Coming off a roller coaster year in the stock market, it is quite natural to be apprehensive about what lurks as 2012 rolls in. Should you buy stocks in 2012 or if you are out of the market now, than should you continue to wait and see? I will let the professional economists look in the crystal ball and tell us what the future holds. It gives me a great satisfaction to ignore the pronouncements of the economists. As an investor, I am solely concerned about how I can maximize profits next year, and every year. Both for me, and my members.
All said and done, 2011 is likely to end as it opened, with S&P 500 around 1250 – 1270 range. The flat index belies the fact that the market remained highly volatile throughout the year. Many have gone on to say that the volatility is the new normal. Perhaps it is, or perhaps there is just too much economic angst around the world that is affecting investor sentiment today. Whatever the case may be, volatility is something that should be embraced, not feared.
Great fortunes are made when the world is awash in uncertainty. This is still true today.
Navigating the Chaos – Focus on the Core Principles
Invest with the market and you will get the market returns. However, the market as a whole is dysfunctional today. There are too many strings that pull the market and the direction it takes depends on what is tugging the hardest. Maybe there are some who know or can predict how the markets will behave tomorrow, or the next week or month. I certainly don’t.
What I do know is the following:
- Ignore the market noise, and focus on good businesses to invest in
- Buy the stock in these businesses if the price is below the intrinsic value
- Ignore the market but obsessively track the underlying business of the stocks you own
- If the price/intrinsic value ratio goes up beyond your comfort zone, sell the stock
Rinse and repeat.
Investing success is closely linked to investing discipline and adherence to a proven and reliable system, in this case it being value investing.
Diversify or Concentrate?
I have written earlier about the fact that excess diversification is useless, to the chagrin of quite a few. To me, either you are an active investor or a passive one. If you want to invest passively, buy an index fund. If you actively buy stocks, than you need to spend time to understand what you are buying, and concentrate your portfolio with 10-20 high quality stock picks. This is enough diversification (assuming you do not buy 20 semi-conductor stocks :-)) and will keep your portfolio highly responsive to any one or more stocks doing exceptionally well. For the stocks that do not perform, you will conduct the Price/Intrinsic value test outlined above at frequent intervals and either sell the stock or buy more. This brings the discipline needed to cut your losses and stay invested in businesses that continue to build value.
What About the Macro Economic Trends?
Once you are invested in a stock, the only criteria to hold or sell should be based on the valuation of the company. It is best to ignore the market and macro trends in these situations. However, macro trends can be useful in that they often create excellent buying opportunities. So if you have a few predictions, go ahead and build what-if scenarios around it, and put relevant stocks on your watch list. When the opportunity comes, and you find that the risk/reward is favorable, go ahead and buy. If the scenario does not play out, you just change your watch list. You do not have to commit capital to a scenario that has not occurred. Focus on the knowns. Be aware of what might be but don’t move until it comes.
There are 1000s of stocks in the market to choose from, so you will not miss out on anything. And just in case, if there is a shortage of stocks to buy using these principles, stay in cash. The market is probably over valued in this situation.
There you have it. My investment advice for 2012. It is the same as 2011 and it will be the same in 2013. Fundamentals don’t change.