Thursday, July 3, 2014

Wall Street Says Investors Have Nowhere Else To Go. Really?


Wall Street Says Investors Have Nowhere Else To Go. Really?

How many times have you heard a talking head on a business news channel say that stocks will continue to go higher because, thanks to the Fed’s zero-interest rate policy, stocks are the only game in town?  Stocks have been rallying brilliantly for more than five years with only a few temporary setbacks along the way.


Source: britefutures.com

How much of the rally in stocks is due to the Fed’s money-printing activities?  How do we know that the Fed has not created another asset bubble?  If so, is there another bubble ready to burst as the Fed winds down its quantitative easing program? Are there alternative investments to simply being long stocks? 

The answer is yes!  Now is the time when investors should be taking a hard look at their portfolio and make sure their investments are as diversified as possible.  After the S&P 500 rallied over 30% in 2013 and a number of high profile momentum stocks rallied even more, now is the perfect time to diversify.

We are not saying that investors should sell all of their stock investments and run for the hills.  What we are saying is that investors should be diversified among a mix of non-correlated investments.  In the 2008 bear market, it was said that all asset classes were correlated with the stock market as investors rushed to sell everything and anything in a rush to raise cash.  Real estate, gold and crude oil each fell with stocks as positions were liquidated.  However, investors who were long treasuries in 2008 benefited from a huge rally.  Some managed futures and automated trading programs also performed well in the 2008 bear market. 

So all asset classes were not positively correlated with the 2008 stock market crash after all!
What does it mean to be non-correlated?  Correlations range from -1 to +1 with zero indicating non-correlation.  If an investment’s correlation with the S&P 500 is close to -1; that means that its price moves inversely with the S&P 500.  According to Moore Research Center, Inc., 10-Year Treasury Note futures and S&P 500 futures have a correlation coefficient of -0.31.  The Dow Jones Industrial Average and the S&P 500 are nearly perfectly correlated at +0.98.  In order to achieve the best diversification and optimize a portfolios return, it is important to find an investment whose performance is non-correlated with other investments in a portfolio.  So-called “alternative investments” can offer non-correlated returns (with the S&P 500).

There are a number of alternative investments options, but not all of them are accessible to individual investors.  For example, timberland, rental properties or real estate investment trusts can be great investments, if you have enough cash or access to capital.  Risk tolerance is another key factor for investors.  If you cannot tolerate risk, your investment options are very limited.  Issues of liquidity and transparency are also a concern.  The point is that each investor is unique and what may be appropriate for one investor may not be the right fit for another.

An often overlooked diversification opportunity is managed futures and self-directed systematic trading.  These are two different categories of investments within the futures industry.  Like a mutual fund, managed futures are completely hands-off.  All trading decisions are made by the account manager.  Managed futures include:
  • Commodity Trading Advisor (CTA) accounts – individual futures accounts managed by a registered CTA.
  • Commodity Pool – commodity pools are often used by hedge funds and are managed by a registered Commodity Pool Operator (CPO).  A commodity pool is similar to a mutual fund in that investor funds are pooled with other investor funds in one account.
Self-directed systematic trading? That may sound contradictory, so let me explain. It is possible for individuals to follow the trade signals of automated trading systems in real time. Recent innovations in trade platforms and execution services have empowered investors that prefer to follow 3rd party trade signals with the ability to turn on or turn off the trade signal depending on perceived market conditions and with only a few clicks of the mouse. 

Although, I recommend turning a system on and letting it run with the expectation that drawdowns can and will occur with any system. Actively turning systems on and off introduces human emotion and can defeat the advantage of an objective and systematic approach. When selecting an automated trading system, maximum historical drawdowns should be noted, however that is no guarantee that a future drawdown will not exceed the prior maximum drawdown. 

With as little as $10,000, individual investors can choose a system and let the trading program do the work. Both managed futures and automated trading systems can eliminate human emotion and long hours in front of a computer, key barriers to success for most investors.

Just because a trading system performed well in 2008 does not mean that it performed poorly in 2013, or that it will perform well again in a similar environment. There are plenty of trading systems and strategies that can perform well at the same time the stock market is rising or falling. This is what we mean by choosing investments that are non-correlated. For most investors, this means choosing investments with performance that is independent of the performance of their primary investment in equities or fixed income securities.
About the Author: Mike Armbruster co-founded Altavest in 1997, (altavest.com) a licensed Introducing Broker, Commodity Trading Advisor and Commodity Pool Operator.  Altavest offers diversification opportunities via its proprietary ThetaTrader and iSystems trading platforms.  Altavest, in conjunction with its educational affiliate, FuturesANIMAL (www.futuresanimal.com), educates clients via live webinars and in-person seminars.  Altavest offers full-service trading advisors at discounted commission rates as well as managed account and automated trading services.

Risk Disclosure: © 2014 Altavest. There is a risk of loss in trading futures & options. Past performance may not be indicative of future results. Proprietary automated trading software cannot be resold.

2 comments:

Alternative assets can help to diversify anyone's stock portfolio and are well worth further investigation.

I agree with you statement.

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