Bank Stocks: Taking A Small Loss To Avoid A Big One

Includes: FXC, FXE, KRE, VGT
by: Gary Gordon

Ever since the famous 50 basis point cut by the Fed in August, I've been writing about the potential year-end run in bank stocks. And I've been wrong... dead wrong. The KBW Bank Index Fund (NYSEARCA:KRE) is lower than when I first expressed interest.

On September 19, I wrote about what one does when the Fed drastically cuts rates and changes the rules of the game. On September 27, I talked about uber-investors like Warren Buffet and Joseph Lewis showing interest in battered financial companies. And on October 1, I emphasized Jeffrey Hirsch's historical assessment for the financial segment in Q4.

Indeed, I had purchased the KBW Bank Index Fund (KRE). What's more, my clients lost money on this trade. Still, all of my clients understand that the success of their portfolios is most affected by how I manage incorrect decisions... not how I manage the winners.

Let me explain.

Every student of the markets... and any investment adviser who's worth his/her weight in gold at $800 per ounce... knows that one cannot predict the future. Each of us processes information and makes decisions accordingly. (It's the information that distinguishes investing from gambling!)

Most of the information -- fundamentals, technicals, contrarian, seasonal, economic, historical -- will lead to good decisions. And yes, sometimes, things do not turn out as one might anticipate.

Now here's the critical part. While you cannot control the markets, you can control the outcome of every investment decision that you ever make; that is, there are only 4 outcomes (i.e., big gain, small gain, small loss, big loss) and 3 of them are good!

(I discussed the wisdom of avoiding the big loss in a web log entry back in April.)

So how does this apply to one of my holdings, the KBW Bank Index Fund (KRE)? I may have bought shares in mid-August at an average of $44 per share. The bank index failed to gain any traction. And today, it set a new low below $40 per share.

That's a 10% loss... and that's enough downside for any position in the portfolios that I manage. In other words, I will always take a small loss to prevent the possibility of the one outcome that can hurt an investor: the big loss.


Meanwhile, my clients are enjoying plenty of upside from multiple strong positions in diversified portfolios. CurrencyShares Euro (NYSEARCA:FXE) and CurrencyShares (NYSEARCA:FXC) have been spectacular. Vanguard Info Tech (NYSEARCA:VGT) has been remarkable. Moreover, exposure to Canada through the iShares Canada Fund (NYSEARCA:EWC) as well as a healthy helping of Vanguard's All-World excluding the U.S. (NYSEARCA:VEU) have given everyone a reason to cheer.

Do I believe banks will lead the markets at some point in the future? I certainly do.  Mergers, rate cuts, inexpensive access to money, high dividends, excessive fear of mortgage exposure... this is the stuff that banks thrive on. But not today.

Secure your investment outcome (i.e., big gain, small gain or small loss). It's okay to be "little wrong." It's not okay to be a "lot right" while shouting from the deck of a sinking ship.

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