The New Investing Landscape

From The Reformed Broker, There is a limit

A lot of people are struggling in this market.

Here is the deal.

I’m going to divulge research that investment firms normally pay hundreds of thousands of dollars for, for free. It’s a very simple way to not lose your shirt in this schizophrenic, mean-reverting market.

First, stock picking does not work anymore *, unless by ‘stock picking’ you mean maybe a dozen or so stocks out all the thousands of stocks listed. But get it through your thick skull that unless your stock is one of those dozen, you should probably not own stocks. This market has been punishing stock pickers for too long, with stocks that perform well eventually getting pummeled (Sketcher’s shoes comes to mind, down 40% in a month). This is because fund mangers, desperate for any edge in an increasingly efficient market, pile in and out of individual stocks, creating erratic bursts of out-performance and then huge selloffs. Stock picking as always been hard, but it seems to have gotten harder. The S&P 500 is flat for the year, but most of the stocks in the index are negative, and this is due to the flight to quality as fund mangers seek only the best stocks and sectors out of thousands of losers. Anything that isn’t top quality eventually get culled.

Some say the market is rigged, but for the market to be rigged would imply that someone if making all the money, yet the performance of active management is in the dumps. That means even the experts, with their $20,000 Bloomberg terminals are as clueless as mom & pop investors. Instead, we’re seeing a race to the bottom, like a beach with some gold at the bottom and everyone is digging for this scant gold.

As for those dozen stocks, here they are:

GOOG – alphabet/google (both versions)
V – visa
MA – mastercard
NFLX – netflix
AMZN – amazon.com
NKE – nike
DIS – disney
MSFT – microsoft
FB – facebook
AAPL -apple
HD – home depot
GILD – gilead sciences

I can probably think of some more: JNJ,COST,LOW, TSLA

Amazingly, this portfolio has not only beaten the market by large margin, but each stock has a >$200 billion market cap. This proves that you get what you pay for, in that the largest companies keep doing better while the smaller ones have poorer risk-adjusted returns.

But a portfolio of a dozen stocks may be insufficiently diversified, so you can get returns that are almost as good with just these two ETFs:

QQQ (large cap tech ETF)
XLY/RTH (large cap consumer discretionary ETF)

Either 50% in QQQ and 50% in XLY or RTH

or 50% in QQQ and 25% in XLY and 20% in RTH

This will give you modest risk-adjusted edge over the S&P 500, because you’re avoiding the weak sectors like energy, material, and utilities.

Large cap tech and large cap retail have been hands-down the best performers since 2013 or so, as everything else has stumbled.

On the fence (these are alright, but not as good as above)

Financials (XLF)
Utilities (XLU)
Transports (IYT)
S&P 500 (SPY)
Dow Jones Industrial Average (DIA)
Biotech & Healthcare (IBB, XLV)
Low Volatility ETFs (RHS)

What to avoid:

Any market that is not America. That means Europe, Australia, emerging markets, and so on.

Any stock or ETF that deals with precious metals, coal, commodities, shipping, mining, energy, drilling, oil, and so on.

Emerging market currencies and bonds

Junk bonds that have energy exposure

Small caps (the small cap premium is dead)

Medium caps (medium cap premium also dead)

Materials (XLB)

Individual stocks (unless it’s one of the twelve listed, any any single stock should not make up more than 1/12 of the portfolio)

The usual objection is, ‘what if the lagging stuff comes back?’ Historically, going back decades, consumer discretionary and tech have been among the strongest sectors. So even if the lagging sectors recover, the expected value with the strongest sectors is still higher.

Again, this is not rocket science. This is brain-dead easy, yet so many people keep getting this market wrong, trying to pick fallen stocks or bottom fishing for lagging sectors in the hope they will come back to life, which they seldom, if ever, do…

* Individual stocks can work if you only allocate a tiny percentage of your portfolio for each stock, and no more than 5% of the total portfolio. I like FNMA and FNMAS as barbell strategies, meaning that these will either become worthless if the government shuts them down or rise 500% or more should they be privatized. The expected value is positive, but there is still a definite risk of losing everything.

Comments are closed.