This article was sent to members via email December 26. That email can be accessed via the link that follows this article.
By Brian Nelson, CFA
Hi everyone,
How about a 1,000+ surge on the Dow today for some holiday cheer!
I can’t begin to tell about the outpouring of support our firm received from member emails recently. It’s always great to have such a loyal subscriber base, and I can’t thank you enough for that. Some of you keep passing along thoughts to make Valuentum better, and I cannot begin to tell you how much I appreciate that.
That said, now is the time to stay focused, and we think laser-focused is the best way to describe our views on the markets. The markets fell fast the past few weeks since the latest edition of the Best Ideas Newsletter, but you’re well aware of our hefty cash “weightings” in each simulated newsletter portfolio.
Well, we’ve made our call heading into this year with an “overweighting” in cash, and it panned out relative to those that were fully invested. We’re now moving our cash “weightings” in both the simulated Best Ideas Newsletter portfolio (5%-30%) and simulated Dividend Growth Newsletter portfolio (7.5%-20%) to 0% and distributing the balance proportionally to each idea in the simulated newsletter portfolios.
How can we possibly do this even though the markets may spin out of control as a result of price-agnostic trading? Well, that’s just it. We’ve already taken our stance on this position and generated alpha with it. When others were saying this fallout couldn’t happen, we disagreed, and put our “weightings” where our views were. Doubling down after winning big is simply foolish and may be just gambling. We’ve generated alpha on this call, and nobody can take that away from us.
So, what are the chances that we do see what could be considered a self-perpetuating spiral lower in the markets due to price-agnostic trading? Well, if December is any indication, I’d put the odds at 50/50. Prior to that, I only had a high suspicion market participants weren’t acting prudently, but it wasn’t truly until this month, the worst December in history through yesterday, that the odds have increased. This month was painful, but it wasn’t painful enough to change behavior. Indexers and quants aren’t going away anytime soon.
Instead of the prior outsize cash positions, I now think the better way to play this idea is through put options if/when the time comes. I do believe that we haven’t seen the worst yet, but locking in the “alpha” from our cash “weighting” call is huge. What was once a drag on portfolio performance the past couple years played out nicely as a cushion against potential losses. If/when we feel the market may once again head south in a big way due to the influence of price-agnostic trading, we may look to swap into put options. Until then, we’re going to watch the market’s next move. Where some are saying this 1,000 point rally in the Dow is great, it only makes me more suspicious of price-agnostic trading.
Investors sometimes get into trouble when they try to double down on their thesis (some call this being greedy). We’ve already been right with a big chunk of the simulated Best Ideas Newsletter portfolio and simulated Dividend Growth Newsletter portfolio on our cash “weightings” this year, and now we have the upper hand against those that have been fully-invested heading into the bloodbath of December. It’s the little things that count. It’s the 10 basis points here, the 20 basis points there, or the few percentage points from a savvy, prudent move to keep a large source of dry powder as the markets swooned.
We expect to provide updated newsletter portfolio idea weightings in the release of the January editions of the Best Ideas Newsletter and Dividend Growth Newsletter. Remember–our best ideas are already in our simulated newsletter portfolios, so increasing the weightings there and considering put options when/if the time comes is better, in our view, than adding the next best idea to the portfolios. For those that are following the High Yield Dividend Newsletter, we released an email in the wee hours of the morning.
It was a great day today, no doubt, but the volatility is raising some big red flags about the health of this market structure. What if the trend had been down today? Would the pile on effects have been 1,000 points lower, instead of higher? Given that the markets were roughly flat an hour or two into the trading session, it sure seemed like a possibility. Volatility works both ways: upside and downside. Let’s keep paying attention and keep those seat belts fastened!
Link to original email: http://campaign.r20.constantcontact.com/render?m=1110817109903&ca=6e1c2c9c-acb3-47e8-a4fc-011e542213a8
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Brian Nelson does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.