How Are The Year’s Investment Themes Playing Out?

2015-road

At the beginning of the year, we identified several themes that might drive investment markets in 2015. Forecasting is a hazardous process, but it’s part of the job for tactical managers who have the freedom to move portfolios according to changes in macro and market conditions.

I recently reviewed our themes for the year (written up in detail in our latest quarterly), and made a few notes regarding how those themes are playing out.

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Man Versus Machine in Investing

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Over the last couple of months, we have been preparing to expand our product offering by launching two new sets of strategies, called the Market series and the Quant series. They are offered as alternatives to our traditional strategies, now referred to as the Prime series, for a chance to help our current and future clients achieve their financial goals. While the Market series and the Quant series are different under many aspects, they share one important feature: under both strategies, a portion of the client’s portfolio is managed according to a rules-based, quantitative model developed in house at Pinnacle. Diversification has always been a core tenet of Pinnacle’s investment process and the way we manage risk. However, with this move, Pinnacle has now further expanded the diversification it offers to clients to a new dimension of risk: decision risk. While the Pinnacle traditional (now Prime) strategies rely primarily on the time-proven judgment, experience, and intuition of the members of the Investment Team, the new strategies are based on a rules- based decision-making process that is more objective and unemotional. In Pinnacle jargon, we say the Prime strategies are subject to manager risk, while the new strategies are subject to model risk. Modern Portfolio Theory tells us that by combining different sources of uncorrelated risks, we can move our portfolio farther out in the efficient frontier and achieve a better expected return-to-risk ratio.

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Evidence of A Slow Down?

slowdown

The MACD (Moving Average Convergence Divergence) Indicator is one of many tools in a market technician’s toolbox. The indicator takes two moving averages (usually the 12 period and the 26 period exponential moving averages) and converts them into a momentum oscillator by subtracting the longer period from the shorter period. There are a variety of ways to interpret the MACD indicator, but for right now we are focusing on signal crossovers. To do that we also create a 9 period exponential moving average of the MACD for use as a signal line.

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Riding an Aging Bull (Market)

Old Bull (Market)

The year has begun in roller coaster fashion, and our team has been busy reading and digesting the many 2015 outlooks that come across our desks. But reading is the easy part, and now it’s our turn to distill the many facets of our process into a workable thesis that allows us to generate attractive risk-adjusted returns in this maturing market cycle. As tactical managers, we’re well aware that forecasts are always fraught with risk, but we also realize that in order to look forward, we need to have views that set the tone for the portfolio in the coming year. Below is our best articulation of how we see the investing world shaping up over the next year or two. Our aim is to inform you of our views, and to explain how they affect current asset allocation decisions.

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How to Pay for College: Three Strategies

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At this time of year, many families with college bound children are busy navigating the financial aid application process. A college education, long viewed as a pathway to the American Dream, remains a desirable goal for many, with some studies indicating as much as a 75% increase in earning power over the course of a career through the attainment of a degree. However, the soaring costs of higher education in recent decades have even middle-to-high income families wondering how best to fund this endeavor without jeopardizing their retirement or leaving their children saddled with huge debt. Finding the most efficient and beneficial path involves an understanding of both financial aid eligibility, as administered through the relevant government regulations and University policies, and the savings vehicles and strategies available to consumers.

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Investing and Hindsight Bias

rearview mirror

The current bull market has been steaming ahead since the market bottomed in March 2009. Consumers of investment advice have noted that passive, buy and hold strategies have outperformed most active strategies over this time period, giving some the false impression that ‘risk management,’ in the context of tactically changing portfolio asset allocation to defend against bear markets, is a fools game.

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Tax Loss Harvesting is All About Timing

Tax loss harvesting

Tax Loss Harvesting is a subject that usually comes to the minds of investors’ right before the end of the year when they start thinking about taxes. While that is fine, we like to be a bit more tactical in finding the right opportunities to harvest losses throughout the year. Investments can be volatile and it’s entirely possible that an opportunity to harvest losses may arise earlier, only to disappear before year-end. It is of course preferable to have a loss disappear because you’ve either made money or broken even. Nevertheless, there is some strategy involved in finding an asset with a short-term loss, selling that asset, and buying another in its place in order take advantage of the tax deferral. This strategy can work to your advantage, when used at the right time.

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Quit Rate Confirms the Jobs Momentum

Resigning

The U.S. jobs markets may still have some structural problems to work out, but cyclical trends in employment have been on an upward trajectory for most of this year. At Pinnacle we monitor a broad array of employment indicators that have been ticking in a positive direction; here are a few examples:

  • Non-farm payrolls have been over 200,000 for nine straight months. The unemployment rate has decelerated to 5.8% and is clearly trending down.
  • Unemployment Claims 4-Week Moving Average, one of our favorite leading indicators of the job market, has been persistently under the 300,000 level for many weeks.
  • Surveys of jobs hard-to-get are falling while surveys of job openings are picking up.
  • Employment components within small business and regional Federal Reserve surveys are trending up.
  • The Employment Trends Index continues to move in a positive direction.

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The Return of the Home Builders

Homebuilding

According to the National Association of Home Builders (NAHB):

The Housing Market Index (HMI) is based on a monthly survey of NAHB members designed to take the pulse of the single-family housing market. The survey asks respondents to rate market conditions for the sale of new homes at the present time and in the next six months as well as the traffic of prospective buyers of new homes.

Our proprietary work shows that the HMI Index is negatively correlated to changes in interest rates, with a lag of about one year. This means that when interest rates fall (or rise), the HMI index tends to move in the opposite direction a year later. The rationale behind this relationship is simple: lower interest rates make new homes more affordable, thus leading to a brighter outlook for housing, as measured by the HMI index. In turn, increases in the HMI index typically coincide with better performance for home builders stocks.

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