After one of the most difficult and volatile years for active portfolio management, 2012 has started out to be quite simple - just buy any dip of 25 basis points. For those that prefer day trading, buy in the morning and sell on the afternoon rip. Works every time, easy money, piece of cake. And, of course, this strategy will work from now on since it appears the stock market will never correct again.
You see, Ben Bernanke wants us in stocks. He wants us to invest, and he will keep interest rates low for as long as it takes to get every last dime that is currently cowering in fear in money markets and T-bills into risk assets. He knows that investors, contrary to popular belief, are most often irrationally driven by fear and greed. Seriously, who in their right mind would buy T-bills at negative interest rates? What rational investor would lock in a ten year yield at less than the inflation rate? Then again, what rational investor would sell out at the bottom and buy at the top? After all, didn't we learn in grade school to buy low, sell high? Note the weekly chart of the S&P 500 exchange traded fund, (NYSEARCA:SPY):
As we can see, volume is highest at bottoms while volume decreases as the market improves. The elevator goes up empty and down full. Investors who were burned in the down times are hesitant to get back in, thus creating the proverbial "wall of worry". As the market improves, fear of losing eventually turns into fear of missing out, or greed. And the process continues as it has since the first stocks were traded under the buttonwood tree.
So, what do we do now that we have yet another "V" shaped rally? Although fighting the Fed has once again proven futile, we must realize that it is improbable that the market will continue at this trajectory forever. Now is a good time to reflect on how we handled the massive three month decline last year. Did we ride the market all the way down, only to sell at the bottom? Or, did we use that as an opportunity to redeploy cash raised during the rally from October 2010?
One way to view the stock market is as a giant retail store that you own. Imagine stocks as retail inventory, mittens, say. If you are in the mitten business, you desire to buy your mittens wholesale and sell them at a higher price to the public. You build into your pricing that some of your inventory will have to be marked down as spring approaches, but if you have the correct amount of inventory you can maximize your profits and use your cash to buy Bermuda shorts to sell in the summer. You have a business plan and, if you meet it, you're happy. You don't particularly care if you could have sold your mittens for a little more, you just price them according to your plan.
Let's compare that to the stock market. You do your homework, buy at lower prices, and try to make a profit by selling at a higher price, right? Yet this strategy seems elusive to many market participants. What happens more often is we hold on until we can't take it anymore, sell at the bottom, then buy when the fear of missing out is greatest.
One question I've asked myself over the years when making a sell decision is, "which would make me feel worse, selling this stock at a nice gain only to watch it continue up in value, or not selling and watching it turn into a loss"? Neither is an attractive proposition until we realize that there is only one reason to buy a stock - to make money. The good news is you can have it both ways. You can sell some of a stock. The way I see it is if it goes up from there, I'm happy I kept some, but if it goes down, I'm happy I sold some.
What about the idea of just buying quality stocks and holding on through thick and thin for the long term? Ask the folks who bought Pfizer (NYSE:PFE), Citigroup (NYSE:C), Bank of America (NYSE:BAC), or Cisco (NASDAQ:CSCO) at $50 a share years ago how that's working out. I'm all for holding on for the long term as long as the stock is doing what it's supposed to do - make me money.
Each investor is different, but think about the past several years and what's happened. Yes, the Fed wants us in stocks and is making them easier to own, but if your inventory of stocks is too high and you were scared to death a few months ago, maybe it's time to ring the cash register - if only a little. After all, isn't that the point of buying stocks - to make money? Buying is so easy a caveman can do it - it's the selling part that separates a good investor from the caveman.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.