Introduction
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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A. Michael Lipper, C.F.A.,
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