PORTFOLIO PROTECTION: HOW WE ANTICIPATE MARKET MOVEMENT

Posted June 28, 2012 by admin. tags:Tags: , ,
Be Prepared


Written by Dave Young, President of Paragon Wealth Management

At Paragon we follow the mantra of the three “P’s” – Private, Proactive, and Protective. These guiding principles direct our unique approach to investment and wealth management. I thought this would be a good time to focus specifically on the Protective side of our investment approach – what we do to monitor and benefit from market movements.

In one of my newsletters, I wrote about how a consistent investment program can minimize the negative effects of inevitable market downturns. Unlike many advisors who talk about accepting what the market gives, we embrace the challenge of getting the best the market has to offer while avoiding the worst. Our portfolios are designed to maintain and/or accentuate the positive movements of the markets while limiting the negative movements. A pretty tall order, right? Well, what else do you hire an investment manager for?

We are often asked about the criteria we use to choose investments for maximum investor benefit. The protective aspect of our investment philosophy leads us to perform quantitative analysis that considers many market indicators to help determine market risk. What is quantitative analysis? I’m glad you asked. Investopedia defines quantitative analysis as “a business or financial analysis technique that seeks to understand behavior by using complex mathematical and statistical modeling, measurement and research.” In other words, it’s a way to objectively measure things.

In the investing world, quantitative analysts are usually stereotyped as pure numbers people who disregard the qualitative aspects (management expertise, industry cycles, labor relations, etc.) of companies or markets. Many investment managers will often adhere to one type of analysis (fundamental vs. technical) while eschewing all others. This is usually a result of their training, education and experience. We find this to be a narrow and incomplete point of view. We don’t believe that any one style of analysis can give a full picture of market behavior by itself. They all have advantages and disadvantages, and we feel it most effective to use the best elements of each style.

At Paragon, we employ a type of quantitative analysis that incorporates fundamental, technical, behavioral and qualitative factors. These quantitative indicators give us a feel for the market at the present time. They help us determine where the strength of the market is, the degree of the strength and any changes in strength that appear to be occurring. We use them to find out what other market participants are actually doing and what they think about both the current market and where it might be headed.

One of the primary models we use is based upon a composition of monetary, economic, valuation and sentiment indicators. This model attempts to identify periods of outperformance and underperformance of the stock market by gauging the external environment of the market while staying in harmony with the primary trend.

Another one of our favorite models is a sentiment model that uses a variety of indicators to measure investor psychology and the changes in attitude as they occur. This model indicates what percentage of all investors can be classified as bullish on the stock market at any given time. This allows us to anticipate reversals in investor psychology, and thus the market. Our policy is to mirror the general sentiment until it reaches an extreme, at which point we take a contrary position. High bullish sentiment has frequently coincided with intermediate-term peaks in stock prices. Conversely, when sentiment has fallen to low levels (meaning investors are bearish), markets have typically been near a bottom. By understanding sentiment we can take advantage of these market movements by anticipating them before they occur.

Another type of sentiment indicator we rely on uses the CBOE Equity Put/Call ratio. When sentiment gets extreme we can use this information to anticipate market movements that are contrary to the general expectations. Put/call ratios track the activity of highly speculative options traders, who are notorious for being wrong when taking extreme action. In practical terms, this means that the S&P 500 tends to perform poorly when an extreme in optimism has been reached. Conversely, extreme pessimism is often accompanied by high market performance. By keeping our eye on put/call ratios we can identify the extreme sentiment levels that tend to precede reversals in the market and move our investments accordingly.

Other models that we use measure items such as earnings yields, Treasury bill yields, price/dividend ratios, median price/earnings ratios and the number of stocks hitting 52 week new highs or lows. By watching each of these indicators we can get a well-rounded picture of the current state of the market as well make good educated guesses about what will happen next.

Our general policy is to stay invested in the market, using these models to assess overall market risk. When our indicators signal an increase in risk, we reduce our exposure to the market by degrees while keeping the majority of the portfolio invested. Only rarely do they signal for us to be entirely out of the market.

While these models do measure a great many financial indicators, they can’t eliminate risk altogether. Many market events are simply unpredictable. The markets, like life, are full of the unexpected, and the only way to succeed is to stay in the game, keep your head up and be as informed as possible.

Disclaimer
Paragon Wealth Management is a provider of managed portfolios for individuals and institutions. Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy. All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Past performance is not a guarantee of future results.

Market Forecasting – Investors Beware (continued)

Posted June 21, 2012 by admin. tags:Tags: ,
Rolling the dice

Written by Dave Young, President of Paragon Wealth Management

Market professionals are not alone in their inability to forecast market behavior. Economists do just as poorly. Every six months the Wall Street Journal prints the results of a survey of leading economists who predict the level and direction of interest rates for the coming six months. 55 high profile economists currently participate in this semiannual forecast. You’d think such prestigious economists in such a high profile newspaper would know what they’re talking about , right? Nope.

The record shows that from 1982 through the beginning of 2003 (43 periods), 71% of the time the consensus of economists could not even forecast the direction of rates, either up or down, for six months forward. If they’d just blindly guessed they’d have a 50/50 chance, but their actual educated predictions turn out to be much worse. And these are the best the industry has to offer!

So if forecasts are a waste of time then what does work? After 20 years of managing money, I am convinced that investors will only succeed when they are able to remove emotion from the investment process. Gut feelings are not a reliable investment strategy-even the gut feelings of so-called experts.

Oftentimes, successful investing requires you to act in a way that is contrary to what you “feel” is right. For example, several of our models measure the overall optimism or pessimism in the investing public. When optimism is high we know that there’s a lot of risk in the market and it’s likely that the market will decline. Likewise, when optimism is low and most investors think that things are really bad, that is usually a great time to invest. This pattern has repeated itself for years.

We take great care to ensure that all of our investment decisions are based on solid, proven models, not hunches. Our portfolio allocation models tell us how much we should be invested based on measured risk in the market. We run the models daily to determine the most effective percentages of investments and cash holdings.

Once we’re in the market, our portfolio focus models tell us where we should be invested. We constantly track all areas of the equity markets on both a macro scale (small cap, mild cap, large cap, value, growth, international and emerging markets) and a micro scale (individual industries, sectors and countries).

The bottom line for Paragon Wealth Management’s clients is that they can be confident that their portfolio isn’t being managed by some celebrity market fortuneteller. Our quantitative models enable us to impartially measure what is actually happening in the market and how much risk there is at any point in time. We constantly evaluate the models to determine how effectively they are working. In my opinion, this is one of the best ways to invest for long term success.

Click here to read the first half of the article.

Disclaimer
Paragon Wealth Management is a provider of managed portfolios for individuals and institutions. Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy. All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Past performance is not a guarantee of future results.

It’s All Greek To Me

Posted June 14, 2012 by admin. tags:Tags: , , ,
Greece

photo by spixpix

Written by Nathan White, Chief Investment Officer, Paragon Wealth Management

The much anticipated Greek elections this weekend promise to produce some potential market fireworks next week.  It seems to be a toss-up as to what the outcome will be and even if the pro-Euro side wins and the market rallies significantly it could be very short-lived.  Right now in the short-term bad news is good news for the market because it increases the odds that the central bankers will come to the rescue.  Case in point – today the markets were tailing off mid-day until a rumors spread that central banks were planning coordinated action in response to what might happen in Greece over the weekend.  The Dow immediately shot up about 200 points in minutes.  Markets love their sugar!

Trying to predict what will happen to the markets in the face of all this uncertainty and volatility can be very hazardous.  It can be very easy to make the bear case but then again so many are making the bear case and buying very expensive protection that perhaps the risks are priced in and any news to the contrary creates violent short squeezes.  In the end the Europeans won’t willingly throw themselves off the cliff.  However, they only move when the markets force them to and by continually dancing next to the cliff they run the very real risk of making a mistake and falling off.  I could go on making the bull and the bear case as both sides have valid points that I agree with but in the end I don’t know how it will all play out.

So what’s an investor to do?  In the long-run (which is what investing is) these short-term “events” won’t even matter.  Markets recover as they always have.  However, these headline events stir people’s emotions and then mistakes are made – something I have talked about in length in previous writings.

We have been raising cash in our portfolios to take advantage of the possible volatility events created by the European crisis.  I look at volatility as an opportunity rather than a risk.  Any sell-off based upon a Greek or Spanish meltdown would probably tend to be violent and short-lived and force the final endgame of the European mess.  As equities are already cheap they would become absolute bargains and this could be a great opportunity and therefore we feel it is prudent to have some dry powder!  However, as stocks are already cheap and pessimism abounds markets could already have priced in the risks and the central bankers could act before a meltdown causing the markets to move higher.  For this reason were are still 75% to 90% invested across our various portfolios/models.  This way if markets move up we will participate and if they move down we have money ready to be put to use.  Seems to be the best trade-off at the present time.

Over the horizon the elections and “fiscal cliff” worries promise another possible round or “opportunity” or volatility…

Disclaimer
Paragon Wealth Management is a provider of managed portfolios for individuals and institutions. Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy. All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Past performance is not a guarantee of future results.  

Market Forecasting – Investors Beware

Posted June 7, 2012 by admin. tags:Tags: , ,
Market Forecast

Written by Dave Young, President of Paragon Wealth Management

Clients who have been with us for years know we aren’t big fans of market forecasts, whether they are made by us or anyone else. Let me tell you why I believe so strongly.

In the January 14, 2008 edition of By the Numbers from Direxion Funds, they published a report showing how the forecasters did last year. The year 2007 appears to be a different year, but the same story. One thing the forecasters can claim is consistency because they are consistently WRONG!

The average prediction made on January 1, 2007 by 58 Wall Street forecasters for the yield on the 10-year Treasury note as of year-end 2007 was 4.88%, an increase of +0.17% over its 4.17% level from December 31, 2006. Instead the actual December 31, 2007 yield did not rise from a year earlier, but fell to 4.02% (source: BusinessWeek).

There’s no shortage of self-proclaimed market prophets. You can find them in the investment magazines, newspapers or CNBC. Although they can be entertaining, they provide no real investment value. They do not help anyone make money. In fact, investors who follow them are more likely to lose money than to gain it.

The way the forecasting game works is that the market guru, seer, pundit or executive continually makes forecasts in an attempt to gain public attention. By sheer luck maybe half of these predictions are proven right-meaning that at least half of them are wrong. On the occasions when the forecast turns out to be correct, the forecaster plays it up. Those many forecasts that don’t pan out (and those many investors who are financially hurt by them) are never spoken of again. In truth, you’re much more likely to get an accurate prediction of the future by listening to the weather forecasters. At least they inflict less damage when they’re wrong.

Ned Davis Research and InvestTech recently collaborated to analyze the forecasts of some of the most highly paid and highly regarded market forecasters in the financial industry. This is a small sampling of the findings:

* Out of the 22 high profile panelists on Louis Rukeyser’s Wall Street program for 2001, none predicted the market to close as low as it did that year.

* Out of the 22 high profile panelists on the same program for 2002, none expected the low close at the end of that year either.

* In 2000, at the prestigious Barron’s Roundtable, one of the 11 Wall Streetstrategists had a forecast that was close to being accurate.

* At the 2001 Barron’s Roundtable, two of the 12 forecasters were close to the actual market year end close.

* In 2002, two of the 11 Barron’s Roundtable participants were close.

* In the 2000 issue of Business Week, 52 of the 55 experts (95%) who forecast the year-end level of the S&P 500 were wrong.

* At the beginning of 2002, Business Week again held their survey of “the smartest players on Wall Street.” The consensus forecast of the 54 participants for the S&P 500 was 1292. The actual close was 32% lower at 880. Not a single esteemed participant came close to the actual close.

These findings may seem shocking to someone encountering them for the first time, but they are far from atypical. This is just a small snapshot of how bad the market forecasting business really is. Yet despite mountains of data that show how ineffective the celebrity market forecasters are, they continue to make their predictions and many unfortunate people continue to base their financial decisions on shoddy, unproven advice.

To be continued…

Disclaimer
Paragon Wealth Management is a provider of managed portfolios for individuals and institutions. Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy. All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Past performance is not a guarantee of future results.  

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