This article was sent to members via email December 27. That email can be accessed via the link that follows this article.
By Brian Nelson, CFA
Hi everyone,
With just an hour or two left in the trading session December 27, the Dow was down some 600 points. Incredibly, it ended up rallying into the close to finish up 260 points. Though there have been a few big intra-day reversals like this one in the past, there wasn’t much news at all today. The market simply rallied 850+ points off the bottom, and that was that. What’s more, this followed a 1,000+ point surge the day prior.
If you recall, yesterday, we moved the cash positions in the simulated Best Ideas Newsletter portfolio and the simulated Dividend Growth Newsletter portfolio to 0%. We had built a sizable cash “weighting” as a result of prudently harvesting some big winners in past years. My guess is that many of you landed some fantastic “entry” points today, given where the market opened and where it rested for much of the day.
The Valuentum process seeks to add undervalued stocks when they are going up and seeks to remove overvalued stocks as they are going down. It’s very simple conceptually. We only consider stocks to be materially undervalued or overvalued when they are trading far from our fair value estimate, and we’re okay with continuing to include ideas in the simulated newsletter portfolios even if they run past our fair value estimates. Remember – value is a range not a precise point estimate, and the market’s opinion, as in pricing direction, simply matters.
A rising stock price, to us, means the market thinks the true intrinsic value of the stock is higher. A falling stock price, to us, means that the market thinks the true intrinsic value of the stock is lower. It becomes obvious in this context that investors should like stocks that are moving higher. Incidentally, this framework helps one avoid falling knives, or stocks that look undervalued but their share prices never bounce back. After all, if one is waiting for a stock to rebound, but it never does, it’s really hard to catch that falling knife. We’ll talk more about this in my upcoming book.
Well, December 27 was another roller-coaster trading session, and while we were on the right side of the trade today, what concerns me the most is that this market could easily spin out of control. Price-agnostic trading, or trading that doesn’t pay attention to a consideration of price-versus-estimated intrinsic value, now controls more than 60% of the trading environment, and some recent estimates suggest that this percentage is close to 85%. We’ve picked up some “alpha” with our cash “weighting” and now by putting it to work, but we’re watching this market with our finger on the put-option trigger.
As I was telling our High Yield Dividend Newsletter members this week, today’s market is not one that is wholly driven by expectations of future fundamentals. We published nearly 20 videos in January and February of this year, if you recall, a series called “Off the Cuff.” It was my attempt at being energetic and exciting to stimulate your interest, but I must admit I was completely out of character.
I tried to be a little like those personalities you see on the business channel, a little like Tomi Lahren, but it was just completely not me. I’m a teacher, a trainer at heart. I’m not an entertainer. In February, we wrote about what we were worried about in the next market crisis, a crisis of market structure. What this means is that the “smart money” may very well be overrun by indexing and quantitative trading if the market should move against the latter two in a big way.
I think December 2018 may mark the first month that this is starting to happen. We’re seeing swings that just aren’t “normal” given the news flow. Sure, the Fed raised rates a quarter point, there’s still some uncertainty with respect to US-China trade relations, Treasury Secretary Mnuchin may have caused a bit of a stir, but the reality is that none of this should be that surprising. There’s something very, very wrong with the structure of this market. This could mean that stocks could spiral upwards or downwards.
We’re now “fully-invested” in the simulated Best Ideas Newsletter portfolio and simulated Dividend Growth Newsletter portfolio, and we’ll be considering adding put options when/if the time is right. Don’t forget to pay attention to asset allocation, too. Only your personal financial advisor knows what type of mix between stocks, bonds, and other investments is right for you.
Link to original email: http://campaign.r20.constantcontact.com/render?m=1110817109903&ca=f5b30521-a9de-408b-bbba-26f1cea5e2ef
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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.