Doc's Diamonds

I just love the knee jerk reactions in the market !!

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Overall, if the market is acting well, it is best to follow the flow of the market (buy stocks or sectors that are in favor) and make money. When high volitility and fear is a predominant factor in market moves, as it is now, you need to watch for opportunities when market inefficiencies or overreactions occur. That way, you can take advantage of those same overreactions on the way up. The only problem with this concept is that, if it were that easy, everyone would do it and we all would make money. Unfortunately, that can't happen because whenever there is a trade someone sells and another entity buys. Both sides of each trade can ultimately make money depending on what the investor does after they make the trade. For example, the one who buys the stock can hold it until it goes higher and sell. The one who sells the stock can use the money gained for another asset purchase and sell that asset for a gain after it appreciates. In this case, both sides of the trade made money after the trade. Conversely, both sides can lose money after the trade. Therefore, it is really how you invest your capital at any point in time and when you sell it that determines the outcome.

My example for today is RIMM. Many players in this game have invested in RIMM for their portfolios and many have made money. I am one of those who has made some money on that particular investment (about 28% since inception). Now, when the market is going up most of the time, it is hard to miss with a high profile and momentum stock like RIMM. You pick a time and invest in it and, if you stay disciplined, you sell it for a gain. As I wrote many moons ago when things seemed to be up every day, stocks do not go up straight line without some rough spots along the way. Therefore, when RIMM hit my short and long term price targets, I sold a large portion of my position. Lately, when it has hit some rough times, I am rebuilding that position. However, market overreactions make the opportunity much greater at certain points in time. Right now is one of those times.

Apparently analysts have decided that this will not be a RIMM christmas. There have been two downgrades by analysts on consecutive trading days. Now, of course, those analysts have had solid reasoning for their opinions but the market reaction has been almost comical. If you had purchased RIMM just two trading days ago, you might have purchased it for about $123 per share. One downgrade caused their price target on RIMM to go from $138 to $134. The downgrade today was simply going from a buy to a hold. Now, if you had purchased a quality stock at $123 it is worth $104 and change. That means you are down a nifty 15.5% in two trading days. Not a great thing. I would contend that our buyer at $123 was not making a dumb purchase but was caught by market fear and downgrades the invester could not have predicted. However, if you are rebuilding a position as I am or starting a new position, you are certainly farther ahead now than you would have been two days ago. No matter which way RIMM goes, if you buy tomorrow, you are better off than the poor soul who bought two days ago.

Therefore, that is exactly what I will do. Purchase some at the market and some at a considerably lower price if it drops further. In my view, RIMM is just as good a stock now as it was 2 days ago, just 15% cheaper.

I hate market overreactions when they go against me (eg. JCP and KSS), but simply love them when they go my way!

And, BTW, remember that if a stock is purchased at a "discount" and goes back to where it was before the discount, your percentage gain is higher than the percentage of loss for the original investor at $123. In this case, if RIMM goes back to $123 and I purchase it at $104, my gain is 18.3% and not 15%.

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Dang it, Bloomberg beat me to it !!

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I was doing my evening research and, wouldn't you know it, Bloomberg had a very good article on the very subject I alluded to in my last post. The article was actually on the difficulties analysts have in placing a "sell" rating on a stock. However, in the article, there was information related to the topic of my last post. I thought my SLO colleagues would appreciate reading this:

This quote is directly from Bloomberg.com and please refer to that site for the complete text. I did not want to copy more than this because of copyright concerns:

"Rating cuts have a bigger impact during bear markets because investors are more easily spooked, according to professors Xia Chen and Qiang Cheng at the University of British Columbia in Vancouver, who are working on a paper on the subject. They have concluded that sell and hold recommendations have about twice the impact during periods when stocks are sinking.

``When markets decline, people are looking for where's the stock with the real problems, and research has more value at that time,'' Credit Suisse's Natella said.

Hedge funds that employ computer-driven trading strategies are known to exploit short-term movements in stock prices caused by analyst rating changes, said Ross Miller, a finance professor at State University of New York at Albany. Managers study the trading patterns after analysts change stock recommendations and program their computers to benefit from them, he said.

Trading the Blips

``Although there seems to be more attention paid to analyst reports these days, these tend to be temporary impacts on stock prices,'' Miller said. ``A lot of hedge funds will trade the blips triggered by such changes.''

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Please realize, More than just the Fed Cut

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Well, unfortunately the Fed didn't quite live up to the market expectations. I had anticipated this happening. The market had priced in a too aggressive rate cut and anything less than a 50 basis point cut would be a disappointment. Further, the Fed did not cut the discount rate by 50 basis points either and cut it 25 basis points. If the Fed had cut the discount rate by .5% (50 basis points) and only cut the funds rate by .25% the market still would have sold off but not quite as severely. Only a .5% cut in the funds rate AND the discount rate was going to please the market.

That is the prevailing logic in the investing and financial press and I certainly agree with that assessment. However, what they aren't telling you (in my humble opinion) is that the market would have sold off even if the market had gotten exactly what it wanted. There were four major factors in play creating the environment for this sell off. 1) The disappointment by the market in the actual cuts I have just outlined. 2) The market was severely "overbought" just prior to the fed action. 3) The VIX (volitility index) had dropped to a very low level just before the fed news (indicating complacency). and 4) The overall fear that remained in the market despite the recent nice runup in all indicies.

In my view, it was almost inevitable that there would be a "sell the news" approach by the market today. That being said, I have mentioned over and over that you can never "outguess" the market and should generally be fully invested at all times with a diversified portfolio. Even though I still believe that is the best long term approach, I realize that this approach will not win me a stockpicking game such as ours. At least not with such a widely swinging market and a fear predominated market. That is the market we have today.

In preparation for this market approach, I sold about 20% of my portfolio before the fed decision. I did hold onto about 80% and realized I might take a beating. That will, at the least, give me the flexibility to pick up some last minute bargins for an end of the game push. This was a good decision, but as with my other moves, was not aggressive enough. If I really wanted to gain some ground, I should have sold all of my portfolio and rebuy at a lower price.

My sincere congratulations to the savy investors who picked the right speculative and nonspeculative stocks that gained 30-40% in months. I still believe I will have a nice gain by the end of the competition, but I will be lucky to finish in the top 100. I just couldn't violate my investment principles for the game and I will pay the price for that.

I am sure my SRO competition realizes that there is a vast difference between winning in a stockpicking game and winning at investing. There are some pretty sharp investors in the top group (my fav is dishwasher) who, if they could invest their own money at the rate they went up in this contest, would be millionaires by now and would never have heard of the strategy lab open. Their annual rate of return would be about 120 - 160%. So, I leave it up to each and every one of you reading this to determine what you have read that makes the most sense for your own portfolio strategies.

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The RIMM Run !!

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It's been 11 days since my last entry and I wanted to update the SLO clan about my RIMM purchase and how it is always good to keep some cash on hand to react to opportunities. Several posts ago I mused about the unfortunate hypothetical investor who happened to buy RIMM at $123 and two days later was staring at a stock price of $104. Not a happy site for a short-term trader or even a long-term investor who picked that exact time to start a position. However, that drop was caused by, in my opinion, a severe overreaction by the market to rumors and analyst downgrades. Those types of market overreactions can present buying opportunities for those who are patient and ALSO have capital remaining to invest in those opportunities.

For my part, I had sold 20% of my positions just before the FED rate decision because I believed that there would be a "sell the news" reaction. That capital was now ready to look for an opportunity. When I take these opportunities it is not good to use a "value" stock because, as with my retail stocks, when they become bargains they may drop further and come back slowly. Excellent growth stocks such as RIMM will recover much faster if you are ready to buy at an opportune time. In this case, I saw the drop back to around 100 as being a chance to pick up a cool 20% or so. Since I am so far behind, I felt that this was a time to place my recently freed up capital to work. I purchased as much of RIMM as I could before the earnings announcement. I should have used all my cash but one of my limit orders did not "hit".

In response to this move, I was able to capture a nice gain and plan to sell part of my position if I see a better opportunity. If not, I will just "ride it out" and see how it stands at the end of the competition. I would be very surprised if it dropped back much considering the excellent earnings and guidance.

In my view, a good portfolio has a "core", an "edge", and an "opportunity stash". This is riskier than a perfectly balanced portfolio, but I think has better return potential in the long run. It also should be diversified in areas you feel comfortable investing. Although I have been thrased in this competition by some worthy opponents, I still want to pass on what Ideas I might have before the competition ends.

Back soon,

DocA

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Riding into the sunset

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Not much to say at this point. I am going to use all available cash to buy about 375 shares of POT. My reasoning is simple. This is a momentum stock that should rise in response to any market positive move. I expect a positive move either today or Monday.

Maybe I can sneak into the top 100 if RIMM and POT comes through to finish the year on an upnote. Regardless, it has been a fun ride and I look forward to participating again if the contest continues. I think 2008 is going to be a tricky investing year and stockpicking will be very important.

I will report again after this round is over. Good luck to all.

DocA

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