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On Long Only Equity Investing in Bear Markets

A reader sent me the following question:

Hi David, this is shall be link to your impossible dream part 2 question.

You mention in the article date May13 that we are probably at #4 part of cycle (looking back great called) Where are we in the part of the cycle? ( I would assume we are in #5) if that is the cast..why you added large 5 of your cash in this sell off? (for trading or for investing) Hope I am not asking too much since I am not a client, only long time reader whom respect your opinion.

Here’s the article he was referencing.  There is a tension between my equity management and the switching strategy I proposed in the first Impossible Dream question.  If we are in a market where we should be allocating asset to safe areas, why am I buying more equities here?

It’s a question of time horizon.  The switch model tells you what will do well for the next month.  I am playing for longer horizons.  That’s why I have my seventh portfolio rule:

Rebalance the portfolio whenever a stock gets more than 20% away from its target weight. Run a largely equal-weighted portfolio because it is genuinely difficult to tell what idea is the best. Keep about 30-40 names for diversification purposes.

My best purchases occur in bear markets.  I buy things that are safe but way out of favor, and they rocket back when the market finally turns.  That adds a lot to my alpha, which is more than the advantage of switching, historically.  That’s why I average down in bear markets, if the thesis behind the investments is still valid.

As for what phase we are in, I would say 5 or 6. Cycles aren’t neat.  In this case, we don’t have a lot of defaults, but we do have a lot of negative momentum in equities. In four months we have moved from top momentum, top valuation, to bottom momentum middling valu1ation.  That is pretty deep in the don’t buy stocks region, but it often offers the best opportunities to long only investors, if one is buying for three years, rather than one-to-six months.

So I continue to buy equities that are attractive, even in a market where bonds might be favored in the short run.  As for my clients, it is a question of investment horizon.  Short-term: bond strategy.  Long-term: equity strategy.

In general, I aim for the long term.

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2 Responses to On Long Only Equity Investing in Bear Markets

  1. [...] David Merkel, “My best purchases occur in bear markets.” (Aleph Blog) [...]

  2. moneygator says:

    Thank you so much for such detail response. I read it twice !!


David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.

Also, though David runs Aleph Investments, LLC, this blog is not a part of that business. This blog exists to educate investors, and give something back. It is not intended as advertisement for Aleph Investments; David is not soliciting business through it. When David, or a client of David's has an interest in a security mentioned, full disclosure will be given, as has been past practice for all that David does on the web. Disclosure is the breakfast of champions.

Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here, at RealMoney, or anywhere else is meant to be formal "advice" in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.

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