No video this week we are out of town.Sometimes I get emails from Motley Fool that promote articles on their site. I actually read one of the articles; it was called Why You Should Sell. The title hooked me in.
In the first part of the article they cite a study that concluded that people hold onto stocks that they no longer think are good buys. They call this Realization utility.
The article then goes on to say you should always sell when you have a better place to put your money -- and today, a host of superior companies are on sale.
There is something to this but from where I sit the article is woefully incomplete and strikes me as reactive not proactive. If you believe in top down portfolio construction then you believe the stock chosen is the least important part of the process (not unimportant but less important than defense or not followed by selection of sector, country, size, style, volatility, yield). In top down most stocks included in the portfolio offer several attributes, for example a large telecom stock from an emerging market that adds volatility. If a stock like that fits in then you would seek out what you think is the best way to capture this.
Maybe you did this exercise three years ago and came up with Telefonica de Argentina (TAR). Then maybe after a couple of years you decided that Argentina was not a good place to stay but you felt from the top down that you wanted to capture some emerging market exposure through the telecom sector so you then needed to find a better proxy for emerging market telecom and maybe that lead you to Magyar Telekom (MTA) the ma bell of Hungary. If TAR was the best proxy but then MTA became a better proxy then it would make sense to swap regardless of when (remember above, the assumption is you still want emerging market telecom).
I would caution against selling a stock simply because it is down, that is not enough information. In the last two years JP Morgan (JPM) is down about 52% while the Financial Sector SPDR (XLF) is down about 75%. JPM appears to be one of the healthier banks and while in hindsight selling at $53 on May 9, 2007 would have been better than holding it a case could be made for JPM being the healthiest proxy for US financials. Selling JPM now to go after some better mousetrap is probably a bad idea. Obviously if you had reason to think that from here JPM would stop being "the healthiest proxy" then you might want to sell.
This is subtle stuff. In sticking with financials, the best thing would have been the top down decision to reduce the exposure when the yield curve started doing funky things. From the top down, reducing financial exposure two years ago become far more important than whether JPM is or is not a healthy proxy.
If you use ETFs and go narrower than SPY/EFA/IWM chances are whatever ETF you think is the best way to capture utilities still has the same attributes you thought it did when you bought. Swapping from one utilities ETF to another (XLU to PUI for example) is unlikely to change the portfolio.
This topic can get more granular with increasing or decreasing position size as I believe in doing and of course when you buy a stock you may be wrong about it being the best proxy. Everyone gets this wrong at some frequency either because the conclusion was wrong or maybe at some point something at the company changes. Bank of America (BAC) was a great proxy for financials until, IMO, the Merrill Lynch merger. The company took action that changed the story.
16 comments:
This is a really meaty topic Roger, thanks.
When a sector is getting pasted, I'm more comfortable personally getting out completely, rather than trying to pick the slowest horse to the glue factory. Financials and real estate (REITs) are but two examples. Healthcare is starting to look the same way; heck, even Buffett dumped a ton of JNJ.
I understand your point, and zero exposure means a bigger bet on my part. It's just that I'm not very good at the nuances, so I've learned the hard way not to touch the stove.
Roger--Doesn't the popularity of sector etfs make stock picking more difficult, ie, subject to the whims of the masses? If a stock I own is in an index, doesn't it get bought and sold as other investors buy and sell the representative etf? Does it follow that it makes sense to pick non-represented stocks for out-performance?
Sorry, I don't mean to pepper you with questions. Just trying to understand how this works.
Thanks very much.
From Warren Buffett's annual shareholder letter.
"Clinging to cash equivalents or long-term government bonds at present yields is almost certainly a terrible policy if continued for long. Holders of these instruments, of course, have felt increasingly comfortable – in fact, almost smug – in following this policy as financial turmoil has mounted. They regard their judgment confirmed when they hear commentators proclaim “cash is king,” even though that wonderful cash is earning close to nothing and will surely find its purchasing power eroded over time. Approval, though, is not the goal of investing. In fact, approval is often counter-productive because it sedates the brain and makes it less receptive to new facts or a re-examination of conclusions formed earlier. Beware the investment activity that produces applause; the great moves are usually greeted by yawns."
I am down 14% this year and most things look pretty bad. But this looks more like a buying opportunity (if I had some cash I did not need anytime soon)
This is an easy time to make a mistake with your portfolio IMO.
anon 716, i know the argument of sector funds pushing around stocks exists but i think it has less sway then some folks think. Once you get away from financials and energy most of the other sectors don't trade what i would consider crazy volume. XLV averages 5.9 million shares while IYH averages 146,000. JNJ, which I own for clients, is 14% of XLV which works out to 840,000 shares of JNJ which itself averages 15 million shares. how much does that matter?
To further detract from those numbers, of the 5.9 million shares that get traded only the creation or redemption process would directly push around the stock. a trade of XLV in shares that already exist would not seem to psuh the shares of the common around.
I do not know the extent to which various types of arbitrage between the common and the ETF or some other strategy might move the common around.
Thanks Roger, for your comments on the top Down process. Is there a book on Top Down Investing that you would recommend?
Roger. This question relates to your comment about ETFs not pushing around stocks. Is it not probable that ETFs GLD and SLV are pushing around the prices of the commodities they hold? I read somewhere that the ETF GLD is the largest holder of gold, and it is certainly one of the larger holders. As the EFT GLD buys more gold to satisfy its requirement to hold gold to meet its number of shares issued, does it not drive the price up, which makes more people buy more shares, and so on until the "bubble" pops? Same logic and question for SLV.
Thanks,
JCarr
Richard I have never read a book on the subject, sorry. My ideas started from what I learned during a short stint working at Fisher Investments which I then built upon with my own observations.
JCarr, GLD's ounces held have been moving higher at almost every turn since GLD's inception. In that time the trend has been higher but it has not been immune from dropping including a drop from $1030, for the metal, down to $750--or thereabouts. I'm not sure that GLD pushes it around a lot--probably some though.
SLV is, to me a different animal because silver gets consumed in industrial use which creates a different dynamic than gold. I do not have the same level of understanding in silver as I do gold and maybe "understanding gold" is not the best description either.
Jason Zweig has an interesting piece in today's WSJ titled, "How Managing Rist With ETFs Can Backfire."
Last paragraph: "The bottom line: Leveraged ETFs are for day traders. You can't manage long-term risk with a short-term tool-especially not with one that can blow up in your face."
The article mainly deals with leveraged index funds and inverse index funds offering 2X and 3X performance.
Anybody else read it? Any opinions?
Hi Roger- Where do you suggest to park cash? Are there any good MM funds or ST bond funds you recommend?
Anon 2:00 - The issue of daily fluctuation and cumulative tracking error with leveraged ETF's has been discussed here several times I think (Roger has discussed using them considerably more than that).
No final conclusions were reached on that specific topic as far as I can recall -- no big surprise there -- but most seem to agree the phenomenon is real enough it is just that some of us, myself included, don't consider it a problem; e.g., even very long-term investors may find it desirable to dampen daily volatility when volatility is high and/or offset loses suffered in long-side holdings when the trend is down but would rather not commit too large a portion of the portfolio to shock absorption; a modest stake in a broad 2x product SDS or QID provides a dampener and when both high-vol and down-trend happen at the same time it feels pretty good too; IOW the risk/reward ratio is acceptable.
No conclusion yet on the 3x products; need to see some more history there. JMO
RW,
I think the point of the article that was cited is that success with these producets over an extended period is luck rather than skill. I know this topic has been discussed here before, but I thought I would mention the article because Zweig did a nice job of presenting the issue.
I know many here have used them in their portfolios for an extended period of time. I have never heard that those products should be used for day trading only. I think the article said one of the products was held on average for 34 minutes.
As usual, I enjoy your contributions.
Roger & Others,
What are your thoughts in including a small portion of one's portfolio with TBT?
Here is an article by Roger discussing TBT...
http://seekingalpha.com/article/91860-how-about-this-for-a-hedge-combo-tbt-and-tlt
Trader Mark likes TBT as well...
http://www.fundmymutualfund.com/2008/11/bookkeeping-initiating-ultrashort.html
protection against rising rates is important but i am not sure about the wrapper. the post you linked to is more of a theoretical exploration.
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