December 16, 2015

Change your investing strategy

There's little question that the market's complexion and character are changing. My baseline expectation is that Wall Street has been undergoing a topping process since May and has morphed from a "one-way" market (i.e., mostly rising) to a two-way one (rising and falling).

This "market without memory from day to day" might continue for some time, and if I'm correct, we'll need for a new playbook. We'll have to deal with the renewed volatility, randomness in stock prices and -- at the very least -- lack of a primary trend. (And at the worst, a nascent bear market.)

So, just like A Chorus Line's fictional character Val Clark -- a foul-mouthed but excellent dancer who came to New York to become a Rockette but couldn't get hired -- we have to adjust.

The debate as to whether global economic growth is slowing and profit expectations are too optimistic will remain core narratives in discussing market direction over the coming winter months (at least). We'll likely see volatility as markets react to economic releases and changes in policy. 

But to me, the accumulating body of evidence is that disappointment lies ahead. My view remains that the global economy faces a false economic dawn, while the corporate-profit landscape is challenging and long in tooth and stocks are overpriced.

As I've counseled over the last year, opportunistically trading on both the long and short side will probably deliver better returns than longer-term investing will. At the very least, you might consider more-active trading as an adjunct to longer-term investing -- although neither shorting stocks nor a trading-oriented approach are for everyone.

.........we can profit by investing and trading longs and shorts opportunistically.

But changing our modus operandi is easier said than done. My advice -- start slowly and ease into both the shorting game and increased trading activity. Expand your involvement only when you're comfortable with shorting and a more action-oriented strategy amid what I suspect will be heightened volatility in a market without memory from day to day.

Here are some parameters to consider:

-    If you normally have a 3-1 mix of investing capital to trading capital, move it into balance by reducing your investment exposure to 50% and increasing your trading exposure to 50%. Personally, given my negative market view, I've for months moved dramatically in the direction of trading over investing.

-    Slowly begin to accumulate shorts of less-volatile (lower-beta) securities, essentially learning shorting as you go. Avoid high-beta shorts and shorts with high short interest.

-    Given the bifurcation and less-certain market ahead, stay more diversified and less concentrated than usual. Keep any industry's concentration to less than 15% of your portfolio and any individual stock (long or short) to under 4% or so. Also keep your shorts to under 2% on average.

-    As I've emphasized repeatedly, err on the side of conservatism. Maintain above-average cash reserves and reduce your portfolio's value at risk (or "VAR"). After all, rising volatility produces a wider profit or loss on the same capital investment.

-    In terms of trading style, I tend to be news- or catalyst-driven and thematic in my portfolio construction. In a volatile market, I also often like to buy the dips and sell the rips. I predominately do this with ETFs.

-    In today's relatively range-bound market, I also have a tendency to buy sector laggards and to sell or short sector leaders.

-    You should also consider pair trades and selling option-premium puts and calls, especially when volatility picks up.

via thestreet