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The bear stock market has done its job. It removed excess bullishness, and it revalued stocks in line with reality. Like previous major selloffs, these resets were driven by major fundamental and forecast shifts. Therefore…
Do not expect the next bull market to be anything like the last one
The times, conditions and attitudes are changing. However, most investors and many investment professionals will be slow to give up on the past. Their comfort in staying with what they know will hinder their adjusting until they are convinced of a newer, better approach. Naturally, that means they will need to see evidence: superior performance and broad popularity.
The pattern will be familiar:
- Amidst high negativity and doubt, some stocks begin to rise
- The stock market stops falling and forms a foundation as negativity eases and buying returns
- The stock market begins rising, producing relief and a willingness to look ahead
- The stock market’s rise becomes clear, raising investor interest and even producing limited bullishness
- The new bull market is mostly accepted, and now comes the realization that some parts of the stock market have far outperformed other, more familiar areas
Therefore, the strategy for today is clear:
Start aiming for new stock ideas that can be the outperformers. Know that they, and the rationales behind them, will be different: new, exciting and fun.
Very. What will emerge are dramatically different “themes” that will encompass the winning stocks. Importantly, they will bear no resemblance to the past, familiar themes.
Why is there always such a dramatic shift? Human nature:
- In a bull market, themes emerge as descriptors of both the rationale and the winning strategy
- In their heyday, the themes become the end-all approach to stock investing
- At their peak of popularity, the themes produce extreme heights of valuations and return expectations
- Those top valuations slip when some concerns are first noticed
- When the concerns begin to temper expectations, the slip becomes a slide, potentially signaling a bear market taking shape
- As the concerns become more widespread and certain, the bear market happens, ending in a flood of negativity that undermines and discredits those bull market themes and beliefs
The key question: How to invest in the next bull market themes?
Realize that the new bull market is not foretold in some magic Wall Street planning book. It will evolve along with conditions, actions and developments. So, the answer is to hitch a ride on Wall Street’s wagon. And that means…
Invest using active managers, pursuing capital appreciation. Diversify among value, growth and eclectic management styles. Also, diversify among company sizes (better yet, find funds that aren’t constrained by size). Avoid the largest funds – they are too unwieldy to make timely shifts, plus they tend to stick closer to the stock market’s overall allocations to keep their performance in line.
An example: My fund choices
I believe that winning in the next bull market will require sound, in-depth research that backs up experienced portfolio managers. Therefore, I have chosen the following four stock funds (three at Vanguard and one at Fidelity).
The three Vanguard funds are managed by independent investment management firms selected by Vanguard’s investment professionals. This multi-management style is practiced by major institutional funds and was the basis of my career. It allows pursuing superior performance from specialty managers while controlling overall risk by diversifying among different management styles.
Here are the three Vanguard funds and the number of investment firms selected to manage each (each is linked to the Vanguard fund page):
- Vanguard Windsor Fund (value fund): Two investment management firms
- Vanguard Growth & Income Fund (growth and value blend): Three investment management firms
- Vanguard Explorer Fund (specialty growth fund): Five investment management firms
The Fidelity fund is managed solely by Fidelity, which has a history of successfully identifying new growth themes. This fund concentrates on top picks and the fund’s smaller size allows it to be versatile.
Fidelity Focused Stock (specialty growth fund):
- Holdings: 40 companies
- Fund size: $3.2 billion
- “Active share” (Scale is 0% for index fund to 100% for full divergence from S&P 500): 66%
The bottom line: Be positive, think different and act now
Investing’s major challenge is dealing with a new, alternate universe that is unlike any predecessor. With a tectonic shift, like the current one, investors’ beliefs in the last set of “basic truths” are undone. In their place are uncertainties that seem to indicate a need for caution.
However, we should welcome the newfound focus on risk amid foggy forecasts. That mindset keeps valuations in check and, therefore, makes potential returns more attractive.
So, be happy that this is the start of something new and everyone is faced with the same unknowns. Now, all we need to do is be invested in a way that allows us to catch the coming new excitement well before it becomes popular.