New Investment Horizon Ahead – Four Steps for Adjusting Our Focus and Strategy

Previously I described why I think the macro investing trend is ending and that, in the midst of its popularity, we need to take a contrarian stand to get ready. [See “WSJ Accidentally Identifies Macro Investing’s Probable End of the Line” (September 28) and “How to Profit from Trend Changes” (September 29).]

Below are the four steps I believe will allow us to focus on the next horizon and capture potential gains without taking on added risk…

Step 1 – Clearly lay out the potential changes coming

In today’s markets, I believe there are two major opportunities, both having to do with US stocks:

1. There is a large under-allocation to US stocks by both individual and institutional (think pension fund) investors. Eventually interest will return, producing a general rise in US stock prices.
2. The “macro-investing” theme looks ready to diminish. If so, investors will likely shift to security selection. A change from macro to specific will cause reassessments of individual stock prices relative to one another.

Step 2 – Determine how to capture the returns if/when the changes occur

The goal here is to keep it simple, meaning no unusual investments (especially newly created Wall Street products) and no complicated strategies.

1. Increase US stock ownership, decreasing other investments that are being used as substitutes for the normal US stock allocation. The purpose is to capture potentially dual gains from company performance and from price rises caused by other investors rebuilding US stock allocations.
2. Use “active” (instead of “passive” or index) security selection to identify better companies/stocks, seeking to earn superior returns

Step 3 – Determine the ways to control risk

The goal is not simply to manage volatility, but also to limit possible underperformance or loss (compared to present holdings).

1. Aim for a US stock portfolio with a market level of dividend yield. Today’s good yields provide a decent income plus some support for stock prices. (Do not try for a higher yielding portfolio because that would indicate poor diversification or abnormally high dividend yields – both resulting in higher risk.)
2. Use actively managed mutual funds (i.e., no index or exchange traded funds) and stock selection to build a portfolio of high quality companies. With all US stocks under-owned and mega-investing focusing on indexes, we can boost potential added return from well-selected, diversified blue chip stocks.

Step 4 – Decide to act

Nothing works quite so well in investing as getting in sync with a coming trend. The way to do that is to take some immediate action, so…

1. Start now by shifting some portion that won’t be upsetting if the market’s first wiggle is down. For example, buying a well-liked fund or stock and selling the highest risk or most mediocre holding.
2. Plan the next moves to fully step into the allocation you’ve decided upon – e.g., moving one-third of the remaining amount in each of the next three months. Then stick to the schedule regardless of what’s happening in the markets.

Examples of holdings

Here are some of my client positions used to meet the objectives above:

Actively managed mutual funds, diversified by management style

• Longleaf Partners (LLPFX)
• T Rowe Price Growth Stock (PRGFX)
• Fidelity Contrafund (FCNTX)

Actively managed closed-end funds, diversified by management style

• Adams Express (ADX)
• General American Investors (GAM)
• Central Securities (CET)

Selected high quality, dividend-paying stocks, diversified by rationale

• Boeing (BA)
• Caterpillar (CAT)
• Coca-Cola (KO)
• Exxon Mobil (XOM)
• Intel (INTC)
• Merck (MRK)

I am presenting this list of holdings to show that investing for the potential moves and returns coming does not entail doing anything fancy, clever or rash. It’s all about earning good returns without taking inordinate risks. In addition, by focusing on the managements of the six funds and the six companies, we can gain a better perspective on the US business and investment world today.

So… With a major trend change possibly upon us, it is important prepare for it, but without taking on added risk. The four steps outline the process: Being clear about the changes, straightforward about pursuing the opportunities, sensible about controlling risk, and committed to taking action.

Tags: Equities, Forecast, Outlook, Stocks, Trend change

This entry was posted on Friday, October 1st, 2010 at 1:44 am and is filed under Beat Wall Street, Contrarian Investing, Investment Insights, Investment Mojo. You can follow any responses to this entry through the RSS 2.0 feed.