Wednesday, February 28, 2007

Correction and Psychology of the Market

The Large drop off on Tuesday, 27th February should not make you panic. In fact, the drop was logical and effectual. Check out Jim Jubak’s Article and Cramer’s Take on why it happened. A combination of China, Technology and natural market tendencies to correct an upswing led to the DOW losing more than 400 points (and about 500 points intra-day). This should not make you panic, rather it should lead to an evolution of a new strategy. Basically, what will happen is that big money (institutional investors) will not abandon the market they simply will rotate into new areas. The new areas that will work is Consumer Product. Hence these dividend rich cash king like Procter, Altria and Pepsi will always work when the economy is expected to go down in flame. As you realize, I did not say we are entering a recession like godfather Greenspan (the harbinger of evil) said on Monday preceding this downturn, I rather said the expectation of recession.

Market trends are about psychology than reality. Generally speaking the market does poorly entering summer time because optimism is largely lacking- and this summer is going to be gruesome and it started early already. With the Christmas behind us and Valentines Day gone past- there is little to cheer consumers or investors so expect a crummy market at least up until July when the patient will be richly rewarded. I still expect the market to swing back in favor and this gloom is just your opportunity to get in cheap to what you always liked- just make sure you spot the bottom right.

Hence, the fear of China will punish any sector levered to the Chinese these are: oil/gas producers (refiners should still do well- as we enter the driving season), miners and basic materials sector, and commodities exchanges. The commodities exchanges should fare badly for a short time and then they will bounce back. The miners will get punished the most and should not return until the mid-summer time while the oil/gas producers will trend towards flat than down. Hence, circulate out of these sectors or at best be underweight in them. An unlikely beneficiary of a bearish psychology will be the brokers and non-commodities exchange. Greater trading due to sector circulation/reallocation and/or just sheer panic will allow these folks bring more money into the house since they make more money when you trade and/or panic. The big five brokers should continue to do well: LEH, MER and GS are my favorites.

The greatest mistake however, will be not taking advantage of this sell off to establish position in very good companies. Timing the bottom will be as crucial in this game as staying off the way of a roaring bear. The strategy is yours to fashion.



t said...

What time frame do you hold for: a few hours or a few years?
It looks like you focus on the few months outlook?

DonCasiragi said...

I think for maximum return, investors need to balance the need for stable hold strategy(investing over the long term) and being weighted in line with market psychology. Understand that by the very fact that you are an individual stock picker you are betting that you can do better than professional mutual fund managers out there or index funds: hence you must mirror their strategy since their trade(big money) is the most singular factor on the direction of any stock you hold. Well, they are sector sensitive traders and they do so on tri-annual or bi-annual basis.

To answer your question- I hold a core holdings that reflect particulr different sectors but always stay over-weight in favored sectors and underweight in out of favor ones. Hence while I always reallocate/reweight funds to thhe sectors on 4-6 months basis, the general content of my portfolio is stable.

DonCasiragi said...

Strategy outlined in previous post:
1. Invest in 15-20(fewer for personal portfolio) best of breed stocks
2. Allocate not more than 10% to a stock; however don't cut any freewiller if they rise
3. Use specific securities to invest in a sector that is favor
4. Use the advantage of fewer stocks to rotate out of out-of-favor sectors