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Client Question: What’s the biggest risk in my DIY portfolio?

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Here’s a commentary by Cormac Mullen of Bloomberg News on September 14, 2017 about “cluster” risk:

“Cluster risk, occurring when performance patterns become correlated among a group of stocks with similar business profiles yet different sector classifications, is a hazard that can often slip under a risk manager’s radar, AB’s David Dalgas, Klaus Ingemann and Thomas Christensen wrote in a blog post.”

“Facebook Inc., Amazon.com Inc., Apple Inc., Netflix Inc. and Google owner Alphabet Inc. — collectively known as the FAANGs — are a prime example, AB said. Together the mega-cap stocks accounted for more than a quarter of the gains in the S&P 500 from the beginning of the year through August and have become increasingly correlated.”

The danger of this correlation risk is when the market falls, this group will fall together with similar losses. It’s also like owning all the Canadian bank stocks.

The moral of the story is to buy one but not all the FAANG stocks or Canadian banks. Most do-it-yourself investors and even some professionals fail to protect their overall portfolio risk by owning stocks that are similar in nature to each other.

It’s better to have a compilation of names that are in different industries, different countries and are of a different size. This diversification should help protect the risk of a big loss. After all, investing is not about how much you make but how much you avoid losing. It’s the latter statement that keeps you in the game for the long term.

Client Question: Why does the market often take off at the end of the trading day?

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Near the end of the trading day, about 2:30 p.m., markets can pick up in both volume and breadth. That’s because Exchange-Traded Funds (ETFs) have to execute their buys and sells based on cash received or demanded during the day.

Below is a chart that shows trading volumes on the S&P 500 during the average trading day:

Composite Volume for S&P 500

It’s important, therefore, that investors understand this relationship. If they, too, are buying during periods of high trading volume, they may pay more for their stocks than expected. For example, if trading volumes increase, the bid/offer spread could widen. Instead of paying an extra five cents a share to buy or sell, it could change to 10 cents a share. Investors should also avoid trading in the first hour after the market opens as that is another volume surge. We prefer to trade when volumes are lower and there’s more consistency in the markets.

 

Client Question: How do you invest a new account?

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We take our time with new clients’ money. Some firms may invest all the money immediately because they counsel against trying to time the market but depending on the market situation, we believe that some prudence is required. Usually ½ positions are purchased in equities, with the remaining 50% allocated depending on what happens later in the market.

According to Lu Wang of Bloomberg News on October 1, 2017: “Theories abound as to why the fourth quarter is so often the best one for equity bulls. Fund managers need to catch up, holiday spending spreads cheer, investors celebrate the January effect in December. Or maybe it’s just dumb luck. Whatever the case, the S&P 500 Index has risen seven times in the last eight years between October and December. And while calendar effects just took a beating with a volatility-free September, betting against any form of momentum remains a losing trade until proven otherwise.”

Also, as noted above, calendar returns from October to October rather than January to December tend to be above-average, especially among the small-cap stocks. Looking at our global stock holdings, the average growth rate from October to October since 1990 has been around 21%. This compares to the index averages of 8%. We believe that is a significant number. Does it always grow at this rate if money is added each October? No, the success rate of the past 27 years has been about 75% (18 of 27 years) but the odds do favour the investor.