When correlations amongst asset classes go to "1" as they have so often during all the crises that have occurred since 2007, traditional diversification is next-to useless as a means to preserve/protect capital.
What is needed is to create "true diversification." This involves incorporating multiple investment strategies and diversifying across holding time frames, manager methodologies, underlying asset classes, and most importantly, investment managers.
Creating a portfolio that utilizes multiple managers, strategies, and methodologies is likely the future of the investment business. The bottom line is that no single investment manager or firm can consistently "kill it" in all asset classes and all market environments. To think otherwise is sheer folly.
The Strategy for 2015 and Beyond
So, when you are plotting your strategy for 2015, think about this. Explore using more than one strategy and more than one methodology. For example, if you currently utilize a short-term approach, consider adding a long-term strategy as well.
Such an approach would have definitely been beneficial in 2014. While most shorter-term strategies have struggled to a certain degree this year, the longer-term approaches have ignored all the noise and kept investors "long and strong."
Thus, using a short-term strategy can help navigate the short- and intermediate-term opportunities in the market while a long-term approach will focus on the really big, really important trends.
In closing, if you want to stay on the cutting edge of the investing game, start moving toward "the NEW diversification" in your portfolio. Such an approach will likely smooth out the ride and hopefully create a lot less angst when things get nasty.
Looking For a Bear Market Protection Plan?
*** NEW SERVICE ***
Check Out HCR's Long-Term Risk Manager System
Turning To This Morning
The primary story this morning is the big surprise out of Japan. Overnight it was reported that the nation's GDP fell by -1.6% on annualized basis, which was well below the expectations for a reading of +2.2%. In fact, the lowest analyst estimate had been for Japan's GDP to grow at a rate of +1.0%. In addition, the decline marked the second consecutive quarterly drop in GDP (Q2's rate plunged -7.3%), which technically puts the country in recession. The overhang from the implementation of a nationwide sales tax back in April was blamed for the surprise drop in economic activity. Across the pond, there are reports that the European Commission is mulling the creation of a €300 billion infrastructure fund aimed at highway development. Here at home there is a big oil merger between Halliburton and Baker Hughes. U.S. stock futures are off their worst levels but continue to point to a soft open on Wall Street.
Here are the Pre-Market indicators we review each morning before the opening bell...
Major Foreign Markets:
Hong Kong: -1.21%
Crude Oil Futures: -$0.87 to $74.95
Gold: +$0.90 at $1186.50
Dollar: higher against the yen, euro, and pound
10-Year Bond Yield: Currently trading at 2.301%
Stock Indices in U.S. (relative to fair value):
S&P 500: -3.56
Dow Jones Industrial Average: -19
NASDAQ Composite: -5.14
Thought For The Day:
Well-timed silence hath more eloquence than speech. -Martin Farquhar Tupper
Positions in securities mentioned: None
Wishing you green screens and all the best for a great day,
David D. Moenning
President, Chief Investment Officer
Heritage Capital Research
Check Out the NEW Website!
Investment Advisory Services Offered Through CONCERT Wealth Management, Inc. An SEC Registered Investment Advisor
The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning’s opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed nor any Portfolio constitutes a solicitation to purchase or sell securities or any investment program.
Any investment decisions must in all cases be made by the reader or by his or her investment adviser. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that the investment objectives outlined will actually come to pass. All opinions expressed herein are subject to change without notice. Neither the editor, employees, nor any of their affiliates shall have any liability for any loss sustained by anyone who has relied on the information provided.
The analysis provided is based on both technical and fundamental research and is provided “as is” without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.
David D. Moenning, an advisor representative of CONCERT Wealth Management Inc. (CONCERT), is founder of Heritage Capital Advisors LLC, a legal business entity doing business as Heritage Capital Research (Heritage). Advisory services are offered through CONCERT Wealth Management, Inc., an SEC registered investment advisor. For a complete description of investment risks, fees and services review the CONCERT firm brochure (ADV Part 2) which is available from your Investment Representative or by contacting Heritage or CONCERT.
Mr. Moenning is also the owner of Heritage Capital Management (HCM) a state-registered investment adviser. HCM also serves as a sub-advisor to other investment advisory firms. Neither HCM, Heritage, or CONCERT is registered as a broker-dealer.
Employees and affiliates of Heritage and HCM may at times have positions in the securities referred to and may make purchases or sales of these securities while publications are in circulation. Editors will indicate whether they or Heritage/HCM has a position in stocks or other securities mentioned in any publication. The disclosures will be accurate as of the time of publication and may change thereafter without notice.
Investments in equities carry an inherent element of risk including the potential for significant loss of principal. Past performance is not an indication of future results.