Investment

The Investor’s Edge

|Let’s take a more nuanced view and talk about individual stocks and not the markets since the word “average” doesn’t seem to apply right now.|

Not much new here. Markets are more manic than normal, though these are hardly normal times. Investor sentiment by most measures remains skeptical and cautious. And yet day trading is back. Almost 25% of the S&P 500 market capitalization now consists of just a handful of technology stocks heading skyward like rockets while most equities are down or flat for the year. From the lowest unemployment rates on record to some of the highest in a century in a matter of weeks. All this notwithstanding,  talk of “bubbles” is getting louder. So let’s take a more nuanced view and talk about individual stocks and not the markets since the word “average” doesn’t really seem to apply right now.

Today’s thought starter, “Should you buy a stock whose price is at a 52-week or all-time high?” And does this really matter to someone looking to invest for the long term? Some very smart investors take opposite sides of this debate.

It has been argued that the overall trend of the market is the key driver of short-term gains or losses.

When the market is moving up, even mediocre stocks can enjoy an uptick in stock price (“the trend is our friend”). Conversely, when the market is moving forcefully down, even good investments can take a hit (“what the hell happened in April?”).  This also means that outside forces can make a questionable investment look better than it is, and still leave good investments available at favorable prices.

Somewhat connected to this line of thought is that over longer periods of time, “reversion to the mean” should be expected. Maybe not. Put another way, stocks that go up too fast should tend to come back down, while stocks that drop precipitously usually bounce back. All of this is, of course, based on the premise that a pop or drop in an equity is not caused by an outlier event like accounting fraud or sudden product failure. But today we’re seeing record numbers of business that won’t ever revert to anything because they are gone. Thousands of companies are reinventing themselves, their operations, and business. New will not look like old.

The conundrums are bountiful here and often contradictory.

It might make sense to purchase stocks at high watermarks when the market is moving up and avoid trying to catch what may turn out to be a “dead-cat bounce” buying stocks not moving with the upward flow. Or, when the market is trending down it might be best to purchase equities at new highs because that should be a sign of additional strength. Does pride come before a fall in price for stocks too? Avoid purchasing a stock on the rebound when the overall market trend is up because this can hide weaknesses? You could just buy an index, but as the S&P 500 makes strikingly obvious right now, a few big winners can hide a lot of companies struggling mightily.

In the final analysis, the basics remain.

The key is understanding what a company does, how it makes money from that activity, and what does it do with profits. Ditto for EFTs and mutual funds. How do they invest, how (or when) will they make a profit and how do they reinvest (or share the money). I typically follow an ETF or individual stock for several weeks, or even months, before taking a position. This allows for time to learn about the investment, fully understand the underlying strengths and weaknesses while also thinking about what might trigger unit price movements. My preference has typically been to buy on weakness, or adverse news (value investing). But reading some of the thoughtful commentaries that suggest purchasing on strength (momentum), has me reconsidering this traditional viewpoint. The golden mean is sounding good these days, 60% value and 40% momentum. I’ll let you know how that works.

No answers here, just something to think about.

Even when considering stocks for the long haul, it makes sense to acquire a position in an equity investment when the odds favor maximizing the long term returns. But short term we should be mindful that for many of us, a serious impairment of capital may not be something we will have time to recover from. As stock prices move over varying periods of time – some because of macro events (pandemics come to mind), others because of events specific to the stock (Elon Musk, whoa!) – the investor should always be looking for an edge. Especially the edge of a cliff.

 

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