Media = Emotion

Should you pay attention to the media? Or the primary trend of the stock market?

Crash? Correction? Or Change in Primary Trend?

With the recent stock market decline I wanted to take this opportunity to reiterate to all clients, both old and new, how we attempt to differentiate between a stock market crash, price correction, and potential change in primary trend using the BLUE LINE INVESTING® (BLI) process. In doing so, I will attempt to do my best to limit my use of technical terms to help relay these concepts in a manner that may be easier to comprehend.

First, let’s define these three terms as follows:

Stock Market Crash – A rapid and often unanticipated decline in stock prices. Two historical examples could include October 1929 and October 1987. In 1929 the stock market declined by approximately 33% from the high to the low, and in 1987 the stock market declined by approximately 31% from the high to the low.

Stock Market Correction – A decline in the market price after extensive price increases. This can occur even when there is no evidence that the increasing price trend should end. A price change of 10% or more from the peak high is common.

Change in Primary Trend – A transition that tends to occur over the course of a few months where prices that have been in a long-term rising trend invert and begin a short-to-intermediate declining trend (or vice versa). One of the better examples of a change in primary trend from positive to negative began back in October 2000 and ended in March of 2003. Over that 30-month period the stock market declined by approximately 49% from beginning to end.

It is somewhat concerning that as I am writing this article it becomes apparent that the examples above all began in the month of October. But moving along, what can be observed right now?

First, using the S&P 500 Index (S&P)¹ as our reference point, the price decline has so far been almost exactly 10% from the recent high earlier this month. So, according to the definitions above it does not fall under the definition of a crash but definitely a correction. So with that said, what would have to happen from here to redefine this recent price decline as a change in primary trend?

Please click here to review the BLI sell process rules and refer to page 7 of the Case Study on the S&P. First, with this month’s price decline, the primary trend can no longer be categorized as positive since the S&P has declined below its Blue Line by over 3%. The primary trend must now be changed to neutral.

Second, as can be seen by our sell process rules, created from historical patterns observed from the S&P dating back to 1926, if the S&P declines by at least 5% below the Blue Line it would trigger a Phase 1: WARNING of a possible change in trend. Since that has not happened yet I will leave off explaining Phase 2 and Phase 3 further. But to visualize what this tends to look like visually, please refer to the following chart of EWI, an exchange-traded fund owning stocks from the country Italy, courtesy of StockCharts.com.

From the recent high, EWI declined by over 7% to the Blue Line. Through today, price has declined an additional 18% since completing Phase 2 and Phase 3. In total, the price decline over the past six months has been approximately 25%. For additional examples of stocks that have experienced these three phases in recent years and their resulting outcomes, check out General Electric and Kraft Heinz Co.

So far the S&P has not triggered a Phase 1:WARNING – yet. But if it does in the days or weeks to come, I believe it will be important to follow the BLI sell process to attempt to limit significant losses that could be on the horizon. Until then, we patiently wait and observe the patterns.

For comparison of what the S&P looks like right now in light of EWI above, please see the chart below.

As I conclude this article, allow me to make one additional comment. On occasion, the BLI process attempts to implement partial protective hedges using inverse exchange-traded funds (ETFs) either preceding or during price corrections. Sometimes they are successful and sometimes they are unsuccessful. But it is only upon a Phase 3: CONFIRMATION event that our process may attempt to profit from a broad-based, stock market downturn, buy using inverse ETFs exclusively. We must have complete belief and conviction that the primary trend has in fact changed from neutral to negative, something that is not remotely close at the present time.

Jeff Link

Founder of the BLUE LINE INVESTING® process

Disclaimers:

Blue Line Investing (BLI) is an alternative to traditional wealth management. BLI uses a disciplined, rules-based investment process to seek investment opportunities, regardless of whether financial markets are rising or falling. Based on technical analysis research, the process applies trend-following using specific Exponential Moving Averages (EMAs) of the market along with other technical indicators. A moving average is a widely used indicator in technical analysis that helps smooth out past price action by filtering out the “noise” from random price fluctuations. EMA’s can be calculated for any time period. Some examples include the 5 day EMA; 50 day EMA; and 150 day EMA. We have attempted to simplify this by calling the various EMAs we use in our process the “Blue”, “Purple” and “Green” lines.

¹ The S&P 500 Index is one of the most commonly followed equity indices, and many consider it one of the best representations of the U.S. stock market, and a bellwether for the U.S. economy. It is comprised of 500 large companies having common stock listed on the NYSE or NASDAQ. The volatility (beta) of the account may be greater or less than the index. It is not possible to invest directly in this index.

 Technical analysis is a method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volumes. Technical analysis attempts to predict a future stock price or direction based on market trends. The assumption is that the market follows discernible patterns and if these patterns can be identified then a prediction can be made. The risk is that markets may not always follow patterns. There are certain limitations to technical analysis research, such as the calculation results being impacted by changes in security price during periods of market volatility. Technical analysis is one of many indicators that may be used to analyze market data for investing purposes and should not be considered a guaranteed prediction of market activity. The opinions expressed are those of Blue Line Investing. The opinions referenced are as of the date of publication and are subject to change without notice. Blue Line Investing reserves the right to modify its current investment strategies based on changing market dynamics or client needs.

Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The information contained herein should not be considered a recommendation to purchase or sell any particular security. This information is intended for educational purposes only and should not be considered financial advice. It should not be assumed that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein. Forward looking statements cannot be guaranteed. 

Advisory services offered through Gordon Asset Management, LLC (GAM). GAM is an SEC-registered investment adviser. Registration does not imply a certain level or skill or training. More information about the advisor, its investment strategies and objectives, is included in the firm’s Form ADV Part 2, which can be obtained, at no charge, by calling (866) 216-1920. The principle office of Gordon Asset Management, LLC is located at 1007 Slater Road, Suite 200, Durham, North Carolina, 27703.

AN EFFECTIVE HEDGE

Price volatility is the price all investors must pay when attempting to increase their wealth through the stock market. And while few complain about price volatility when stock prices rise, some complain, or at least become more concerned, when stock prices decline. Today I want to provide an example of how some investors can apply a protective hedge to their investment portfolios during periods when stock prices are correcting, as they have been in recent weeks.

Before continuing this article, I suggest you first read an article I wrote back in 2016 titled “Attempting to Profit From Falling Prices” that can be found here. As was highlighted in that article there are ways to attempt to profit from falling stock prices, and one particular way is by using inverse Exchange-Traded Funds (ETFs). But that article pertained to stock markets that were already in a negative primary trend. Since we currently believe the stock market continues to remain in a positive primary trend, we believe our goal should be to add a protective hedge to some of our existing investments to attempt to help limit financial losses. Here’s how we do this within our process, and if you have your own process, I believe you can do it too. Before proceeding, allow me to set the stage using technical analysis for illustration.

Look at the chart below of the Vanguard S&P 500 ETF, representing the past twelve months of price activity, courtesy of StockCharts.com.

The red arrow illustrates the point where price began to decline in earnest, or approximately $265. Within a few days price dropped 6 ½% lower to $248. But notice that on this decline price stopped just short of the gray line – a previous technical resistance and support zone that was established earlier this calendar year. When prices began to rally, our expectation – according to technical analysis – should be for prices to retrace 50% of the recent decline, which would be approximately $256.50. That number becomes our target. As it turns out, price rallied to approximately $258, a little farther than expected. But now we come to the purpose of this article – how to implement a protective hedge using inverse ETFs.

Let’s assume you own VOO in your investment portfolio. Based on the technical information observed above, if you believe that prices will soon resume their decline after the “bounce” you could add an inverse ETF, such as SH, to your portfolio that is an inverse ETF to the S&P 500 Index. By doing so, you are attempting to limit further losses on your investment in VOO without having to sell it. Look at the next chart of SH, courtesy of StockCharts.com.

This chart shows that SH performed in an almost exact opposite manner to VOO from the time of purchase. So, if you purchased SH on the “bounce,” based on some percentage of your investment in VOO, you could have effectively “hedged” some or most of your risk in VOO. This “hedge” can help you reduce or eliminate your downside price volatility depending on how much of SH you bought, and the specific price when you purchased it.

The next step will entail deciding when to sell your investment in SH, since this may not be an investment you want to own for very long. In my next article I will illustrate what we are currently monitoring to help with that decision.

Thank you for reading and please share this article with anyone you believe may find it of benefit. We hope this article helps you learn how to view the stock market from two dimensions, rather than one, and how you can take proactive action to attempt to protect some of your stock investments against declining price volatility.

Jeff Link

 

Disclaimers:

Blue Line Investing (BLI) is an alternative to traditional wealth management. BLI uses a disciplined, rules-based investment process to seek investment opportunities, regardless of whether financial markets are rising or falling. Based on technical analysis research, the process applies trend-following using specific Exponential Moving Averages (EMAs) of the market along with other technical indicators. A moving average is a widely used indicator in technical analysis that helps smooth out past price action by filtering out the “noise” from random price fluctuations. EMA’s can be calculated for any time period. Some examples include the 5 day EMA; 50 day EMA; and 150 day EMA. We have attempted to simplify this by calling the various EMAs we use in our process the “Blue”, “Purple” and “Green” lines.

Technical analysis is a method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volumes. Technical analysis attempts to predict a future stock price or direction based on market trends. The assumption is that the market follows discernible patterns and if these patterns can be identified then a prediction can be made. The risk is that markets may not always follow patterns. There are certain limitations to technical analysis research, such as the calculation results being impacted by changes in security price during periods of market volatility. Technical analysis is one of many indicators that may be used to analyze market data for investing purposes and should not be considered a guaranteed prediction of market activity. The opinions expressed are those of Blue Line Investing. The opinions referenced are as of the date of publication and are subject to change without notice. Blue Line Investing reserves the right to modify its current investment strategies based on changing market dynamics or client needs.

Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The information contained herein should not be considered a recommendation to purchase or sell any particular security. This information is intended for educational purposes only and should not be considered financial advice. It should not be assumed that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein. Forward looking statements cannot be guaranteed.

Advisory services offered through Gordon Asset Management, LLC (GAM). GAM is an SEC-registered investment adviser. Registration does not imply a certain level or skill or training. More information about the advisor, its investment strategies and objectives, is included in the firm’s Form ADV Part 2, which can be obtained, at no charge, by calling (866) 216-1920. The principle office of Gordon Asset Management, LLC is located at 1007 Slater Road, Suite 200, Durham, North Carolina, 27703.

Distinguishing a Price Correction from a Change In Trend using the Blue Line

With the current stock market correction in full gear we thought this would be a great time to expound on the comment we made in an article posted on January 26th – “Is the DOW within 3% of a temporary top?” Why would we say “temporary” rather than just “top?” We believe the answer can always be found with the Blue Line.

At the time of this writing, the S&P 500 Index² (S&P) has dropped 7 ½% in under two weeks. But even with that drop the S&P still remains above the Blue Line. Since 1980, the first thing that has to happen before the market can transition into a Negative Trend is price has to drop below the Blue Line. Right now the market is still 4% above the Blue Line (but we would not be surprised to see it drop below the Blue Line before this corrective phase is over). Therefore we continue to believe this to be a “temporary” top and not THE “top.”

So historically speaking, what are some examples of price corrections in the S&P worse than the present that did not cause an end to the bull market that was in process at that time?

1987     30% price correction from October to December (3 months)

1998     21% price correction from July to September (3 months)

2010     16% price correction from April to July (4 months)

2011     18% price correction from July to September (3 months)

2014     09% price correction from September to October (2 months)

Even in 1987, during the long bull market in the Tokyo Nikkei 225 Index ($NIKK), the NIKK experienced a 20% price correction from October through November (2 months) before continuing the bull market.

So what do we expect from here? We expect the stock market to experience a price bounce in the coming days or maybe weeks. We intend on making some strategic changes to our strategies at that time in an effort to protect against what could be another decline that occurs thereafter. We expect the markets to touch the Blue Line before this corrective phase is over. For new clients to Blue Line Investing, the Blue Line is our preferred purchase point when clients are holding cash in their accounts, as well as to invest money held within cash equivalents within our BLUE LINE INVESTING™ Strategies.

Of course, anything can happen, but we are making preparations based on what we expect may happen. If the data changes from what we expect, we will modify our plan accordingly.

Please do not hesitate to call us at the number at the top of the page with any questions or concerns. As a value-added service to our clients, we would be happy to talk with family, friends, or co-workers who may be concerned during the current price correction.

Jeff Link

Disclaimers:

¹ Blue Line Investing (BLI) is an alternative to traditional wealth management. BLI uses a disciplined, rules-based investment process to seek investment opportunities, regardless of whether financial markets are rising or falling. Based on technical analysis research, the process applies trend-following using specific Exponential Moving Averages (EMAs) of the market along with other technical indicators. A moving average is a widely used indicator in technical analysis that helps smooth out past price action by filtering out the “noise” from random price fluctuations. EMA’s can be calculated for any time period. Some examples include the 5 day EMA; 50 day EMA; and 150 day EMA. We have attempted to simplify this by calling the various EMAs we use in our process the “Blue”, “Purple” and “Green” lines.

² The S&P 500 Index is one of the most commonly followed equity indices, and many consider it one of the best representations of the U.S. stock market, and a bellwether for the U.S. economy. It is comprised of 500 large companies having common stock listed on the NYSE or NASDAQ. The volatility (beta) of the account may be greater or less than the index. It is not possible to invest directly in this index.

³ The Nikkei 225 is a stock market index for the Tokyo Stock Exchange (TSE). It is a price-weighted index, operating in the Japanese Yen, and its components are reviewed once a year. Currently, the Nikkei is the most widely quoted average of Japanese equities, similar to the Dow Jones Industrial Average. The volatility (beta) of an account may be more or less than an index. It is not possible to invest directly in an index.

Technical analysis is a method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volumes. Technical analysis attempts to predict a future stock price or direction based on market trends. The assumption is that the market follows discernible patterns and if these patterns can be identified then a prediction can be made. The risk is that markets may not always follow patterns. There are certain limitations to technical analysis research, such as the calculation results being impacted by changes in security price during periods of market volatility. Technical analysis is one of many indicators that may be used to analyze market data for investing purposes and should not be considered a guaranteed prediction of market activity. The opinions expressed are those of Blue Line Investing. The opinions referenced are as of the date of publication and are subject to change without notice. Blue Line Investing reserves the right to modify its current investment strategies based on changing market dynamics or client needs.

Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The information contained herein should not be considered a recommendation to purchase or sell any particular security. This information is intended for educational purposes only and should not be considered financial advice. It should not be assumed that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein. Forward looking statements cannot be guaranteed.

Advisory services offered through Gordon Asset Management, LLC (GAM). GAM is an SEC-registered investment adviser. Registration does not imply a certain level or skill or training. More information about the advisor, its investment strategies and objectives, is included in the firm’s Form ADV Part 2, which can be obtained, at no charge, by calling (866) 216-1920. The principle office of Gordon Asset Management, LLC is located at 1007 Slater Road, Suite 200, Durham, North Carolina, 27703.

Be Mindful of Complacency

The illustration above highlights the calendar year performance for the S&P 500 Index (S&P)² since 1928. Do you know what percent of those years the stock market was positive or flat compared to negative? The answer is 71% and 29%. Historically, stock market investors have been favored by a positive ratio of approximately 2-1. But should this ratio bias their investment decisions and cause complacency? How easy it can be to forget that price volatility within individual calendar years can be significant.

Consider 1987 as an extreme example. The S&P began January 1987 around 242 and rose to 336 by the end of August, rising almost 39% over that time. By the beginning of December it dropped to 225, declining almost 33%. By the end of the year it scratched its way higher to close at 247. So even though in hindsight the S&P finished the year in the positive by a boring few percent, the actual experience for the investor was anything but boring.

When experiencing positive trends like at present, with downside price volatility almost nonexistent, can investors become too complacent with investment decisions; specifically, how they manage risk? After all, stock markets rise and fall. Prices ebb and flow. Before becoming eager to chase new money into what seems to be a runaway stock market we believe you should pause, take a step back, and reflect on what history has taught us. Rather than buying more stocks with the expectation they will continue to rise, maybe it is time to challenge your perspective. Rather, we believe it may be prudent to begin looking for opportunities to add protective hedges to your existing investments in an effort to help protect any unrealized gains during the next price correction. We will discuss one way to attempt to accomplish this in one of our upcoming articles.

Jeff Link

Disclaimers:

Illustration courtesy of Macrotrends – www.macrotrends.net/2526/sp-500-historical-annual-returns.

¹ Blue Line Investing (BLI) is an alternative to traditional wealth management. BLI uses a disciplined, rules-based investment process to seek investment opportunities, regardless of whether financial markets are rising or falling. Based on technical analysis research, the process applies trend-following using specific Exponential Moving Averages (EMAs) of the market along with other technical indicators. A moving average is a widely used indicator in technical analysis that helps smooth out past price action by filtering out the “noise” from random price fluctuations. EMA’s can be calculated for any time period. Some examples include the 5 day EMA; 50 day EMA; and 150 day EMA. We have attempted to simplify this by calling the various EMAs we use in our process the “Blue”, “Purple” and “Green” lines.

 ² The S&P 500 Index is one of the most commonly followed equity indices, and many consider it one of the best representations of the U.S. stock market, and a bellwether for the U.S. economy. It is comprised of 500 large companies having common stock listed on the NYSE or NASDAQ. The volatility (beta) of the account may be greater or less than the index. It is not possible to invest directly in this index.

Technical analysis is a method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volumes. Technical analysis attempts to predict a future stock price or direction based on market trends. The assumption is that the market follows discernible patterns and if these patterns can be identified then a prediction can be made. The risk is that markets may not always follow patterns. There are certain limitations to technical analysis research, such as the calculation results being impacted by changes in security price during periods of market volatility. Technical analysis is one of many indicators that may be used to analyze market data for investing purposes and should not be considered a guaranteed prediction of market activity. The opinions expressed are those of Blue Line Investing. The opinions referenced are as of the date of publication and are subject to change without notice. Blue Line Investing reserves the right to modify its current investment strategies based on changing market dynamics or client needs.

 Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The information contained herein should not be considered a recommendation to purchase or sell any particular security. This information is intended for educational purposes only and should not be considered financial advice. It should not be assumed that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein.

 Advisory services offered through Gordon Asset Management, LLC (GAM). GAM is an SEC-registered investment adviser. Registration does not imply a certain level or skill or training. More information about the advisor, its investment strategies and objectives, is included in the firm’s Form ADV Part 2, which can be obtained, at no charge, by calling (866) 216-1920. The principle office of Gordon Asset Management, LLC is located at 1007 Slater Road, Suite 200, Durham, North Carolina, 27703.

How should I invest my 401(k) to earn the best return?

We are often asked this question from 401(k) participants and wish we had an easy answer. Unfortunately, there is no “one size fits all” since every participant has unique needs and different financial circumstances. But over the years we have identified 4 steps we believe participants can follow during their working lifetime to attempt to answer the question above. The 4 steps are:

  1. Create your Asset Allocation
  2. Create your Equity (Stock) Allocation and Fixed Income (Bond) Allocation
  3. Create your Deferral Strategy
  4. Create your Rebalance Strategy

This process is for the participant who wants to be active with their account but with limited time commitment. Part 1 explains the four steps, part 2 provides an example, and part 3 provides additional information. It is being presented as an alternative to a single investment Target Date or Life Cycle investment option available within most 401(k) retirement plans.

Part 1:

Step one is to create your Asset Allocation. Several sample allocations include:

100% Stocks; 0% Bonds

90% Stocks; 10% Bonds

80% Stocks; 20% Bonds

70% Stocks; 30% Bonds

60% Stocks; 40% Bonds

50% Stocks; 50% Bonds

We believe the asset allocation selected should be the one that takes the least amount of risk to earn the annualized rate or return you are attempting to achieve. For instance, if your goal is to achieve a single digit, long-term annualized rate of return, you might select an Asset Allocation from the samples above at the lower end of the list. If however, your goal is to achieve a double digit long-term, annualized rate of return you may need to select an Asset Allocation from the samples above towards the top of the list. Investors tend to invest more money into stocks when they hope to earn higher potential rates of return over the long-term (but at the risk of experiencing greater investment losses as well).

Step two is deciding how you will invest the money within each asset category selected in step one. For purposes of illustration, let’s assume from the samples provided above you selected 70% stocks and 30% bonds. For the money invested to these categories you will need to decide if you will invest all the money in one investment option, or spread out your money over multiple subcategories. This decision may be impacted by the choices available for investment within your 401(k) plan. When in doubt, we recommend that you consult with your existing financial professional if you are working with one, or the financial professional overseeing your company 401(k) plan.

Step three deviates from the previous two steps by focusing on new contributions to your 401(k) account only. In this step you will decide which category – stocks or bonds – will be the primary recipient of your new contribution. We believe a good rule of thumb to follow is based on the number of years you have until retirement. We believe if a participant is many years away from retirement, and depending on how their assets are invested, then they may want to consider investing a large percentage of new contributions into stock investments. If however, the participant has few years remaining to retirement, it may be more appropriate to consider investing more of the new contributions into bond investments. The purpose of this step is to either invest new contributions to attempt to take advantage of price fluctuations when stock markets rise and fall, or take a more defensive approach to attempt to avoid stock market price fluctuations, as much as possible.

Step four is the easiest and final step of the process. It consists of selecting and scheduling a rebalance strategy, if you choose. With today’s technology this step can be automated. First, select how often you intend on rebalancing your 401(k) account – annually, semiannually, or quarterly? We believe quarterly may be too often and annually may not be often enough. Therefore, we prefer semiannually. Then, decide the dates you want to schedule for the rebalancing. One possibility is May 1st and November 1st. According to the late Richard Russell, author of Dow Theory Letters, the six months of the calendar year that are historically associated with positive stock market returns tend to be November 1st through April 30th, while the negative stock market returns tend to occur between May 1st and October 31st. Of course, this may not hold true in any given calendar year, so any two equidistant dates may serve the same purpose.

Next, schedule a recurring reminder on your calendar for those dates each year. When the reminder pops up each year simply log into your account and rebalance your 401(k) account to the allocations you created in Steps one and two. While it may seem like a lot of work to initially set this up we believe it may be worth it. After the initial set up, you may be able to automate the process. The main decisions you will make over the remainder of your working lifetime are: (1) whether to make changes to investment options you are using if new options are added or removed by your company; and (2) whether to change your asset allocation in step 1 as you get closer to retirement (if necessary).

In Part 2 we provide an example to tie all these concepts together.

Part 2:

To illustrate the points made in part 1, the following hypothetical follows a participant who is 40 years old, has earnings from their employment of $75,000 per year, is contributing 10% to their 401(k) account each year, and has a current 401(k) account balance of $50,000.

Step 1: Create your Asset Allocation.

For simplicity let’s assume the participant decided on 70% stock and 30% bond investments. Therefore, of the $50,000 account balance, $35,000 will be allocated to stock investments and $15,000 to bond investments.

Step 2: Create your equity (stock) and fixed income (bond) allocations.

Let’s assume the participant selects investments that fall into the categories below to further subdivide their asset allocation into the stock and bond allocations:

Large Cap Stock Index Fund                                                              25%

Mid Cap Stock Index Fund                                                                 15%

Small Cap Stock Index Fund                                                              10%

International Stock Index Fund                                                         20%

Broadly Diversified Bond Mutual Fund                                            30%

Total                                                                                                      100%

Step 3: Create your deferral strategy.

Since, in this hypothetical illustration, $7,500 is being contributed into the 401(k) during the course of the year, and in this example the participant has many years remaining until retirement, 100% of the new contributions would be allocated to the stock investments only. Since this hypothetical illustration does not include an allocation to bonds, a few simple calculations related to the stock allocation will need to be made. To determine the new percentage for each stock investment being contributed to the plan, this sample participant may choose something similar to the following:

Large Cap Stock Index Fund     25% (from Step 2 above) / 70% = 36%

Mid Cap Stock Index Fund        15% (from Step 2 above) / 70% = 21%

Small Cap Stock Index Fund     10% (from Step 2 above) / 70% = 14%

Int’l Stock Index Fund                 20% (from Step 2 above) / 70% = 29%

Total:                                                                                                       100%

Step 4: Select and schedule your rebalance strategy.

Remember – Parts 1 & 2 pertain to the money already invested in this 401(k) account for example, while Part 3 pertains to new contributions only.

Part 3:

What is Asset Allocation?

Asset allocation is an investment strategy that aims to balance risk and reward by apportioning a portfolio’s assets according to an individual’s goals, risk tolerance and investment horizon. The three main asset classes – equities (i.e. “stocks”), fixed-income (i.e. “bonds”), and cash and equivalents – have different levels of risk and return, so each will behave differently over time. (Investopedia.com).

Why should I consider using a different allocation for new contributions compared to money already in my 401(k) account?

The money at risk is the money already invested within a 401(k) account. It is that money that we believe may require a strategic asset allocation. We believe new contributions may be useful to attempt to take advantage of price volatility in stocks over the long-term and during periods between rebalancing.

Why should I consider rebalancing my 401(k) account?

When stock markets rise, asset allocation tends to change and may become “over-weighted” towards stocks. In an attempt to minimize losses in any gains within the account, when stock markets experience a price correction, an investor may choose to rebalance their account. This may help “lock in” some of the gains from appreciated stock prices by moving those gains into other investments that may be more conservative, in nature.

Likewise, when stock markets decline asset allocation tends to change and become “over-weighted” towards bonds. Rebalancing during these times may allow a participant to attempt to “buy low” by selling some of the bonds and invest the proceeds into stock investments that may have experienced a sell-off and are currently trading at a lower price. We believe rebalancing can help take advantage of stock market price volatility over time.

Disclaimer:

Advisory services offered through Gordon Asset Management, LLC (GAM). GAM is an SEC-registered investment adviser. Registration does not imply a certain level or skill or training. More information about the advisor, its investment strategies and objectives, is included in the firm’s Form ADV Part 2, which can be obtained, at no charge, by calling (866) 216-1920. The principal office of Gordon Asset Management, LLC is located at 1007 Slater Road, Suite 200, Durham, North Carolina, 27703.

Achieving Balance

Achieving Balance

Blue Line Investing, Article 12 of 12

The image above shows several stacked stones. Beginning with the foundation stone, each successive stone must remain stable and in balance in order to act as a foundation stone for the one to follow. In similar fashion, each of the articles in this series is like one of the stones above, with each establishing a principal and foundation for the one to follow.

Our first article laid the foundation stone, which questioned the logic of centering the investment decision on you (and your age) rather than the stock market itself. You may recall at one point in history man believed the earth was the center of the universe. And as foolish as that may seem today, we believe the same can be said of centering investment decisions on your age, an approach that requires luck. For instance, the investor who retired at age 65 in the early 1980’s likely had a far different retirement experience compared to the investor who retired at age 65 in the late 1990’s. One was lucky, while the other was not. After questioning this logic our second article proposed changing the focus of time. Rather than time being a factor of your age, why not view time as a perspective? Specifically, learn how to observe the stock market from different perspectives of time to conclude whether your choice to take risk at current prices could be rewarded or punished, regardless of your age? In our third, fourth, and fifth articles we provided illustrations from the daily, weekly, and monthly perspectives of time to explore this concept in real time.

Beginning with our sixth article we began to explore deeper concepts within our investment philosophy and process. We explained the idea of using “witnesses” to see if the market itself could provide clues, or “tells,” of whether the current primary trend is expected to continue or if it might be in a state of change. In our seventh article we questioned if diversification by itself really helps to reduce risk? In our eighth article we explored a common practice in the investment industry where in some cases, active management has become a commodity. This common practice entails charging a fee to substitute investments, all the while remaining fully invested often without regard for the primary trend of the stock market. In our ninth article we explored how a sell discipline over the long run could help you minimize your losses during major stock market downturns. By doing so, it could put you in a position to buy again at lower prices in the future. In our tenth article we explained a few reasons for why we prefer using exchange-traded funds (ETFs) compared to most individual stocks and mutual funds. And in our last article, we introduced the concept for how to use inverse ETFs in attempt to protect your investment portfolio, or even potentially profit, during major stock market downturns.

While the future remains unknown, we expect it to mirror the past. Markets will rise and fall. Primary trends will change: from positive to negative; from negative to positive; and from positive to neutral. But regardless of the primary trend, we believe a disciplined, rules-based investment process can help achieve balance. Balance with your emotions. Balance with how you make investment decisions. Balance with how you search for investment opportunity. And balance in life. Thank you for reading this article series and please visit our website at www.BlueLineInvesting.com to learn more about our services and investment process.

Disclaimer:

Past performance is not indicative of future results. This material is intended for educational purposes only and is not financial advice or an offer to buy or sell any product. The investment strategy discussed may not be suitable for all investors. Investors must make their own decisions based on their specific investment objectives and financial circumstances. The opinions expressed are those of Blue Line Investing and are not necessarily those of Gordon Asset Management, LLC and are subject to change without notice. Blue Line Investing reserves the right to modify its current investment strategies based on changing market dynamics or client needs. Advisory services offered through Gordon Asset Management, LLC (GAM). GAM is an SEC-registered investment adviser. Registration does not imply a certain level or skill or training. More information about the advisor, its investment strategies and objectives, is included in the firm’s Form ADV Part 2, which can be obtained, at no charge, by calling (866) 216-1920. The principle office of Gordon Asset Management, LLC is located at 1007 Slater Road, Suite 200, Durham, North Carolina, 27703.

Attempting To Profit From Falling Prices

Attempting To Profit From Falling Prices

Blue Line Investing, Article 11 of 12

To many investors, inverse exchange-traded funds (ETFs) can be a dangerous investment. But for some investors, inverse ETFs can open a whole new world of opportunity. We will explore one such opportunity in this article. But before we do, let us explain what an inverse ETF is.

An inverse ETF is an exchange-traded fund that uses derivatives in attempt to profit from the decline that occurs in a different investment. In other words, when the price of a specific investment goes down, the price of the corresponding inverse ETF investment goes up (and vice versa). Inverse ETFs can be purchased for use in many different markets, including stocks, bonds, currencies, and commodities. In our previous article we discussed the negative primary trend the U.S. energy sector experienced from the summer of 2014 until early 2016. That sector dropped in price by over 48% from the top to the bottom. While this could have been unfortunate for many investors who owned investments within that sector, it may not have been unfortunate for every investor.

Those investors who moved money into an inverse ETF in the energy sector could have realized gains while others were suffering losses. For instance, suppose your investment process could help identify potential turning points in the primary trend of markets, or as in this case, the U.S. energy sector. As soon as your process suggested a change in primary trend, you would then be in a position to make a proactive choice. Assuming you are not a passive investor, your first choice might be to buy the inverse ETF in the energy sector in attempt to protect, or hedge, investments you want to continue to own in that sector. Your second choice might be to sell investments you own in the energy sector and look for new investments in other market sectors. A third choice might be to sell your investments in the energy sector and purchase an inverse ETF in the same sector. By doing so, it is possible that as the price of the energy sector declines, the price of your inverse ETF could rise. As one goes down, the other goes up. This is one way you could attempt to profit from falling prices.

To effectively use an inverse ETF as part of your investment strategy requires a thorough understanding of how they work and the potential risks their use entails. And while it is not the objective of this article to explain those risks in detail, we do want to comment on a few things we have learned from their use over the years. First, we believe you should set your expectations correctly. You are not likely going to profit from the entire decline in another investment when using an inverse ETF. We believe your goal should be to capture a portion of the profit that might be generated through the use of the inverse ETF. Second, avoid being greedy! In our view, this should be a temporary option to consider for your investment portfolio while you continue looking for other investments that are in positive primary trends. Third, we believe you should already have a target sell price before you make your initial investment in the inverse ETF. And finally, your time horizon for using such an investment in your investment portfolio should range from as little as a few days to a month or two at the maximum. This is not a buy and hold investment in our opinion.

We believe inverse ETFs can prove beneficial as an investment tool in your use. They can be used as a protective hedge during volatile and potentially uncertain market environments. Or, they can be used in attempt to profit during a negative primary trend, like the recession from 2000 – 2002. But no matter how you choose to use them, the one thing they will do is open your eyes to investment opportunities regardless of whether markets are rising or falling.

Disclaimer:

Past performance is not indicative of future results. This material is intended for educational purposes only and is not financial advice or an offer to buy or sell any product. The investment strategy discussed may not be suitable for all investors. Investors must make their own decisions based on their specific investment objectives and financial circumstances. The opinions expressed are those of Blue Line Investing and are not necessarily those of Gordon Asset Management, LLC and are subject to change without notice. Blue Line Investing reserves the right to modify its current investment strategies based on changing market dynamics or client needs. Advisory services offered through Gordon Asset Management, LLC (GAM). GAM is an SEC-registered investment adviser. Registration does not imply a certain level or skill or training. More information about the advisor, its investment strategies and objectives, is included in the firm’s Form ADV Part 2, which can be obtained, at no charge, by calling (866) 216-1920. The principle office of Gordon Asset Management, LLC is located at 1007 Slater Road, Suite 200, Durham, North Carolina, 27703.

 

 

 

Why We Prefer Using ETFs

Why We Prefer Using ETFs

Blue Line Investing, Article 10 of 12

Individual stocks, stock mutual funds, stock exchange-traded funds (ETFs) – which one(s) are right for you? While we can not answer that question, we would like to share why we prefer using ETFs as our primary investment choice. In addition to how well ETFs conform to our Blue Line Investing process, additional benefits include diversification, marketability, and selectivity.

From a diversification standpoint we prefer ETF’s over individual stocks. To be clear, this doesn’t mean we don’t or won’t invest in individual stocks. It simply means we prefer to minimize the risk associated with investing in individual stocks. ETFs help us accomplish that by allowing us to invest in a diversified sector rather than invest in a few individual companies. For instance, share prices of medical device company Zimmer Biomet Holdings, Inc. (symbol ZBH) recently dropped over -20% in the past two weeks. In comparison, shares prices of the iShares U.S. Medical Device ETF (symbol IHI) dropped over -4% over the same time period. We prefer to capture most of the upside with less of the downside rather than attempt to capture all of the upside along with all of the downside.

From a marketability standpoint, we prefer ETF’s over mutual funds. Consider for instance the Vanguard 500 Index mutual fund (Admiral Shares symbol VFIAX) compared to the Vanguard S&P 500 ETF (symbol VOO). At first glance these two investments appear the same. They both invest in the same 500 stocks that represent the S&P 500 Index, both own those 500 stocks in the same proportions, and both have the same annual underlying expenses. So in essence they are the same, right? No, they are not. The reason is their individual marketability. For instance, with all mutual funds, no matter when you place your buy or sell order during the trading day, you always receive the share price at the close. Since ETFs are marketable like individual stocks, whenever you place your buy or sell order during the trading day, you receive the price at that moment in time. Depending on the specific day of purchase and sale, and depending on the volatility of the market on those given days, you can realize a different return over the long run by investing the same amount of money in these two similar, yet different, investments.

From a selectivity standpoint, we again prefer ETF’s over mutual funds. There are occasions when it can be advantageous to avoid certain sectors of the stock market, especially when a sector is experiencing a negative primary trend. This can be one of the drawbacks to investing in indexed investments over the long run that remain fully invested in all sectors. For instance, during the summer of 2014 the energy sector topped. By the time that sector reached the bottom in early 2016 it lost over -48%. So for passive investors who invested in an index-type investment, their return was impaired for the year by the negative performance from that one sector. Is there a way to avoid this? We believe there is. One possibility would be to reconstruct the S&P 500 Index by using sector ETFs in similar proportions. Then, when any sector violates your sell discipline just simply remove it from your investment portfolio. This could help lessen the negative impact to your investment portfolio from the price decline in that sector.

Depending on your investment philosophy and process you will likely use one or a combination of these investment choices. Now that we have explained why we prefer using ETFs, in our next article we will explore some of the potential benefits of selectively incorporating inverse ETFs in your investment portfolio.

Disclaimer:

Past performance is not indicative of future results. This material is intended for educational purposes only and is not financial advice or an offer to buy or sell any product or to adopt a particular investment strategy. The investment strategy discussed may not be suitable for all investors. Investors must make their own decisions based on their specific investment objectives and financial circumstances. The opinions expressed are those of Blue Line Investing and are not necessarily those of Gordon Asset Management, LLC and are subject to change without notice. Blue Line Investing reserves the right to modify its current investment strategies based on changing market dynamics or client needs. Advisory services offered through Gordon Asset Management, LLC (GAM). GAM is an SEC-registered investment adviser. Registration does not imply a certain level or skill or training. More information about the advisor, its investment strategies and objectives, is included in the firm’s Form ADV Part 2, which can be obtained, at no charge, by calling (866) 216-1920. The principle office of Gordon Asset Management, LLC is located at 1007 Slater Road, Suite 200, Durham, North Carolina, 27703.

 

 

 

 

Reducing Risk with a Sell Discipline

Reducing Risk with a Sell DisciplineBlue Line Investing, Article 9 of 12

In our previous article we explored two different investment strategies. The first is based on remaining fully invested at all times and substituting investments within your investment portfolio. The second is based on being willing to keep portions of your portfolio in cash by making strategic sell decisions. Our experience has found the second strategy tends to be difficult for many investors to embrace. The usual reason is because they worry they will miss out on the upside by not remaining fully invested. And while this may be true part of the time, by remaining fully invested they are likely to capture all the downside when it occurs.

The late Richard Russell, author of Dow Theory Letters, always emphasized an important investment concept. He stressed that when bear markets occur, they tend to retrace one-third to two-thirds of the preceding stock market advance. In other words, without a sell discipline, your investments that can take years to accumulate, can be significantly impaired or lost within a matter of weeks or months. Consider 2008 as a case in point. Almost the entire price decline occurred from September 2008 through March 2009 – a mere six months. And in that time the entire stock market advance of the previous 5 years (2003 – 2007) was wiped out. What could have helped many investors was the use of a sell discipline. By using and relying on a sell discipline, your focus remains on your process, rather than your emotions. Process can help minimize your emotions and personal biases when making investment decisions. In addition to helping you with a sell decision, your process can also guide you with your purchase decisions as well.

CNBC recently published a portion of an interview on October 12, 2016 with Jim Cramer, the famed trader and the TV host of “Mad Money.” His comments echoed our philosophy and process relating to the benefit and use of a sell discipline. He says it better than we can so we are reposting an excerpt from the article below.

The biggest mistake Jim Cramer sees investors make is that many think they are supposed to be fully invested at all times. Heck, even some money managers have told him that they are supposed to have all their money in stocks. This is complete nonsense! Having cash on hand when a market correction occurs is the key to protecting a portfolio. Sometimes the market will stink, and there is nothing to do but just sit in cash. “In fact, one of the chief reasons that I outperformed pretty much every manager in the business during my 14-year run as a professional money manager is that there were substantial blocks of time when I was largely in cash,” the ” Mad Money ” host said.

We believe it is important for all investors to keep in mind that cash is an asset class, and the rules of investing don’t only say “buy and hold.” To outperform over the long run, we believe it is important to have a sell discipline as part of your investment process. To learn about ours, please review Our Process by visiting www.BlueLineInvesting.com/about-us/.

Disclaimer:

Material presented has been derived from sources considered to be reliable, but the accuracy and completeness cannot be guaranteed. Past performance is not indicative of future results. This material is intended for educational purposes only and is not financial advice or an offer to buy or sell any product. The investment strategy discussed may not be suitable for all investors. Investors must make their own decisions based on their specific investment objectives and financial circumstances. The opinions expressed are those of Blue Line Investing and are not necessarily those of Gordon Asset Management, LLC and are subject to change without notice. Blue Line Investing reserves the right to modify its current investment strategies based on changing market dynamics or client needs. Advisory services offered through Gordon Asset Management, LLC (GAM). GAM is an SEC-registered investment adviser. Registration does not imply a certain level or skill or training. More information about the advisor, its investment strategies and objectives, is included in the firm’s Form ADV Part 2, which can be obtained, at no charge, by calling (866) 216-1920. The principle office of Gordon Asset Management, LLC is located at 1007 Slater Road, Suite 200, Durham, North Carolina, 27703.

Sources:

Richard Russell, Dow Theory Letters, www.DowTheoryLetters.com

Stevenson, Abigal. “Cramer Reveals the No. 1 Reason He Outperformed the Market as a Money Manager.” Yahoo Finance. CNBC, 12 Oct. 2016. Web. 27 Oct. 2016

Substitute or Sell?

soccer-resized

Blue Line Investing, Article 8 of 12

 

For as long as we can remember the investment industry has maintained a standard investment practice with how they apply active management to their client investment accounts. But we believe in recent years it appears the industry may be questioning how effective it is over the long run. This practice consists of substituting investments rather than selling investments. Understanding this difference can have a material impact on your rate of return over the long run, especially when the primary trend of the market changes from positive to negative.

We will use the game of soccer to illustrate the substitution strategy. During a game the players get tired. So when the coach makes a substitution he is effectively exchanging one player for another. After the substitution the number of players on the field remains the same. Compare this with how active management is conducted at many investment firms and financial institutions today. They, like coaches in the game of soccer, are making substitutions to investments. For instance, they remove the ABC Growth fund owned within their client investment portfolio to replace it with the XYZ Growth fund. Or, maybe they might become displeased with the performance results from the 123 Real Estate fund and substitute it for the 456 Real Estate fund. In effect, like the players on a soccer field, the substitution strategy keeps all money fully invested within the portfolio at all times regardless of whether the primary investment trend is positive or negative.

Continuing with our soccer analogy, during play one of the players might receive a red card from the referee, resulting in their ejection from the field. Should this happen there will be no substitution of players. The team loses that player and must continue the game playing one man down. While not a perfect analogy, we liken this to the idea of a sell rather than a substitution change. We believe improvements to clients’ long-term rates of return can be made by making sell decisions rather than substitution changes. In other words, when the primary trend of the market is negative, then doesn’t it seem logical to keep the proceeds from a sell decision in cash rather than reinvesting it immediately into another similar investment? Of course, this all depends on the primary trend of the market.

For instance, consider when stock markets were in primary negative trends, like 2000-2002 or 2008-2009 (which coincided with the broad market remaining below the blue line for the duration of the stock market decline). By substituting risk investments like stocks, the value of your investment portfolio is likely going to decline along with the stock market decline. But by taking the approach of making a sell decision and keeping the proceeds in cash you could afford yourself the opportunity to reinvest the proceeds at cheaper prices in the future after the primary negative trend is exhausted. After all, isn’t the old adage, “Buy low, sell high?”

We believe that during a rising stock market a substitution strategy will work fine and likely result in financial gains for investors. But when markets change from positive to negative primary trends, the substitution process will likely result in losses, which could be material depending on the extent of the market downturn. We believe a successful investment process must have a sell discipline to reduce risk to the overall investment portfolio and this will be discussed further in our next article.

Disclaimer:

Past performance is not indicative of future results. This material is intended for educational purposes only and is not financial advice or an offer to buy or sell any product. The investment strategy discussed may not be suitable for all investors. Investors must make their own decisions based on their specific investment objectives and financial circumstances. The opinions expressed are those of Blue Line Investing and are not necessarily those of Gordon Asset Management, LLC and are subject to change without notice. Blue Line Investing reserves the right to modify its current investment strategies based on changing market dynamics or client needs. Advisory services offered through Gordon Asset Management, LLC (GAM). GAM is an SEC-registered investment adviser. Registration does not imply a certain level or skill or training. More information about the advisor, its investment strategies and objectives, is included in the firm’s Form ADV Part 2, which can be obtained, at no charge, by calling (866) 216-1920. The principle office of Gordon Asset Management, LLC is located at 1007 Slater Road, Suite 200, Durham, North Carolina, 27703.

 

 

 

Does Diversification Reduce Risk?

Does Diversification Reduce Risk?

Blue Line Investing, Article 7 of 12

 

Stocks? Check. Bonds? Check. Real Estate? Check. Commodities? Check. “Don’t put all your eggs in one basket” as they say. You are likely familiar with this saying, and in theory we believe it is prudent advice. But when it comes to actual implementation, does it make sense? Presuming you are already familiar with the potential benefits of diversification, we believe the answer to the title of this article is yes – diversification can reduce investment risk – but at what cost?

Diversification can help reduce the risk to your investment portfolio depending on your asset allocation. Asset allocation is how you choose to invest your money among categories of investments like those listed above.  Some categories are considered “risky” (such as stocks, real estate, and commodities) due to the potential volatility of their prices, while others are considered “risk free” (such as bonds and cash equivalents) because the volatility of their prices is more stable. It is this asset allocation decision that will likely have the largest impact on how much you reduce risk as you diversify your investment portfolio.

But therein lies one of the main costs of diversification – the more money that is allocated to “risk free” investments in attempt to reduce your risk, it will likely lower your expected rate of return over the long run. And further, the more you broadly diversify your investments within each of the categories listed above, the more likely you are to own investments that are in both rising and declining trends. It is those investments experiencing negative primary trends that detract from your total portfolio returns. So what can an investor do? Is there a way that can help to reduce risk without necessarily having to limit the potential return on your portfolio? We believe the answer is yes.

We have found that when a publicly-traded investment falls below its blue line by more than 5%, it may be the markets way of providing an early warning to investors. When this 5% warning happens, and if thereafter the investment’s price goes through the next 2 steps of our sell discipline, then we believe there is a high probability that prices are now in a negative primary trend and will continue to fall further. At that point in time we believe the investment should be sold. We believe it is preferable to identify and own those investments that trend above their blue line while avoiding those that, at least at that moment in time, do not.

While we believe diversification can help reduce risk, we believe it is likely to lead to an average return over the long run. For investors striving to achieve an above-average return instead, we believe a sell discipline (not a substitution discipline) is required in your investment process. Our next article will distinguish this difference.

Disclaimer:

Past performance is not indicative of future results. This material is intended for educational purposes only and is not financial advice or an offer to buy or sell any product. The investment strategy discussed may not be suitable for all investors. Investors must make their own decisions based on their specific investment objectives and financial circumstances. The opinions expressed are those of Blue Line Investing and are not necessarily those of Gordon Asset Management, LLC and are subject to change without notice. Blue Line Investing reserves the right to modify its current investment strategies based on changing market dynamics or client needs. Advisory services offered through Gordon Asset Management, LLC (GAM). GAM is an SEC-registered investment adviser. Registration does not imply a certain level or skill or training. More information about the advisor, its investment strategies and objectives, is included in the firm’s Form ADV Part 2, which can be obtained, at no charge, by calling (866) 216-1920. The principle office of Gordon Asset Management, LLC is located at 1007 Slater Road, Suite 200, Durham, North Carolina, 27703.