Investing Philosophy for the New Year:

While the New Year will bring prosperity, health and happiness to some, almost as many will suffer from impoverishment, ailments and grief of loss of the dear ones. There will be moments of joy and periods of sorrow in every life. It is impossible to predict what the climate change, terrorism or political upheaval will dump on us and where. These are uncertain times but that is how every year has been and 2012 will be no different.

The issue in the minds of all investors is simple to state: How to handle our investments in the stock market under different scenarios we are likely to face? Extreme downside is not a consideration because if the world comes to an end what happens to our money doesn’t matter. We invest in a system which is moving forward whether stumbling or running at full tilt. Investment in commodities and real estate has undue risks because there trading tends to be quite irrational and prone to hype. Yes, the stock market too is not rational but only on a day to day basis. Over the term of a few months one can see the patterns and relate them to reality. This has worked in the past and should work in the New Year too.

The indices for the U.S. and Canadian exchanges rose sharply in the first quarter of 2011 to give up these gains and some more in the third quarter. In the fourth quarter they fluctuated in a 1000 point range, centered at 12,000 for TSX. Many acute hedge fund managers made money by shorting when the index was 12,500 and covering the shorts at 11,500. This trading by large funds may have played a part in the volatility. The U.S. economy, shaky banks, the problems of Euro and heavily indebted European economies were perhaps the reasons for drop from the peaks of the second quarter but their ups and downs did not correspond to the volatility in the last few months and may have had little to do with it. I suggest that the market will trade in the same vein for next few months. This pattern will change downwards if there is a catastrophe like a repeat of 911 in the West, political upheaval in China or India, major confrontation in the Middle East or unforeseen significant weakening in a major Western economy. Conversely, there will be an upward move if Europe resolves its problems convincingly (not likely in the short term) or the U.S. economy shows signs of life (possible if President Obama stands up to Tea Party Republicans and taxes are raised to reduce the budget deficit) or India and China reverse recent declines and commodity markets begin to rise again. Isolated natural havocs like Tsunami in Japan don’t seem to have a lasting impact on the economy except on the communities of the region. What a series of such disasters in quick succession will do is too awesome to contemplate and plan for. That said, an investor who watches for and reacts to the signs around him will reap profits whichever way the economy moves.

Rather than balance the portfolio for different sectors of economy or for geography, it is better to balance it on the basis of yield, risk and the prospects of individual companies. Even a seven figure account can own only one or two companies in any sector. For example, which bank or insurance company to hold to represent the financials is a key issue and needs the attention of the investor. Generally, it is better to invest in second tier companies than the largest in their industries for two reasons. First, second tier companies are often bought at a premium by their peers or by the leaders in the industry. Second, these companies are usually not on the radar of hedge funds and are not as volatile as the top tier companies. It is often profitable to put a small percentage of the portfolio in companies which have either hit the rough spot and have a good prospect of recovering or the start ups which have an unusual and proven (as much as anything can be proven in this business) potential. In my experience, many of the big losers of last year are likely to be big winners this year. It helps to sleep better if an investor remembers that over the short term, performance of the portfolio is critical, not that of each individual component, because these may fluctuate in a large range for no good reason and trading based on daily price alone causes grief more often than joy.

There are many tomes, media columns and blogs advising investors but there is no proven technique. Generally, buy and hold is better than day trading even when trading expenses are negligible. On the other hand, there is a time to buy a stock and there is a time to sell. Long term investors develop an instinct which guides them on when to trade which works for them more often than against them. Not every investment in 2012 will work even for the sage of Omaha. However, more of them should succeed than fail for a good investor and the portfolio should be ahead at the end of the year after counting for inflation and taxes. Any gain on top of that is gravy.


Throwing stones while living in a glass house:

Picking junk may have made Smiling Barracuda rich, as Mr. Delaney claims (Smiling Barracuda, Globe and Mail, Dec. 17), it has not done much for his his investors. Stock of Sherritt was $8 in 1996; This week, fifteen years later, it trade around $6.00.

Another company loved by the media is Westjet. In five years its stock is down from over fifteen dollars to around eleven. Yet, watching the CEO being interviewed you would think that it has made its investors fabulously rich. Running down your competitors sounds better when you have something worth shouting about.