Archive for December, 2009

You got to know when to hold ‘em
Know when to fold them
Know when to walk away- Kenny Rogers, The Gambler

It was a year that came in like a bear and went out like a bull. All told, that left us with a surprisingly strong bull year. When the days were darkest, we think investors panicked and sold when assets were the cheapest, best buys we will see for a very long time. How else can we explain investors dumping GE stock for less than $6 a share? Oh, but that was months ago and memories are short. We now have investors willing to drop their money on assets that look very risky to us. What will 2010 bring us? We think it will most likely bring us some more big ups and downs on the roller coaster.

Is it time to hold ‘em or fold’em? As an intelligent gambler, that should depend on what you are holding. It is, in our opinion, no time to bluff when you don’t have much in your hand. Look to take some profits in areas like high yield bonds and stocks with little or no earnings. If you are holding some aces, we would stick with them for now. Keep your eye on the game however. If is turns against you once more, don’t be afraid to fold ‘em and live to fight another day.

It was a terrific year which did much to restore account values. However, it appears unrealistic that this bull run can go on too much longer. As we move from underpriced back to overpriced, the odds start to stack up against us in the short run. Be careful and thankful as we welcome in a new year!

As those of you who have been acquainted with us for long know well, we believe avoiding the Style Box approach to investing that is promoted by Morningstar is the best thing you can do. Style boxes provide very little true diversification and drag down portfolio results by as much as 3% per year.

Now, Advisor Perspectives has published an interesting study showing that the Morningstar Star Ratings fail to predict performance through a market cycle. So, moving from a “3 star” fund to a “4 star” fund is no better than flipping a coin to decide which fund to hold. Russel Kinnel of Morningstar admits the star rating is “not a forward looking measure”.

This finding does not surprise us at all. Investing with style boxes and star ratings using a rear view mirror approach is a losing concept, particularly in a secular bear market. You need strategies and tactics that make sense moving forward, emphasizing return of capital as well as return on capital.

Should you be a buyer or a seller between now and year-end? That seems to be the question on everyone’s mind as we enter December. The answer is, of course, that it depends. If you were wise enough to invest early in this bull market you should be considering peeling back some risk at this point.

That is, reducing your level of investment in high yield bonds and/or low-quality stocks. We would not advise abandoning them altogether but taking some reasonable profits. If, on the other hand, you are late to the party and are now thinking about taking money from the sidelines and placing it back into the market we would suggest you do that with caution. Specifically, you don’t want to chase gains that have taken assets to above fair value. Many parts of the market are currently overheated and likely will not produce above-average results going forward.

Looking at it in another way, you need to determine whether the odds are on your side or against you going forward. They certainly don’t seem to us to be strongly in your favor. On the other hand, we certainly have no reason to be sure that the market will not continue to run from here. A plan to cautiously reinvest might be the most prudent. You could plan to buy into the market monthly for the next six or eight months. If we did then see a market correction, you could use that opportunity to alter your plan and  purchase more aggressively into the market.

Your focus should be on buying high quality assets on which you have conviction that they will do well for years to come. That should be a recipe for success as we move forward through turbulent waters.