the lens of supply and demand and what we at Spectrum call “indicators” of future activity. Technical analysis applies at individual security, sector and asset class levels. Tenets of Technical Analysis Market action discounts everything. All known information related to the security is reflected in the price, including fundamental factors. As soon as new information comes to light, it is immediately reflected in the stock’s price Prices move in observable trends with a tendency to stay in trend. The repetitive nature of price movements is attributed to market psychology. The trend is considered to be intact until the trend line is broken, and the adage “the trend is your friend” means you should trade in the same direction as the trend. Technical analysis analyzes the mathematical relationship between data points to evaluate what has happened to the price of a security or index in the past with the expectation that history tends to repeat itself. Many of the patterns in technical analysis have been used for more than 100 years. They are still relevant because they illustrate patterns in price movements that often repeat themselves. An example of this is the Fibonacci sequence and the golden ratio to target price objectives. The art and science of technical analysis is the interpretation of data as a directional clue to future price activity. Fundamental analysis refers to the financial aspects of a company. Through the analysis of its financial statements, financial ratios, and other factors like economic and industry influences, an estimate of the fair market value of its stock can be achieved. Technical analysis does not care about the “value” of a company. Technical analysis is only interested in the price movements in the market. At Spectrum, we use fundamental and technical factors to analyze portfolio holdings. We believe the interplay between the two methods is essential to active stock selection by providing clues of what to buy (fundamental) and when to buy, hold or sell (technical).
What is Factor Investing? While rooted in academia, factors are broad, persistent drivers of returns and typically include characteristics associated with size, value, momentum, quality, and low volatility, among other potential drivers. By capturing or avoiding certain factors, returns can be improved, risk reduced, and diversification enhanced. While we acknowledge that the use of factors is elusive as they go in and out of favor (consider the underperformance of the value factor post-2010 to date), there is still merit in evaluating stocks through a factor lens. At Spectrum, we begin our monthly portfolio screening process by evaluating over 200 factors. We believe focusing on quality and momentum factors in security selection is essential. We find these factors have had an enduring impact on long-term appreciation, which has provided a source of outperformance against relevant benchmarks for our All Cap, Dividend Growth, and Growth and Income strategies. Why Use Quality as a Factor? While there is no commonly agreed-upon definition for the quality factor, at Spectrum, we focus on the following attributes: earnings growth, earnings growth stability, high profitability, high return on assets (ROA), low debt ratio and low accounting accruals. It seems that one would always want to own the stock of a company deemed to be “high-quality”; however, the market does not reward high-quality companies all of the time. For instance, low-quality stocks tend to outperform after recessionary periods or periods after a market sell-off. However, over the long term, high- quality stocks have outperformed low-quality stocks. Why Use Momentum as a Factor? Factor investing has attracted substantial research over the last few years, and momentum, a technical factor, is often cited as the strongest factor. Factors spark interest not only because they have been associated with the outperformance of market-cap-weighted benchmarks but also because they are not supposed to exist. The efficient market hypothesis predicts that you should not outperform a random basket of securities after adjusting for risk because security prices reflect all publicly available information. As such, factors have often been called “anomalies” in academic papers.
INVESTING
Our Investment Process – A Primer
Leslie Thompson CFA ® , CPA, CDFA™ Editor and Chief Investment Officer Co-Founder
Without a doubt, the most powerful strategy for building wealth is saving, then investing these savings for long-term growth. When investing, we believe a portfolio should include a combination of managed index funds—or, in our case, exchange-traded funds (ETFs) and individual stocks. Of course, bonds may have a role within a portfolio as a volatility reducer and, hopefully someday, an income provider. Still, the subject of this article will focus on growth assets, specifically the selection of individual stocks. We believe owning individual
companies through publicly traded stocks provides a connection to what you own, reducing emotional bias by allowing you to remain on course over difficult investment conditions. To this end, we have devoted this article as a primer to how we invest in individual stocks. What is Technical and Fundamental Analysis? Technical analysis studies past market activity to gauge what the market might do in the future. At its most basic, it is the study of behavioral finance through
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PERSPECTIVE Fall 2021 9
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