Conservative Investors: Step Up!

Back on September 20, 2018, I posed the question: Should conservative investors take the paper bags off their heads? and offered some stock ideas for those inclined to answer in the affirmative. Since then, the market has had some rocky episodes (see, e.g., tech, FANG stocks, trade, worsening political tribalism, etc.). But that’s not necessarily why I’m now suggesting that those averse to risk should do more than uncover their heads and should step up, step out and start preaching. It’s about the investment community’s nearly 2-year party and precedent that suggests this sort of thing has a limited shelf life.

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Reign In Risk

Academicians and investment practitioners have long been well versed in notions of risk and how it interacts with return. But even now, decades after we nailed all this down from a theoretical standpoint, it can still be hard to truly understand what it means in human terms. I still recall the Herculean but ultimately unsuccessful effort I made back in my Reuters days to try to explain to an editor who reported to the news organization what the CBOE Volatility Index (VIX) was all about; I ultimately gave up trying to explain that neither a rising VIX nor a falling VIX was bullish or bearish for the stock market 

In the spirit of erecting a wall, a taller one than Trump dreams of for our southern border, between risk and return, understand that I am not now offering a forecast of the general direction of stock prices. The topic for today is a risk, and I’m speaking to those who, based on whatever analysis or tea leaves they choose to read or policy they need to follow, are going to be in U.S. equities for the foreseeable future. My goal. is to address the kinds of equities I believe should be favored.

On September 20th, I semi-sheepishly suggested that lower-risk stocks get more love than they’ve had over the past couple of years. Today, I’m doubling down based on what I think maybe a more stark picture of what’s been going on out there.

Attitude Indicators

There’s no shortage of market indicators out there, even sentiment indicators. Most are based, if not on survey or economic bean counting, on price and volume. But with the wealth of specialized ETFs that have come out over the past decade or so, we now have at our disposal a bunch of new ways we can measure things. 

As interesting as something like VIX is in measuring risk, it’s only useful for those who really get the mathematics of the market. For normal humans, it's just a misinterpretation waiting to be acted upon. So taking some dabs from the contemporary palette of strategy-focused ETFs, I came up with a 2.5-component suite of trends one could calculate, observe, and try to use as a basis for understanding. 

Each trend measures the daily percent change of ETF “A” relative to ETF “B” with A and B being logical opposites. Here’s the trio:

  • GV, or Growth over Value, represented by the iShares Russell 1000 Growth ETF (IWF) compared to the iShares Russell 1000 Value ETF (IWD).
  • MC or Momentum over Conservatism, represented by the iShares Edge MSCI USA Momentum Factor ETF (MTUM) versus the iShares Edge MSCI Minimum Volatility ETF (USMV)
  • LS or Large over Small, represented by the large-cap iShares Russell 1000 ETF (IWB) compared to the iShares Russell Microcap ETF (IWC).

That’s three pairs of ETFs, not 2.5. Actually, though, I’m counting LS as only half an indicator and probably wouldn’t bother to use it at all except for the fact that so many investors think in terms of large versus small, as do so many quants who, still basking in the aura of Eugene Fama and Kenneth French, continue to study size as a “factor,” whether it’s significant, whether it’s a good factor, etc. Skipping the empirical data (“what” is observed) and favoring logic (“why the data is what it is), I see size-related performance driven heavily by the MC and to a lesser extent, the GV considerations. (Click here for a prior post explaining the inherent, distinct largely quality/risk-related characteristics that separate small companies form large firms.)

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Disclosure: None. 

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