Pull Your Portfolio Out of Its Rut
06/11/2010 9:20 am EST
You can't rely on old investing habits to guide you in this volatile market; instead, explore your discomfort zone. Here's how. Also: Three finds from out-of-the-way places.
If the seesaw market of the past ten years has taught investors anything, it's to not get too comfortable.
As an investor, it's incredibly hard not to get trapped in the rut of the familiar. We all tend to invest in what we know, to try to stay in our comfort zones by putting our money into the comfortable.
But over the past decade and more, investing in the same stocks from one bull market cycle to the next hasn't been the way to score the biggest returns.
During this period, not only has the stock market been extraordinarily volatile, but the leadership in each bull market rally has been radically different from the leadership in the previous rally.
Keep that in mind as you get ready for the next bull market—whether it's just a cyclical bull rally within a longer secular bear (as I suspect) or a long secular bull like the one we enjoyed in the 1980’s and 1990’s (as I hope, but I doubt). For more on why I think we're in a long secular bear market, see my February 19 column, "Why Stocks, Worries Are Both Rising." And keep that view in mind as you revise your watch list of stocks you'd like to buy in the next bull. (I started a big overhaul of Jim's Watch List in my June 9 column.)
Today's topic is how to bust your investment thinking out of any ruts. And I'll be adding some of those rut-busters to my watch list with this column.
Spinning the Sector Bottle
As I noted, a different group of stocks has starred in each bull market cycle of the past decade plus.
In the bull market that ended in 2000, technology stocks led the way. The Technology Select Sector SPDR (NYSE: XLK), an exchange traded fund, was up 65% in 1999, for example.
But in the next bull market, technology stocks stunk; you would have done much better with energy shares. In 2005, for example, right in the middle of the bull cycle, the Technology Select SPDR returned 0.18% for the year. That same year, the Energy Select Sector SPDR (NYSE: XLE) returned 40%.
In 2009, you would have done fine with the Financial Select Sector SPDR (NYSE: XLF), with an 18% return for the year, or the Energy Select SPDR, with a 22% return. But the big momentum had swung back to the Technology Select SPDR, with a 51% return, and to the Materials Select Sector SPDR (NYSE: XLB), with a 48% return. (What's in the Materials Select SPDR? Stocks such as DuPont (NYSE: DD), Monsanto (NYSE: MON), Freeport-McMoRan Copper & Gold (NYSE: FCX), and Nucor (NYSE: NUE).)
And for the next bull?
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In my June 9 column, I gave you my top-down macro view of where you'll want to put your money. My recommendation was to overweight emerging market stocks, commodity stocks, and financial stocks.
But this kind of top-down thinking still leaves you vulnerable to getting caught in a rut when it comes to picking individual stocks in those sectors:
- Do you want to own BHP Billiton (NYSE: BHP) in the next rally because it's familiar and because it returned 82% in 2009, when commodity stocks did so well? But what about the Australian government proposal for a 40% tax on mining products, which has roiled the industry there? Are you just picking BHP Billiton because it's a name you know?
- Among the financials, should you buy Goldman Sachs (NYSE: GS) because it's familiar and because it returned 102% in 2009? Even though it looks like the company could be charged with obstruction of justice by the commission investigating the global financial crisis?
- Among emerging market stocks, should your pick be Baidu (Nasdaq: BIDU) because it's familiar and because it returned 215% in 2009? Are you really betting that another dominant global competitor—à la Google (Nasdaq: GOOG)—is going to pull out of China's market in the next 12 months?
Maybe you really do want to add these past winners to your watch list for the next bull rally. But I'd advise that you do so only after you've scoured your discomfort zone to find unfamiliar stocks that may be better bets for the next cycle.
So how do you explore your discomfort zone for potential watch list stocks?
I have a technique I call reading in the margins.
Most newspaper, magazine, and Internet stories about sectors, trends, or market moves begin with companies and stocks you know. It makes perfect sense: Writers and editors know that a larger percentage of their audience is interested in news on Exxon Mobil (NYSE: XOM), for example, than on Occidental Petroleum (NYSE: OXY) or on Swift Energy (NYSE: SFY). If the story is on the financial industry, the lead example is likely to be Goldman Sachs, Citigroup (NYSE: C), or JPMorgan Chase (NYSE: JPM) and not Middleburg Financial (Nasdaq: MBRG) or Bank of Marin Bancorp (Nasdaq: BMRC).
But if you go to the end, you'll see throw-in examples that flesh out the story. That's where I found Aixtron (Nasdaq: AIXG), a maker of equipment to manufacture LEDs, which I recently added to Jim's Watch List. (See this blog post on my Web site for more.) At the end of a Financial Times wrap-up on the day's stock market action in Europe was a half-sentence mention: Among the biggest losers on the Frankfurt exchange was Aixtron, the leading manufacturer of LED equipment.
That was it. But that's all the lead you need. From there it's just a research job to find out that Aixtron isn't just a leading manufacturer of LED equipment, but also the dominant maker of machines that deposit the thin films that make up an LED.
The daily market summaries on the last page of the Financial Times are one of my favorite "discomfort zone" hunting grounds.
Reading an exhaustive story or package from an angle that's 90 degrees out of alignment with the editorial mission of the writer is even more productive. For example, The Economist did a huge cover package in April titled "The New Masters of Management" (you can read an overview here).
I'm not especially interested in management or in the trends that make one management style hot today and not tomorrow. But a story like this could throw up lots and lots of one- or two-sentence references equivalent to the Financial Times mention of Aixtron.
And it does—but none that is really investable right now.
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Bharat Forge, a company in India, recently teamed up with KPIT Cummins to produce an inexpensive automobile hybrid conversion kit. Unfortunately, the stock trades only in Mumbai. Not every company mentioned leads to an investable idea.
Tata Consultancy Services recently bought Citigroup Global Services, the outsourcing arm of Citigroup. (Who says the global financial crisis didn't produce any winners?)
This one, too, trades only in Mumbai.
Infosys Technologies (Nasdaq: INFY), on the other hand, trades on the Nasdaq Composite Index. The Indian information services company grew sales by 40% in 2009. Unfortunately, it might be too expensive for my watch list. The stock traded at $57.38 on June 8, and the 52-week high was only $63.73. The recent selloff hasn't done much damage to this emerging market stock.
But my hope is always that even if a particular article, post, or report isn't especially rich in investment ideas itself, it will provide leads that are. So The Economist package mentions a study of new global leaders from emerging markets by the Boston Consulting Group. And lo and behold, the 2009 study, "The 2009 BCG New Global Challengers," is available for free online. (For my own take on a similar group, see my October 23 column, "How to buy the next McDonald's.")
At first, the study seems as frustrating as the package in The Economist. Brazil's Votorantim Group is one of the world's top five zinc producers, but it doesn't trade on any US market. India's up-and-coming United Spirits trades only in Mumbai. Marcopolo, a leading global producer of buses and bus components, trades only in São Paulo, Brazil.
But gradually things start to look up. Johnson Electric, a leader in the manufacture of small electric motors, trades good volumes in Hong Kong and on the pink sheet market in the United States. Mexichem, which is the number one or number two producer of plastic pipes in Latin America, also trades on the pink sheets.
What to Watch For
And finally, investable ideas worth a spot on my watch list:
- Gerdau (NYSE: GGB) is the dominant and low-cost steel producer in Brazil. Its major markets are Brazil and the United States, and the company shows a return on invested capital of 22% over the past decade, according to Morningstar. It trades as an American depositary receipt on the New York Stock Exchange.
- América Móvil (NYSE: AMX) has used the cash flow from its 70% share of the Mexican wireless market to expand into the rest of Latin America. Brazil now provides 20% of the company's revenue.
- Li & Fung (OTC: LFUGY) is one of the biggest creators of customized supply chains in China. Its customers include Wal-Mart Stores (NYSE: WMT). The company is also the largest operator of convenience stores in China.
I'm going to add these three stocks to Jim's Watch List as of today. And then I'll keep looking for more stocks that fall outside my comfort zone and that will keep my portfolio out of a rut in preparation for the next bull market.
At the time of publication, Jim Jubak owned shares of the following companies mentioned in this column: Bank of Marin Bancorp and Middleburg Financial.Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com