Wednesday, October 20, 2010

RSY XIIV: GAIN's Gain;Stock Picking is Dead, Long Live Stock Picking...

Rock Solid Yields {RSY} recently recommended a buy on LUBRIZOL CORP {LZ} at a limit price of $112.51. Yesterday, the market gaped down on opening at a price of $112.37 and then continued to slide for the first 15 minutes to as low as $110.75. RSY will record this trade at the opening price of $112.37. As mentioned before when recommending the buy, LZ options could provide us opportunities to enhance our returns and reduce downside risks. Of course it should be pointed out that writing covered calls reduces upside gains as well.

I think there are three possible contenders for a good contract earning substantial profits. March 2011 has two contracts above the strike price of LZ at $115 and $120 that could get us around $7.50 and $6 respectively per share. For RSY though, I think the longer term contract for June 2011 at a strike price of $120 is a better deal at about $8.50 per share. For holding the contract 3 more months we net around $2.50 per share and also collect one more dividend payment at 34 cents. That works out to just over 2 1/2 percent gain on initial investment over the three month period.

Sabrient Systems recently changed data providers, and as a result of some of our changes, we dropped some from our universe of covered stocks. It just so happened that two, that RSY recommended, were in that group. Luckily for us they have gained value since being added to RSY portfolio and were paying handsomely in dividends. Instead of completely selling out of these positions, I think it is best to do some "profit harvesting". RSY recommends a sell order of GAIN at $7.29 of 200 shares of the initial 400, and a sell order of NGPC at $9.99 of 300 shares out of the 500 shares {both GTC}. This will leave us with a smaller portion of each, but allows more diversification of the portfolio while still holding on to some good performing dividend stocks.


Stock Picking is Dead...Long Live Stock Picking.
The Wall Street Journal recently had an article titled 'Macro' Forces in Market Confound Stock Pickers. When Tom Lauricella and Gregory Zuckerman talk about stock pickers he seems to be talking more along the lines of institutional investors compared to the individual type of investor, but much of the same analysis would pertain to them as well. The heart of the analysis lies in this portion of the article.
In recent months, stocks have been moving in lock step to an almost unheard of degree. A widely followed statistic called correlation measures the tendency of investments to move together in a consistent way. Between 2000 and 2006, on average, the correlation of stocks in the S&P 500 was 27%, according to Barclays Capital. That meant that most stocks were moving independently of the index, driven more by company fundamentals, says Barclays stock-market strategist Barry Knapp.

In the run-up to the Iraq war in 2003, correlations approached 60%, suggesting that the looming war was driving stock prices, says Mr. Knapp.

Between October 2008 and February 2009, at the height of the financial crisis, correlation hit 80%, meaning lots of stocks were moving in lock step. When stocks rallied last year, the figure fell to 40%, then it spiked back over 80% during the European debt crisis, according to Barclays. What has caught many investors off guard is that correlation stayed high over the summer. In mid-August, correlation was 74%. In recent weeks, it has drifted down to 66%.

It certainly gives reasons to throw in the towel and pick index funds or as Matt Koppenheffer says at Is Stock Picking Dead?, "the market has its ways of grinding down on investors until they cry uncle and agree to do what is probably not in their best interests." Also picking funds, that are based on someone's interpretations of which stocks would perform best based on a set of macroeconomic forecasts, has not fared so well also.

One way to think about these macro factors that are driving the whole market is that the stocks are not converging but maintaining their relativity to each other. As the underlying factors change in the individual companies then eventually this "divergence" will catch up to the market and eventually investors will again start pricing based on fundamentals and growth prospects. As Matt states, this should be a great opportunity to pick stocks and then wait for the market to catch up with us. He also agrees with the RSY portfolio that dividend yielding stocks is a good answer for when markets are driven by the macroeconomic factors more than individual company performances. This way, no matter which direction the economy goes, a portfolio will be benefiting from dividend payments, or as Matt says, "collecting a healthy, growing stream of cash payouts."

For myself, I realized that macroeconomic forces can control the direction of a portfolio, no matter if it is well diversified or even diversified away from idiosyncratic risks.
Referring to legendary stock pickers Benjamin Graham and David Dodd, he says: "I'm a Graham and Dodd value investor, and geopolitical issues didn't matter 10 years ago. But they sure matter now." {WSJ}

Ten years ago makes it after the dot com bust, and then the next year was 911. They were certainly wake-up calls then. For the first event, I felt I was not exposed to much of the high flying tech-stocks, and the second event, I was not into airline stocks. Both ultimately adversely affected my portfolio as the whole market took a serious beating.

THE RISING INFLUENCE OF BETA

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