Submitted by Steve Selengut
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Investment Performance Expectations: MCIM Portfolio Fine Tuning
Contrary to popular belief and Wall Street propaganda, investing is not a competitive event. Rather, it is a uniquely personal, goal-directed activity that individuals must organize and control for themselves. Too few appreciate that it is a long-term enterprise and only a handful have discovered that DJIA and S & P 500 numbers are only useful at their extremes.
You need to be buying when the doom and gloom is thick enough to cut with a knife, and selling at reasonable profits when the averages seem like they can only go up.
As much as you love to hear about quarterly market value numbers and comparisons with the averages over short-term blinks of the investment eye, you will not be accommodated here. We're going to talk about investing, and some more meaningful numbers that should allow you to fine-tune your "market value" performance expectations.
Why is market value in quotes? Because the relevance of a market-value-only focus is, itself, suspect. Isn't it the type of thinking that threw the financial markets into a death spiral in 2008? Years ago, lenders sought as much collateral as possible to secure their loans; to some, defaults were welcome. Interest rates charged were commensurate with risk.
The less worthy a borrower was, the more collateral the lender required --- and the higher the interest rate charged. Still, the fact that a secured loan could become under-collateralized due to market forces was a given ---part of the business, and the reason for reasonable down payments.
The fact that the loan is greater than the current market value of the jewelry, car, boat, refrigerator, or shopping center does not make them worthless --- just cyclically uncomfortable for lenders. The payments keep rolling in, most of the time.
How many of us are going to stop making payments on our toys and necessities because we can't sell them for more than some fool loaned us for the purchase? This is simply the way commerce is done. If you are "under water", you'll get over it. If your collateral is less valuable than you would like, help the debtor make the payments.
From either direction, the stuff just can't be considered valueless --- unless big dumb brother makes it so. Abandon "mark-to-market", disarm all derivative time bombs and get back to business as usual --- and plain vanilla stocks and bonds. Amen.
Generally speaking, the analysis of calendar period numbers accomplishes little while generating transactions that often damage the long-term viability of investment programs. Investors are encouraged to sell things that move lower in price and to buy those that become most pricey --- the unofficial cycle of fear, greed, and bubble.
How can I get you to stop fixating on monthly market values and to focus on the purpose of the securities within the portfolio? Most of us are trained to deal with seasons, fashion trends, biological changes, waning sports dynasties, etc. Instinctively, we expect, and prepare for change effectively --- but not when it comes to investing, where planning and preparation is just talk.
Steps one through three in the fine-tuning process are these:
1) Understand that all investing involves some form of risk --- risk that can be minimized by diversifying properly among investment grade, income-paying securities. Each level of "derivatization" compounds all risk.
2) A security's price, or market value, is a function of far too many variables, and cycles, to be either predictable or meaningful in the short term. Most often, price is determined more by investor emotions and speculator's bets than it is by security fundamentals --- especially under Modern Portfolio Theory hypnosis.
3) Most high quality income securities can be expected to continue producing income regardless of their market price and most investment grade equity securities purchased at relatively low prices will eventually provide an opportunity for reasonable profit. Both will constantly repeat their cycles.
With this understanding alone, investors at all levels (most of us are not fat cats) could spend less time avoiding profits and bargains and pay more attention to the purpose of the securities we own. Income securities are acquired for cash flow. If they fall in price, buying more reduces average cost and increases yield. A rise in price to a reasonable profit level must be jumped upon with a huge smile.
Equity securities are much more complex, but IGVSI securities in a Market Cycle Investment Management portfolio may be added to at lower prices to assure a more easily attainable, and profitable, exit point. No reasonable profit should ever go unrealized.
With these parameters branded on your investment portfolio forehead, there are just three numbers you need to track in order to form valid value expectations for your equity positions:
One: Issue Breadth statistics are the single most reliable indicator of what is going on in the stock market. Clearly, if more issues are going up in price than down, for a meaningful period of time, so should the equity bucket of the portfolio --- and vice versa.
Two: 52-Week High/Low data compare the number of issues establishing new 52-week high ground with the number sinking to new 52-week lows. Superficial analysis is very straightforward --- there should be more highs in an upward trending market and more lows during a correction.
Three: The IGVSI bargain level monitor reports on the number of investment grade value stocks that are at and near acceptable purchase levels. The longer the list, the more likely your market value numbers are lower than you would like.
So what about the thirty percent or more of your portfolio that should always be invested in income producers? There are fewer things to consider, but never even think the words: "I don't need the income, I'm just investing for growth", it exposes your amateur status.
Get a feel for the aptly acronymed IRE (Interest Rate Expectations) in the market place--- and a feel is really all that is necessary. If expectations are for lower rates, prices should move higher. If they haven't, make sure you understand why --- like the 2008 credit crisis, for example, and its impact on income CEFs.
The other is to get the income job done years in advance of retirement by using a cost-based asset allocation plan--- The Working Capital Model.
So, if you asset allocate properly for your objectives, and stick to your plan throughout the many cycles that will roller coaster your emotions and market values, you will find that your income constantly rises --- and so will your productive invested capital.
Whoa, that's the way it's supposed to be.