All, here's an excerpt from the 1st of the year that may help you in the days to come. Hope you enjoy.
RB
The Phantoms' Wake Up Call Email Hotlist" (tm)
January 1, 1998
STRATEGY AND TOP PICKS FOR 1998
QUOTE DU JOUR:
When one door of happiness closes, another opens; but often we look so long at the closed door that we do not see the one which has been opened for us. -Helen Keller
1998 MARKET ASSESSMENT
Let me start by saying that I remain cautiously optimistic as we head into 1998.
This past year has rewarded us with an incredibly rich abundance of opportunity across a broad range of sectors. It truly has been a year to be thankful for.
For better than half a decade now I have remained an optimistic bull, but the past six weeks has cast a shadow of doubt over an otherwise enthusiastic and positive viewpoint. I believe this general air of skepticism is pervasive and many others have also come to share the same doubts. I also feel that this skepticism is what has lead to such an exaggerated correction over the past 2 months.
Key words from the aforementioned paragraphs are skepticism and doubt. And to add credence to what I am saying is the old Wall St. clich‚, "when in doubt, get out." And that is exactly what they did, in mass.
Unfortunately we have all been lulled into a false sense of security over the past five years (minimum) and have assumed that every correction was just another opportunity to pick up those stocks that we missed on the first run-up. All with good reasoning though, as the past few years we have also been blessed with an ideal economic environment of low inflation, low interest, a declining deficit, and sustained economic growth. If nothing else, the recent correction can be considered a wake-up call of what it's like in a not so perfect world of investing.
What more could one ask for?
Over the past 6 weeks I have spent endless hours searching for the Holy Grail. There was much to choose from, mostly from the ranks of the small-cap issues as I felt they were still offering up some of the best values. But without fail as I keyed in on some of these selections, I quickly witnessed an ensuing erosion of price, almost across the board. But even then, I wanted to rationalize the lower prices as a windfall of opportunity, the stock gods had answered my prayers.
Then this windfall of bargain pricing turned from elation to skepticism as the market got uglier and uglier. Sentiment quickly changed as the Asian fiasco worsened, and notoriously bullish market mavens became bears, turning one-hundred and eighty degrees.
Was I missing something?
Pru-Bache's chief market analyst, Ralph Acampora switched from a raging bull predicting a Dow 10,000 by mid 98, and rolled over to reveal a bearish prediction of Dow 6200 in 98. Now I'm not saying that old Ralphie-Boy is the last word, mind you. But when a bull becomes a drag queen flaunting a bearskin rug, it's time to pay closer attention to what might really be going on.
But what has really, truly changed?
Seemingly the economy couldn't be better, the 30-year bond is printing a yield under six percent, inflation is in check, unemployment is not a problem, the countries deficit is improving at a better pace then most anticipated, and the general economy is chugging along just fine.
So what's the problem? Asia?
I say Asia "my butt!!" Granted Asia is a force to reckon with, but not to the point where it should effect all sectors and wreck havoc on our general economy. For example, what does Asia have to do with the oil stock sector getting hammered? For that matter what does Asia have to do with domestic airlines, regional banks, or just about any company that derives its revenues domestically?
Answer: "It doesn't."
Plain and simply put, the United States economy couldn't be better. And to top that, we are the global economic force, period. We have stability, and a sound economic policy, backed by a strong dollar. We represent investment quality worldwide. That can only equate to other countries investing in the US economy, our markets, our bonds, and our dollar.
Sure exports may suffer for a quarter, possibly two, as the various global markets try to adjust to the Asian problem. But there is a good chance most European markets, like us, should also remain strong and adjust rapidly. As long as the Clinton administration addresses the dollar's strength by continuing to promote free trade zones, while keeping a tight reign on inflation, we may very well see a further strengthening of our economy as the result of even lower interest rates.
It is my contention that a danger exists, but it's not necessarily Asia. I see this Asian mess as nothing more than an excuse for the big boys to lock in profits, shut off the lights, kick out the cat, take a few weeks off, thus allowing panic to drive the price of Filet Mignon down to that of lunchmeat.
Ah, what a wicked web they weave.
If that is the case, then they may be flirting with what I perceive to be the real danger, a credit implosion. For a long time I have been of the belief that the real problem in the US is credit related. Take a drive through any upscale neighborhood in just about any city and pay attention. Young families, in their mid-thirty's, 4500 sq. ft, two upscale cars in the garage, possibly a third being a sport utility vehicle waiting to shuttle the two kids off to a private school. Whoops there's mom now, rushing out the door with her hot cup of Cappuccino in one hand, a brief case in the other, two youngsters in tow, and "Sunshine" the golden retriever close on their heels. Isn't life grand?
What do you think?
Could it be that all three cars are leased? The house is on a 2 or 3 year adjustable rate mortgage? Of which, there is a high probability that it is leveraged and secured with a minimum down payment? The credit cards are probably testing their limits? Maybe, just maybe, if it was not for the fully margined securities, that in some case are even further leveraged by credit cards in this seemingly endless bull market, both the husband and wife's incomes would never have cut the mustard?
What happens if we do go into a deeper correction? Margin calls?
The house of cards starts to fold? Rapidly becoming out of control. The first thing that goes are the toys. Bye-bye Explorer, adios Mercedes, "oh what you do for me", Toyota.
Just read a story that in Thailand, foreign businessmen are flocking to buy repossessed luxury cars. Parking lots in downtown Bangkok are being used for storage lots, banks have shut down dealerships, hell even the government is looking to rebate import tariffs to help bail out defunct dealerships so that they in turn can help pay back bank loans. Ex-owners of luxury cars are now driving Vespa motor-scooters to work. All happened within the last 6 months. Scary.
Is it possible? Oh yeah, you bet it is!
What happens if the Dow craters another 15%? Margin calls would become the order of the day. This in turn could trigger further demands of credit-card support, placing not only a burden on the participants of such a tactic, but also the overall economy.
Over the past few weeks I feel that we witnessed an inkling of just that, a sell-off induced by margin calls. Consider this, the one area of the market that I suspect was most leveraged, by margin, was the high-tech sector. And it is my feeling that as people started to get margin calls, rather than sell off Compaq or Intel, they nipped at those stocks that were not in effect on margin, thus raising the most cash value while holding onto their sacred cows.
Unfortunately as the other stocks get sold off, we edge closer to that day of reckoning, and if that comes, then we would witness a sell off of twice the amount of the margin call to make up for that 50% leverage. Meaning these same stocks could be subject to a sell off at twice the pace.
Sobering thought, it hurts to even think about it.
But do think about it, as it could become very real if the bleeding doesn't stop soon. It is not just the markets that would suffer irreparable damage, our economy could go into a tailspin, real estate prices would plummet, and financial institutions would fall like flies.
Now that I have your attention, let me say that I don't believe the Federal Reserve, the banks, nor the brokerages and mutual funds, all of which control our markets, will allow that to happen. Especially the later two, as they would be the first to feel the pain.
My real point is that continued selling could apply exaggerated pressure on the markets, and any rapid deterioration from these levels could spark panic selling, which would only bring even further undue pressure.
As it stands right now, the funds are sitting on unprecedented amounts of cash and the "CrŠme de la CrŠme" stocks are flashing neon buy signals. Technology leaders have been given 30% haircuts. Intel sitting at $70 off of $102, Motorola at $56 off of $90, Texas Instruments at $44 off of $71, Qualcomm at $46 off of $72. Consider this, everyone is squawking about Asia, yet China is like a high-technology sponge. They are building an entire infrastructure in China, all dependent on the latest technologies from communications, to environmental issues, to power generation.
My intent in writing the above chilling scenario is not to instill fear, but rather to bring attention to the delicate balancing act that exists in the financial world. It is an atmosphere predicated on constant smoke and mirrors, upon which the resulting self-inflicting sentiment is perpetrated. Even though the story may be Asia, it may only be presented to cover a different set of circumstance, whether real or imagined. My interpretation of what is a problem is just that, one mans theory. Whether it is Ralph Acampora, or me, or even Alan Greenspan is unimportant, it all boils down to opinions and no-one is right all the time. Nor, is it the story (Asia or whatever) that is important. But rather that you be aware that your thoughts may only be a manipulation brought on by the influences of others, therefore being self imposed. That awareness is what is important. That is why it is imperative to not let emotion play a part of your investment decisions, have a plan and let the tape tell you when to execute that plan. After all the tape is real, all the rest is superficial.
STRATEGY FOR 1998
To err on the side of caution, always is a prudent strategy. Today's market environment is such that it allows no other alternative, after all, missed opportunities beat capital losses any day of the week. Positioning your portfolio to be able to capture even a portion of the upside, while limiting downside exposure is far better then putting your hard earned cash at risk in the hopes of capturing a bigger percentage gain. A certain amount of safety can be derived through diversification not only in what you buy, but also in how you allocate your funds, weighing risk, upgrading to higher quality, and by following a plan that has flexibility and adaptation built in to it.
It has been very difficult in trying to establish a strategy for the coming year, the reason being, is that there is no clear-cut trend to base a strategy on at this time. Resulting in the only reasonable alternative being a defensive strategy coupled with a flexible plan that will allow for a quick restructuring in the event that the market takes a decisive direction.
My obvious hesitation in following an aggressive strategy is based on my evaluation that the present market is what I would call a "traders market". A market where day traders or position traders are nipping at stocks, scalping a small percentage, then running away with the bootie, not sticking around to see end-game.
That reminds me of the opening quote by Helen Keller, what appears to be a closed door, may in fact have opened a new door, it's just that it may be from a different perspective.
By that I mean this; even though the correction has eroded investor confidence and today's market doesn't appear to be an enticing environment for investing, it has created an extremely oversold market condition. Thus making otherwise strong stocks, candidates for a nice bounce with any renewed interest. This would also fit the parameters of limited risk, by positioning after a particular stock has found a support level. As long as one stayed flexible and had no hesitation in backing out of the position if in fact it started to falter, then risk would be extremely limited. Unfortunately this sounds more like trading, but in fact is only a defensive move to help preserve capital, yet keep a portion of your money working even in uncertain overall conditions. If in fact the market did find a new set of legs to run on, you would be positioned and be able to take advantage of the upward momentum.
I know many of you endorse the theory of finding a good stock and hanging on for years. I'm not saying that a long-term investing approach would be wrong, only that I do not feel comfortable in saying that we have necessarily reached a bottom.
To help adapt to the present environment I feel it may take more then just a change in trading implementation, that it may also dictate a restructuring of the portfolio mix. With that said, a good tact may be to lean heavily towards quality and balance portfolios with less speculative securities. Again that is not to say that low cost equates to low quality. Nor does it say that speculative issues shouldn't be a part of 1998's portfolio, but rather, that relying heavily on unproven companies may carry even more risk then usual.
To assist in that goal, you will find attached a system (PARAMS SYSTEM). I devised the PARAMS SYSTEM last year, as a tool that I feel will be an effective method of measuring your exposure to risk and help rate the quality of your portfolio holdings. By having such a tool it will enable you flexibility in adapting to the ever changing market conditions.
At the present I would highly recommend an overall portfolio "PARAMS rating" of 4-5 or lower. By balancing an extremely strong issue with possibly a weaker more speculative issue, you could in theory average out your portfolio to maintain a higher degree of quality resulting in less risk.
There were many factors that contributed to the following selections, but if you take the time to understand the PARAMS SYSTEM methodology, you will quickly realize that the various issues chosen have one of two opposing characteristics. Either they are within the bottom one third of their respective 52-week trading range, or they are close to printing new highs. Another criteria that weighed heavily in my selection process was the evaluation of risk vs. reward. I have attempted to choose those stocks that offered up at least a 2:1 ratio of upside potential versus downside risk.
Even though flexibility may be an integral part of dealing with a market that could swing wildly in either direction at the drop of a hat, it does not preclude having some steadfast rules to follow.
Become regimented, not only by having a plan to buy-in, but also a plan to evacuate, then stick to it.
Until the markets can offer up reassuring indicators that we are out of the woods, then my primary strategy will be to remain ultra conservative, with cash preservation as the top priority. Having a pre-set steadfast exit point on the downside, thus limiting risk. But more importantly sticking to the pre-established exit points, executing the sell, no emotion, no hesitation, just implementing the plan, that is what is absolutely imperative.
I myself employ a self-imposed plan of pre-established guidelines, one that I refer to as my "ten-percent solution". I loosely pre-set a 10% stop loss on any initial purchase. I also sell when the stock has made an upward run, falters, and then backs off 10%. If it then regains its legs and takes out the pre-established high, I buy back into the position. That way I will always catch the biggest part of a run-up, locking in profits. If the stock should retrace 50% from a rapid move up, I also buy back in when I see renewed support come back in after the retreat. Thus, the resulting 40% savings more then makes up for any 10% I gave up on the top-end. Statistically and in actuality, this method is one of the greatest tactics I have ever used. I'm sure you have heard of buying low and selling high, but try doing it, it is difficult to say the least. Most anybody you talk to will say that buying a particular stock is the easy part, knowing when to sell is the difficult part. By employing my "ten-percent solution" you now have a plan for selling, while limiting risk, and locking in on profits. Try it, it works.
The following is a brief outline of my strategy for the first part of 1998:
1. Preserve capital, always "numero uno" in any list of importance.
2. Upgrade portfolio to have a PARAMS rating of 4-5 or lower.
3. Buy stocks that show strong fundamentals going forward, are at the bottom third of their 52 week trading range or are within striking distance of new 52 week highs.
4. Lay out a plan that is adaptable, allowing flexibility to react to changing market conditions. The stronger the market, the more risk I can take, resulting in a higher PARAMS rating average, and vis-a-vie.
5. Limited diversification, no less than five issues, no more then ten.
6. Adherence to a stop loss limit, I use ten-percent, but the number can vary to your degree of risk or market conditions. The only thing that is important is that you stick to a given number, plus or minus one percent, and that you have a plan in place for exiting, then stick to it no matter what the circumstance.
7. As profits are taken, rolling those proceeds into existing positions that are displaying the strongest momentum and performance going forward. This correlates with #2 in the constant upgrading or your portfolio.
8. Maintaining a reserve of cash, the percentage depending on overall market conditions. At present I am approximately 25% cash,
just a week ago I was 35%, but have been taking advantage of high
quality stocks that have recently gone on sale. That is what it is
all about.
Following this post I will be sending the PARAMS system. Although it is dated from last year and the examples may not be accurately priced, the methodology is timeless. The beauty of PARAMS is that it is simple, and applies to a broad universe of stocks. You can easily apply it to any stocks that you may be considering, then apply that rating to an overall portfolio average rating. It gives you a quick, and simple method that allows you to assess your risk in comparison to changing market conditions so that you can quickly adapt to a comfort level that is suitable to your circumstance and investment style. The PARAMS System, like most anything, should only be used as a general guide, and its intent is just that, to give you a general idea as to the amount of risk your portfolio is reflecting. Use it accordingly.
Study it, understand it, and hopefully you will use it. If you have any questions about it, please feel free to ask.
I will then be sending the actual picks for 1998 in a separate posting.
Again I apologize for the tardiness, and the stringing out this important issue. But the recent difficulties with the hard drive and corrupted files have resulted in my having to basically rewrite this entire letter.
Thanks again for your patience, and I wish you all a very healthy, happy, and prosperous New Year.
Raleigh |
