Tuesday, September 4, 2012

Our Strategy (message to clients)

Europe remains messy and China's growth has slowed markedly of late.The U.S. wrestles with an atypically slow recovery, is mired in class warfare, suffers a seemingly unbridgeable political divide, and is nearing the edge of a "fiscal cliff". And, oddly enough, U.S. stocks are positive on the year.

So what gives? Do stocks, in spite of it all, make fundamental sense - or have prices been bid up entirely on the anticipation of more aggressive global monetary easing? It depends on whom you talk to. I've been making the case all year that stocks, particularly cyclicals (tech, financials, etc.), all things considered, have been fundamentally attractive (that said, our clients' portfolios [in the aggregate] are currently weighted more to [economically] defensive sectors, such as consumer staples [stuff humans have to buy to live], than they've ever been). Others would tell you this year's gains have been little more than smoke and mirrors. That is, smoke signals coming from the Fed and mirrors of previous Fed-action-induced rallies.

So who has it right? For short-term traders, that may be an important question - for if the smoke-and-mirror crowd have it right, and the Fed and/or the ECB were to disappoint, this year's gains could be gone in a heartbeat. For long-term investors [who rebalance periodically] however, it entirely doesn't matter.

You see it's important to distinguish traders from investors. A trader looks to exploit day-to-day (at times minute-to-minute) pricing action - to capture even the minutest movement, in one direction or the other. The prospects for long-term earnings and dividend growth are the furthest things from the minds of traders. Sure, they play the earnings announcements, hoping to catch a buck or two (per share) bump (or drop if they're short), but never with the intent of owning a solid company and sharing in its long-term growth. In the mind of a trader, life, and often his/her career, is short. An investor, on the other hand, buys into the notion that, for the appropriate portion of his/her portfolio, owning the companies that will supply an ever-growing world population with the goods and services it wants and needs offers the best potential for achieving an above-inflation rate of return over time.

The act of rebalancing is simply the periodic (we recommend every six months for most) repositioning back to a target allocation, say 60% stocks for example. Thus, when stocks are on the rise, and the investor's exposure is therefore (when the rebalancing date rolls around) above target, he sells (back to target). And when stocks are declining, and the allocation is below target, he buys. Forever moving against the herd.

Therefore, if you're our client, and the fiscal cliff (for example) becomes reality (my the political ramifications, regardless of who wins the White House), and the market takes it in the chin, you'll be buying, while most people are selling (prices lower). If compromise is had, and the market rallies (assuming it's not already baked in), you'll be selling, while most people are buying (prices higher). The former, you might say, is Buffet-esque "buy when there's blood in the streets" mentality.

And yes, we do recommend tweaking sectors in an attempt to improve results at the margin. The current weighting to staples (for example) is an attempt to lessen volatility in the midst of extreme uncertainty. While I've been tempted (particularly in Q1) to recommend pulling back that position, we expect to keep it there until there's more visibility with regard to Europe and the other issues I outlined at the top. Our modest exposure to emerging markets is an attempt to take advantage of the prospects for growth where 85% of the world lives. And, make no mistake, the demographics and infrastructure needs of those markets make for exciting growth potential (extreme political and market volatility notwithstanding) in the years to come.

In the meantime I'll continue to impose my free-market bias upon you at every opportunity.

Stay tuned...


  1. When do you think it is best to get into natural gas stocks? They appear to have bottomed out, but it is hard to tell.

  2. Yes, it is hard to tell if nat gas has "bottomed out". I don't think I'd try time the bottom. I.e., if you want to take a (long-term) nat gas only position, I wouldn't wait. Clearly, as you know, the going-forward prospects are very good. Be patient, expect volatility...