The Deipnosophist

Where the science of investing becomes an art of living

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Location: Summerlin, Nevada, United States

A private investor for 20+ years, I manage private portfolios and write about investing. You can read my market musings on three different sites: 1) The Deipnosophist, dedicated to teaching the market's processes and mechanics; 2) Investment Poetry, a subscription site dedicated to real time investment recommendations; and 3) Seeking Alpha, a combination of the other two sites with a mix of reprints from this site and all-original content. See you here, there, or the other site!

09 August 2009

Da parvis grandis acervus erit

The chains of habit are too weak to be felt until they are too strong to be broken.
-- Samuel Johnson

While there are many tactical methods to make money when investing, there are only two primary strategic methods: top-down and bottom-up.
Top down investors view the economy with a birds-eye perspective, and zoom in -- in this order-- on the national markets, then asset classes, then sectors and groups (for equities), then attempt to discern the companies that will benefit most from their expectations, and finally purchase the shares of those companies. (Read a better definition here.)
Bottom up investors ignore the big picture, and instead (attempt to) find the companies with a winning/leading track record, determine whether group and sector strength corroborates that company's individual strength, etc, and then buy the shares of those leading companies. (Read a
better definition here.)
I am both, and neither. While more closely in tune with bottom-up investors, I instead seek the leading stocks rather than the companies. Then I determine whether the group and sector corroborates that individual stock's strength, and finally investigate the company (or companies). The stock will make it on my Core Opportunities list if, and only if, the company itself passes muster. Solid fundamentals, low valuation, and high quality executive talent are among the hurdles the company must jump over to qualify. To buy a stock solely on the basis of its positive but ephemeral price action is folly, and defies sound money management.

Even so, I seek stock strength first for the company to even warrant my attention. I reckon, perhaps oddly to you, that the stronger the stock's price rise (see bullet points below), the better the long term picture. It matters not at all if I do not own the shares yet; I will. But I want to know whether the stock, and therefore the company, provides sustainable investment interest for other investors; institutional investors, in particular. You can witness this investment interest by...
• The speed in getting from point A to point B. (The slope of the pace rise.)
• The capacity to exceed upside, and thwart downside, expectations.
• Volume increases during up phases in prices and diminishes during decline phases. (Do not impose artificial start and end points, such as one day, on your analyses; do segregate discrete price moves.)

"Keep rising!" I say. And during the stock's initial price rise (maximum thrust, nigh vertical), I perform due diligence on the stock and company: Does the stock exceed upside price objectives? Does its rising trend exceed expectations? Does the company continue to exceed expectations? What is its product? What is the quality of its executive and management teams? Does its sector grow? Etc. All to the good, if yes.

Again, I seek strength on top of strength, fundamental (company) and technical (stock) -- even if I do not already own shares. The higher and stronger the rise, the better; at some point, the stock will correct, and build either an intermediate term (typically, 3 to 6 months) or a long term (months to years) base. And I will have my opportunity: a leading company, a leading stock -- a company and stock investors want to own -- and one that now moves temporarily against bullish trends down into my waiting hands.

One example would be (the previously mentioned) Colgate-Palmolive/CL...

[click on charts to enlarge]

Note the intermediate term base that builds now atop the massive long term base (1999 to 2007). My clients purchased Colgate-Palmolive/CL (at $58), once it became obvious (to me) that the stock would base rather than decline into a trend of lower highs and lower lows. (Which trend pattern I qualify to be a bear market.) Trends always change, but the opportunity to invest in a company of Colgate's caliber at a fire sale price excites me; I hope it did you, as well.

McDonalds/MCD also appears to build an intermediate term base atop a large 8 year long term base (1999 to 2007). I believe the stock's recent pattern to be a symmetrical triangle; stocks typically hesitate following the initial thrust from a breakout before continuing in the direction of the primary trend. Thus, the ultimate resolution of McDonalds/MCD's recent hesitation points out and up. I have begun to accumulate the shares, albeit slowly.

Predictions of bull and bear markets have a strategic purpose that should inform your tactical decisions, and therefore have a place in your decisions. For example, any price trend, measured quantitatively and qualitatively, pauses sooner or later, so your timing of new purchases and sales should proceed accordingly. However, leading stocks rise and decline before the general market follows suit, so this timing thing becomes rather tricky and best left to professionals. Unfortunately, most investors allow their strategic outlook to become their tactics. For example, "I like the company and I really like the stock (action, of late), but because I believe the market trades in a bear trend, I will stand aside until lower prices occur." Sound familiar? The lack of a position holding, of any size, means no opportunity to profit. Sure, possible losses could become probable losses; temper this possibility by position size, timing, and the long term quality of the opportunity.

You would not have read this far, if you did not also want to know my perceptions of the market today. I view the market to be in a wide trading range, in existence since 1997, and one that continues today -- and should for several more years.

Correct chart analysis does not require you to know how to draw trend lines A & B (chart above) before even one data point occurs, but you should know how to correctly identify and delineate after the data points occur; it is the breach of the salient inflection points that create trend changes. Yes, I know that many bears hang their continuing bearish perceptions and expectations on the ferocity of the recent decline (the Great Panic of 2008), but that decline merely brought the market back to the less-than-stringently identified trend line B. B represents a sequence of inflection points (as does any line): a sustained breach would manifest a serious change of character for the market -- as would a bullish breach of trend line A. I repeat myself, I know, but this point is crucial.

The pattern is a high level consolidation (HLCs). High level consolidations, which occur surprisingly regularly, have specific rules by which they must abide, as do all chart patterns. (I have shared these rules in a previous post.) The first problem of analysis occurs for most investors when the pattern's simple appearance supplants its technical aspects. That remark aside, high level consolidations (or trading ranges) can endure for years, even decades, although its typical duration lasts for ~16 years. The horrid market conditions of the 1930s and the 1970s were circumscribed by HLCs, which I revealed in a previous post’s annotated charts.

Which all means that I perceive the market's decline of 2008 as nothing other than a rapid decline to the lower trend line of its high level consolidation, the same trend line that has contained all previous tests for the past 12 years. Moreover, the velocity of that decline is not really predictive of more declines to come; the passage of 9 months since the market hit bottom and the constant refrain of bad chart and technical analysis by the bears proves that point.

The cool thing about high level consolidations is that new bull markets frequently emerge, albeit in specific groups and sectors -- all while the general market meanders sideways (range-bound). To witness this truth for yourself, you need only break the market down into its constituent parts, aka sectors and groups, and you will find many potentially profitable opportunities that await your discovery; past, present, and future. The truly wonderful thing about the Great Panic of 2008 is that investors today can invest in (high quality) growth at value prices.

And consider how strong the market’s leaders will be when the market they drag higher finally rises of its 'own' power; the general market can assume its role as engine rather than caboose to a few leading stocks and sectors. Imagine the many companies that grow faster, and whose stocks rise more quickly than the two I mention in this post; they exist, and await your discovery. Begin by shedding your fear of the market. And profit accordingly.

Full Disclosure: Long the markets via many leaders, Colgate-Palmolive/CL and McDonalds/MCD included.

Dat rosa mel apibus
-- David M Gordon / The Deipnosophist

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