Sunday, August 25, 2019

A Wave Is Coming, But You Have Limited Ammo…

Does the post title sound ominous? If you are thinking of a zombie hoard coming at you but you only have six arrows left for your crossbow, then yes that is bad news indeed.

Well, that is really not the case.

The “wave” that I mention here is the market direction, and it is those extreme ones. Yup, sharp rises and falls, those types.

The “ammo” is the amount of funds that you are ready to deploy when the wave comes, which for almost all of us, is a limited resource.

And the whole context is about selecting the right counters with finite funds in a bull or bear market.

Got the gist? Great. Now let’s move on.

Looking At The Right Wave

Before jumping into which counter to get, we must get a grasp of what and where the wave is going to be. The big clue here is to look at how the various asset classes behave in a given situation.

Equities tanking? This implies that bonds, commodities and to a certain extent, REITs, may go up. Bonds falling? This shows that equities and REITs may be in vogue. Yields of all asset classes going down? Expect a commodities (gold) rush.

The key thing here is not to look at what is going or about to go up, but to look at what is coming down. That is where the actual wave is going to be.

When To Use The Ammo

Back to the zombie wave analogy, if you fire your arrow too early, chances are you may not hit any target since the zombies are still far away, and this will cost you precious ammo.

When prices are free falling, it is very tempting to go in at the first instance. The problem is, no one knows for sure how much the prices are going to fall, and if you commit too early, you may get buyer’s remorse.

There are a few ways to determine when to go in. My “10-30 rule”1is one of them with regards to equities. The other way is to look at the oft-used “52-week low”, which is the low price point of a counter for the said period, though you can extend this period longer. Another way is the so-called “reversion to the mean”, which is the price (or any other parameter such as NAV or P/E) is going back to the moving average point over a certain period, usually more than one year.

Though the markets are unpredictable and we do not know how low the prices will go, the methods mentioned above serves as guidelines to adhere to at least.

Sometimes when the wave suddenly receded (like a sudden market reversal, e.g. the surge after Christmas last year), then it is wise not to mount a pursuit, i.e. chasing after the markets. Just fall back and live to fight another day.

Where To Use The Ammo

Selecting which counter is always a headache, because there are so many choices available. This is when the shortlist (or wishlist)2comes in useful, where you have drawn up a number of counters and securities to go into. In this way, coupled with fresh information, you can just do a quick review before deciding, rather than doing a new fundamental analysis from the ground up, which may cost you some time.

Another easier way is to do an averaging down of your existing holdings that are still fundamentally sound, subjected to the guidelines stated in the previous section. 

Loading Up Additional Ammo

Feeling constrained with just six arrows? Why not pull out the arrows from zombies that were shot earlier and re-use them?

Whenever we think of funds, they are either sitting at the cash portion of your Bedokian or other investment portfolios, or drawn from other non-investment sources like your emergency funds. However, there is still another place to get your ammo from: your current holdings.

On an overall portfolio basis, you can find which counter(s) is overvalued, e.g. above NAV, higher price-to-earnings ratio, yield is being compressed, etc., be it from the same asset class or others. You can have the choice of divesting it and voila, new fresh funds are available for something else better.

Do Not Forget The Overall Picture

The last message for this post is not to lose the overall picture, and that is always keep in mind the diversified portfolio. It can be tempting to go all-out on a few bargain counters, but please do not create an imbalance to your asset allocation ratios or worse still, replace your entire portfolio with those bargains. Having a return-risk approach is still paramount, at least in my opinion. 

1 – The Bedokian Portfolio, p119-120

2 – ibid, p94-95

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