Investing: Top Down or Bottom Up?

by: Wall St. Cheat Sheet

By Elliot Turner

This morning was another Monday morning with the futures indicating a slight gap up. We have two things at work here: first is that contrary to Friday afternoon’s gloomy talk, the world as we know it is still here after two days away from financial markets and second, we have several substantial mergers to digest. I’ll leave the merger talk for another post, as the first point deserves some attention. Friday was the first semi-substantial down day in equity markets since basically the end of August and the financial talking heads used that as an opportunity to roll out the doom and gloom talk.

The late-week CNBC cast starred Jeremy Grantham in a leading role, and featuring the real doom-and-gloombers Meredith Whitney, Nouriel Roubini and Marc Faber in supporting roles. They might as well play "It’s the End of the World as We Know It" in the background as these smart people put forward their coherent and tightly nit narrative as to why the world as we know it is most certainly coming to an end. Surprisingly, as gloomy as these folks may sound, I can almost guarantee you that none of the above have invested in an inland cave stocked with a thousand year supply of canned foods and bottled water.

There’s something I want to get at with regard to the sentiment around this powerful rally. Each and every step of the way, the masses have doubted the market’s ability to move higher. When I wrote the Top Five Reasons to Trust this Rally back in mid-September comments on nearly all venues where the post appeared labeled me misguided and even crazy. But it’s not merely that people didn’t think the market could go up, it’s more that even the less negative of the bunch spoke about buying stocks in such hedged terminology. We hear stuff like “I’d give it a try here” or “I’ll look to get involved on a pullback” without much conviction in the belief that there really were (and are) reasons to own stocks.

Well you know what? The pullback to buy is finally here on this rally yet the people who said to wait for it are now so caught up in the negative rhetoric that it becomes nearly impossible to get involved. It amazes me that after the first somewhat tempered week of rally the talk takes such an extreme turn to the negative. It’s at the point (ok I think I’m late here, this point was reached long ago) where people really need to filter out the rhetoric in order to hone in on a steady investment approach in this day and age. Brandon summed it up well in a post this weekend, when the market rallies the focus is on the micro, while on the pullbacks the focus is consistently macro.

And you know what? That’s by and large a good thing if you start from the premise that stocks are interests in real companies. That’s why this is a fact that is so important in and of itself that it must guide your entire approach to equity markets. Let me repeat, people need to understand that when buying or selling a stock we are talking about something that entitles you to a portion of the future cash flows of an entity. We are not buying past cash flows, we are not buying a macro economy, we are buying an actual profit-seeking entity with its own business prospects that are somewhat intertwined with that of the broader economy, but really just depend on a whole slate of variables that are far more complex than whether GDP growth will be 1, 2, or 3 percent. At the end of the day, there are plenty of good companies worth owning independent of the broader economic landscape.

The fact that the market rallies on micro-catalysts is confirmation in and of itself that these companies are worth owning. Some companies are great due to their balance sheet health, while others are great because they are benefiting from secular growth trends that have continued throughout the deepest depths of the financial crisis.

So how do you go about buying this pullback now that it’s finally here? The key is to identify a basket of companies that meet your metrics for a company to own. Then identify a price level (using a combination of fundamental and technical metrics) while patiently waiting for your time to strike to arise. In the long run there’s no need to rush, but there is a reason to be invested in quality enterprises.

Disclosure: None