INSIDE THIS EDITION:
Moving Averages and Your Portfolio
Weekly Technical Comment
November is National Family Caregivers Month
401k Plan Manager *Updated on 10/23/2018
Investors sometimes rely on simple moving averages to determine trading opportunities in financial markets. The reason is that moving averages can indicate new trends in asset prices. They may also use simple moving averages for managing portfolio risk.
Take for example, the investor who uses moving averages as a market timing tool. When moving averages flash a buy signal this investor might decide to be fully invested. When the moving averages flash a sell signal this same investor may decide to reduce their exposure.
The chart below shows how an investor using the 200-day simple moving average might have avoided a large part of the overall total market decline between March 24, 2000 and October 9, 2002 and again between October 9, 2007 and March 9, 2009. Using the simple moving average on the S&P 500 index to reduce portfolio risk would have kept the investor from a large portion of the total decline experienced by the broad market in both instances.
Of course, there are several ways to slice and dice moving averages. Some investors use the 50-day simple moving average, others use 100-day simple moving average, and yet others use the 200-day simple moving average illustrated in the chart above. While there is no perfect way to avoid market drawdowns, using simple moving averages has shown to help improve the odds of success.
One flaw however in the simple moving average cross strategy is that this indicator can be highly susceptible to a whipsawing effect because they are prone to respond very quickly to price changes.
Luckily, simple moving averages aren’t the only tool in the investors arsenal. At STA Wealth Management, we favor 20-day and 50-day exponential moving averages (EMA’s) and the 50-week and 100-week exponential moving averages for determining when to de-risk or re-risk portfolios. The 20- and 50-day EMA’s serve as our short-term signal and the 50- and 100-week EMA’s serve as our longer-term signal.
Exponential moving averages are similar in principal to simple moving averages with one exception – the exponential moving averages place a heavier weight to the most recent price changes. This means that the exponential moving averages respond more quickly to changes in trend and can make them much more effective than simple moving averages for risk management while keeping trading frequency and cost in check.
The frequency of trading is important because trading costs can provide a drag to performance. For this reason, exponential moving averages may be better suited for risk management when used with the appropriate time frames.
Simple Moving Average vs. Exponential Moving Average
The following two charts help illustrate the difference between the simple and exponential moving averages in terms of trading frequency and show their effectiveness identifying inflection points that can result in drawdowns.
The first chart, shows the simple 20-day and 50-day moving averages for the MSCI Emerging Markets Index. The second chart shows the exponential 20- day and 50-day moving averages for the same index.
Simple Moving Average Chart – 20/50 days:
Exponential Moving Average Chart – 20/50 days:
Two important observations can be gleaned from these charts. First, both simple and exponential moving averages can help identify market inflection points. The blue circles indicate the potential start of a bullish trend while the red circles identify the potential start of a bearish trend. While those inflections may or may not persist for long periods, identifying them in the charts may help investors de-risk or deploy capital at opportune times. Second, it shows why we favor the exponential moving averages over the simple moving averages. The first chart shows that simple moving averages led to a whipsaw in December 2017 where a sell signal was followed by a buy signal shortly thereafter. The second chart of the exponential moving averages shows that the whipsaw was not observed and would have reduced potential trading costs.
In the end, it is important for investors to have a discipline when making tactical changes to their portfolio exposures. However, having a discipline and executing on that discipline are two different things. As you evaluate your advisor, as them how they manage risk and whether they executed the last time markets entered a drawdown. After all, having a sound risk management discipline that can be executed on when volatility is elevated should be part of your advisor’s value proposition.
The DOW Leads Stock Upturn
Major stock indexes are building on their November gains on the day after the midterm elections. The Dow is leading on the upside.
Chart 1 shows the Dow Industrials already trading above chart resistance at 25,800 and trying to clear its 50-day average. Chart 2 shows the S&P 500 gapping above its 200-day line which clears an important chart barrier. A more difficult test, however, may come at its previous peak at 2816 and its 50-day average. The Nasdaq Composite (not shown) is nearing a test of its 200-day line. Chart 3, however, shows the Nasdaq 100 (QQQ) already trading above its red line. The QQQ is getting a lift from the Technology SPDR (XLK) which is also trading above its 200-day line (not shown). Those major stock indexes are trying to repair chart damage done during October. A bigger test for most of them will be their ability to clear their 50-day lines and their mid-October peaks. While short-term indicators have turned positive, weekly and monthly charts still have a more bearish look to them. The battle currently underway is between the usual seasonal strength during November, especially after a midterm election, and longer-range technical warnings that the bull market may be in the process of topping.
Weekly Snapshot of Global Asset Class Performance
If you have any questions, please feel free to email me at firstname.lastname@example.org.
STA Investment Committee
Luke Patterson, CEO & Chief Investment Officer
Mike Smith, President
Andrei Costas, Senior Investment Analyst (Equity Strategies)
Nan Lu, Senior Investment Analyst (Fixed Income Strategies)
November is National Family Caregivers Month
By presidential proclamation, November is National Family Caregivers Month. Each day, parents, children, siblings, and spouses selflessly sacrifice their time and energy to care for family members affected by illness, injury, or disability. Caregiving can exact an emotional, physical, and financial toll. It is important for caregivers to know that their labors of love are appreciated, and to recognize that they need care and support as well.
Caregiving often involves providing for the needs of our older population. As the number of older Americans rises, so will the number of caregivers. While we take this time to recognize our caregivers, it’s also a good time to consider planning for potential long-term care.
According to recent U.S. Department of Health & Human Services information (www.longtermcare.gov), almost 52% of people over age 65 will need some type of long-term care during their lifetimes. Between the ages of 40 and 50, on average, 8% of people have a disability that could require long-term care services. The average yearly cost for long-term care in a nursing home is about $82,182 for a semiprivate room, while the average annual cost for care in an assisted-living facility is $43,536.
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by STA Wealth Management, LLC (“STA”), or any non-investment related content, made reference to directly or indirectly in this article / newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this article / newsletter serves as the receipt of, or as a substitute for, personalized investment advice from STA. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. STA is neither a law firm nor a certified public accounting firm and no portion of the article / newsletter content should be construed as legal or accounting advice. A copy of the STA’s current written disclosure Brochure discussing our advisory services and fees is available upon request. Please Note: If you are a STA client, please remember to contact STA, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. STA shall continue to rely on the accuracy of information that you have provided.