December 10, 2010
Written By Keith Richards
In Canadian newsletter The MoneyLetter, Keith Richards, a portfolio manager at ValueTrend Wealth Management, makes the argument that the market will trend sideways for the foreseeable future, perhaps six years. His advice for investing in such a market will actually help conservative investors make money regardless of what the market does:
Step 1: Hold short-term fixed income securities.
“An investor’s overall strategic mix between stocks, bonds and cash should be the cornerstone to any portfolio. For longer than I can recall, I have insisted on holding a fairly substantial weighting in short- to mid-term fixed- income investments for clients of our wealth management services. Long bonds probably don’t make sense at this point in the interest rate cycle. I also hold an element of inflation-adjusted bonds through the iShares DEX Real Return Bond Index (XRB 21.73 Toronto – yield n/a). [U.S. Investors can achieve similar inflation protection by purchasing Treasury Inflation-Protected Securities (TIPS) or an ETF that holds them, like the iShares Barclays TIPS Bond Fund (TIP 107.93 Amex – yield 2.50%).] If you believe that the current governments’ money-printing policies may lead to eventual inflation, this is a good hedge. A rule of thumb that I like to follow is to place your age, as a
percentage of your portfolio, into fixed income. Thus a 60-year-old investor might hold 60% of their portfolio in bonds and other fixed-income securities. I’ve come across too many investors who are overexposed to equity, especially in light of current market conditions. If you believe that you hold too much equity, I believe that markets will provide an opportunity to lessen equity exposure over the next six months. Technical indicators that I follow currently suggest that reasonable targets are 11,500 to 12,000 for the Dow and 13,500 to 14,000 for the S&P TSX 300. At that point, selling equity and rebalancing one’s portfolio will likely make sense, given the long range ‘ceiling’ I have previously discussed, and the potential for valuations to reach unsustainable levels in the coming months.
Step 2: Hold some gold.
“Diversification is the name of the game lately—lest we get caught holding too much of the wrong sector or asset class at the wrong time. Gold tends to act as a hedge against inflation and a declining U.S. dollar. Inflation may be looming, and a further decline in the U.S. greenback is quite possible, given some of the factors I’ve discussed previously. I should note here that I believe gold is a bit overbought at this time, and may take a breather for a while. Consider buying gold on a correction. Gold may be a screaming buy at or near US$1260/oz. Commodity ETFs such as the SPDR Gold Trust (GLD 136.92 NYSE – yield n/a) … play the commodity, while iShares TSX Global Gold ETF (XGD 26.92 Toronto – yield n/a) plays the gold stocks. [A U.S. alternative is the Market Vectors Gold Miners ETF (GDX 62.43 NYSE – yield n/a).] I should disclose here that ValueTrend Wealth Management holds XGD.
Step 3: Buy predictable stocks.
“Predictability of earnings growth is the single most important screen I use when analyzing current and potential stock candidates. In times of rapid market swings, often led by sudden revisions in earnings estimations, it is becoming increasingly important to own only those stocks with highly predictable earnings growth profiles. For example, our managed account currently holds Canadian National Railway (CNI 67.02 NYSE – yield 1.60%) and Teva Pharmaceuticals (TEVA 48.74 Nasdaq – yield 1.40%), both of which have illustrated a very smooth earnings growth pattern over the past five or more years. To illustrate the effectiveness of embracing high predictability of earnings, both of these stocks experienced about one-half of the downside of the overall markets during the 2008 markdown.
Step 4: Sell when the time is right.
“Let me emphatically state: buy and hold is dead! If the Dow approaches the top of its 10-plus year trading range at around 11,500 to 12,000, consider reducing your exposure to stocks. That’s why I love ETFs—you can trade an ETF according to the cycles and trends that you observe without falling in love with the story of a ‘good company.’ It will never hurt you to hold some cash when market valuations are getting frothy and near the top of their technical trading ranges. But it can hurt you a lot by failing to sell when the time is right.”
Keith Richards, The MoneyLetter, 11/10