This article was sent to members via email December 28. You can access that email at the link that follows this article.
By Brian Nelson, CFA
Hi everyone,
I hope each and everyone of you is having a wonderful holiday season!
Boy was this week an exciting one. Yours truly has been warning about excess volatility for many months, and the month of December showed just how damaging price-agnostic trading (indexing, quant) can be to the marketplace. According to MarketWatch, Monday amounted to the worst trading session for a Christmas Eve ever. Wednesday was the biggest one-day point rise in the Dow ever, and Thursday had the biggest intraday swing for the Dow since 2011. According to SentimenTrader, there has only been one other day since 1984 where the S&P 500 had been lower by more than 2% at 2:30pm ET and changed course to close up more than 0.5%.
I know many of you have been following our simulated newsletter portfolios very closely. Since inception in 2011, the simulated Best Ideas Newsletter has averaged roughly a 25% cash position. We wrote up an extensive summary of the simulated Best Ideas Newsletter portfolio recently, and one of the biggest takeaways was that we “held” a rather large cash “weighting.” Our move to “fully invested” should be kept in context. It’s not a matter of having a large cash “weighting” one day, and then not having one the next. It’s that we have had a large cash “weighting” for years and years (and still did very, very well), and now we don’t have one. Here’s an example of how much members love what we’re doing:
“I want to thank you for all your wisdom. I too have been ~30% cash since late 2017 because of your insight. I listened and resisted the temptation of buying as things looked good. It would have been easy to get caught up in the flurry of the market back then while watching our retirement accounts grow. “Putting all our money to work” as others around me did, would have been costly. In fact, a life time of membership fees would not come close to what was potentially saved. As painful as the last 3 months have been, it could have been much worse. I value your research, your newsletters and I look forward to your new release. Congratulations!” — Chip G.
Given the changing market structure (indexing, quant), where a “melt up” is certainly a possibility, as much as a market crash, in my view, I’ve taken the view that being “fully invested” in the simulated Best Ideas Newsletter portfolio and simulated Dividend Growth Newsletter portfolio and using put options if/when the time comes may now be the best route. It’s more of a change in strategy in how to capitalize on this thesis, and sitting on the sidelines for a melt up is not something I want to happen.
Investing is about considering probabilities and covering both upside and downside scenarios. Remember–those huge cash “weightings” allowed us to capture alpha as the markets swooned this December, and while we’ve now moved to being “fully invested,” it doesn’t mean that we don’t think a downside scenario isn’t still possible. In some respects, we’re expecting one of two outcomes–either the markets spin uncontrollably upward or the markets spin uncontrollably downward, the cause of either outcome the proliferation of price-agnostic trading. This market is not “normal.”
The most important thing, however, is that if you missed any of our emails this week, my colleague Kris adds them to the website, and we manage our business such that if you read them one or two or even several weeks after, it shouldn’t matter much given our long-term perspective, or probably more appropriately, the price-versus-estimated intrinsic value perspective. Granted, it was fortuitous that the market surged yesterday from the intra-day lows, which may have offered some good “entry” points, but our process is not one in which you’re going to miss “something.” We hardly make any changes to the simulated newsletter portfolios and when we do, we’re not looking for daily or even weekly returns. This might change with put options though. If/when we see a meltdown coming, we’re going to seek protection.
That said, I need you to continue to focus on the things that matter. Stock prices and returns are driven by changes in future expectations, namely the causal impact of the influence of public-to-private arbitrage in driving prices. If you’re talking about past data and worrying about precision, your efforts are largely wasted. The value of a business is based on the future enterprise free cash flows it generates for shareholders. It is not based on what P/E ratios were 20 years ago, for example. There’s going to be tons of meaningless data out there. Please focus on the data that matters, data that captures future expectations: the fair value estimate, the fair value estimate range.
Many of you have wondered what a market might look like if price-agnostic trading completely takes over. This topic is covered extensively in my new book. I believe there is one way to combat this changing market structure, however, and that is a focus on enterprise valuation, an understanding that stocks have intrinsic monetary worth based on their future expected free cash flow streams. If things get completely out of whack as a result of price-agnostic trading, public-to-private arbitrage means that companies with “cash-based” sources of value are a safe haven, provided investors have enough liquidity to wait out the storm.
Just a few changes to the upcoming schedule as a result of the new holiday.
Thursday, January 3rd: Release of the Dividend Growth Newsletter and High Yield Dividend Newsletter
Saturday, January 5th: Release of the Exclusive publication
Saturday, January 12th: Release of the Quarterly Financial Advisor publications
Tuesday, January 15th: Release of the Best Ideas Newsletter publication
In January – Value Trap: Theory of Universal Valuation
Many thanks again for all of your kind words! Here’s to an exciting 2019 and beyond!
Link to original email: http://campaign.r20.constantcontact.com/render?m=1110817109903&ca=427d96fe-c8ec-46b4-86dd-8ce91178d2c4
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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.