Many stocks in my portfolio have recently tested new highs, some for the second time in 6 months. Those same stocks are now gently retreating on lower volume. I don't generally pay attention to technical indicators, but right now it suits my conformational bias, so let's have a look. It looks similar IBD's cup and handle.
This is relevant to me because I see all the signs of a second leg of a bull market. Firstly, there is plenty of fear around. Everyone I know is anticipating a correction any day now, which is a critical component to a sustainable bull market. The Baby Boomers are retiring, peak oil and developing countries are keeping energy prices high overall, analysts are seeing bubbles everywhere. Everyone sees risk everywhere, which is absolutely great as far as I'm concerned. And no, I didn't forget that "Sell in May and go away" could result in lower volume.
We are coming off of multiple global financial and economic problems, which has left many with a warped and depressed outlook on economic progress. But there are many upsides that people are afraid to believe.
There are many people who have had lost income and presumable not invested in their retirement while struggling to stay afloat. There maybe be significant pent-up demand for housing and durable consumer goods. Many people in their 40's and 50's may also have to catch up on their retirement plans when their income recovers, having cut investment while spouses are out of work or small business income suffers. The banking scandals like LIBOR that involved mispriced assets may result in higher investment income for communities, and cheaper prices for commodities going forward as the price collusion stops (read Matt Tabbi for more about that). Technology continues to progress and improve efficiency little by little, which is constants upward pressure on profits and productivity. This last note was well realized in the 90's, but forgotten after the irrational exuberance bubble popped. The US government seems to be maintaining the status quo of favoring business over citizen interests... angry poor and middle class citizens is, to some extent, reflecting of capital having the upper hand. And let's not forget the ever present specter of inflation, which when it actually hits us will be reflected as increased asset prices as well.
We have had a great run in the markets so far. Way too many people are aware and scared of downturns for one to happen now. Way too many people are saving cash equivalents in fear, and need something to do with that money. I don't necessarily expect a pleasant end to this bull market, but I think it's got quite a bit to go yet.
Wednesday, May 22, 2013
Sunday, March 17, 2013
Diversification in stocks: finding the sweet spot
I learned early on that diversification is a double edged sword. On the one hand, risk of dramatic loss is decreased. "Don't put all your eggs in one basket." If you don't diversify, you might as well "head to the roulette table and put all your money on red." So diversification is clearly good, and those of us that don't comply are more gamblers than investors. On the other hand, risks of a big win are reduced at the same time that risks of a big loss are reduced. Boo. So much for wishful thinking of getting rich, or even being the next Warren Buffett.
So where does that leave me as a stock picker? I'm not interested in index funds or massive diversification, because, well, I like analyzing and picking stocks. I don't want to over-diversify and own the market, good and bad companies included. But I don't want to lose everything on a bad pick. Even if I could be right 90% of the time, 10% risk of loss isn't something I'm willing to face. I suspect I'm not the only one in this boat.
What I was missing early on in my investing career is this: For a competent stock picker, the right level of diversification will reduce my risk of loss much more dramatically than it will impede gains. If someone really is good at picking stocks, then it should not threaten their returns to have a portfolio of 20-40 stocks. We are more likely to see our true skill reflected in returns, and not be knocked out of the game with a couple bad picks.
What I was missing later in my investing career is this: reduced risk from diversification allows for more confident use of margin. I generally avoided margin, and that's because I carried few enough stocks that the concept made me nervous. No longer.
My new attitude to diversification is this: pick more stocks, reduce risk, let my true success rate shine through, and use the confidence to leverage my portfolio a bit. As a bonus, with my margin account re-opened I can get back into shorting a few stocks here and there.
So where does that leave me as a stock picker? I'm not interested in index funds or massive diversification, because, well, I like analyzing and picking stocks. I don't want to over-diversify and own the market, good and bad companies included. But I don't want to lose everything on a bad pick. Even if I could be right 90% of the time, 10% risk of loss isn't something I'm willing to face. I suspect I'm not the only one in this boat.
What I was missing early on in my investing career is this: For a competent stock picker, the right level of diversification will reduce my risk of loss much more dramatically than it will impede gains. If someone really is good at picking stocks, then it should not threaten their returns to have a portfolio of 20-40 stocks. We are more likely to see our true skill reflected in returns, and not be knocked out of the game with a couple bad picks.
What I was missing later in my investing career is this: reduced risk from diversification allows for more confident use of margin. I generally avoided margin, and that's because I carried few enough stocks that the concept made me nervous. No longer.
My new attitude to diversification is this: pick more stocks, reduce risk, let my true success rate shine through, and use the confidence to leverage my portfolio a bit. As a bonus, with my margin account re-opened I can get back into shorting a few stocks here and there.
Tuesday, March 5, 2013
Inflation and the "inevitable" stock market correction
It seems that many people seem to think the stock market is currently due for a correction. QE is winding down, the rally has been too long, the Fed is messing with money and inflation blah blah uncertainty etc. I see things happening differently.
Here's how it goes: Fed increases money supply with QE. Inflation ticks up. Eventually the record hoards of corporate cash feel enough inflationary pressure to get spent in spite of current economic uncertainty. As cash flows in, economic indicators will improve, giving positive feedback to other companies waiting to invest. This will snowball into record amounts of investment, both adding to inflation and increasing revenue for all those companies on the receiving end of the investments. The boom of our favorite boom and bust cycle. At this point I expect the Fed to put on the brakes, leading to the correction that everyone has been predicting since the start of this bull market.
So what's the point? There is a big rally ahead, and anyone trying to time the market to dodge the feared correction is risking missing the biggest gains. The best part is, that even if my reasoning is all wrong, I am still likely to be right about the rally. Check out historical charts of epic bull runs, and most of the gains are made at the beginning and end of the rally. This fact alone should discourage market timing, but that's for another post.
This year, like most of last year and unlike any time since the tech bubble, is full of buying opportunities for stock pickers with a long term outlook. The negative sentiment is only icing on the cake.
Here's how it goes: Fed increases money supply with QE. Inflation ticks up. Eventually the record hoards of corporate cash feel enough inflationary pressure to get spent in spite of current economic uncertainty. As cash flows in, economic indicators will improve, giving positive feedback to other companies waiting to invest. This will snowball into record amounts of investment, both adding to inflation and increasing revenue for all those companies on the receiving end of the investments. The boom of our favorite boom and bust cycle. At this point I expect the Fed to put on the brakes, leading to the correction that everyone has been predicting since the start of this bull market.
So what's the point? There is a big rally ahead, and anyone trying to time the market to dodge the feared correction is risking missing the biggest gains. The best part is, that even if my reasoning is all wrong, I am still likely to be right about the rally. Check out historical charts of epic bull runs, and most of the gains are made at the beginning and end of the rally. This fact alone should discourage market timing, but that's for another post.
This year, like most of last year and unlike any time since the tech bubble, is full of buying opportunities for stock pickers with a long term outlook. The negative sentiment is only icing on the cake.
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