My $100,000 Portfolio Strategy for this Changing Market

David Sterman's picture

Monday, January 30, 2012 - 1:30pm

by David Sterman

Roughly a month ago, I was quite excited to launch a new $100,000 Real-Money Portfolio here at StreetAuthority. The market offered plenty of bargains and was looking quite healthy from a technical perspective. Sure enough, the S&P 500 is up nearly 5% in January and up roughly 15% from the start of the fourth quarter of 2011.

But this creates a real conundrum.

Is it best to infer that the recent strong market performance is simply a precursor to even more gains for the rest of 2012? Or is it wiser to take a foot off the gas and hold off on further purchases until the market catches its breath?

Technical analysts are beginning to cite concern, noting we're "overbought." They usually say this after every market rally, so I prefer to trust the fundamentals. But I also have to acknowledge a clear trading pattern that has been unfolding in the past two years: The market tends to swing from rally to sell-off at fairly regular intervals. So the best recent investment strategy has been to sell into rallies and buy into drops.

Holding tight
Make no mistake, I'm painstakingly building a portfolio for the long haul. Every stock I've bought has a clear path to rising sales and profits in 2013 and 2014. In almost every instance, I've cautioned that these stocks are quite inexpensive, simply because the near-term results are not as likely to be quite as endearing. So when I see a stock like Ford (NYSE: F) pulling back in the face of a tepid quarterly report, I am simply undeterred. For that matter, a company like Alcoa (NYSE: AA) may struggle under the weight of aluminum prices for a while to come. It's best to assume the most conservative scenarios.

Yet, you can expect me to hang onto these stocks for quite some time. I only sell a stock under one condition: When the investment thesis has been altered. If I am expecting a company to deliver a certain level of sales, margin or profit results, and the company no longer looks set to meet these targets, then I'm a quick-seller.

But even as I sit tight on what I believe to be a solid set of stock picks, I still need to move in step with the changing market dynamics. As I noted earlier, the market's strong recent gains may end in a bout of profit-taking. If so, I'd be wise to deepen the focus on stocks with clear downside support (which axiomatically become harder to find as a market strengthens).

Or, I could take the market's strength as a bullish sign. Indeed, the prospect of a resolution of the European crisis has led many investors to "whistle past the graveyard."  Ford's stock action provides clear insight into the current mood: Shares fell 4% on Friday, Jan. 27, in the face of a weak quarter. (Still, I'm already sitting on roughly a 3% gain in my $100,000 Real-Money Portfolio.) But they could have fallen by twice as much if investors were in a less-forgiving mood.

We also saw this a few weeks ago, when Cree Research (Nasdaq: CREE) -- also a portfolio holding -- went on to rally after delivering weak quarterly guidance. This should have been an excuse for investors to sell. Instead, they see Cree's glass as "half-full" rather than "half-empty." The fact that the U.S. economy grew 2.8% in the fourth quarter of 2011, right in the face of huge headwinds created by a struggling Europe and still-stressed U.S. consumers, gives the impression we may finally be turning a corner.

Indeed the "half-full" view characterizes my current investment stance. The recent gains make me a bit nervous, but the broader market backdrop has a real air of confidence to it. That's why I'll be adding battery-maker Exide Technologies (Nasdaq: XIDE) to my portfolio on Feb. 2. (Remember, you always get two days' advance notice before I buy a stock.)

Exide is a high-risk/high-reward investment that will be atypical for this otherwise conservative portfolio. If the market can simply hold its own in coming weeks and months, then investors will "move out on the risk curve," which means buying trends won't simply be limited to large and stable blue chips.

A well-constructed portfolio needs at least some exposure to smaller, riskier stocks. I'm not changing course from the portfolio I set out to build, but simply making course corrections along the way.

The converse also applies. If the market starts to get choppy, then investors will move back in from the risk curve. In this case, I wouldn't hesitate to sell riskier holdings such as Exide. In effect, you can expect me to stay the course with my blue-chip picks and have a fair bit of turnover in the small cap/high-risk portion of my portfolio.

Action to Take --> To be sure, January has given us plenty to digest. A month from now, earnings season will have ended, the European crisis will (presumably) be that much closer to resolution, and investors will be assessing what the economic data points tell us about what to expect for the rest of 2012. That should help dictate the next moves in my $100,000 Real-Money Portfolio.

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David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of AA, F, CREE, HAS, ZIP in one or more of its “real money” portfolios.