Listeners of our weekly GWS market insights are accustomed to hearing Founder & CEO John Gatewood and me hash out our views on the economy and financial markets. This week I had the pleasure of interviewing Thaddeus (Ted) McDonald, an outside consultant for Gatewood Wealth Solutions’ Investment Strategy.
Ted’s Interest in Investment
Ted started to get into investing when he was in high school, more than 70 years ago. It all began with a very good teacher that taught algebra and calculus. He worked well with her direction and discipline, leading him to get an Engineering degree from the University of Notre Dame.
Ted thought that a manufacturing career would be the way to go, but analysis is what appealed to him the most. During his years working in the investment industry, he learned a lot. Ted stated, “I think each little segment of my life has added to the whole of the investment strategy that Gatewood Wealth Solutions is applying today.”
Profit Magic of Stock
Ted began developing his investment strategy while in Wichita from reading three influential books he kept on his shelf, one being the Profit Magic of Stock. He studied cycles and models that helped him observe how order always comes out of chaos. A pattern always exists, but it never tells you how to predict the next movement.
Similarly, there is the Fibonacci Ratio that Ted and I have discussed in the past, which is derived right out of nature. There is a unique cycle that we, as humans, observe when we walk into a movie theater. “Chances are we will sit 62% from the front of the screen. Once a person sits at the 62% mark, the next person tends to sit either 62% further up or 38% further back,” said Ted. This phenomenon had a significant influence on Ted over the years in building his investment strategy.
Ted doesn’t remember when he started to apply this investment strategy. Looking back to when he took the CFP® exam, and he was already developing technical analysis for investments utilizing the phenomenon he observed and theories he learned. Ted’s strategy encompassed two core technical indicators: quantitative and qualitative. He began by measuring price changes over time, which is the foundation of the book Profit Magic of Stock.
He then began combining what he learned through this quantitative process with how it related to income statements in order to assess his decisions. As Ted refined his research and investment process, he was asked to teach an investment course at Newman College in Wichita on the fundamentals of his developing investment strategy and theories.
Fundamental Analysis of an Investment Strategy
Fundamental analysis explores the characteristics of a company’s balance sheet income statement. It considers things such as earnings per share, the amount of debt held, the price per share, and how these values change over various periods of time, both long and short.
In Ted’s view, “By combining fundamental and technical analysis, one then has the tools to create investment management strategy that captures both company quality and its price change trend.” Good money management s first and foremost about company quality.
Investors sometimes find themselves in what’s called a “Value Trap”. While they seek quality companies to buy, they also want to buy them “cheap”, i.e., buy low.
Value traps are investments that are trading at such low levels that they appear to be buying opportunities for investors. The investment may be low priced and is often accompanied by extended periods of low multiples. A value trap is a poor investment when the company’s low price and low multiple is due to financial instability and or little growth potential.
Investors may seem eager to buy low priced stocks, hoping to buy low and sell high. Remember, company fundamentals are key to determining quality. Don’t get caught buying an unloved stock as it may result in a buy low – sell low situation.
Modifications to the Strategy
Overtime Ted made modifications to his investment strategy. Incorporating better interpretations of price changes was vital as this was also reflective of the supply and demand for a stock. Tying this price variability with fundamental analysis formed the foundation for the rules and technical indicator measures that are utilized to determine whether a security has momentum going up in price or down. Investors use many techniques for trading determine when to buy or sell a security. These include charting trend lines, channels, tops, bottoms, ranges, and more, all of which can be combined to traders to create strategies which they believe will best meet their risk-return expectation.
While GWS already employed strategies for its model portfolios, Ted consulted to add his insights in hopes of improved risk-return and benchmarked performance. Back to the motion model. Ted worked to incorporate his findings into the existing strategies to better separate noise from the signal. Through targeted time periods and logic, Ted’s help helped the GWS strategies better reflect where trends appear as the “signal”, while blocking out the noise of short-term volatility.
Greed and fear are the two elephants in the room when individuals make investment decisions. Ted says, “It is better to formulate rules based upon indicators flowing through the technical analysis, which then removes the emotions from trading decisions. This takes the guesswork and emotions out of trading decisions, which is especially important when the market experiences extreme volatility as we saw in 2020. While no system is perfect and cannot guarantee a positive result, rules-based investment strategies tend to do better than judgement based.
It is not enough to know the rules and read the signals, execution on these is also critical. Ted modified his approach over the years by tweaking the rules to buy or sell based on price change compared over specific time periods to determine whether securities were gaining or losing momentum. These technical indicators compare short, intermediate and long-term periods of price change.
The GWS Investment Strategy
We have expanded the strategy to uniquely compare like-kind securities with each other - mutual funds and ETF’s against their peers. We also compare these securities against their respective market benchmarks and the portfolio models. The GWS strategy measures the performance of asset classes through proprietary rules to determine the allocation tilts for client portfolios.
Our goal at GWS is to earn enough excess return to cover client fees and add some excess return above the comparative benchmark.
As John Gatewood always says, “Every investor should first start with a financial plan”. Establishing a financial plan that reflects each individual or family's financial and other personal goals that includes quantifiable trackable metrics is key to helping them achieve their desired outcomes. How do you know if your making progress without something to measure?
While investment performance is important, success is not measured by whether one's investments beat a benchmark but whether one achieved the outcomes set out in his or her financial plan. Together with understanding one's ability and willingness to take risk, these goals then become the basis for the portfolio strategies and allocation targets selected for growing and preserving one's wealth.
The Year of 2020
Our strategy signals pushed us into technology in early 2020. Then came the pandemic, the lockdowns, and a steep market selloff. No one panicked. While it didn’t feel good watching portfolio values decline, our rules-based strategy kept our team confident in its portfolio management decisions. We certainly did not anticipate this past year’s recession, but we know they happen from time-to-time, and our strategy worked as designed.
We followed the signals and executed upon the rules. We could not have known the market would have responded the way it did, especially with the S&P 500 down almost 35% in March, only to end the year up more than 15%. Even Ted says he never experienced a market quite like this in his more than fifty years working in the investment industry.
During the year, changes were made to the portfolio when security price were depressed. It doesn’t matter whether or not an investor harvests a loss, but if there is an opportunity that may outperform that security going forward? Our strategy is designed to push us into the things that are working and out of the ones that are not.
The Strategy Going Forward
Ted believes John Gatewood and his partners have invested significant resources into creating an infrastructure to deliver high touch hyper-personalized service. They attracted a superior team of highly credentialed young professional able to successfully operate this investment strategy for years to come. He said, “Today, GWS has the scale to efficiently and effectively deliver its investment management and financial planning services to a wider client base nationally.”
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Disclosures:
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. All investing involves risk including the possible loss of principal. No strategy assures success or protects against loss. Dollar cost averaging involves continuous investment in securities regardless of fluctuation in price levels of such securities. An investor should consider their ability to continue purchasing through fluctuating price levels. Such a plan does not assure a profit and does not protect against loss in declining markets.