Many people don’t realize that sixty percent of all stock price movements are related to the overall trend of the market. This suggests that your ability to make money in the stock market is in direct proportion to your ability to invest only when the percentages are with you. Given this, the right strategy is one that starts top down.
This approach is known as Macro Analysis, and assumes that if you are correct about the overall trend of the market, you can place your bets at times most favorable for investing, and avoid the market at times that are least favorable.
While intuitive in the abstract, I first got clued into how to actually apply this method of analysis when I read, “The Vital Few vs. The Trivial Many,” by George Muzea.
In the book, Muzea segments the investment marketplace into two buckets – The Vital Few and The Trivial Many. The Trivial Many includes the so-called experts, media and the millions of investors that they influence. In coldly pragmatic terms, this group, which makes up the majority of investors, perennially underperforms the market, and as such is to be bet against. In the last 50 years, for example, expert selections have underperformed the market 75% of the time. Hence, a basic first part of your investment strategy should be to not follow the experts. Similarly, as what the media writes is a reflection of expert opinion, look at what they are recommending, and bet against their recommendations as well.
By contrast, The Vital Few are corporate insiders, corporate officers, board members and major shareholders. Generally speaking, such insiders sell into price strength and buy into price weakness. In other words, by watching what insiders actually do with their own personal money, you can track your buying and selling decisions to those whose actions are not only predictive but public as well (insider actions are filed with the SEC).
Since reading the book, I always ask myself before making investing decisions (not just in stocks but across all segments) whether I am tracking with The Vital Few or The Trivial Many. This is a great book and a quick read.
In any event, one of the macro strategies that is upcoming for investors is known as “Tax Loss Buys.” In this strategy, you buy beaten down stocks in Mid-October and sell them all in mid-February the following year, which means this is a four month strategy.
The logic behind this strategy is that while individuals have until December 31 to offset losses with gains to take advantage of tax loss selling opportunities, the mutual fund industry must take these actions by October 31st of each year. This creates an artificial supply for stocks in the September-October period each year as the mutual fund money managers sell their losers to offset capital gains that they had during the year. When the institutional tax loss selling ends on October 31st, the stock market will usually rise, as the downward pressure on the macro market dissipates.
Moreover, as 401K pension plans and IRA investments must be made before April 15th of each year (otherwise the IRS will disallow them), and the tax year ends of December 31st for individuals, most of the money flows into these plans in the first quarter of the year. When this flow of money has been invested, usually by the end of April, the market typically drops as demand dries up.
Taken together, this means that you can buy into a market facing downward pressure in September-October and sell into a market facing upward pressure in February-March.
So how do you find stocks well positioned to take advantage of this macro window of opportunity? The basic workflow is as follows. Start by finding the NYSE “New Low List” in Barron’s Weekly and Wall Street Journal Daily. From the stocks in this list, subtract liabilities and long term debt from assets, removing stocks that have a negative number. Then, from the list that remains, go to Yahoo or Marketwatch and look at the ten year chart of each remaining stock. If the stock is not in the lower third of a ten year price history, cross it out. Next, check institutional ownership of these stocks, ensuring a minimum of 30% ownership. Finally, cross out entries that have not at least shown a penny of profit in last quarter.
What this will give you is ~10 stocks from an initial list of 100 “New Lows” that have both strong balance sheets and current earnings, be in the bottom range of their 10 year trading history, and down pressured by the institutional tax loss selling that must be completed by October 31st. The final step is determining your total investment and buying equal dollar amounts of each of the quality stocks and then selling them all by mid-February. For what it is worth, the author has used this strategy successfully in 24 out of 25 years.
(Side note: I attempted to automate as much of this as possible, and was able to find the 52 week lows that meet institutional and earnings criteria using the Yahoo! Finance Stock Screener (Java based but free), which means that by hand I only need to filter on 10 year trading histories and balance sheet assessments.)
Moving forward, are you going to invest with The Vital Few or The Trivial Many?
