The Times They Are A Changin’

Another word for risk is volatility – specifically negative volatility.  Webster defines volatility as the tendency to vary often or widely, as in price.  Obviously, we worry more when stocks vary downward as they do in bear markets.  April and October are the market’s most volatile months.  It is during these months that companies report their first and third calendar quarters.  The first quarter is important as it sets the tone of the year’s earnings expectations.  By October, enough of the year is ‘on the books’ for the company to give a rough idea of what the year will actually look like.  It is a time when ‘confessions’ are made if the company was too optimistic earlier in the year.  It also used to be a time when management expressed excitement if they had an exceptionally good year.  SEC Regulation “Full and Fair Disclosure” has effectively minimized those wildly optimistic statements because of the liability brought if they are not met. 

This April has been instructive in a number of ways.  First, earnings suggest recovery in many industries as well as continued strength in some that never really slowed down, such as housing and autos.  We have also seen significant price strength in many stocks, not measured by the popular indices, as the number of stocks making new highs has consistently outweighed that of those making new lows.

When we dissect the list of new highs, at least two major points can be made.  One, is the list is comprised mostly of small companies with very small and unknown companies.  They generally have too little trading volume to allow us to establish a meaningful position in them.  At the other extreme are the very large companies making new highs.  You know their names, like Aetna, Coca Cola and Gillette.  Investors have flocked to these stocks because they represent safe havens during periods of uncertainty.  Many of these companies are significantly overvalued when earnings potential alone is considered.  When investors refocus their attention on earnings growth and become less concerned with cash balances, debts, balance sheets and accounting accuracy, over valued stocks will become cash sources for new, more promising, investments.

There are significant opportunities in this market, but to benefit from them, we must make some changes in the way we operate our portfolios.  I’m not suggesting that we abandon the time honored philosophy of long-term investing, but some significant changes must be made in our tactics to address today’s high volatility, significant uncertainty regarding management and Wall Street analysts’ credibility, and the persistent negative impact of the excesses in technology spending.  This market forgives nothing and punishes on even a hint of disappointment.  Current markets are so dominated by fear that bad news, even innuendo, in the case of General Electric, can send the stock of a good company down by 10%, 20%, even 30% in a day.  Bristol Myers fell 40% in a little over a week in late March.  When a stock falls that quickly it can have a dramatic effect on a portfolio.  A drop of this magnitude has a 2% overall impact on a portfolio of twenty stocks.

The times call for more downshifting in the risk parameters of our portfolios.  I sent an email to our Aggressive Model clients earlier in the week with many of the comments that follow.  The aggressive portfolio held many more technology companies longer than the more conservative models for reasons that are beyond the focus of this brief.  Suffice it to say, the volatility of that portfolio has been extreme, but through measures being taken now and in the recent past, we hope to improve performance and reduce risk in all of our portfolios.

Until markets return to some reasonable semblance of normalcy, the changes and enhancements we are making include some of the following:

  • Core, long-term holdings are subject to sale when      significant negative sentiment and/or sufficient technical analysis      override near-term fundamentals.       Gains held too long can erode or disappear when traders and short      sellers take aim.  They are better      equipped with information tools as well as the ability to persuade markets      now more than ever before.
  • We will not buy beaten down stocks in hopes of quick      turnarounds as there is little or no market interest in them now.
  • We will look in new places for portfolio      winners.
  • Wall Street analysis is useful for monitoring our      holdings, but buy/sell decisions should not be based solely on an      analyst’s opinion.  (We rarely do      this, but now make a point of strictly avoiding it.)
  • We will shorten our time horizon for earnings      expectations as well as the confidence placed in the eventual number.
  • Finances and balance sheets are more important now      than earnings probabilities.

I believe we can find numerous profitable opportunities in the market over the coming months.  We will continue to use a long-term lense as we look for opportunities, but we’ll keep the other eye open for near-term threats and we’ll be more inclined to protect our investment than to ride out the specific threat.  Thank you for your patience and perseverance.  Please call or write if you have questions or comments.