Algorithmic trading ups the pace on Wall Street

On Monday Feb. 5 the Dow Jones Industrial Average suffered its largest one-day drop ever, falling nearly 1,600 points in the middle of the day before closing 1,175 points below the prior day’s close to register a one-day drop of 4.6 percent. In the intervening days the Dow, along with the rest of the stock market indices, appear to have stabilized somewhat and traders have bid prices back up – at least in the short term. The initial catalyst for the selloff was a sudden fear on Wall Street that inflation and interest rates might rise more rapidly than previously thought.  High interest rates cut into corporate profits and so a re-evaluation of what corporate shares are worth caused a number of investors to trim their holdings in equities.  But what happened next is the real story. To understand why stock prices experienced such drastic swings over the past week, we have to go back almost two decades to when Wall Street firms like Goldman Sachs, Merrill Lynch and others invested heavily in computer technology and human capital to take the guess work out of investing and also make their trading more efficient.  The big Wall Street banks sent recruiters to prestigious institutions like MIT, Cal Tech and Stanford to find and hire the most talented mathematicians and computer scientists to study the stock market and design trading strategies that would bring mathematical precision to the decision-making process and tie them to the most powerful computers to execute trades in fractions of a second. These mathematicians designed what are called “algorithms.”  Algorithms are a specific set of clearly defined instructions aimed at carrying out a task or process.  A simple algorithm can be found in your home’s thermostat.  The thermostat is programmed to turn the furnace on when the temperature falls below a pre-determined degree.  Trading algorithms, by contrast, are extremely complex with pre-determined factors running in the hundreds.  One… | Read More »

Several factors support an optimistic view of 2018

As stocks markets around the globe soared on accelerating corporate profits and strong economic growth, 2017 turned out to be a stellar year for investors.  It was the third best showing for the U.S. stock market since the 2008 financial crisis, with only 2009 and 2013 having higher average returns.  What was different about 2017, though, was that the prodigious stock market returns were, for the first time since 2008, attended by strong underlying economic fundamentals.  Fourth quarter earnings won’t be reported for a few weeks, but based on the first three quarters, together with Wall Street’s best estimates for this quarter, earnings growth for the 500 companies that comprise the S&P 500 are expected to be about 10 percent for the full year.  That would be the best earnings growth we’ve seen since 2011. During the slow, arduous crawl out of the global recession corporations managed to grow their earnings, primarily, by cutting costs and reorganizing their business models.  But in 2017 businesses finally saw a sustained pickup in demand, both at the consumer level and in business-to-business transactions.  As economic activity accelerated during the year we began to see in the financial press a new phrase that, by December, had become the defining theme of 2017.  That phrase is: synchronized global growth. Europe, Japan, China and emerging market economies such as Brazil, India and the Pacific Rim have all experienced some of the highest GDP rates in a decade, creating a virtuous cycle of growth that has provided an extra boost to the U.S. economy. Consider that somewhere between 30 to 38 percent of revenue generated by the largest corporations in America comes from these foreign countries. All indications are that this “synchronized global growth” should continue well into 2018.  Indeed, the latest Purchasing Managers Index for Europe showed “robust intakes of new business” that “tested capacity.”  As current capacity gets squeezed, businesses likely will have to invest… | Read More »

Diversification key to robust portfolio design

The key to designing a robust portfolio that can withstand a multitude of market pressures is choosing stocks and funds that have diversification across all asset types, investment styles and industry sectors . That way, if one part of the market struggles, other areas take up the slack and lift the portfolio. For instance, right now the best stock market gains are being achieved by a core group of technology and internet-based stocks that Wall Street dubbed the FAANG stocks.  FAANG is an acronym that stands for Facebook, Apple, Amazon, Netflix and Google.  We have invested in these stocks because we have been impressed by their fundamentals, and, as a result, we have made nice gains in this sector. These companies have revolutionized the way people all over the globe buy and sell goods, get their news, and build social networks. Indeed, it is hard to conceive of modern life without them.  Their ubiquity in our personal and social lives is reflected in their dominant economic position, which is likely to continue for the foreseeable future. It’s tempting, for even the most disciplined investors, to invest heavily in those parts of the market that currently have the best returns.  But such a narrow focus carries with it hidden dangers.  The FAANG stocks are in such a dominant position because they disrupted and overturned successful business models of the past.  Does anyone remember Hewlett Packard, or IBM?  These companies are still around, and even making a profit for their shareholders, but they are no longer the dominant players they once were and their stock price reflects their relative decline.   You can be sure that in a business incubator, or even a garage, the next disruptive technology is being conceived that will knock one or more of these dominant players off their perch. That is why, even when the best gains are to be had in a narrow segment of the market,… | Read More »

Choose volatile investments

When it comes to investing, high risk and high returns usually go hand in hand. Riskier, more volatile investments — those that tend to bounce up and down in value — will generally earn greater profits over the long haul than investments that slowly, but steadily, gain in value. If you’re saving well before you actually need the money, you can take advantage of this rule by investing in more volatile assets (typically stocks) and getting a higher return on your money. If you are in your forties, or even fifties, you probably won’t actually need the money for decades, so it won’t matter if your portfolio loses value this year, it’ll likely rebound in the next. That can lead to some pretty heart-palpitating moments as your investments see-saw up and down, but just grit your teeth and remind yourself that it doesn’t matter how much those stocks are worth today, what matters is how much they’ll be worth when you need them. The fact is, since the first American stock market opened in Philadelphia in 1817, the stock market has always gone up more than it has gone down.  Think about it.  There has never been a time when the stock market went down and just stayed there.  It has always recovered – always.  And here we are, in 2017, after the crash of 1929, after the crash of 1987, after the crash of 2000-2001, after the crash of 2008, and the stock market has posted a string of new record highs.  Yes, you can lose money in the stock market, but those losses are always only temporary.  After a time, the market recovers and your investment gains return. We tend to overlook these facts because of something psychologists call “loss aversion.” Consider again the age-old investing axiom, “The greater the risk, the greater the reward.” When we hear this we are likely to fixate on the risk… | Read More »

Four reasons you need a Roth IRA

In our last post we talked about the importance of saving enough in your employer sponsored retirement plan and cautioned that even if you were contributing your full match, it might not be enough. The vast majority of us will need additional savings and a good place to accumulate that is in a Roth IRA.  A Roth IRA is an excellent savings vehicle because, unlike the traditional IRA, the money in a Roth grows tax free and the withdrawals are not taxed either.  This makes it preferable to the traditional IRA for retirement savings, but there are other advantages to a Roth IRA as well. Here are four reasons you should save money in a Roth IRA: The Roth IRA gives much more freedom of choice.  In an effort to keep the plan simple, many 401(k) and 403(b) plans do not include investment choices that would help diversify your portfolio, nor do they offer the most cost-effective investments available.  Most employer plans limit you to investing in only a handful of mutual funds.  While mutual funds are good investment vehicles, ETFs (Exchange Traded Funds) have emerged as a favorable alternative to mutual funds because of their lower cost and flexibility.  In a portfolio that is large enough to accommodate them, individual stock holdings are also a good choice for low expense and diversification. The money in a Roth IRA that is not inherited is not subject to a Required Minimum Distribution (RMD).  Roth IRAs are funded with after-tax money and the withdrawals from a Roth are not taxed on the way out. Because of this, the IRS has no need to force withdrawals from a Roth because there are no taxes to collect.  Not being subject to an RMD makes the Roth IRA a more flexible option for retirement income.  You can also continue to contribute to your Roth after the RMD mandatory age of 70½ if you are still… | Read More »