Financial Glossary

 A dictionary of professional investment jargon

Asset Allocation   |   Best Guess   |   Bottom-Up   |   Coppock Curve  |   Current Account  |   Dollar Cost Averaging   |   EPS  |   Equity Risk Premium   |   Forex  |   GTA   |   Index  |   Market Timing  |   Mkt. Cap.   |   Momentum   |  Moving Average   |   Odds  |    P/E Ratio  |   Quant  |    Real Effective Exchange Rate   |    Real Interest Rate   |    Real Yield   |   SmallCaps  |   Spare Capacity  |   Style   |   Top-Down  |   Total Return  |   Value  |   Yield   |   Volatility

 

Deciding on what type of investment to make

Asset Allocation: - The process of risk reduction by diversification, not just between different stocks and shares in one's home market, but by allocating proportions of assets between different asset classes or different countries. The latter is called global asset allocation. Tactical asset allocation is the use of market timing to adjust the balance to reduce risks and maximise performance. Investors RouteMap engages in both global and tactical asset allocation. Strategic asset allocation is the judgement of an appropriate risk profile in response to age and financial circumstances.

Even the best forecast is little more than a guess
Best Guess (alias estimate, forecast, prediction, picks & tips): -  We chose this term for means of looking into the future to remind subscribers about the level of uncertainty in an activity, where to get the direction and order of magnitude right and be on the right side of average more often than not represents out-performance, even though we believe our best guesses are based on better than average analysis.

Assessing markets by adding up estimates for individual companies
Bottom-Up (See also Top-Down): - An intellectual approach for analysing whole markets by aggregating the sum total of individual companies. This approach has a bias towards optimism because analysts' estimates are based on what the companies tell them, and they generally can't see beyond the end of their order book. However it does recognise the influence of company specific factors, which top-down analysis ignores. Please note that Investors RouteMap relies solely on top-down analysis.


Stock market losses are like bereavement. It takes a year to recover

Coppock Curve: - An investment tool used in technical analysis for predicting bear market lows. This concept was invented by Edwin Coppock in 1962 and based on the idea that bear markets are like bereavement. The curve is constructed by making time weighted moving averages of between 11 and 14 months. An upturn from levels below zero generates buy signals. These have proved highly successful, but the corresponding sell signals do not work so well. A modified version of the Coppock indicator is a component in our chart technical analysis for alternative assets, foreign currency, government bond and stock markets worldwide.

This shows if a country is living beyond its means
Current Account = Exports of Goods & Services - Imports of Goods & Services: A high deficit is often seen as a risk of devaluation. However this may not necessarily be the case if offset by capital inflow from foreign investors, or repatriation of earnings by workers overseas, so it is more useful to look at changes in the ratio of Current Account / GDP over time in each country. This is included in the Forex chart library because it is a useful warning indicator. However it is not a component of predictive models.
Beat the averages by being average Dollar Cost Averaging (See also Portfolio Rebalancing): - A rigid mathematical process for allocating new cash flow into funds in a regular savings. By investing the same sum every month, irrespective of the level of share prices, the investor acquired more units when prices are low and more when they are high, so his performance will be above average. The only disadvantage is that lump sums can usually be invested at a lower charge.


Far from perfect, but still the best way to assess a company's progress
EPS (alias Earnings per Share) = After Tax Profits / Number of Issued Shares: - This is the most widely used, and often abused, basis for valuing shares as it adjusts for new share issues and takeovers. While it is now supplemented by a variety of other sophisticated analytic measures, it retains its value for simplicity, wide usage, and long historic data runs. Apart from the United States there are no official time series for whole market EPS, so we have calculated our own series for all countries in our Shares RouteMap. Data quality issues mean that these should be seen only as a historical reconstruction.



The extra return investors expect to justify the risk of stocks and shares
Equity Risk Premium = Return on investment in equities - Return on risk-free assets: - Typically the return on equities is defined as dividend yield + capital gains over some specified period and the the risk-free return is the current yield on long term government bonds. However this calculation is both meaningless as it compares a backward-looking stock market statistic with a forward-looking bond market statistic and also pointless as capital gains depend on the choice of starting and end dates. Instead the valuation strategies in our Shares RouteMap compare PE ratios and bond yields.  We also compare PE ratios and short term interest rates across all markets.


Exchange rates against US$ or SDR
Forex (alias Foreign Exchange): - While many currencies generally trade freely against each other, that is not necessarily the case. Some are fixed permanently against each other, as in the Euro since 1/1/1999, others are fixed until further notice by government policy, as in the case of Hong Kong and a few countries employ a crawling peg policy by which the exchange rate depreciates at a fixed rate to adjust for inflation, as in Chile, Hungary or Israel. Subscribers to the Forex RouteMap should bear this in mind.
The when rather than what of investing GTA (See also Market Timing): = Global Tactical Allocation: - This is a buy-and-sell strategy as opposed to the conventional long-term buy-and-hold strategy. It aims to generate excess returns by concentrating on the when rather than the what of investing. Its comparative advantage is strongest during extended trading ranges such as 1963-1982 or since 2000, rather than secular bull markets, such as 1982-2000. This is what Investors RouteMap does and our track record shows that it works. 

Normally market-capitalisation weighted geometric average of share prices
Index = Sum of Mkt. Cap. for all companies - changes in issued capital:- Widely respected as indicators for overall performance in bond or stock markets, price indexes normally exclude dividend income, unless described as Performance Indexes or Total Returns. We calculate our own proprietary indices for each asset class, specially designed for investment decision-making.


Buy & Sell, rather than Buy & Hold
Market Timing:(See also GTA): - The alternative to the conventional "Buy and Hold" investment strategy. Decisions to get in or out of the stock market are typically based on research into economic cycles, chart technical analysis or contrarian indicators of investment sentiment. At one extreme short term traders may use the futures markets to do this for an entire portfolio even on an intra-day basis, while at the other extreme pension funds may make only marginal changes every few months. During the great one-way bull market since 1982, market timing fell out of fashion in favour of asset allocation, but changed once markets resumed cyclical fluctuations. It works for us.


The total value of a company
Mkt. Cap. = Share Price x Number of Issued Shares: - The ratio of Mkt. Cap. / GDP is an important investment tool, that enables investors to adjust for temporary extremes in company profits during booms and recessions. This ratio is similar to the Price / Sales analysis for individual companies, much favoured by corporate acquirers. That is why it is one of the valuation tools used in the Shares RouteMap.



The trend is your friend
Momentum = Rate of Change: - Often dubbed "the trend is your friend", this school of investment believes in running winners, and cutting losses. It has the great advantage that one can participate in a winner, without knowing why, as the reasons for success often only become general knowledge later. However there is the risk of frequent whip-sawing as it takes time to identify a trend, and by definition momentum investors never buy low. Price momentum is a core component of our Chart Technical Analysis. Our rating systems take into account both momentum and value philosophies of investment.


A statistical way of reducing noise
Moving Average = Average(T1.....T?): - Much like the Dolby noise reduction system, this not only reduces the statistical influence of erratic factors, but also makes charts more readable. To reduce noise in the charts, we take a single point month-end price to eliminate daily fluctuations and also use averages of up to 12 months. Some of these may be time weighted to give greater significance to the latest data.  The technical models use moving averages in combination with the Coppock curve. Results of our track record show this technical algorithm to be very successful.

The chances of betting right
Odds = Percentage Chance of Profit: - That is to say 66% represents odds of 2:1. This is our preferred method for expressing our Best Guess when using annual Seasonal Trading Patterns. This can be applied effectively to the analysis of both stock and bond markets as well as exchange rates.
Stability to beat investment fashions Portfolio Rebalancing (see also Dollar Cost Averaging): - A rigid mathematical process for switching funds from assets that have performed well into those that have performed less well in order to keep the proportions of a portfolio in different assets constant. This has the advantage that it leans against investment fashion and works well in cyclical markets, but at the expense of reinforcing weakness in secular bull markets, and it is administratively much more work.



The most popular way of valuing shares
P/E Ratio = Share Price / Earnings per Share: - This has traditionally been the best yardstick for measuring valuation for shares, because it includes both retained and distributed profits. While this ratio is now supplemented by a variety of other sophisticated valuation tools, it retains the dominant valuation role on account of its simplicity, widespread use and long historic data runs. We use it to compare the valuation of shares against alternative liquid investments, specifically government bonds and cash held in short term deposits, as our version for the equity risk premium. However, given the volatility of corporate profits, it is preferable to rely on cyclically-adjusted P/E ratios.
Quant works because it is too boring for butterfly brains Quant = Quantitative investment management: -An investment process based entirely on statistical data which differs from traditional fund management, which is based on field research through extensive company visits. This approach has the advantage that it is entirely objective. It is well-suited to offset the counter-productive human instincts of fear and greed, by diverting attention from the selective nature of media and sales hype. However its disadvantages are that, by definition it cannot cope with exceptional circumstances, and in practice it has difficulty adapting to changing circumstances, without itself falling into the trap of selectivity.


The competitiveness of any currency compared to its trading partners
Real Effective Exchange Rate = Average exchange rate adjusted for inflation. This is a complex calculation. An average exchange rate index (alias effective exchange rate) against major trading partners is first calculated by weighing each according the significance it represents in terms of imports and exports. Next a similar index is calculated to establish a weighted average index of consumer prices in the trading partners. This is then adjusted for the rate of domestic inflation, or unit wage costs to create an index of relative inflation. Finally the average exchange rate is divided by the relative rate of inflation to turn the effective exchange rate into a real effective exchange rate. Changes in this index are the best way to see if a currency is becoming over- or under-valued.

The income really earned on cash after deducting inflation
Real Interest Rate % = Short Term Interest Rate % - Inflation %: - This provides a fair measure of return to investors who leave money on deposit, after allowing for inflation. We use the last 12 months increase in the consumer price index as an indicator of generally expected inflation. As probably the single most important measure of economic policy, we use trends in real interest rates to predict the direction of foreign currency movements, government bond and stock markets.

The income really earned on bonds after deducting inflation
Real Yield % = Yield % - Inflation % p.a.: - This provides a fair measure of return to investors in long term bonds after allowing for inflation. We take the last 12 months increase in the consumer price index as an indicator of generally expected inflation. The Bonds RouteMap uses real yield as its measure of value.

Companies with little market value
SmallCaps (alias companies with low market capitalisation): -  These typically represent the smallest 10% of a stock market in terms for market capitalisation, but account for the vast majority of shares by number. While different players use different definitions, $1 Bill. may generally be regarded as a ceiling. Almost by definition when seen from an international perspective, SmallCaps have greater significance in the stock markets of smaller countries. SmallCaps are one of the investing styles analysed in our Styles RouteMap.

The main influence on profit margins and hence also EPS growth
Spare Capacity (alias GDP Output Gap) = Potential GDP - Actual GDP: - Simple in theory, but difficult to calculate in practice, as there are no figures for potential GDP. Because of their importance in predicting all kinds of markets, we have made our own estimates, which track those of leading supranational organisations closely enough for our purposes. Ours appear to have better predictive value because they are based on investment in past periods, not on projecting trend-line growth.

Investing on the basis of either high growth prospects or low valuation
Style Investing (alias investment fashions):- This refers to particular investment strategies employed by investment managers to differentiate themselves either within a region or globally. Typically this is displayed as a matrix with growth value and large / smaller companies, on the other axis. The former focus on dividend, earnings or sales per share growth rates. The latter compare ratios of share price to book value, cash flow, earnings per share or dividends. The former are more likely to engage in forecasting, while the latter normally prefer to compare the latest reported ratios with historic or peer group averages. All six RouteMaps combine both growth and value strategies. The Styles RouteMap analyses shares that are highly leveraged to different investing styles.  

Assessing markets by their overall economic prospects
Top-Down(alias Macro): - An intellectual approach for analysing whole markets by using economic data, for predicting market direction, and estimating profits growth, as opposed to aggregating bottom-up company specific information. Of those who use this approach, forecasters normally describe themselves as top-down, whereas hedge funds describe themselves as macro. This approach has the advantage that it sidesteps the positive bias of bottom-up analysis that results from listening to the managements of companies, but it has the weakness that it usually fails to take into account company specific factors. Please note that Investors RouteMap relies solely on top-down analysis.

Capital Gains + Income
Total Return = Capital Gains + Foreign Exchange Gains + Current Yield: - Long established stock market indices were traditionally calculated based on price movements alone, owing to the additional complications of computing yields. However both the need and ability for total return indexes has grown over the past two decades. The need has grown from the requirements for performance measurement of fund managers and growing computing power has provided the ability. The DAX and Wilshire Indexes are the best known total return indexes. Unless stated otherwise the proprietary indices in Investors RouteMap are calculated using price only, as these are intended as barometers of market behaviour and not for performance measurement of funds.

Investing on the basis of low valuation rather than high growth prospects
Value Investing:- Like beauty, value is in the eye of the beholder, as there are many alternative definitions to choose between. Value investing strategies have the advantage that they enable investors to buy low and sell high, but the disadvantage that they may take a long time to pay off. Value shares tend to perform well in times of strong economic activity and inflation. The amount of spare capacity in the economy is usually low on such occasions. Our rating systems take into account both momentum and value philosophies of investment.

Income in the current year
Yield % = Dividend / Price: - Only the regular annual income of an investment is included. Thus this excludes special dividends for distribution of capital gains e.g. by US closed end funds, and for bonds it excludes the pro-rata annualised difference between current price and redemption value, which is known as the redemption yield. Yield is normally expressed in terms of pre-tax return to a foreign investor, and excludes any tax credits to local investors. While foreign governments often withhold a proportion of the dividend, this can usually be offset against income tax in an investors home market. 
A misleading proxy for risk Volatility (often mistaken for Risk) = Standard deviation of monthly returns:- This is a core component in many fund selection systems. When combined with average returns it is used for calculating 'risk-adjusted returns'. These are based on historical data, usually 3-5 years. Use of these ratios can be especially dangerous to financial health because they confer spurious precision and can be grossly misleading because volatility varies with the stage of the investment cycle. Instead, our RouteMaps define risk in terms of bad value and poor trends.