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Is Your Investing One Dimensional?

May 8, 2013

by Jerry Wagner

of Flexible Plan Investments

At the National Association of Active Investment Managers (NAAIM) Uncommon Knowledge Conference in Denver last week, a reporter from Financial Planning magazine asked us, “What is ‘active investing’?” Many confuse the phrase with the simple act of running a mutual fund populated with stock picks within the strict guidelines of a prospectus, as opposed to running an index fund, where the manager simply buys and holds the shares making up a particular stock or bond index.

While there were many better definitions offered, I thought I would take a different tack at supplying an answer. See what you think:

Buy and hold – two words linked together by a connector. But a single conjunction, “and,” does not make the phrase two dimensional.

Buy and hold is really just one dimensional – you buy – holding is not a word of action. Following this approach is passive investing in its purest form.

Graphically, one dimension is a dot. It has no length, width or depth – it’s a dot, just like the period at the end of this sentence. Like the period, it can appear at any place on a page – high or low. Like the return from a buy and hold investment, it just is – it’s the return of the underlying index and that’s all there is. When the S&P is up, like it is this year for example, the dot is higher. When it’s down 55%, like it was in 2007-2008, that’s all she wrote – you get what you see.

Most investors are two dimensional investors. They buy and… they sell. Both verbs denote activity – buying and selling. That makes most investors active investors.

While passive investors often focus only on the state of the investment itself in one dimension, i.e. the factors about the investment that caused them to buy in the first place, active investors view investing in at least two dimensions. They focus on both buy and sell factors. They care whether the market environment and/or economy in general are favorable or unfavorable for stock investment as well.

Still, they differ further. Some buy and hold a long time, while others buy and hold for a short time. Two dimensional investing, then, is like a line. And that line can be long or short.

Dynamic, risk managed investing, is like a cube. It’s three dimensional. It has width, length and depth.

Beyond the simple acts of buying and selling, a lot more goes on. We have factors that influence when we buy – just like the buy and hold investor. We also have factors that indicate when to sell. Both the buy and sell factors are quantitative – that means they are solely numbers based – no emotion, no subjectivity, just disciplined, mathematical investing.

In addition, to add the risk management dimension – price momentum, the potential downside, the price movement of one investment as it relates to another – all come together to determine the position to take in an investment and the size of that position. Hedging, shifts to cash and bonds determined by volatility and tactical timing measures, and stop loss signals, can further enhance the risk management methodology.

Finally, think of each of those dynamic, risk managed investing cubes, those separate strategies, as bricks. Combine them and you have the safety of a home. Together, strategically diversified, dynamic, risk managed, investing, like your home, is intended to weather the fourth dimension – time.

Investors need the solid, combination of all the bricks, to form a home, to weather the storms that roar through the financial environment over a full financial cycle – the times when the markets are up and the times when they are down.

The Markets

Stocks soared to new heights Friday, on “just right” news in the form of a Goldilocks Jobs Report in a fairy tale market. The 165,000 in new jobs reported (still short of the 200,000 per month needed just to replace retiring workers) was weak enough to insure the Fed wouldn’t change directions and raise rates, and strong enough to top expectations battered by fears of the economic effects of cuts in the rate of government spending. It was just right and the bulls were licking up every drop of the porridge. Clearly no bear was at home.

Although they were absent, I do think they’ve left a few crumbs on the floor that may be big enough for the bulls to stumble over in the weeks ahead. Despite the good job report, most economic reports continue to disappoint. Last week there were 28 economic reports and 17 were below economists’ expectations. So even though a slowdown has been expected, in some respects the economy is putting on the brakes harder than many guessed would be the case.

Second, as first quarter earnings reporting draws to a close, the season has been mediocre at best. While more companies than not have outperformed the analysts’ guesses, the percent outperforming (59% vs. the mid-60s) is at the lowest level since the bull market rally began in 2009. Still, there are some bright spots: reports of revenue “beats,” while still low, have been steadily rising as the reporting progresses. And although the percent of outperformers for the average company has yet to break the 60% mark – for S&P 500 member companies – 65% have beaten analyst earnings estimates.

Source: Bespoke Investment Group

Lastly, interest rates spiked up a bit at the end of last week, despite the jobs report being ”just right” –contradicting the general opinion given for the stock market’s rise on the news.

Still, the trend is up, the Fed’s still buying, our Political Seasonality Index, which usually tops the first week in May, shows a top this spring in the May 10-17 period, and volatility has retreated to bullish levels, so a stumble may be all the bears have to savor.

A quick note on gold – you’ll recall when gold was falling 10% a few Mondays ago I ventured the opinion that it might be a good buying opportunity. Well, gold is up 12% in the two weeks since then, and it looks like it could go higher if it can solidify its break above the price it began the day of the break at some two weeks ago.

Source: Bespoke Investment Group

All the best, may the new week be “just right” for you and yours,



© Flexible Plan Investments