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IronBridge Private Wealth

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Houdini’s Hole

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The Paramount Theatre in Austin, Texas is a city treasure. It has an amazing variety of shows, and the list of notable performers is unmatched. It was built in 1915, and began mostly as a vaudeville house.

Just a few of the notable performers in its history are Miles Davis, the Marx Brothers, George Carlin, Ray Charles, Billy Joel, Don Rickles, Chuck Berry, Gladys Knight…the list goes on. Learn more about the Paramount Theatre: https://www.austintheatre.org/

Harry Houdini

One of the most famous performers to grace the Paramount stage was Harry Houdini. And his presence can literally be seen to this day.

Houdini performed there in 1916. At the time, he was one of the most famous people in the world. His slight-of-hand tricks mesmerized audiences worldwide.

One part of his performance was a suspended levitation trick.

He would dangle from the ceiling and escape a straightjacket or chains or some other kind of concoction.

He most likely performed this trick at the Paramount during his eight shows in Austin. To accomplish it, the theater operators drilled a hole in the ceiling of the Paramount and dangled the global superstar over the audience.

The hole they drilled is still in the ceiling today, over 100 years later, as shown in the picture below.

Houdini’s hole can be seen in the green area to the top-right of Saint Cecilia’s right hand. Photo courtesy of the Paramount Theatre website.

The details of Houdini’s trick that night are unknown.

But as with any kind of “magic” trick, it’s not about how the performer escapes. It’s all about distracting the audience to create an illusion of making the impossible possible.

This same type of “magic” is happening in financial markets today.

Suspended Levitation

Harry Houdini mastered the art of the suspended levitation tricks.

In today’s markets, there appear to be two Houdini’s: the Fed and the mega-cap tech stocks (such as Tesla, Facebook, Google, Amazon, Apple and Microsoft).

We’ve discussed the Fed a LOT in these reports.

But we came across a new chart that shows just how big of an impact the Fed may have had in market growth over the past decade.

Bank of America Global Research did some very interesting analysis.

What they did is look at how much of the market growth can be explained by earnings growth, and how much can be explained by the Fed’s balance sheet.

The first chart below shows how much of the returns of the S&P 500 can be explained by changes in the earnings of the companies within the index.

Earnings Contribution to changes in the S&P 500 Market Cap

This chart paints an interesting picture.

Traditional investors assume that when earnings increase, so should the stock price. That’s what we’re buying after all, right? Shares in a company whose business should grow?

But the chart above tells us that’s not quite the case.

It tells us is that from 1997 to 2009, only 48% of the changes in the index can be explained by earnings growth.

And after the 2008 Financial Crisis, earnings only accounted for 21% of the changes in the S&P 500!

That’s pretty amazing. Only 21% of the increase in the market over a decade-long period is due to earnings?

What would explain the rest of the growth?

There are a variety of things that impact stocks:

  • Earnings: Higher profits or revenue can lead to more valuable companies.
  • Flows: More money chasing stocks makes it go higher, less money makes it go lower.
  • Sentiment: Optimism creates more buyers, while pessimism means more sellers.
  • Investing Alternatives: When stocks have competition for returns, less money goes into the stock market.
  • Liquidity: When there is more money in the system, there is additional capital to put to work that is not tied up in other areas like inventories.

We could write dissertations about each of these categories.

But let’s focus on the last item, liquidity. This is the main avenue where the Fed has an impact.

Fed-Driven Market Growth

Bank of America also did the analysis on how much of the price changes can be explained by changes in the Federal Reserve balance sheet, which is shown in the next chart.

Fed Balance Sheet Contribution to changes in the S&P 500 Index

Here we really start to understand just how much impact the Fed has on markets.

From 1997 to 2009, literally zero percent of the return of the S&P 500 can be explained by changes in the Fed balance sheet.

Granted, the Fed’s balance sheet wasn’t that big before the financial crisis. But that’s kind of the point.

Since 2010, a whopping 52% of market performance can be attributed to the Fed. That’s even more of an impact than EARNINGS had in the 12 years leading up to it.

No wonder the Fed is nervous about what happens when they start to reduce the size of the balance sheet. (Read our article earlier this year The Fed is Stuck.)

They are creating an illusion, just like Houdini.

What started in 2009 as proper policy to keep the financial system operational, has since turned into a permanent juicing of the markets to keep them chugging higher.

The Fed starts to talk about tapering, and reverses course at the slightest whiff of risk.

Case in point…the Fed started to talk about tapering right before Thanksgiving. Markets fell a quick 5%, and next thing we know it’s off the table.

We’re not talking about the COVID Crash, where stocks plummeted 40% in a few short weeks. We’re talking about a normal 5% correction. They blamed the Omicron mutation, but that was just an excuse to postpone making tough decisions.

Our job as investors is to make money. So we appreciate what the Fed is doing.

And it may continue to work for a long time still. But we have to think about what happens next.

But the Fed isn’t the only one doing the heavy lifting. Tech stocks have helped tremendously this year.

Big Tech Stocks

The other market magician is the biggest-of-the-big tech stocks.

There have been increasing acronyms that represent these stocks:

  • First it was FANG. Facebook, Apple, Netflix and Google.
  • Then it became FAANG. Add Amazon to the mix.
  • Then it was FANMAG. Microsoft needs love too.
  • Now we can include Tesla and Nvidia. Who know what that will spell.

Whatever it spells, it’s yet another way the market is levitating.

We discussed the 5 largest stocks in our Strategic Growth Video Series, which you can view HERE.

To view just how much of an impact the 5 largest stocks have had this year, look at the following chart from S&P Global Research.

This chart is quite shocking.

As of December 6th, when this chart was published, the Nasdaq index was up almost 20% for the year.

Without the largest 5 stocks, the index is DOWN over 20%.

Let’s hear that again. The index goes from UP 20% to DOWN 20% by removing only 5 stocks.

(By the way, these 5 stocks are Amazon, Google, Tesla, Facebook and Nvidia.)

Jiminy Christmas, Houdini, that’s some trick.

We can interpret this two ways. And these two ways have extremely different outcomes.

On the one hand, this could be positive.

The fact that so much of the index has fallen means that a large majority of stocks have actually gone through a pretty tough stretch. Many have gone through outright bear markets when viewed individually.

Maybe these stocks are ready to begin to move higher.

That would provide excellent investment opportunities outside of these big tech stocks.

On the other hand, if these stocks do start to falter, watch out.

If these handful of stocks start to weaken, and there is NOT a rise in the majority of the other components of the index, we could start to see a market that shifts from slowly drifting higher to quickly falling.

Reality is probably somewhere in between.

If the magicians of the market stop rising, but a majority of the other stocks start to do better, we could see an environment where the overall indexes are choppy and flat, but without any major losses.

That seems like the likely outcome while the Fed remains accommodative.

So far, every little dip has been bought. The scary 5% correction that we saw a couple weeks ago really didn’t amount to anything.

So the slight of hand continues and the performance goes on.

The market Houdini’s have escaped harms way for quite some time now. But if the Fed doesn’t continue to escape, they could leave a hole that we will be able to see for generations to come.

Invest wisely!

Safeguarding and Passing on Your Digital Assets

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cryptocurrency theft concept on smart phone screen. Big red hacked message and empty wallet. Phone on a laptop computer.

Google searches for “cryptocurrency” hit all-time highs in May. A survey from CNBC found that 1 in 10 people now invest in crypto. Of that group, 65% got in the crypto market within the past year.2

As crypto becomes a more significant part of the financial picture, it’s essential to ensure that the assets are safely and appropriately stored and that you have a plan for the eventual transfer of them – but this process doesn’t work the same way as for traditional assets.

Taking Careful Inventory

One of the first steps to safeguarding your digital assets is taking inventory of what you have. With how many ways there are to purchase and store crypto, it’s easy to forget where all of them are located and since the space is still new, there isn’t really an easy way to keep track of them all.

Taking inventory looks different for everyone, but one of the most common ways is using a simple Excel or Google spreadsheet. You would want to include a few things: the name of the asset (bitcoin, ether, etc.), how much of it you own, your original purchase price(s), and where it’s located. This information will help you keep everything in order and makes the information easily accessible for when tax time rolls around.

There is software out there, such as CoinTracker, that can help keep track of your digital assets, but not every software integrates well with others. Right now, it may be easiest to keep it simple and stick to manual input until more sophisticated solutions exist.

Storing Crypto in Your (Digital) Wallet

There are two different kinds of wallets. Hot wallets (also known as ‘soft’ wallets) live online and are usually an extension in your web browser or an app. These would be brands such as MetaMask, Rainbow, or Strike.  The other kind is a cold wallet (also known as a ‘hard’ wallet). These exist offline, and are like a USB drive. A hard wallet plugs into your computer and because it’s not always connected to the internet, it’s generally considered to be more secure than a hot wallet. Some common hard wallet providers are Ledger and Trezor.

Secure your crypto in three ways; private keys, public keys and a seed phrase

Public keys

Every wallet comes with a set of private & public keys and a seed phrase. Wallet keys are a long string of random numbers and letters assigned to your wallet, and your public keys are like your home address. Just like how you would give out your address to someone if they wanted to send you a package, you give out your public address if someone wants to send you crypto.

Private keys

Your private keys are like the keys that unlock your home. You never give them out to anyone, and their primary purpose is to allow you to complete a transaction. So, if someone had both your public and private keys, they could drain your wallet of all funds.

Seed phrase

Finally, your seed phrase is a 12-word phrase generated from the private keys to make it easier to remember, and its purpose is to serve as a backup if you were to misplace or forget your wallet credentials. If you have the seed phrase but lost the keys, all the assets in that wallet can typically be restored.

Custodial wallets

With both hot and cold wallets, you’re in control of the private and public keys, giving you full access to the funds. This is important to note because the last type of wallet does not grant that same ability.

Custodial wallets are provided by exchanges, such as Gemini and Coinbase, and the key distinction between custodial wallets and non-custodial wallets is that with custodial wallets, you generally do not have access to the private keys. The exchange keeps them private, and because of this, some investors prefer not to store large amounts of crypto on their custodial wallet after purchasing.

Using a custodial wallet comes with less responsibility than a non-custodial wallet, but the tradeoff here is security. With a custodial wallet, in the event of a hack or data breach of the custodian, your crypto would be unsecured and vulnerable. With non-custodial wallets, you’re the only one who has access to the private keys and data (unless you were to give them out mistakenly). However, one positive attribute that custodial wallets hold over non-custodial wallets is that they are generally FDIC insured up to $250,000.

Whatever route you decide to take with wallets and storage, the main thing to remember is never to give out your private keys or seed phrase. Doing this can make all the cryptocurrency you hold in that wallet accessible to whoever gets ahold of them.

Planning to Transfer Assets

Suppose you’ve thought about investing in crypto or you currently own some. In that case, you may be wondering how these assets can be passed down since there are no standard legal procedures and holding crypto and moving it around looks different than the traditional finance framework.

The main issue in passing down digital assets and cryptocurrencies is the storage and transfer of the private key. Since it must be stored in a private location, it’s not recommended to write the private phrase in a will as it can become public record after death. In certain situations, the contents of safety deposit boxes may also become part of the public probate record, so storing the keys there may not work either.

So, how can you store the private key and ensure that the assets are passed on securely? Luckily, technology solutions have been built and are constantly being developed.

One of the best solutions currently available is using a multi-signature (or multi-sig) wallet. These wallets have multiple sets of keys and the wallet requires several of those signatures to complete a transaction. For example, if a wallet had 5 keys, two of them could be given to your attorney and the issuing company, and the remaining three could be held by you, your spouse, and your child. Then upon death, the assets in that wallet could be accessed by using a combination of 3 of the 5 keys. This allows for more security and helps mitigate the risk of someone inappropriately distributing or accessing the assets.

If you are holding your crypto assets in a non-custodial wallet, your estate planning may be better accomplished with a trust. This avoids probate and can allow the original owner to maintain control. And depending on the type of trust, the original owner may also set certain rules for how the assets are managed after death.

Custodial wallets (those provided by exchanges) generally don’t have trust support, meaning that the assets held in those wallets would be subject to probate. This is another reason why some investors prefer to hold their larger amounts of crypto in their private, non-custodial wallets.

The Takeaway

It’s estimated that 20% of bitcoin is lost forever due to forgotten or misplaced seed phrases or simply not keeping inventory and forgetting it was owned in the first place. As cryptocurrency and digital assets make their way into more investing conversations, the need for education and proper asset management is becoming more important.  This is because cryptocurrencies are managed from a security and estate planning aspect is different from their traditional finance counterparts.

Keeping track of your holdings, ensuring the cryptocurrency you hold is in a secure wallet, and beginning to think about estate planning solutions are a few ways you can begin safeguarding and building a plan to pass down your digital assets.

  1. Manoylov, MK. Google Search Volume for Cryptocurrency Topics Break All-Time High. The Block. May 20, 2021.
  2. Reinicke, Carmen. One in Ten People Currently Invest in Cryptocurrencies. CNBC. August 24, 2021.

This work is powered by Seven Group under the Terms of Service and may be a derivative of the original. More information can be found here. The information contained herein is intended to be used for educational purposes only and is not exhaustive.  Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return.  If applicable, historical discussions and/or opinions are not predictive of future events.  The content is presented in good faith and has been drawn from sources believed to be reliable.  The content is not intended to be legal, tax or financial advice.  Please consult a legal, tax or financial professional for information specific to your individual situation.

Be a Mercenary: 3 Ways to Improve Your Investment Process

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Photo of a soldier in camouflage and tactical gloves putting money in pocket.

When investing, listening to common wisdom can be very productive. But not all “wisdom” is worth listening to.

Here are three philosophies that can help you improve your investment results.

1. You Don’t Have to Own Stocks Forever

There is a lot of potential risk in markets right now.

But guess what? There always is.

We’ve been trained to think that if you buy stocks, you must own them forever or else you’re doing it wrong.

Don’t buy into that kind of thinking.

It’s okay to get out. It’s okay to have stop losses. It’s okay to allocate capital to stocks right now, as long as you have the proper risk management strategies in place. In our opinion, that means having rules to move out of stocks and back into cash.

In fact, we think that you should intentionally be thinking shorter-term when it comes to stocks right now. There are signs that the stove could get hot. But avoiding it means you may be passing up on solid investment returns in the meantime.

2. Separate your Emotions from your Actions

We believe in having rules. This allows you to not have a vested emotional interest in the outcome of the stock market.

When humans predict something will happen, they create both a confirmation bias to that prediction as well as an anchoring bias to the predicted outcome.

A confirmation bias is when we look for things that support our way of thinking. Politics and social media are the ultimate examples of confirmation bias today. People like to watch and read things that support their view.

Anchoring bias refers to how we view an array of information based on an initial assumption or data point. If we view the market as one that should be rising, we tend to subconsciously view that as the primary outcome we should expect. And we don’t only actively seek out confirmation of our theory, we interpret data points and events to be supportive of that belief, whether that is the accurate way to interpret it or not.

Both of these biases result in viewing markets without the objectivity and discipline needed to be successful investors.

3. Be a Mercenary

This means you want to fight for the side that both pays you the most money and avoids the most harm.

Tech is doing well? Great. Invest there.

Inflation is coming? Great. Invest in areas that are showing benefits to that inflation.

Markets are crashing? Great. Have more cash.

Bottom line: Don’t be dogmatic. Don’t be a permabull or permabear. Try to fight for the winning side. You won’t always be right, but you’ll be on the right side of the big trends when they happen.

Having a process will help tremendously when markets get confusing. Remembering these three

We’re All Cats on a Hot Stove

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Waiting for a correction in the stock market? It may have already happened.

If a cat sits on a hot stove, that cat won’t sit on a hot stove again. That cat won’t sit on a cold stove either. That cat just don’t like stoves.

mark twain

It’s hard to believe, but the COVID market crash ended 16 months ago.

It was truly a black swan event. Something that came out of nowhere and was unlike anything the global financial markets have seen in over 100 years.

One of the most common questions we receive is, “When is the next crash going to occur?”

This is a good question, and a very logical one. And one we think about quite often.

After all, we are seeing a rise in the Delta variant, many cities are re-instituting mask policies, and there is discussion of additional lock-downs. Sounds like February and March 2020, right?

On top of that, we have the random 1,000-point decline that happened on July 19th. Read our comments in our article “Are the Dog Days of Summer Over?“

So there are valid reasons to be expecting a sharp market decline.

But we have been receiving this question for well over a year now.

In the past year, there has been a great deal of hesitation to put cash to work in the stock market. Granted, some people were very quick to put cash to work, but most were very hesitant. And many remain so to this day.

Why?

To fully answer both the question “Why?”, and the question of whether we should expect another market crash soon, we need to understand the human behavior factors at play.

We’re All Cats That Sat on a Hot Stove

As humans, we don’t arrive at skepticism by accident.

In fact, being skeptical is an extremely valuable survival tool. Especially when we see conditions that were similar to past experiences that caused us pain or harm.

The are three basic components of skepticism:

  1. You perform an action.
  2. You experience pain.
  3. You learn to avoid the conditions that caused the pain.

It isn’t rocket science. In fact, we can probably just file this alongside the long list of other things we’ve said that won’t win us a Nobel prize.

In the quote that we referenced at the beginning of this report, Mark Twain presents the ultimate completion of this three-step cycle:

  1. A cat sits on a stove.
  2. The cat burns his you-know-what.
  3. The cat never sits on a stove again, regardless of whether it is hot or cold. Because every stove now looks like a hot stove to the cat.

Pretty simple, right?

Sort of.

Most problems in life arise when we forget to do Step 3: Learn from past experiences.

We have all experienced situations that may have caused us pain that we ended up right back in for no good reason.

Substance addiction, bad relationships, a bad job…there are all sorts of examples of people forgetting about Step 3.

Many times we’re cats who sit right back on top of that stove. And many times we are once again burned.

But what happens if learning from past experiences is the REASON we are harmed in the future?

What if we perform Step 3 beautifully, learn to avoid the situation that caused harm, only to then be harmed MORE by the fact that we avoided the situation that previously caused us pain?

This is what happens in financial markets.

When you lose money in the stock market, you have to go back on the same exact stove that burned you if you want to get back in.

This is where the complexity starts to set in.

In markets, you have to think about Step 3 differently.

The lesson learned cannot be one of complete avoidance.

You must have the cognitive ability to reshape HOW you learn lessons about what got you in trouble in the first place.

After losing money in a big market decline, most of us think that the lesson should be to NOT get back onto the market stove. After all, it looks pretty hot, right? Delta variant, super high valuations, a massive rally from last March and an out-of-control Fed all make us think the temperature on the stove is pretty darn hot.

But just because these things are happening doesn’t mean you should avoid it altogether.

Don’t Avoid the Stove, Just Start to Use a Thermometer

Instead of avoidance, you must begin to use tools that can assess both the current temperature of the stove (markets), as well as the direction and rate of temperature change of that stove.

It is a rational response to avoid the stock market after getting walloped by it. In fact, it is the exact response that would help you avoid that pain in the future.

Many investors go through a big decline and turn into real estate investors. Or private equity investors. And that’s okay.

Markets are not for everyone.

But don’t believe that getting burned on stove means that there is something inherently wrong with stoves.

There is an opportunity cost to avoiding the stove.

The public financial markets provide access to fantastic investment opportunities with a tremendously high degree of liquidity. The primary benefit of liquidity, or the ability to get out of your investment quickly at little to no cost, is that you don’t have to be right all the time. You can change your mind and you can easily get out of things that aren’t working.

You simply need to start using tools that allow you to assess the temperature of the market.

At Ironbridge, we use a wide variety of tools. We won’t get into the specifics, but we use momentum analysis, trend analysis, RSI, MACD, DeMark Signals, and many other data points that help direct our decision-making. We have then developed sets of rules that drive our actions.

The whole point is that it’s important to have some gauge of the temperature of that burner, and not not simply guess when we jump onto it.

So Is the Stove Hot or Cold Right Now?

Okay, enough of the long analogy about stoves. Let’s get to the market analysis.

Bottom line, while the S&P 500 has not seen a correction since last November, we have already seen a correction in many assets.

Let’s look at the following charts to show what we’re talking about:

  • Russell 2000 (Small Caps)
  • China Stocks
  • Emerging Market Stocks
  • Big Tech Names
  • S&P 500 Sectors
  • S&P 500 Index itself

Before we start, a brief note on stock corrections.

Corrections can take two forms. They can happen via TIME, or via PRICE.

A price correction is what we usually think of when we think about a market pullback. Stock prices were going up, then they fall anywhere from 5% to 30%. Then resume their move higher.

But markets can correct in TIME as well. This simply means that they go through an extended, multi-month period with little price movement up or down.

Both time and price corrections serve the same purpose: remove excesses from the markets and get the ratio of buyers and sellers more in balance.

Okay, on to the charts.

Russell 2000 (Small Caps)

First, let’s look at the Russell 2000. After a strong surge following the Presidential election, small caps have been little changed since February/March.

The Russell 2000 small cap stock Index has been in a sideways consolidation for most of 2021.

The blue box in the chart above is a classic correction in TIME. Small caps have been choppy with no direction for six months now. These patterns tend to resolve themselves higher, so we should expect that as the base case scenario.

However, a break below 208 in the chart above would be a more ominous signal. This could lead to selling pressure expanding across the market, and not just be isolated to small caps.

International Stocks

Next, let’s look at China and other international stocks.

The next chart is that of China Large Cap Stocks, using the ticker FXI.

China large cap stocks are down 25% from the 2021 highs. Ticker FXI.

This is a classic correction in PRICE. Stocks are down 25% since February. There is little doubt the direction of this trend.

The same is true of other, more broad international stock indices.

Emerging market stocks are down over 15%, as shown in the next chart. This is no real surprise since China is the largest component. But it is another example of a major global equity market component that is experiencing a correction right now.

International stocks have been weak. There is no question about that.

U.S. Stocks

What about some of the major U.S. stocks?

Well, here is when we start to see what is really happening in U.S. stocks right now.

The next chart shows four of the largest U.S. stocks: Amazon, Apple, Microsoft and Netflix.

These charts show us that each of these stocks went through some sort of TIME correction in the past year.

  • On the top left of the chart is Amazon (AMZN). It was in a sideways move for almost a year. It broke higher, but fell back into it’s chop zone last Friday after a 7% decline following earnings. This is called a “false breakout”. Meaning it may have longer to go before it breaks out of its sideways correction.
  • Apple (AAPL), on the top right, shows a classic break higher from a sideways correction. It also spent over a year in a TIME correction before resolving higher.
  • Microsoft (MSFT), on the bottom left, was in a TIME correction for the second half of last year. It has steadily been moving higher since the start of the year.
  • Finally, Netflix (NFLX) is shown on the bottom right. This was a darling of the COVID period, and remains in a TIME correction since this time last year.

Each of these stocks experienced a correction. And these are major components of the S&P 500.

The fact that these stocks are breaking higher suggests we should have a bullish tilt to our thinking.

S&P 500 Sectors

Looking some of the sectors in the S&P 500, we see a similar picture.

The next chart looks at the Energy, Industrials, Tech, Financials and Consumer Discretionary sectors. We could have chosen more, but the chart gets way too busy.

Each of these sectors have all seen some sort of correction in the past year. Most have been correcting in TIME.

Energy has been the biggest winner since the election. There is an excellent lesson here. The pundits on CNBC and elsewhere all predicted a Biden presidency would harm energy companies. That would make sense logically. But the market responded in exactly the opposite way. The lesson? Using the financial media for investment decisions is not a sound strategy.

This sideways movement of the major S&P sectors suggests that corrections are actually happening under the surface of the market.

But what about the overall market itself?

S&P 500 Index

But here’s the strange thing: Despite corrections happening in both the major stocks and major sectors within the index, the S&P 500 Index itself has been very strong.

Despite the underlying TIME corrections happening in various sectors, and despite the obvious PRICE correction in international markets, the S&P 500 is up. In a very, boring, beautiful pattern higher.

So What Does All of This Mean?

It means that if you’re expecting a stock correction, it may have already happened.

As strange as this sounds, the underlying components in the markets have all mostly corrected already. Without an overall market correction.

Chalk this up as a win for indexers.

This is also why at IronBridge we have both active and passive strategies in place.

In fact, we have had the highest exposure to the S&P Index in our four-year history. We could only go about 5% higher in our portfolio weighting to the S&P 500 Index based on our rules. At the high point, clients had exposure of anywhere from 25-35% of their portfolios, depending on the risk level.

While the S&P has been boring, it’s more interesting to look at the small caps and international stocks.

Earlier this year, our clients had exposure to both of these areas. And both were stopped out at relatively small losses.

For small caps, that wasn’t such a big deal. Prices are similar to where they were when we exited.

But for international stocks, they are down 15-20% lower than where we exited.

Such is the nature of risk management.

We don’t know when things will reverse higher, chop sideways, or continue lower. Guess what, no one else does either.

But was has been interesting about this year is that there has been both volatility and no volatility at the same time. The stove is both hot and cold.

So it would be completely logical to expect the S&P to experience some sort of correction, either in PRICE or TIME.

But the underlying components suggest that we shouldn’t bank on it either.

There is a chance we have already seen the correction via the underlying components and the selloff in other areas.

If this is the case, the second half of this year should be strong. And will likely extend into next year.

If the S&P 500 does start to experience a correction, the likelihood is that it is relatively mild and most likely happens via a TIME correction.

In the meantime, look for opportunities to put cash to work, and stick with a disciplined risk management process.

Invest wisely!

Why We Believe in Active Management

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A businessman holding a compass to navigate the business with marketing of icons and business growth graphs, Stock market and data exchange.

In 2019, the amount of money invested in passive funds in the United States surpassed that of active funds for the first time.1 Over the last decade, passive funds have increased assets under management to $11 trillion, from $2 trillion.2 Given the title of this piece, are we saying that all that money is in the wrong place?

Our issue isn’t necessarily with passive funds – we deploy some ETFs in our investment management strategies. Our issue is with the sea-change in portfolio management that the availability of low-cost index-tracking funds has brought about. It’s the prevailing idea that you can create an effective, all-weather asset management strategy by buying a bunch of different funds that represent different asset classes.

The Commodity Trend

Our foundational insight is to turn on its head the belief that asset management has become commoditized. We believe that for much of the asset management industry, investors are the commodity. Most advisors use a one-size-fits-all pie chart strategy. They do a little tweak for your age and how far you are from retirement, and their tools spit out a portfolio recommendation with a bunch of different funds in it. Their theory is that these magical beans funds are going to work together to lower risk and maximize return.

They believe this because they are using data mostly since the early 1980’s to support their recommendation. The problem, as we discussed recently in our “Inflation Waves” report, is that almost every asset class has risen since then.

So they are looking at data that does not include some major market cycles. Specifically the one that we believe we are entering into now…one of rising interest rates and rising inflation.

The words “broadly diversified” have become a mantra, used by large and small firms alike, recommending that investors should be in all asset classes at all times. And meanwhile, broad market indexes like the S&P 500 are only getting more concentrated. It’s hovering around 27% in the IT sector, as defined by GICSs. But if we include companies like Google, Amazon and Facebook, tech exposure is close to half of the index. So, what is that doing to asset allocations?

The notion that diversification is an investment strategy that can replace a disciplined, rules-based investment process is where we draw our line in the sand.

Market Cycles are King

An asset allocation based on age is going to bump up against the realities of the world. Economies and businesses have cycles. Add in the natural human behaviors of fear and greed and you have the market cycle.

And the market cycle doesn’t care how old you are.

If you are lowering your risk during a period when market cycle signals indicate risk is low already and the potential for return is high, you are leaving money on the table. And vice versa.

Diversification Doesn’t Manage Risk

We aren’t suggesting that risk management isn’t necessary…quite the contrary. We believe the management part is important. Volatile markets require a system to manage risk. Being 50 years old or five years away from retirement isn’t a system, it’s a statistic.

Unfortunately, diversification fails exactly when you need it to work. Data shows that asset correlations rise when volatility rises. This means that when markets undergo stress, most assets fall at the same time.

The reported benefits of diversification (having assets that perform differently during different periods) simply isn’t true. In fact, the opposite what happens in the real world.

Rules Are Good

So if passive investing is not the way to go, and broad diversification isn’t all that great, what can you do?

First, we must recognize that investing is inherently emotional. We spend a lot of time with our clients to ensure that their emotions will not impinge on their investment plans. The best thing a client can say to us is that they don’t worry about the money we manage for them, and we strive for that with every client. 

We do the same thing with the money we invest. We are tactical investors that follow a rules-based process in each of our portfolios. Simply put, we look at the underlying trends and momentum in the markets to determine good and bad environments. And then we make adjustments to our client portfolios, daily, weekly, monthly – whenever we identify either an opportunity to exploit or a risk to avoid.

That might mean we are broadly exposed to different asset classes; it might mean we are relatively concentrated in our exposures. We just don’t believe that identifying asset classes and then keeping exposure to them through every environment is a successful strategy.

The goal of our process is to participate in up markets and mitigate risk in down markets. Said a different way, our goal is to do more of what’s working and less of what’s not.

Passive management cannot do that. It can only allow you to participate in up markets while also participating fully in every down market.

Ultimately, a passive investment strategy works in up markets. But that is only part of the market cycle. When the down market comes, your (or your advisor’s) emotions take control. That’s when mistakes happen.

The answer is simply to develop, test and implement a rules-based process.

If you can prove a process works in different environments, and stick to that process, then you can have confidence that your system will work during all parts of the market cycle.

That is active management. And that is what we believe works.

  1. Lowery, Annie. Could Index Funds Be ‘Worse Than Marxism’? The Atlantic. April 5, 2021.
  2. Ibid.