Evolution of Process

A frequent flier here at Random Air emailed a question in response to my taking what the market gives comment from the other day. First let me say that I have written about that several times on the blog before.

The reader specifically asks how I have come to have the approach that I do. I'll do my best to address this with out it being too much like a manifesto (cabin in the woods humor).

I have been working in the industry since 1984 (I was 18). Right from the start I have been fascinated by all aspects of capital markets. Throughout my time I have always read, watched and studied more than anyone else I have known or worked with. This continues today. The time spent on the computer and watching CNBC Asia has often come up a sore spot in my marriage. To give you an idea, my wife and I have negotiated that if she is up on Saturday I can't watch the Fox shows. I have to TIVO them and watch Sunday morning before she gets up.

Over the years I have held on to most of the market history I have lived through (anyone remember when the Dow fell 200 points in 1989 because the UAL LBO fell apart?) and studied history that was before my time. I do believe that history tends to repeat itself but precedent can only be an aid not the entire decision process.

I have often written that stock selection is the least important part of my process. I have read several studies in my time that helped me develop my beliefs here. I readily concede that it would be easy to find a study that says whatever you want it to say. As a matter of my sense of history though, in many years big cap financials tend to do about the same thing, or similar pharma names have tight correlations more often than not. I have made good calls on AIG and Pfizer but not because I picked apart the balance sheet and found something. Both calls were top down as being the wrong sector.

I was decently early about Australia, New Zealand and Norway. This was even bigger picture, these economies will benefit from demand for basic materials. For the time being materials have the wind at their backs, but a properly diversified portfolio needs some of this exposure if for no other reason than these countries historically are at different points in the economic cycle.

The way I try to add value is being able to see things like current events and blend that together with how the market historically works and hope that result in getting more picture themes right than wrong.

The market goes up most of the time and down some of the time, sound familiar? Think about all the nasty corrections you can personally remember. What happens every time? The market comes back (please note that I respectfully differentiate between corrections and bubbles). At some point the S+P 500 will take 1500 back. I could guess at the timing and be wrong by a little or a lot. Good companies tend to do the same thing. To prove my point I randomly looked at Ingersoll Rand (IR). since January 1, 1995 the stock has had, by my count, 38 corrections that were 10% or greater (I would guess that 1/3 of them were 20% or more but I did not count) yet according to BigCharts IR is up 250% in the last decade compared to about 130% for the S+P 500. Honestly that was the first name I thought of. I did not know there would have been than many dips and I don't know how representative that is of other companies.

Over the last ten years I don't recall any death blow news coming for this company. At some point in the future the company may go the way of Bethlehem Steel or Polaroid but not now.

I believe that with this perspective in your corner it makes weathering bad stretches in the market much easier. Despite all these corrections, this one random name has wildly outperformed the market. I have no idea how many of those 38 corrections were because of the market and how many were caused but IR's own news but I feel safe in assuming that none of the news changed company.

There is some news that, for me, does change the company. My favorite story along these lines, and I've written about it before, is Worldcom. I remember hearing, while the stock was still in its heyday, that Bernie Ebbers had huge margin loans on his stock. CEO's of large public corporations don't need margin loans. I don't know why he had them but that was all I needed to know.

I often write about supply and demand being behind a lot of the themes I invest in. I heard about this time and again in any interview with someone I was told was smart. As time went on I saw how this was right more often than not. Obvious supply and demand issues are no guarantee but can put the odds in your favor.

All of my ideas about portfolio management, and there are some I have missed as this has evolved over 20 years, come from the same place. Picking stocks is very difficult. If you pick a portfolio of stocks and manage that portfolio you will get some right and you will get some wrong, no one is immune from that. I look for ways to put the odds in my favor, to do some heavy lifting for me. Oil is an obvious theme and has been for a couple of years. Basic materials is another one. In another year or three there will be a new obvious theme. Common sense big picture things are an easier starting point than industry specific, bottoms up trends like wafer size or something new with protease (spelling?) inhibitors.

My primary job is to make sure I get my clients to their goal with as little volatility and stress as possible. Remaining emotionally detached from the volatility allows me to help clients manage their concerns. My ability to remain emotionally detached comes from my unyielding faith in how the market works.

Stocks go up, stocks go down. Always maintain a clearly defined trigger point for getting defensive. Ride out flat periods and be there for the huge up years. Thanks for the question and hopefully that covers some of it.