Portfolio management – an alternative

Modern portfolio management theory emphasizes risk management through diversification. Simply put, investors are advised to spread their investments across sectors and asset classes, offsetting risk among component weightings. However, this rigid system of diversification avoids market timing aspects of risk and often exposes investors to drawdowns that could be avoided with an approach that better adapts to the market environment.

There are few money managers that employ more aggressive diversification strategies. One upstart investment firm is focused on systematic trading and has caught my eye – Acorn Global Investments Inc. of Oakville, Ontario. A recent paper explains Acorn’s approach:

Systematic Trading: Diversification Done Right

Stock picks in the security industry

A fragile balance between global economic recovery, sovereign debt problems, and potentially threatening commodity inflation is the thematic market headline challenging investors early in 2010. However, the stock market is also reminding investors that security issues are a major business opportunity in our time. Threats to our economic security remain the primary driver of capital scurrying between asset classes, but a big challenge for economic well-being in our age is securing commerce - and the population - from threats big and small. Almost a decade after the history-altering terrorist act now referred to as 9/11 stewards of the global economy remain anxious to find systems and technological solutions to security risk. Judging by the performance of many of the stocks that represent this effort to make the world a safer place, the market is doing its job of accepting this challenge.

Although companies in the security industry range across a broad scope of service and systems – from typical security services to high tech applications of screening and warning devices – this loose grouping of enterprises devoted to reducing risks of harmful acts, as well as natural disasters, is worth watching. Recent stock market trends show that investors know the stakes are big, and that economic dislocation and crisis is a tremendous cost for failure to defend against security risk. Some of these security industry stocks are currently delivering trend trading opportunities.

One of the best performing stocks on the Toronto Stock Exchange since the market bottom almost a year ago has been Garda World Security Corp. (GW-T). This Montreal-based security services firm has a worldwide presence, but the 2008 recession pummelled its shares to a penny stock from much loftier heights. The stock took off last year, though, and became Stock Trends Bullish in early June after its initial rally more than tripled the share price from its 2009 open. Since its rebirth as a bullish stock GW has doubled in value again and is now scaling new 52-week highs as its shares approach $12. The share price would have to double again to challenge the highs prior to the stock’s 2007 perch, but trend investors can look toward an advance to the $15 area as an immediate objective.

 

OSI Systems, Inc. (OSIS-Q), a security scanning systems provider, saw its stock break out in early 2010. Although it has been Stock Trends Bullish for the past three quarters, OSIS upward sloping 13-week moving average is now helping the stock regain a footing above $30 (US). If the share price manages to push ahead of its January high, eclipsing $33, investors will look positively toward adding to their positions.

 

ICx Technologies (ICXT-Q) develops sensors and surveillance systems. Its stock, along with the shares of identity security firm IntelliCheck Mobilisa, Inc. (IDN-A), had a huge breakout in the short trading week before the New Year - the holiday attempted airline bombing a blunt reminder of the powerful lever terrorist acts have on these stocks. Share prices in both companies have since slipped back to their 13-week moving average trend line and are trading only lightly now. However, investors can again look at this as another launching pad.

Another bullish trending stock, American Science & Engineering Inc. (ASEI-Q), is currently trading at its 13-week moving average trend line and could also rally to its January high. The shares of this x-ray inspection systems firm would add in excess of 10 per cent on that move.

Analogic Corp. (ALOG-Q) makes explosive detection equipment, but its stock has been somewhat of a dud since its bullish breakout in the first quarter of 2009. For the past 11 months the stock has been in a trading range, struggling to top $40 and slipping back to the $34 area. Currently the shares trade at the ceiling of the range - $42 – and could provide a cue for buyers to pick up the stock if it breaks out of the long term trading range.

Other stocks that deserve attention include L1-Identity Solutions, Inc. (ID-N), maker of biometric identity devices, L-3 Communications Holdings (LLL-N), an intelligence and surveillance systems provider, and Cogent, Inc. (COGT-Q) a name behind fingerprint identification systems. Shares of L-3 Communications rallied off trend line support a month ago and are now making new 52-week highs. L1-Identity’s stock is a current Stock Trends Bullish Crossover (signalling that the 13-week moving average trend line has crossed above the 40-week moving average trend line. Cogent will also be a Stock Trends Bullish Crossover soon.

Security stocks not currently sharing in the positive price trends of their peers include Magal Security Systems Ltd. (MAGS-Q) (computerized security systems), FLIR Systems Inc. (FLIR-Q) (thermal imaging and broadcast camera systems), and Optelecom-NKF, Inc. (OPTC-Q) (advanced video surveillance). There may be other security-related stocks not mentioned here, but surely investors should look favourably on the opportunities in this important growth industry.

Emerging markets slipping below trend

The market’s date with a correction is approaching. Whether that correction amounts to a short-term setback or an expiry of bull market trend that started ten months ago, investor anxiety ratchets up with each down day recorded in global stock markets. This week’s drop in stock prices challenges the bullish price trends that have propelled global markets in the last two quarters, with emerging and European markets taking the biggest slap in the face. Many of the exchange traded funds representing these markets are in, or in danger of, turning Stock Trends Weak Bullish – a signal that should alert investors to re-evaluate their position.

Drops in the prices of a number of BRIC funds, including the SPDR BRIC 40 ETF (BIK-N), iShares MSCI BRIC ETF (BKF-N), Claymore BNY Mellon BRIC ETF (EEB-N) and the Toronto Stock Exchange-listed Claymore BRIC ETF (CBQ-T) are tripping trend alerts. All slipped over 5 per cent on the week by the end of Thursday’s trading, falling below the trend line support of the 13-week moving average. Funds invested in European countries also shared in that decline. Although Canadian equities dropped significantly this week with the materials sector, only gold stocks are currently in a Stock Trends Weak Bullish trend. This retreat in emerging markets, as well as resource equities, hardly arrives unexpectedly – but investors should be concerned about whether this is the beginning of a more serious correction. Is this time to take money off the table in global markets? Or is this a new opportunity to increase exposure to commodity and emerging market equities?

The monetary condition that has re-inflated these equity classes is plainly stated: negative real interest rates. Cheap money is always the source of asset bubbles, and the equity rally that ignited from the depths of a global recession owes a great deal to the immense amount of liquidity pumped into financial markets. However, eventually this excess must come to an end. Markets have spent the last few months trying to figure out when that time will come. A recent retreat in the price of gold, a tentative oil market, and the seeds of a relatively revived U.S. dollar are possible signals that a low short-term interest rate policy (oh heck, it’s a zero-interest rate policy in the U.S.) may end sooner than we think. If the punch bowl is taken away, commodity stocks and emerging markets will not rebound from the current weakness.

If U.S. interest rate changes are due, investors will be quickest to hit the sell button on emerging markets. The BRIC and Latin American funds that have dropped in recent sessions, in particular, deserve attention. The iShares MSCI Brazil ETF (EWZ-N), for instance, dropped to the $68 level this week, a mark it also fell to at the end of October when a chill hit the global reflation trade. Although a 15 per cent rebound from here would entice short-term commodity bulls, this Latin American fund, as well as others, are now below a supporting trend line – unlike the autumn retreat. A rally off this level is possible, but investors should be concerned about this trend line violation.