The Big Picture For The Week Of June 18, 2006

Regular reader, Tom in Indy left the following comment/question.

I have pouring over Jay Walkers June 14th posting about how poorly individual investors time the market. Ouch! I resemble those remarks! The first step in correcting a problem is recognizing it. It almost seems as if we (John Q Public) should be buying the opposite of what the market is doing. I guess the problem is knowing when the market (other investors) are acting in a reasonable manner. What do you use to judge if a buying spree is overdone?

Wheesh, a lot of meat on the bone here in Jay's post and the question.

One part of this debate (I hope you did read Jay's post) has to be the understanding that you will be wrong some portion of the time. This is an absolute certainty. It is just as certain that you will get some right.

Jay cites some work that yields excellent results by being contrarian and using mutual fund flow as the indicator. Before you change your style based on this method, haven't we all seen studies cited that show just about every single approach beats the market? Be contrarian? The trend is your friend. Both are valid and can work. Going with the trend worked for the first four months of the year. Being a contrarian started to work best on May 10th.

This starts to get into the realm of data mining and will confuse the issue for many do-it-yourselfers.

With the caveat that you can't stop studying stocks you own and you have to be willing to sell any thing that you own, stocks of good companies tend to go up. Markets tend to go up; in fact the US market has an up year 72% of the time. Earlier this week I mentioned that in the last ten years the S&P 500 is up 84%. From June 1986 to June 1996 the market was up 170%.

The point of that last paragraph is to give some 30,000 foot perspective about how stock markets work. The context here is that people too often succumb to emotion. There is comfort in selling a lot of stock after the market has declined and getting back in when things are better.

I have tried to convey what I think is my systematic approach for reducing exposure. Despite some critical comments left, I neither look to sell into strength nor weakness, that is more about shorter term trading. In critiquing the sales I made, some were into strength and a couple were into weakness. It might be a while before I know the extent to which the sales were smart or dumb.

For long-term portfolio management I want to stay as fully invested as is prudent. Trying to out-nimble a small drop is difficult and has a good chance of leading to whipsaw. Despite whatever emotion you might be feeling,the market is only down a little, my cash level is in the high teens to low 20's (percentage-wise) depending on the client. This is far from an everyone in the bunker mindset. I'll reduce more exposure if I think the market is likely to get worse.

The strategy I use is the one I outlined in the first few posts on this site in 2004. I am simply sticking to my plan. I write time and again about picking a plan of action for your portfolio (hopefully at a time when you are not very emotional) and then just sticking to it. My goal is to miss big chunks of down a lot and be in there the rest of the time.

If your approach involves more trading, fine, but hopefully you have some basis to expect some success. You may not be able to control how often you are right versus wrong but you can control the extent to which you stay disciplined to your plan. Obviously you need to make some changes if you are never right.

I'm not sure I have answered the question very well but trying to grope around for a better mousetrap during a panic of some magnitude is probably the wrong thing to do.