Small Cap & Large Cap Investments Are Not Enough

Rodney Johnson | Wednesday, October 3, 2012 >>


I wrote yesterday about the current markets being much more like Vegas than any reasoned approach to analysis. Market participants, professional and amateur alike watch their screens on government-announcement days to see what sort of fresh incentive will be offered. Then they spend the next hour or two trying to figure out if it’s good or bad.

That’s no way to restore confidence in our financial markets, but given that we all hold financial assets we are forced to be in the game.

However, we are free to choose how we participate. We can watch out for pitfalls and strategically avoid them when we see them ahead. And we can grab opportunities that come into play.

The pitfall I brought to your attention yesterday was that which lies with growth stocks.

The opportunity lay in hedging.

Today, we look at the pitfalls found inside boxes…

In this Economic Winter Season, it is vital to think outside boxes… in particular, the Morningstar box.

Morningstar always made me smile. The company grew to fame by creating a nine-box matrix that neatly categorized equity investments from growth to value and then small cap to large cap.

Once the boxes were fixed, the race was on to “balance” one’s investments among the different styles listed.

This led money managers to focus solely on one area… to the point where they became known as a “large cap value man” or a “small cap blend manager.”

My smile was brought on by the thought of what these guys do when their particular type of investment fell out of favor. While a guy might be riding high on mid-cap growth stocks, when the tide turns and these stocks get hammered, his best bet is to shift into whatever is favored next. Unfortunately, many of these managers are bound by their prospectuses to remain in a certain area of investing.

Don’t fall into this trap.

Style Has No Place Here

One of the keys to success in the current environment is recognizing that style has no place here. There is no distinguishing between large cap growth and small cap blend. The only thing that matters at the moment is “risk on” and “risk off.”

The difference is a determination as to whether global sentiment believes we will all be saved by central banks and that inflation among risk assets is a gift… or that nothing can save us now, all currencies will die and we should hunker down for the great implosion.

This manic depressive market view drives everything. And it seems to change about once a quarter.

Knowing this allows investors to take a step back, turn off the TV, put down the paper and ask a few questions.

When the world is “risk off,” what might do well? Income investments come to mind.

When the world is “risk on,” what’s the best choice? Commodities are a start.

From this simple starting point investors can build a short list of “risk on” and “risk off” investments that they choose to hold either as a group, knowing they will participate in both phases but also give a little back, or they can choose to move back and forth with the rhythm of the investment world.

Whichever you choose, make sure to stay out of the boxes.

Rodney

P.S. Have you visited us on Facebook yet? It’s another way for us to keep you posted on economic and market goings-on. It’s also a great way for you to communicate with us. “Like us” now.

Ahead of the Curve with Adam O’Dell

A Win-Win In a Difficult Market

While the Morningstar boxes often constrained portfolio managers, they provided a key benefit to investors: diversification.

 

 

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Categories: Economy

About Author

Rodney Johnson works closely with Harry Dent to study how people spend their money as they go through predictable stages of life, how that spending drives our economy and how you can use this information to invest successfully in any market. Rodney began his career in financial services on Wall Street in the 1980s with Thomson McKinnon and then Prudential Securities. He started working on projects with Harry in the mid-1990s. He’s a regular guest on several radio programs such as America’s Wealth Management, Savvy Investor Radio, and has been featured on CNBC, Fox News and Fox Business’s “America’s Nightly Scorecard, where he discusses economic trends ranging from the price of oil to the direction of the U.S. economy. He holds degrees from Georgetown University and Southern Methodist University.