When I first started writing my views publicly in January 2011, the environment was absolutely ripe with opportunity. It allowed for a wide swath of ideas or picks to be had without much worry for downside given the excessive pessimism that provided dark cloud cover from which those opportunities were born. At that time, it was delightfully obvious to profit-minded individuals that the markets were setting up for something dramatic on the upside, as the mix of pessimism, excess liquidity and accelerating growth created a near perfect environment for unexpected upside.
We are now in the midst of the upside that I spoke about on a near weekly basis in 2011 and 2012. The environment we are in today, while retaining opportunity for profit before risk of loss, has become much more challenging in nature. The first month and a half of trading in 2015 demonstrates the challenges perfectly. In fact, the last six months of trading demonstrates the challenges. The challenge comes from the fact that there is no longer imbalance bubbling beneath the surface of the market, forcing investors into uncomfortable situations that have a perceived uncertain outcome. There is a great degree of certainty that profits will grow, the economy will remain resilient and asset prices will appreciate.
That certainty is the problem. It is that certainty that causes risk/reward on stocks to become balanced, not allowing investors to take on positions at points that are advantageous. Instead, investors must hold hands with other investors who are just as certain to the future outcome of an investment, creating efficiency in the pricing of the asset, which leads to greater risk for decent reward. It also leads to good deal of backing and filling, to borrow a technical term. Or sideways trading, if you prefer.
No-brainer opportunities are few and far between, whereas several years ago they were plentiful for those who embraced uncertainty and the imbalance that it brings to pricing of equities. Such is the nature of a bull market, however. As it progresses, more investors become involved, bullish ideology experiences a convergence along a singular path and pricing of equities becomes balanced. Balance, as I pointed out in a recent client letter, creates difficulties for investors due simply to an excessive number of participants all looking for abundant joy on the same roller coaster. That roller coaster will inevitably slow down as more weight piles on. The ride is not nearly as fun as when there were only a few onboard with the ride ripping to new heights as a gaggle of onlookers were still undecided as to whether they wanted to get on.
Investors would be well suited to take a longer-term outlook towards opportunities that possess any type of edge, as those opportunities will grow increasingly sparse as this bull market progresses. Excessive diversification will only plunge a portfolio into correlated behavior that will likely underperform the average that it is being emulated. As Soros is quoted as saying, when an opportunity arrives that you have tremendous conviction in, you must "go for the jugular." There is no dancing around that reality of outperformance in the equity markets.
The essence of what it takes to excel in this environment is very simple: 1. Do your homework 2. Don't fool yourself into thinking you do good homework if your homework sucks 3. Have conviction enough to "go for the jugular" 4. Understand that wealth is built through concentration and time, not by jumping around the market like a 6 year old on a doughnut high.
Here's to outperformance by taking the road that is not just less, but rarely ever traveled.
