August 23rd, 2013

Portfolio Management – Part 5: The Hidden Cost of Diversification As “Insurance”

Risk and Opportunity


In economics, risk is defined as volatility. Furthermore, one truth of economics is that high risk accompanies high return while low risk means lower return. Investment managers put us in a dilemma when they play on our fears by asking us to take the safe course by accepting low volatility and lower returns. They want to convince us to diversify away from the higher volatile and higher return of stocks by adding a large dose of lower volatility/lower return fixed income securities to our portfolios (the standard is a 60/40% mix). But what are the sorts of risks they warn us of? How likely are they to actually materialize?

Investor advisors essentially try to convince us that sometime in the future, they don’t know what or when, our portfolio could be significantly impaired sometime in the future if we don’t diversify to reduce its volatility, probably just when we need to liquidate some of the assets to provide funds for a specific large expenditure like tuition, a wedding, a 25th anniversary trip, extraordinary medical costs, job loss or retirement. They claim that the values of our portfolios are vulnerable to a wide range of real world risks, including:

  • Company risk from
    • financial or operating performance which, if the market perceives to be negative, adversely impacts the price of that company’s stock
    • technological risk
    • competitive risk
  • Industry risks including
    • government regulation
    • product or technological obsolescence,
    • international competition
  • Economic risk arising from
    • either governmental fiscal or monetary policy,
    • international events and
    • inflation risk
    • interest rate risk
    • exchange rate risk
  • Political risk

There’s no question that these sort of “risks” can actually happen; they happen all the time but how significant is that risk? For the time being, let’s put aside individual stock risks and focus instead on risks that influence most stocks, the economic or political risks that are characterized as “systemic” risks. No one knows what, how or when these sorts of risks will become real events but, when they do, their impacts are huge and affect nearly every single stock. As a matter of fact, in today’s global investment climate, they impact most investment vehicles both domestic and foreign stocks and bonds. There’s usually no place to hide, no safe haven. These risks often manifest themselves as stock market crashes.

For example, the recent Financial Crisis Crash significantly damaged real estate values, cut stock prices in half and even brought down international stock markets. Because of the fear of financial collapse and corporate failures, the value of all debt with the exception of US debt was also adversely impacted (until the Fed stepped in with their Quantitative Easing program that drove debt values higher and interest rates down).

Since the stock market suffered two major crashes in the past decade, investors are especially loathe to invest in stocks. Investment managers play on these fears and push such strategies as the “Ultimate Buy-and-Hold Strategy” as a panacea. But how unusual were the events of the past decade and how likely is it that they and other risks will occur over the long-run future? Should any of these risks materialize, what sort of impact might they have on the stock market and a stock price volatility? Putting individual companies risks aside for the moment and instead focusing exclusively on systemic, total market risk, we find that the probability of significant stock market declines (i.e., declines of more than 15% in a year) are actually quite rare:

Risk Dimensions

There have been 894 months over the past 75 years since 1939 when, during that period, the market suffered monthly declines 41% of the time however in 57%, or more than half, those declines were less than 2%. In fact, during any single month, almost none of those declines were more than 10%.

What happens when the holding period is extended to a year? During the 882 rolling, sequential 12-month periods, 70% ended in a gain; 12 month loss occurred in less than 30% of the cases. In fact, many of those declines were bunched together in short time periods since they occurred during extended market crashes. In the 30% of cases when there was a loss at the end of 12 months, the losses were less than 10% more than half the time. The market increased fairly regularly over the past 75 years and the increases have been substantial:

Profit Opportunities

The market closed higher in 70% of the 12-month periods since 1939 and in almost half of those instances the gains were 10% or more; in a third of those periods, the gain was 15% or more. Among the nearly 900, shorter 2-month holding periods, the market advanced 62% of the time and nearly half of those gains were 2% or more.
One way of interpreting the trade-off presented by the market In the very short-run (i.e., each and every single month):

  • hold stocks for a month for a near 60% likelihood of capital growth with a 35-40% probability that the growth would be 2% or more and
  • a 30% likelihood of a capital loss that has a 57% probability of being less than 2%.

For two months is succession, clearly enough time for someone to evaluate the market’s longer-term risk and adjust a portfolio’s exposure to that risk the market, a typical trade-off is:

  • hold stocks for two month for nearly a 62% likelihood of capital growth with a nearly 50% probability that the growth would be 2% or more and
  • a 37% likelihood of a capital loss that has a 44% probability of being less than 2%.

The past 75 years probably cover nearly every possible type of macroeconomic, technological and geopolitical event and the above statistics summarize the stock market’s reaction to them all. Could the future introduce anything more dramatic than these and could the stock market’s behavior in the future be much different? I think not. These statistics cover all sorts of market conditions including:

  • World War II, Korean, Viet Nam, Iraq and Afghanistan and the first attach on U.S. soil,
  • two secular bear markets (the 1970’s and the 2000’s), crashes (Tech Bubble of 2000-2003 and Financial Crisis of 2007-2009)
  • 17-year bull markets (post war 1949-1966 and 1962-2000)
  • technological upheavals with the beginning of space age, biotechnology, PC’s and the introduction of the Internet into everyday life
  • major geopolitical events like the fall of Soviet Union
  • global economic crisis including the 20-year Japanese economic winter, Federal budget and debt ceiling crisis and the launch and near collapse of the Euro
  • presidential assassinations, resignations and near impeachments
  • natural disasters including hurricanes, earthquakes and tsunamis
  • market flash crashes and the largest single day stock market loss of 22.6% on October 19, 1987

Even though they say they are looking out for you personally, the typical investment manager has many clients and protects you through a cookie-cutter, one size fits all approach. You don’t want your manager to be a passive manager but instead an active one continually reacting to ever changing environments.  Instead of paying your investment advisor fees to continually anticipate extreme yet relatively infrequent market declines, expect them to navigate around major declines when and if they happen. You should expect them both to protect your portfolio and to earn returns greater than could be earned by owning an index fund.

During the next parts of this series, I’ll discuss my approach that’s less costly than the “insurance premium” by intentionally foregoing profit opportunities (higher volatility); that approach is to incrementally, in part or totally, move to the sidelines when volatility increases in the wake of bear markets and crashes.

July 10th, 2012

Earnings Reports Season Is No Basis to Evaluate Prospects

As we’re constantly being reminded we’re going through earnings season.  Stocks announce results for the past quarter and outlook for the remainder of the year.  These announcements by company management are compared against the collective wisdom of the “brains” on Wall Street as measured by their average sales and earnings projections and based on whether these two numbers are close, the institutional holders of those stocks will either sell or rush to buy driving prices either higher or lower.

I usually find all these “Earnings Alerts” and the resulting reactions comical because I can never tell whether the “misses” resulted from the “brains” being overly optimistic or pessimistic.  Clearly, we can’t usually argue with the actual results,  so we have to assume that it was the Guru’s on Wall Street that were wrong.

But no one can argue with the very optimistic picture many longer-term stock charts are now presenting.  I have assembled a list of close to a hundred stocks where prices are close to or recently have crossed above resistance levels that extend back 5-10 years.  Every day, new names join the group of stocks that have succeeded in making the cross over into new high territory, some 4-5 year new highs and some all-time new highs.

Without revealing too much information that Members receive in their subscriptions, I offer the following post I shared with them on June 10:


Last January, I posted a piece entitled “Is the Secular Bear Market Close to Ending?” in which I included 18-years charts for WMT, MSFT, AMGN, QCOM, DIS and IBM. These weren’t pretty pictures (click on the above link to see those charts). The price of each of these large cap stocks was constrained under a ceiling that went back to the 2000 Tech Bubble Crash. I concluded that


“What we’re all waiting for are stocks like IBM to breakout because when more do, we’ll be certain that the 12-year secular bear market will have ended.” Since then, DIS and QCOM have joined IBM at being able to penetrate, just barely, those ceiling prices levels.”


This past week, WMT crossed above that long-term ceiling (click on image to enlarge):

Biotech and other healthcare stocks are among those leading the market so I suspect that AMGN won’t be far behind in being able to cross above that long-term hurdle:

If you’d like to learn more about these stocks and others, join the Membership site below.

May 3rd, 2012

Rohrbach on Market Timing

I shouldn’t but I will anyway.  I shouldn’t whine but you’re all friends or you wouldn’t be reading this so I’ll borrow your shoulder to cry on and your ear to hear my complaint.  OK, here it goes, “I don’t understand why more of you haven’t subscribed?”

I happened across a series of interviews on with Jim Rohrbach of Investment Models about using moving averages to spot trend changes.  The essence of Rohrbach’s message is that:

  • “[You] can’t look into the future. If you can just identify when the trend changes, that’s all you need.”
  • “[Most traders] don’t know how to identify a change in the trend in the market, and it’s not that difficult, if you spend the time to try to figure it out.”
  • [most investors] are being told constantly by brokers, etc., ‘Don’t try to time the market…it can’t be done.’
  • [Rohrbach] “spent seven years working on the mathematics of that thing. I kept stumbling, but I finally came up with a way where I can take certain ingredients, which I’m not going to tell you what they are, and if I applied them to the mathematics, I could tell on a daily basis what the trend of the market was for that day.”
  • “Convert the action of the market into a number. That number represents the trend for today. If the market is going up several days in a row, that number will go up, and vice versa.  But you’ve got to know the ingredients, and you’ve got to use mathematics. Don’t listen to those guys on the Street, or wherever, who tell you the reasons for the market going up or down, because they have nothing to do with reality.”
  • “And you’ve got to stay in [Apple] if you’re really going to capitalize on this thing. If you get out because Apple dropped ten points today, that might be a big mistake…… Stay in, stay in, stay in. Even if the market goes down 200 points.”
  • “You don’t have to be smart. You have to be intelligent. You have to have a strategy that tells you when to get in and out….if you have something that’s worked for 40 years, then once you know where the market’s going, the trend of the market, then you can start playing around with individual investments.”
  • “Just play it with the market. It’s telling you—and I know that’s kind of difficult for the average person to do, and it’s also very difficult for them to have the discipline to act on every signal. Your emotions get involved in this game, especially when your money’s involved.”

I tell you all this because I want to demonstrate what I’ve been writing here about since starting this blog over six years ago are the same things that others in the know have been doing also.  I also studied the market’s action since 1963, almost 50 years worth of history, and came up with my own mathematical indicator as to the strength of the market’s momentum and direction; I call my indicator the Market Momentum Meter.

If market conditions remain relatively unchanged over the next several weeks, the Market Momentum Meter will approach a critical level early in June.  Members to Instant Alerts see what the Meter’s reading is each time I make a trade; each day’s reading is recapped in the Weekly Report.

Rohrbach charges $395/yr for his market timing service or, as he says, “about a dollar a day”.  My service is less expensive plus you can see how I translate my Market Momentum Meter into actual trades shortly after their execution.  I also keep track of the the performance of those trades in a Model Portfolio because market timing needs to be followed with a high success factor in stock selections (even the best in baseball strike  out once in a while).

The market is at a critical point.  Is it correcting or reversing?  Should you sell in May and go away or buy in anticipation of a market resurgence?  Become a member to see what I’ve done.  Don’t put it off, act now!

May 1st, 2012

Don’t Let the Train Leave Without You

At the beginning of the year, I outlined my process for assembling an Watchlist of stocks that look like suitable candidates for purchase (see “The Challenge of Assembling a Watchlist” of January 18, 2012).  In short, the process involves running four scans that identify stocks meeting certain fundamental performance and technical momentum criteria and then manually looking at the stock’s charts to identify those that: 1) look as though they are about to cross above the apparent upper boundary of a congestion zone (either reversal bottom or consolidation chart patterns) or 2) haven’t moved too far above the previous congestion zone increasing the risk of the stock being susceptible to succumbing to a downdraft in the event of a market correction.

The market has been trapped in a very narrow trading range since mid-February and is again approaching the upper boundary in another attempt at breaking above and continuing to drive higher.  Therefore, it’s time to assemble another watchlist.

This time, using the process described above, I culled a list of 132 stocks that, in my judgement, meet the criteria.  The four scans delivered an additional 346 stocks  but most of those stocks have already had huge runs and are far above their most recent previous congestion zone.  Many of the names on the larger list of momentum stocks contains the names of stocks that are now familiar leaders; 71% have increased 10% or more since the beginning of the year while 35% are up 25% or more.  I was fortunate in having added 26 from the list to my Model Portfolio and show gains on them.

My most recent Watchlist consists of 26 healthcare, 24 tech and 30 resources and manufacturing stocks:

It’s from this list I suspect (it’s probably safer to say “hope”) that the momentum leaders in the market’s next up-leg will come.  That’s not to say that the movers since the beginning of the year won’t lead also in the next leg; I only say that if you are afraid of buying into such high fliers as AAPL and PCLN, then you can probably get some nice percentage moves in some of the new comers without at the same time suffering acrophobia.

Members have access the list and now you can also (click here).  Be prepared for the next leg higher.  Learn the price levels that signify a breakout and trigger a purchase.  Know when a stock may have run to far ahead to catch without risk.  Don’t let the market’s next move leave you standing on the sidelines watching as others make money.  Act now!

February 15th, 2012

Don’t Let A Stock’s Price Scare You

Traders frequently harbor an aversion to high priced stocks, however, that shouldn’t necessarily be the case.  A perfect example would be a stock that I purchased for my portfolio on January 17 at 189.48.  The stock was TNH (Terra Nitrogen) and I informed members of the trade through an Instant Alert as follows:

TNH produces nitrogen fertilizer products. Although the Group doesn’t appear to be among the top tier, TNH has a 7.55% dividend yield. The stock looks like it may be on the verge of clearing out of an ascending triangle form of congestion and begin moving higher.

TNH was a stock captured in the “Stocks on the Move” Watchlist of January 6.

TNH did break out of the triangle and as of this morning is up to 236.99 for a 25.07% gain in a little over a month.

Fortunately I wasn’t scared off by the stock’s high price.  That high dividend yield is still locked in and looks even better now; the question now is whether to lock in the profit or let it ride?  What say you?

But the way, I’ve added 17 stocks to my portfolio since the beginning of February in an effort to put more risk on the table.  Members were alerted minutes after the trade for my own account is completed.  If you’re interested in seeing what I’m doing for my own account, click on the Membership tab at the top or the Subscribe button below.

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January 11th, 2012

The Breadline for Financial Bloggers

Time have been tough for hedge fund managers, big and small.  John Paulson, for example, needs to generate a 104 percent return to recoup a 51 percent drop in one of his largest funds after wagers on a U.S. recovery went awry.  Until he hits that mark, Paulson will have to forgo his 20 percent performance fee, and will collect only his 1.5 percent management fee.  According to the San Francisco Chronicle,

“Hedge funds are on track for their second-worst year in more than two decades. They’ve dropped 7.6 percent from their peak asset value in April, according to Hedge Fund Research. At the end of the third quarter, about 30 percent of the 2,000 funds that make up the firm’s benchmark index were below their so-called high watermark, or previous peak value.”

That’s the herd but what’s happening to the individual investor?  According to the NY Times, in an article entitled “Small Investors Recalibrate After Market Gyrations”,

“small investors withdrew hundreds of billions of dollars from American stock funds, and they kept bolting as the market rebounded sharply for much of last year….The timing for those people was off, and now they are being buffeted by the steep drops on Wall Street or bailing altogether. Still others who have been holding on in recent years have had enough.”

Some investors fear that the markets have become dominated by high-frequency traders blitzing in and out of stocks, or by sophisticated hedge funds running mind-bending algorithmic trading programs that can outsmart the ordinary investor.  After years of underperformance or losses, some individual investors are questioning whether the long-term outlook that has been drilled into them by Wall Street financial advisers and professionals is really the best advice.

As reported on Yahoo! Finance, “The WSJ says all this volatility is detrimental to the markets … Plus, the swings scare off individual investors, leaving only the big players on the field.”

But the high volatility and lack of trend is a double-edged sword for us financial bloggers.  Not only do we struggling like other individual investors to make a reasonable return on our own investments but we also suffer because so many individual investors have thrown up their hands and resigned themselves to sitting on the sidelines or exiting the market all-together and are, therefore, in no mood to plunk down a membership fee.

But having abandoned the market, those individual investors aren’t aware that what we may be witnessing is the withering end of a secular bear market that’s held us hostage for the past 12 years.  By remaining uninterested, uninvolved and uninformed, those investors could run the risk of missing out on the quickest and most inclusive of all stock market moves … the exit from a long horizontal trading range.

Rather than turning away, investors should be now looking for the most reliable and objective source for market timing.  I believe with our proprietary Market Momentum Meter, the Stock Chartist blog is answer.

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November 1st, 2010

Digging for a Consistent and Accurate Market View?

This is what I love about the stock market: if you wait long enough or search hard enough you’ll find any point of view that you can agree with. But is that what you really need to help you succeed in trading this market?

What you need is a perspective that is both short-term and long-term at the same time. Opinion that you can rely on not changing direction 180 degrees with the jobs report or interest rate announcement.

I was struck by a recent headline from Bloomberg BusinessWeek (Bloomberg completed the acquisition of Business Week magazine from McGraw-Hill on December 1, 2009). But what really caught my eye were links to several opinions with a completely opposite point of view highlighted in a box to the right of the lead article.

I dug further and came up with a wide range of opinion pieces from a wide cross-section of institutions and analysts. I even found one institution (UBS) that distributed articles a couple of months apart (July and Sept) from different analysts with diametrically opposing projections.

Here are some of what I found:

Date Article Institution
28-Oct Fibonacci Chart Says S&P 500 May Reach 1,350 Bay Crest Partners
25-Oct S&P 500 Sell Signals Indicate Limited Gains: Charles Stanley (London)
19-Oct Bartels Sees S&P 500 Near ‘Key Resistance Bank of America
18-Oct Goldman Boosts 12-Month S&P 500 Estimate to 1,275 Goldman Sachs
8-Oct Leuthold Boosts Stock Holdings, Sees New S&P 500 High Leuthold
7-Oct S&P Shares Over 50-Day Average May End Rally Bespoke Investment Group
29-Sep S&P 500 Has Limited Room for Gains, UBS Says UBS
7-Sep Oppenheimer Joins Barclays 2010 S&P 500 Estimate Cut Oppenheimer
2-Sep Record Correlation Raises S&P 500 Vulnerability to Jobs Report PIMco
26-Aug Birinyi Says S&P 500 Bull Market Intact, Cuts Outlook Birinyi
18-Aug Worth Says S&P 500 Direction Is Coin Toss Carter Worth
2-Aug Bulls Redeemed as Birinyi, Shaoul See S&P 500 Rally Birinyi
28-Jul Credit Suisse Cuts S&P 500 Forecast, Stays Bullish on Stocks Credit Suisse
14-Jul ‘Sell Rallies’ Before S&P 500 Correction UBS
14-Apr Credit Suisse Raises S&P 500 Estimate 13% to 1,270 for 2010 End Credit Suisse

To avoid being whipsawed by the conflicting information you’re continually being subjected to, you need to find one source that you’ve found to be consistent and usually correct. Subscribers to Instant Alerts know that I’ve had basically the same view of the market’s near and long-term direction and have followed a consistent game plan in my own personal trading based on that view. To subscribe, click on the icon to the right.

August 9th, 2010

Waiting, Vacations or Just Plain Boring?

Art Cashin, head of floor operations for UBS, said this afternoon that coming to work today almost wasn’t worth the price of a subway token because trading had been so slow and boring. While some Talking Heads on CNBC said the reason was just that it was a lazy, August trading day when many are on vacation. Others said it was slow because many traders were sitting on the sidelines waiting to hear what sort of new stimulus the Fed might come up with in tomorrow’s meeting (and if they don’t, that will give the Bears an excuse to sell the market lower).

I’ll take a purely technical view and say that the market (that is, many of the market’s participants) are waiting to see whether all the others are able to push the Index above the 100-dma for the first time since it slammed through it from above in the beginning of May while a few others of a different persuasion are waiting for some safe distance beyond tomorrow’s full moon (according to the Lunar Cycle Theory, trading days in the waning phase, Full to New, are supposed to be more bullish than the other).

A move above that 100-dma would be significant for a number of reasons:

  • Index will be above all moving averages (50-, 100-, 200- and 300-dma) for the first time since the beginning of May
  • Index will have crossed above a neckline (somewhere in the 1120-1125 zone) of what we will later call an intermediate double-bottom
  • Since the decline from the April peak was so severe and so sudden, there’s relatively little resistance up to 1165 (+3.25%) and from there up to 1218, that April peak.
  • Interestingly enough, the distance from current levels to 1218 would be 9.5%, just about the same as the distance from the July low (1022) to the neckline.

Although I’m writing in mid-day, the market looks strong enough for me to say that the wait may be over and the market will successfully break above those double hurdles, the 100-dma and the neckline:

Readers to my Instant Alerts service (for more information, click here or the link to the right) already have seen that I’ve changed view of the market’s near-term direction. Rather than waiting for the correction that never came (11 months, with the market moving horizontally), I now see the odds of the market hitting 1165 greater than the odds that it will hit 1050 (the first step on the way to the missing correction’s ultimate goal of 950). I added 26 stocks to the model portfolio since July 22 and brought the percentage invested up from 35% to 55%. A cross above 1165 on increased volume and I’ll move to be fully-invested.

It could get very interesting as we approach the mid-term elections and after. Subscribe to Instant Alerts and you’ll see what moves I make shortly after I make them.