To be a succesful investor you need to have the right attitude, know what mistakes to avoid, develop some winning traits, identify some key investment themes for the year and develop and execute a plan around them. Words: 1606
In further edited excerpts from the original article* Jeff Miller (http://oldprof.typepad.com) goes on to say:
The Winning Perspective
The objective for 2010 is to find successful investments. This requires three things:
1. Identifying companies where business prospects are better than most expect.
2. Finding an attractive stock price to establish a position.
3. Waiting for the market to recognize what you have already seen.
You are not rewarded for being accurate in economic forecasting, since stocks are not GDP futures. In particular, you are not rewarded for confusing your political opinions with investing.
Three Mistakes to Avoid
1. False Comparisons
There is a popular methodology that is very expensive where the analyst finds some time in the past that he thinks is comparable and goes from there, e.g. this recession is like the 70’s, or the yield curve is like Japan or here is the path of job recovery in the last several recessions. This is all completely bogus, and you should ignore it. There are not enough cases and there are too many dissimilarities. Any disciplined researcher would reject this approach. Most people these days are aware of the dangers of computer models that “post-dict” by looking at all of the old data. The human mind is the most powerful computer, with plenty of imagination.
2. Ignoring Data
There is a powerful movement encouraging people to ignore data. Many pundits find something wrong with every report. At the extreme, the government reports are characterized as political and manipulated. The private reports are often viewed as biased as well. This is a powerful leveling force for those who have limited methodological skill. In a world where anecdotes rule, everyone can tell a story.
3. Getting Political
The investment discussion became highly partisan early in 2009. We can expect another year of the same. It is a serious investor error to confuse political opinions with forecasts about the economy or the market. I call it political agnosticism – a willingness to make money no matter what party is in power.
1. Find Solid Forecasting
Predicting the economy is not easy. It is easy to criticize economists, saying that they are all foolish. Successful investing does not require perfect economic forecasting, it only requires an edge. In 2008 those making the most extreme calls got a lot of notoriety. I recommend taking a longer viewpoint. The consensus of economists is an interesting piece of information. Some of the respondents in these polls have their own macro-economic models. Most are interpreting the work of others.
2. Mid-Course Adjustments
No matter how well a forecast is prepared, things change. When the circumstances change, you must be willing to adjust. In 2008, the fall of Lehman was a game-changer for the economy and all related forecasts. No one knew for sure what would happen. We now know what occurs when there is a complete cessation of normal lending.
In 2009, many pundits expected a complete economic collapse. They underestimated the combined force of massive government interventions. This was also a game-changer, and it called for a revised forecast.
3. Ignoring the Political Debate
Many of the arguments – measuring the number of jobs created or saved is a good example – depend upon sophisticated methods, assumptions, and conclusions where there will never be agreement.
Investors should focus on data, not the political spin. Focus on real measures of progress, or the lack thereof.
1. Market valuation is quite attractive.
We have not yet hit the initial target of pre-Lehman market prices, even though the depression-like scenarios are off the table. The market has traded in line with corporate bond rates (based upon forward earnings). The rates still reflect elevated risk, and bonds also carry the risk of increasing rates. The market is attractive by comparison. This is a stronger approach than the backward-looking methods that give excessive weight to the post-Lehman earnings.
2. Economic growth is looking brisk.
There is plenty of additional running room. The mere removal of negative factors, like the decline in housing, adds to economic prospects. Many critics ignore the natural economic tendencies – using slack resources and adding productivity.
Corporations are starting to invest. Recent earnings reports show that business investment is beginning a rebound. This is only a start, with room to run. Delaying investment was an easy choice during the recession. It can be a driver as it is reversed.
3. Government stimulus continues.
Many do not realize that the stimulus package is spread over three years, with most of it still to come. The Fed remains accommodative.
What to Watch
1. Housing sales and prices seem to have stabilized with the help of various programs. With continuing mortgage resets and high foreclosure rates, this bears watching.
2. Credit growth. Everyone understands the problem of excessive lending. The economy depends upon what I call normal and sensible lending. So far, credit is still tight, especially for many emerging businesses.
3. Employment must start to come around. Job growth lags the economy and the market, but we need to see improvement.
I see several strong investment themes. My standard is the expectation of 25% appreciation, a double in three years. It does not pay to be greedy and swing for the fences. Obviously, I do not hit the target with every pick, but using this guideline helps to find a balance of winners.
This will be an early move for businesses and it should have legs. Investors can look to the big names in the group to get appropriate exposure. I like and own Microsoft (MSFT) and Intel (INTC).
Every portfolio needs some growth stocks. There are several choices, but I continue to like Apple (AAPL). If you back out cash holdings and look at forward earnings, you see an attractive price-to-earnings growth (PEG) ratio. You can play technology and growth more conservatively via XLK.
The year-long cloud over health stocks has lifted. Investors can look to the sector for choices in managed care, big pharma, hospitals, and information technology. You can play the sector effectively with an ETF – XLV.
4. Cyclical Stocks:
As the economy improves, some companies are poised for exceptional profit growth. I look for stocks with exceptional leverage on operating earnings. This is a work in progress, but my current favorite is Allegheny Technologies (ATI).
This is a special case. There is slack in energy markets, but it could be taken up quickly. I am less enthusiastic about energy as an immediate play, but we could find ourselves back to the tipping point as the year progresses. I have de-emphasized energy at this point, but I could revise my opinion rapidly if the global economy comes around.
6. Emerging Markets:
I expect more stability in the dollar, but a continuing secular growth story in emerging markets. There is plenty of news in individual countries so investors can play this via ETFs including EEB or EEM.
There is a widespread feeling that the “easy money” was made last year. In fact, we actually just got back to square one. The many skeptics set up a traditional environment for a rally. As corporate profits and revenue growth prove out, the relevant stocks will react.
Investors have trouble buying stocks that are well off of the lows. This is a mistake. Few people call an exact bottom in any stock. At some point, the fundamental story becomes attractive.
Individual Investor Implications
For the investor who has “missed the rally”, there is still time. I do not see the market rally as in the “late innings”. Well-chosen specific stocks can do very well—gains of 20%+.
For those with a negative world view – suppose you think that the Fed, the President, and the Congress are all blundering – you do not need to be “all in” on this viewpoint. Consider allocating some investments to stocks with great potential. A few big winners can help you if your overall political viewpoint is incorrect.
For those who are worried about risk – consider a program with a built-in asset allocation method. There is a demand for this. We have developed such a product, and so have others. It allows you to dip in, with a limit on possible losses and attention to increased risk.
Each investor is different. You need to consider your investment goals, your full range of assets, your risk tolerance, and other factors. Most new investors I talk to are under-invested in stocks, ill-prepared for retirement, and have nothing to combat inflation. A general rule is to determine your “normal” stock allocation and increase it by about 10% to reflect the current opportunity.
– The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
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