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Why Stock Picking Is Nearly Completely Useless

24 November 2011 24 Comments

Old Wall Street and old financial planning was defined by the following:

  1. Buy and hold strategy
  2. Diversification
  3. Stock picking
  4. Discouragement of alternative assets like gold
  5. Discouragement of any attempt at market timing

This led to an explosion of the following:

  1. Financial advisers – there are tons of financial advisers that really all tell you the same thing (see the list above).
  2. Newsletters which offer “hot stock tips”
  3. Wall Street profits – The above list was very conducive for maximizing wall street profits because it meant you gave them all of your money at all times

This system worked for a while. In fact, it worked well for a few decades. It worked well as long as the macro-economy was essentially a rising tide, making all boats rise in tandem. The economy was a tailwind pushing all traditional asset classes higher which meant things like buy and hold worked well.

Now where did stock picking fit in? When times are good, stock picking means you’re essentially just picking some stocks that beat other stocks but still all of them are doing ok.

Stock picking was all the rage because everyone was convinced that stocks were where you should be because the performance was so great. Stock picking gave individual investors the idea that they could generate even larger returns therefore they ate it up. Hot stock tips spread via newsletters and word of mouth like wild fire. The reality is that these tips could work if someone read the fundamentals right. Unfortunately all of this ended in 2008.

When the government intervened in the markets in the name of “stability” and to prevent “catastrophe” as we were told over and over by politicians of both parties, no longer did business fundamentals become the bigger predictor of a stock’s future performance. Traditional stock picking died.

Now, instead of diving in and finding an undervalued company, it is much more valuable to be able to dive in and predict the following:

  1. When will the government intervene again? Specifically, what is the Fed’s policy actions going to be in the near future?
  2. What global macro events will hit the markets? Today, a good example of this is the European debt crisis)

The markets have record high correlation between individual stocks and the overall market – this means more than ever, stocks are all trading together in unison based on the overall direction of the market.

Focusing your attention on the macro events and the government policies which are driving the markets much more than business fundamentals is much more valuable versus traditional stock picking. The market is really hardly an open market anymore.

What the Wall Street folks who are pro-Fed and pro-easy money might not realize is that this is eroding the confidence of the individual investors in the market. More and more investors are saying screw this and are pulling money out of the markets. This will continue to hurt the old Wall Street business models that we discussed in the beginning of this article.

The bottom line is that I hardly spend any time picking stocks. I have a few companies I like and monitor, but the majority of my focus is on the global macro environment. I’ve been telling friends now for over a year to watch Europe and wait. I tell them to wait until Europe implodes (its coming) and then to put money into some good multinational stocks which will get hammered upon Europe’s implosion. Put money in those companies then ride it back up. Stocks like Philip Morris (PM) fit that bill well. There.. I just picked a stock, but its less about PM and more about the macro environment. You could replace PM with another multinational and the performance would be similar.

The other thing we haven’t talked about yet is timing.

By focusing on macro events you can time them. When the markets rally because of another central bank printing more money, perhaps this is cause to pause and consider how long-lasting such a rally might be. Wait for stocks to come down before allocating more cash.

Lastly, often times the stock picking I do is on the short side. Most stocks I pick are the overvalued ones that people have gone nuts over. For example, Groupon (GRPN). The business model is a joke and I shorted it at $30 the day it debuted on the market. I just covered yesterday for under $17 a share. That’s a 40% plus gain in a couple weeks. I’m not a day trader and I don’t recommend day trading, but I do some trading when I see extreme case.

I am implementing this strategy at my example mutual fund that you can monitor by clicking here.

 

24 Comments »

  • Ken Faulkenberry said:

    Kevin I agree with most of your arguments, but strongly disagree with your conclusion. Buy and hold only works in bull markets and correlations between asset are definitely becoming more positive. I also agree that macro economic factors and the federal reserve play an increasing role in market volatility. However all these factors make it more important than ever to pick individual stocks! Finding stocks with quality balance sheets, rising cash flow, and strategic advantages will outperfrom other strategies in this kind of volatility. Add a tactical asset allocation strategy that takes over all valuations into consideration and you have a proven winner throughout market cyles. I'm doing it; it works! http://arborinvestmentplanner.com/tactical-asset-

  • Bingo said:

    Kevin I agree with most of your arguments, but strongly disagree with your conclusion. Buy and hold only works in bull markets and correlations between asset are definitely becoming more positive. I also agree that macro economic factors and the federal reserve play an increasing role in market volatility.

  • Baralho Cigano said:

    By focusing on macro events you can time them. When the markets rally because of another central bank printing more money, perhaps this is cause to pause and consider how long-lasting such a rally might be. Wait for stocks to come down before allocating more cash.

  • Helen said:

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  • Brian Moseley said:

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  • fxgeorges said:

    From what I have heard, to professionals, it's hilariously easy to pick real locks. Just like in the games. Strange that, I would have thought it was games exaggerating.

  • Mih_India_Inves said:

    I agree with your timing the market strategy using Macro economic factors. Here in India, the opportunity in the Indian markets was huge after the 2008 crisis. The American crisis caused lot of good Indian stocks to crash. Their business was sound but the stocks crashed to 1/4 of their value. I managed to invest at the bottom and made spectacular gains (though on a smaller capital as I had made losses in derivatives in 2008).

    However, I feel picking good stocks with solid fundamentals still works. A combination of both strategies is better. For example, I have invested in some solid stocks, but have also kept substantial cash to invest in case of a crash (caused by European crisis).

    The articles on this blog are amazing! Keep writing.

  • Mih_India_Inves said:

    I too agree that picking fundamentally solid stock works, but we also need to consider macro factors before investing in Penny stocks especially for the short term.

  • Investment Resources said:

    Passive investing can be a bit boring. The best way is to create a core satellite portfolio.
    The core made of some index mutual funds or ETFs and few stock picks.

  • santa said:

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  • martial arts said:

    The economy was a tailwind pushing all traditional asset classes higher which meant things like buy and hold worked well.

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