Sunday, October 2, 2016

The Art of Selling Wisely


With the growing evidence of a rising stock market, now is the time to ensure that investors are well schooled in the art of selling some of their stock investments. The market is going up despite that many experienced investors are urging caution. Perhaps one reason is that Credit Suisse, among others believes a President Trump would at least temporarily be good for the market in anticipation of significant infrastructure spending. Regardless of the motivation of the excess of buyers over sellers, prices are rising. Thus, it is the time to remember the law of the market that I heard during one of my first elevator rides at the New York Stock Exchange building when one floor broker asked his companion, "Do you know how to make a small fortune in the market?” The answer was "start with a large one." This quip was the stock market equivalent of the law of gravity. After sustained gains, losses will follow.

Various academics and other pundits devote much of their breath to informing us what and when to buy. Because we have been living in a world since the dark ages of intermittent, but generally rising secular growth, the odds of some success were in favor of the buyers most of the time. However, what counts is not the size of your poker chips at its zenith, but what your winnings are at the end of the game. Further this goal should be measured in after-tax and after-inflation in the currency of choice with appropriate allowance for anxiety suffered during the game.

Sell signals come in different sizes and shapes for different investors. Some are market related. Others are related to specific securities, sectors, or investment policies. Some sell signals are very personal in nature which has to do with changes in the capabilities and conditions of the investor.

Recognizing the Short-Term Power of Upward Stimuli

All stimuli are like the winds of a hurricane and no matter how strong at one moment eventually become docile. A list of some of the stimuli that I expect to weaken in the future are as follows:

  • ·       According  to a long-term stock market analyst who makes sense to me, he is worried that the stock market's next rise will reach the upper limits of a channel that goes back to 1929 and from the next peak will fall precipitously, correcting most of the rise at least to the latest bottom.
  • A decline in the number of buybacks and their impact on stock prices.
  • Friday's last few minutes of market action when the Dow Jones Industrial Average fell more than 40 points to finish the day up 164 points.
  • Almost all economic comments are top down starting with a precise view as to the movement of GDP. For example, Credit Suisse is forecasting a speed up to a growth rate approaching the top of its recent channel. Since the number is small I have been suspicious as to its accuracy which is far too close to its admitted error rate. Now I have some support from an official body. Historically, I have always been impressed by the accuracy of Japanese data. Not necessarily its forecasting ability, but its measurement capability. Now, according to the Financial Times, the Japanese government is rethinking its GDP measure. In one recent period its published GDP figure was a -0.9 % as compared with a newly constructed index based on more current data which showed a gain of +2.4%. Thus the Japanese policy makers have joined the US Federal Reserve Board, Departments of Labor, Commerce and the White House which have demonstrated that they have been flying blind. Our modern societies and economies are much more complex than our budget-starved official statistical organizations.
  •  Globally our very smart policy leaders do not understand our collective realities. This is the main reason that the "experts" around the world were surprised by Brexit. (I was not when I looked at the polling techniques.) Thus, I expect that "experts' will be surprised at various points in the future.
  • In a period of leveling industrial demand as in 2016, non-energy commodity prices are up 30% this year. Another sign of my concerns raised above. All they had to do is to look at one of the oldest measures in an industrial economy, chemical activities which has been strong all year.
  • My final concern is that various political and economics commentators do not understand that no matter who sits in the White House next, they are likely to have at least one down market year in the first term, possibly combined with a recession. If the occupant wants to be renewed they would be wise to bring on the recession in their first year in order to improve the odds by the 2020 election that we are in a strong upturn.

Time to Reduce Position Sizes

One of the reasons that I have constructed the TIMESPAN L Portfolios® is to focus on what should trigger a cutback in equity exposure. Basically, I believe that periods under five years will probably be exposed to at least one year of down markets. If the down year comes late in the period, the portfolio may not have time to recover so it can meet its funding responsibilities. On the other hand those portfolios that are invested in the longer duration Endowment and Legacy periods can tolerate most cyclical declines and have the benefit of secular growth. My rough rule of thumb is that periods of five years or less are likely to be exposed to at least one year when the equity market will decline 25% from its peak. Endowment and Legacy portfolios may suffer as many as three down years in ten and once in a generation a decline of 50%.

Pre-Decline Cutbacks

There are times when a careful investor suspects that there is too much enthusiasm for a security; e.g., Apple* at $130, for a sector; e.g., Housing, or the market S&P 500 20,000 level. Each of these should have triggered some cutbacks. Normally, it is too late to begin to cutback when prices are declining.  An early sign when to begin is the chatter one hears from media or gatherings of smart people.
*I have owned for a long time.

Integrity Gaps

Any time an investor has a question that is not satisfactorily answered which involves an employee, product, or statement one should begin a dismounting process. Accelerate if there is announcement of a breach of integrity. During periods of stress, one should rely on the financial statements. During such periods the biggest trap is price to book value as we are seeing with various troubled financial institutions.

Better Bargains

One of the techniques that the late and great Sir John Templeton, (a consulting and data client), used in managing his various portfolios was to compare a new attractive investment with his other holdings. He drew cash from the least attractive to the new most attractive. This was a way to keep his portfolios fresh with the current market.

Internal Changes

Each investor in a security or a portfolio is in effect a partner with some responsibility. If internal conditions change one or more holdings may no longer be appropriate. For example in our holdings of funds and fund management companies if I (or my Vice President in charge of fund selection) were for any long-term reason not able to supervise these particular investments, the positions should be sold in an orderly fashion. More general positions can probably be well managed by other competent managers and can be retained under their supervision.

The Disposal Process

Up to this point I have left open the choice of immediate sale or size reduction. This decision should be made separately for each transaction. There are two general rules to govern actions. The first is a follow on to Sir John's strategy. The question to be addressed is what are you going to with the proceeds. If an investor does not have a good place for the money, assuming there is not an urgency to sell, reduce the size of the position in an orderly fashion. In absence of any other guide the market on an absolute basis during our lifetime generally moves up. This is not an efficient way or even prudent way to manage money.

The second is a study recently reported in a monthly review by London’s Marathon Asset Management by an independent group. From 1983 through 2006, 2/3 of stocks underperformed the Russell 3000. In addition, 40% of the stocks had negative returns. If an investor did not own the top 25% of the performers over the period the investor’s total return would have been zero. (This is not an excuse to index as most stocks in an weighted index enter after their best years of performance.)

In Conclusion

Matthews Asia has a useful way of looking at portfolio decisions, and I may add business decisions. They divide them between strategic and tactical. Strategic decisions are not expected to change other than a long- term need to fundamentally leave one process to move on to a new one. Tactical decisions can be easily reversed as conditions change and possibly reverse. Strategic are fundamental decisions that are not expected to change except under dramatically different expected conditions. Tactical decisions are more market price sensitive influences.

Bottom line:  selling well is much more difficult than buying well. Take as much time, energy, and intellectual capacity as buying. Selling is always a short-term consideration, but it should be viewed as to its longer term implications.   

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