Saturday, January 07, 2006

When you miss out on a bull run 3 comments

(P.S: Sorry for any disturbances the advertisements above may have caused you)
Every investor/trader has gone through this. The stock market charges up but it picks out only selective sectors or themes to favour. Of course, there is the most recent one, what I can now call the Jan 2006 Capricorn rally which has benefited primarily China stocks and technology stocks (and blue chips to a smaller extent).

Taking me as an example, with the exception of two tech stocks which occupy only about one-tenth of my portfolio that appreciated ~20-30% in the run-up (actually, recovered after hitting lows) the rest hardly moved (that is including a China technology stock which despite being at the confluence of the China and tech themes, shamefully refused to rise an inch). This was a recovery rally, which facilitated the rebounding of those stocks that had bottomed in 2005 ie. China and technology stocks whose sellers had been exhausted.

I think there are a few things one can do when one misses out on the rally, and in fact the recommendations are independent of whether one has missed out or not. Having one's decisions being affected by the thought of having missed out on the rally (and hence feeling the need to "make up for lost time") is akin to watching the Top Gainers list every trading day and agonising over how much money one has "lost" by not buying those stocks. The market is always there: on dips it offers you opportunities to pick bargains, on rallies it offers you to sell into strength, so there are plenty of cycles in the future to allow you to make the correct choices. So why worry about missing on one particular rally? (A bit Ah-Q, you might say, since I missed out on the rally hahah).

Ok so what're those few things to do? As follows:

(1)Add to holdings ie. buy more stocks. A bull run often assumes a momentum of its
own even when doomsayers keep expecting it to end; one may have heard of the
saying that a bull market scales a wall of worry, circa the mid-late 1990s bull
market. Hence if one has cash in hand he may want to practise dollar cost
averaging upwards and catch the momentum. One might have missed out, for example,
on the 1980s market recovery, but if he had kept adding to his position he would
have more than made up for it with the biggest bull run in history in the 1990s.

(2)Sell into strength and hold cash. When the index runs ahead of its fundamentals
it must eventually peak and reverse. Cue the sharp correction following the 1998-
2000 dot-com frenzy. Many fund managers find such rallies the best time to unwind
their huge positions and perhaps you might think it's the time too (think Wasatch
and their paring of their stake in MMI recently). That is a bit of market timing,
but well, it worked for Warren Buffett in 1969-70.

The above two are mainly issues of asset allocation, and depending on one's view on the market valuations and future direction he might pick one of the two mutually exclusive positions.

(3)Hold current stock positions. Even though these stocks might not have
participated in the rally as of now, it does not make sense to liquidate and
switch to others eg. China stocks or tech stocks currently, solely because they
have come into favour. If one takes the view that price rises are composed of a
fundamental (systematic) component and behavioural/psychological/emotional
(random) component, then it follows that since fundamentals for those stocks that
have rallied can't have changed in such a short while, it has been enthusiasm
(emotional) that has driven the price rises --- if there is any law governing
random events, it is reversion to the mean. That is why I feel it doesn't pay
overall to switch to hot sectors during a rally. Instead, assuming one had solid
fundamental reasons for buying his current (non-performing) portfolio of stocks
in the first place (ie. seeing their fundamentals as better than that of those
that have instead sprung into life in the current rally), then surely it makes
sense to hold. If the fundamentals (systematic component) remain intact and
market attention has not focused its spotlight yet, that is surely the best one
to buy... and in fact you don't have to buy it, you already have it.

(4)Switch stock positions. This is follow-up reasoning from (3). Only if one
perceives that the fundamentals for the "hot stocks" has improved significantly
and are behind the reasons for their charge up, then it might make sense to
switch into them. What kind of fundamentals? Either real or implied. For example,
MMI's key customer Seagate is buying over Maxtor and this means more likely
business for MMI in the future --- that's real fundamentals. In another case,
Templeton took up a whole hock of placement shares (think it was 30 million) in
Celestial at 44 cents, only 6% off the then trading price of 47 cents, suggesting
great confidence in the company --- that's implied fundamentals, and one should
have changed his view on the risk/reward equation for the stock then (indeed the
market re-rated it from 47 to 77 cents).

The last two are mainly issues of stock allocation, and it is often that I adopt the position (3) for most of my stocks but sometimes switch holdings for some of my stocks as per (4) after review. As explained above, it depends entirely on context, there is no clear line, and that is what makes investing/trading so fun.

(PS: Of course, if one keeps missing out on rallies, then that sounds like a systematic failure of his investing/trading technique and judgment: then it's time to re-think the entire philosophy.)




Anonymous Anonymous said...

Nice. I enjoy reading your blog quite a lot. I actually employ TA+FA but lean more towards the TA side. It refreshing coming in here to read more about the FA perspective. Keep it going.

1/11/2006 7:32 AM  
Blogger DanielXX said...

Cheers. Hope you didn't miss out on the bull run :-)

1/12/2006 6:54 AM  

Market timing is the reason investors miss out on stock rallies.

12/11/2012 4:18 PM  

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