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September 2009 Update

September 1, 2009

By Tim Chapman

Back to School Basics
 
Do your eyes glaze over when someone starts talking investment-speak?  Don't be embarrassed; you're not alone.  In fact, surveys show the vast majority of investors don't understand the lingo and jargon that investment professionals and market junkies toss out with regularity.
 
I can't decipher the entire world of investment language here (not enough room for a lingo 'Rosetta Stone') but as another school year is starting for kids, I thought it might be a good time to clarify some of the basic terms that often show up in our newsletters and conversations.  Hopefully, a better understanding of what some of this stuff means will make future newsletters more interesting and helpful.

S&P 500, NASDAQ, Russell 2000, Dow Jones Industrial Average
 
Each of the above is a stock market "index".  The Dow Jones Industrials is the most recognizable because it is the most reported.  Every local newscast, at some point in their broadcast, will let their viewers know how the Dow did that day.  But most investment professionals don't consider the Dow to be very relevant because the index only contains 30 stocks, which is not a good representation of the overall general market.
 
The S&P 500, an index of 500 stocks selected by Standard & Poor, is considered to be a much better barometer of the overall market because the stocks in that index are spread across various sections of our economy, like Technology, Health Care, Financials, Consumer Staples, Consumer Discretionary, and Materials.  This is why most mutual funds or investment strategies compare their performance to the S&P 500.  At Stadion, we like it for the same reason. It doesn't hurt that our "winning by not losing" approach has worked so well in comparison, but the truth is, the clients to whom we are most appealing would be more likely to have their money in the safety of a low interest rate CD than in an unmanaged rollercoaster ride like the S&P 500.
 
The NASDAQ (National Association of Securities Dealers Automated Quotation) is an index of almost 4,000 stocks.  This index used to be the home to small cap stocks only, ("Cap" is short for "capitalization" which simply means the total size of the company. AT&T is a large cap stock; a company you've never heard of is probably a small cap stocks), but that is no longer the case.  Today you'll still find most of the large technology companies like Microsoft, Dell, Apple, and Cisco Systems trading on the NASDAQ. 
In fact, the NASDAQ has more trading volume per hour than any index in the world, so it is understandable that here at Stadion, it is the most watched index and most heavily weighted in our model.
 
The Russell 2000 is an index of 2000 stocks created by the Frank Russell Company.  It is the index we now use most often as a proxy for small cap stocks since the NASDAQ no longer fits that profile
 
There are lots of other indices - Russell 1000, Wilshire 5000, etc. - and even subsets of indices like the S&P Technology index which includes just the Technology stocks from the S&P 500.

Exchange Traded Funds (ETFs)
 
In the good old days (just a few years ago!) traditional mutual funds were bought or sold once per day based on the closing 4:00 p.m. price.  Advances in technology brought about ETFs which are like the old traditional index mutual funds but they are re-priced every 15 seconds so they can be traded like a stock throughout the day.  For example SPDR (sometimes called "spiders") is an ETF for the S&P 500.  If we buy SPDRs in your portfolio, that literally means your money is invested in all 500 stocks that make up that index; if we buy IWM, your money is spread across the 2000 stocks that make up the Russell 2000; and so on.  When our portfolios are fully invested we typically own 8-12 different ETFs!  Diversification is a good thing and when we are fully invested, we are very diversified.

Market Indicators
 
We talk a lot about the "indicators" that make up our technical model, which helps us measure risk and dictates how much equity exposure we should have at any given time.
Think about visiting your doctor.  A typical visit might include a blood pressure check, taking your temperature, blood work to measure cholesterol and sugar levels, maybe even an MRI or CT scan.  The doctor doesn't just look at the "external", he or she has to look at the "internals" to get the true picture.
Likewise, we don't just look at the "price" of the market indices because that only gives us an external view.  The internal measures we look at include things like new highs and new lows, up volume and down volume, advancing stocks vs. declining stocks, and relative strength comparisons of small cap stocks compared to large cap stocks.
This internal look doesn't give us a special crystal ball, but we can know when conditions are healthy and favorable for making money in stocks, or when conditions are weakening and a cautious approach is more prudent.
We can never "predict" market tops or bottoms but our internal look prepares us to "react" as the price direction changes in a meaningful way.  Remember, our goal is to capture most of the good times and miss most of the bad times, and our long-term performance has proven the wisdom of that approach.
 
Hopefully this information will help many of you better understand the "language" we speak here at Stadion.  With that, we wish you a beautiful early Fall.  Class dismissed!