If you were to Google “Stock Market Volatility”, you would find a wide range of observations, conversations, reports, analyses, recipes, critiques, predictions, alarms, and causal confusion. Books have been written; indices and measuring tools have been created; rationales and conclusions have been proffered. Yet, the volatility remains.

Statisticians, economists, regulators, politicians, and Wall Street gurus have addressed the volatility issue in one manner or another. In fact, each day’s gyrations are explained, reported upon, recorded for later expert analysis, and head scratched about.

The only question I continue to have about all this comical hubbub is why don’t y’all just relax and enjoy it. Jon Methuen nailed it in his August 15, 2011 parody of the financial world’s ridiculous obsession with “volatility”. “A Reasonable Guide To Stock Market Volatility” is a must view — but only for mature adults with a semi-sick sense of humor.

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Decades ago, a nameless college Statistics professor brought me out of a semi-comatose state with an observation about statisticians, politicians, and economists. “In the real world”, he said, “there are liars, damn liars, and any member of the groups just mentioned”. An economist or a politician, armed with a battery of statistics, is an ominous force indeed.

Well, now all the economists and statisticians have high powered computers and the ability to analyze volatility with the same degree of certainty (or is it arrogance) that they have developed with regard to individual-stock risk analysis, economic and geographical sector correlation dynamics, and future prediction in general.

But the volatility (and the uncertainty it either causes or results from, depending upon the expert you listen to) persists.

Modern computers are so powerful, in fact, that economists and statisticians can now calculate the investment prospects of just about anything. So rich in statistics are these masters of probabilities, alphas, betas, correlation coefficients, and standard deviations that the financial world itself has become, mundane, boring, and easy to deal with. Right?

Since they can predict the future with such a high degree of probability, and hedge against any uncertainty with yet another high degree of probability, why then is the financial world in such a chronic state of upheaval? And why-o-why does the volatility, and the uncertainty, remain?

Why the Volatility and Uncertainty Remain

I expect that you are expecting an opinion — yet another opinion — on why the volatility is as pronounced as it seems to be compared with years past. I’ll do that next. But, first a sentence or two on “uncertainty” — the playing field of the NFL (National Financial League). An uncertain environment is the only “for real” certainty you will ever experience in investing. Every investment has some form of risk and uncertainty.

Volatility, on the other hand is simply a force of nature — one that you need to embrace and deal with constructively if you are to succeed as an investor.

But this new force of nature, this extreme volatility that we have been experiencing recently, has been magnified by the darkest forces of the Dismal Science and the changes that it has encouraged in the way financial professionals view the makeup of the modern investment portfolio.

On the bright side, enhanced market volatility enhances the power of the equity and income security trading disciplines and strategies within the Market Cycle Investment Management (MCIM) methodology — an approach to market reality that embraces market turbulence, and harnesses market volatility for results that leave most professionals either speechless or in denial.

But, with no statistical data necessary (or available) to support the following opinion, consider this simplistic rationale for the hyper-volatility of today’s stock market.

Volatility is a function of supply and demand for the common stock of a finite number of dirty, evil, greedy, polluting, congress corrupting, job creating, product and service providing, innovation and wealth developing, foundation supporting, gift giving, tax-collecting corporations to finance their growth and development.

“Tax collecting” raise an eyebrow? Look at a rental car statement or your next hotel bill. Those greedy corporations collect more money for state and local governments than the income tax collectors — but that is a whole ‘nother issue.

Those of us who trade common stocks in general, IGVSI stocks in particular, owe a debt of gratitude to the real volatility creators — the hundreds of thousands of derivative products that bring an entirely speculative kind of indirect supply and demand to the securities markets.

Generally speaking, the fundamental, emotional, political, economic, global, environmental, and psychological forces that impact stock market prices have not changed significantly.

Short term market movements are just as non-predictable as they have ever been — they continue to cause the uncertainty you need to deal with using proven risk minimization techniques like asset allocation diversification and trading.

The key change, the new kid on the block, is the impact of derivative betting mechanisms on the finite number of shares available for trading. Every day on the New York Stock Exchange, thousands of stocks are traded, a billion shares change hands. The average share is “held” for mere minutes.

On top of derivative trading in real things such as sectors, countries, companies, commodities, and industries, we have a myriad of index betting devices, short-long parlor games, option strategies, etc. What’s a simple common share of Exxon to do?

Market volatility is here to stay — at least until multi-level and multi-directional derivatives are relocated to the Las Vegas markets where they belong.

Most people never forget their first love. I’ll never forget my first trading profit — but the 600 1970 dollars I pocketed on Royal Dutch Petroleum was not nearly as significant as the conceptual realization it signaled.

I was amazed that someone would pay me that much more for my stock than the newspaper said it was worth just weeks ago. What had changed? What had happened to make the stock go up, and why had it been down in the first place? Without ever needing to know the answers, I’ve been trading RDSA for over 40 years!

Looking at scores of similarly profitable, high quality companies in this manner, you would find that: 1) most move up and down regularly (if not predictably) with an upward long-term bias, and 2) that there is little if any similarity in the timing of the movements between the stocks themselves.

This is the “volatility” that most people fear and that Wall Street loves them to fear. It can be narrowly confined to certain sectors, or much broader, encompassing practically everything. The broader it becomes, the more likely it is to be categorized as either a rally or a correction.

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Most years will feature one or two of each. This is the natural condition of things in the stock market, Mother Nature, Inc. if you will. Don’t take her for granted when she gets high, and never ignore her when she feels low. Embrace her volatile moods, work with them in whatever direction they travel, and she will become your love as well.

Ironically, it is this natural volatility (caused by hundreds of variables human, economic, political, natural, etc.) that is the only real “certainty” existent in the financial markets. And, as absurd as this may sound until you experience the reality of it all, it is this one and only certainty that makes Mutual Funds in general (and Index Funds in particular) totally unsuitable as investment vehicles for anyone within seven to ten years of retirement!

How many Mutual Fund investors have retired recently with more liquid financial assets than they had 12 years ago, way back in 1999? There will always be rallies and corrections. In fact, it is worthwhile to “go back to the future” to establish a realistic long term investment strategy.

In the last forty years, there have been no less than ten 20% or greater corrections followed by rallies that brought the market to significantly higher levels. The DJIA peaked at 2700 before its record 40% crash in 1987. But at 1700, it was still 70% above the 1000 barrier that it danced around with for decades before — always a higher high, rarely a lower low.

The ’87 debacle was followed by several slightly less exciting corrections, but the case was being made for the more flexible, and realistic, Market Cycle Investment Management Methodology. Modern Portfolio Theory was spawned by great minds selling future predicting snake oil; Mother Nature, Inc. is a much too complicated enterprise, even for them.

Call it foresight, or hindsight if you want to be argumentative, but a long-term view of the investment process eliminates the guesswork and points pretty clearly toward a trading mentality that keys on the natural volatility of hundreds of Investment Grade Value Stocks (Google IGVSI).

During corrections, consider these simple truths: 1) although there are more sellers than buyers, the buyers intend to make money on their purchases; 2) so long as everything is down, don’t worry so much about the price of individual holdings; 3) fast and steep corrections are better than the slow attrition variety; 4) always accept even half your normal profit target while buying opportunities are plentiful; 5) don’t be in a rush to fill your portfolio, and if cash dries up before it’s over, you are managing the process correctly.

Most of the problems with Mutual Funds and much of the increased opportunity in individual stock trading are functions of growing non-professional equity ownership. Everyone is in the stock market these days whether they like it or not, and when the media fans the emotions of the masses, the masses create volatility that rarely under-reacts to market conditions.

Rarely will unit owners take profits, particularly if they have to pay withdrawal penalties or taxes. Even more unusual are expert advisors who encourage investors to move into the markets when prices are falling. A volatile market creates opportunities with every gyration, but you have to be willing to transact to reap the benefits.

A necessary first step is to recognize that both “up” and “down” markets are forces of nature with abundant potential. The proper attitude toward the latter, will make you much more appreciative of the former.

Most investment strategies require answers to unanswerable questions, in an effort to be in the right place at the right time. Indecisiveness doesn’t cut it with Mamma — in or out too soon is not an issue with her. But wasting the opportunities she provides really ticks her off.

Successful investment strategies require an understanding of the forces of stock market nature, and disciplined rules of portfolio management. If you can transition back to individual securities, you will do better at moving toward your goals, most of the time, because the opportunities are out there — all of the time.

So let’s adopt some new rules for this investment game and learn to live with them for a few cycles: Let’s buy IGVSI stocks new and old at lower prices during corrections. Let’s take reasonable profits on those that go up in price, whenever they are kind enough to do so.

Let’s examine our performance based on the results of these trading transactions alone and at market cycle examination points for a smiley faced change of pace. And one other thing:

Let’s drink a toast to an uncertain and volatile Mother Nature, and, of course, to our first loves.
Author Steven Selengut

Back in the day when relatively few non-professionals even thought about investing in corporate stocks and bonds, a focus on company financial statements was the gospel of conservative (meaning safer) investment theology.

Investment gurus studied Profit and Loss Statements, Balance Sheets, and endless footnotes to determine which businesses were most likely to continue to grow, prosper, increase their dividends, etc. Then, they assessed the quality of “management” before forming conclusions about the economic viability of the enterprise.

The quality of the numbers being analyzed was audited by well respected financial analysts while scores of research MBAs from throughout academia studied business and economic trends within company relevant markets. Sectors of businesses were also put under a fundamental microscope to further fine tune future stock market trends and performance expectations.

“Top-down” or “bottom(s)-up”, fundamentally sound companies were identified, classified, categorized, and fantasized over in much the same way as was being done by the very technicians that the fundamentalists laugh about at cocktail parties.

Certainly, it was presumed, the most financially sound companies would be the most resilient in the face of whatever surprises the economy, global politics, and the weather had to offer. Companies that had “grown up” profitably would have what it takes to continue in the right direction.

Clearly, both schools of financial thought have generated libraries full of useful (and questionable) information that marauding bands of Wall Street product advertising agencies can use against one another in their glossies.

Neither approach should be totally ignored; neither approach should be totally accepted; and neither approach has what it takes to do what its advocates want you to believe it can do — predict what’s going to happen next.

More recently, the analytical elite have reinvented themselves with fundamental analytics sub-divided by capitalization levels, sectors, countries, hemispheres, and more. The supply of data is endless — so much so we are expected to believe, that only very special Wall Street affiliated super computers can make enough sense of it all to really “know” which stocks are worthy of investment.

Frankly, I think they have all traveled way off course in their pursuit of some fundamental nirvana, pretty much to the same extent as their friends in the technical arena. No matter how long the train of growing profits, or how strong the balance sheet, every business has to adjust its model to outside influences to survive long term — and so does every investment plan.

There are a few fundamental fundamentals that demand as much serious attention as the fundamental technicals mentioned above, starting with long term profitability and current financial ratios. (If you haven’t looked at both, you are a speculator, not an investor — no buts, end of discussion.)

Dividend payout history provides information (indirectly) about the quality of a company’s management, products, business model, financial acumen, profitability, and respect for its shareholders. Don’t believe the growth company baloney; if they are not paying you a dividend, they are absolutely overpaying your senior employees.

If you are thinking: “what about start-ups, IPOs, emerging markets, commodities, etc.”, don’t. Those are speculations, not investments. This is not a judgment that all speculations are bad — it’s simply a warning that you must sift through the euphemistic descriptions and figure out what kind of bets you are being asked to place.

Profitability, current assets vs. current liabilities, market share, product mix, and regulatory environment are other key fundamentals that are fairly easy to get your head around — and pay particular attention to the latter.

Very few politicians act as if they know anything about business, capitalism, markets, etc. Very few theoreticians (particularly research economists) seem to know anything about actually running anything for real: business, government, investment portfolio, whatever.

And this brings us to MPT — the fancy new scourge of the financial markets.

Technical Analysis — Blinded By The Math

Without too much of a stretch, it could be documented that the Investment Grade Value Stock (not just “value stocks”) bubble of 1987 was caused by investor focus on company fundamentals. It would be a piece-of-cake to prove beyond any doubt at all that blind faith in technical analysis created the dot-com bubble at the turn of the 21st century.

More recently, blame for the late 2007 through early 2009 “financial crisis” could easily be nestled down at the feet of big government, misguided regulators, and maniacally creative Modern Portfolio Theory (MPT) practitioners, not to mention their ROTF-LOL institutional mentors. What’s next?

Pick a day, any day, where the DJIA is up or down by more than 100 points. Take a look at the “most advanced” or “most declined’ listings and note the shortage of plain vanilla common stocks. What you see is a pari-mutuel spreadsheet listing of the most popular derivative betting mechanisms, adjusted day-to-day, depending on the direction of their wagers.

With index ETFs significantly outnumbering the companies whose prices they are attempting to keep track of, isn’t it even less likely than in the past that technical analytics can be useful? Aren’t these numbers simply the result of demand for casino-esque sector funds and their seemingly limitless varietals?
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So as you sit at your desktop, studying the charted presentations of your favorite technical indicator software, keep in mind how the “fundamental quality” of the numbers they report upon has changed. How much of the volume is the second or third level derivative result of derivative trading by speculators who couldn’t care less about which candlesticks are on top of whose heads and shoulders.

Should an up-tick in a “triple-short-the-S & P 500″ index be considered a positive or a negative? Can NYSE new high and new low numbers be trusted? How much of the daily volume is the backing and filling within indexed portfolios? Are support levels reality or fiction anymore, either on an overall market or an individual stock basis?

Yet, the problems that I have with technical analysis have nothing to do with the numbers themselves, most of which are fascinating and useful in lessening the need for head scratching about the past. It’s the “quid pro quo” projection into the future that I think is total foolishness.

The technical analysis employed in the Market Cycle Investment Management (MCIM) methodology is essential in determining where we are within the various cycles, right now. However, absolutely nothing (either technical or fundamental), can tell us what may or may not happen in either the immediate or more distant future.

Any claim to precision; any attempt to time the market; any hope of being at the right place at the right time, most of the time, is just not a reality of investing. And there’s the rub for both forms of analysis, and for “the emperor’s new clothes” risk assessment techniques and “active asset allocation” processes so popular in MPT.

So long as we live in a world where there are tsunamis and Madoffs; politicians and terrorists; big corporate egos and far more dangerous big government; and imperfect intelligence (both human and artificial) — there will be no hope of certainty. Get over it, reality is pretty cool anyway once you’ve accepted it.

The future is uncertain, for certain. No numbers of any variety, in any combination or with any correlation or probability, will ever achieve the alchemy needed to reliably, even consistently, change leaden reality to golden certainty.

The only certainties you really need to know about concerning financial instruments and financial markets are that their long-term cyclical price movements (and short-term volatility) are neither certain nor predictable. The trick is to plan better for the upcoming gyration with a clear and consistent set of decision-making disciplines that make sense in either direction.

But, at the same time, technical trends, levels, totals, averages, etc., can give you significant expectation creation nourishment. For my purposes, IGVSI (Investment Grade Value Stock Index)Issue Breadth numbers, a Bargain Stock Monitor, and New 52-Week Highs vs. Lows relationships provide enough information to chart the current cyclical location pretty accurately.

But these numbers are unique in one very important element — they have already been screened for fundamental quality.

A Stock Market sell off may be about to begin which could take the Index lower  for the full year. These six reasons demonstrate why one of the most impressive stock market runs may have ended:

1. Markets can’t rise all the time. This probably is obvious to most people. A significant is what a market requires to go higher for a market which has more than doubled in two years. Recent economic news shows that support to be lacking. The S&P has risen to more than double from 683 in March 2009 to almost 1,400 two months ago.

2. Corporate earnings have been pressured by an economic slowdown and margin drops. Many companies in the retail, transportation and manufacturing sectors counted on low commodities prices back in 2009 and 2010 to help profits. That help is gone. Oil has rallied from below $50 in mid-2009 to almost $100 recently. The price is down from $110, but it is still historically high. Prices on cotton and many agricultural commodities have also risen in the same period. The result: The cost of making and moving goods is higher, and margins on items like clothing have dropped.

3. Consumer sentiment has faltered. Recent data from from the Conference Board said “Consumer Confidence Index, which had declined in May, decreased again in June. The Index now stands at 58.5 (1985=100), down from 61.7 in May.” Many retailers have posted slow same-store sales. Activity at the world’s largest retailer, Walmart (WMT), has been down on a same store basis for its U.S. operations.

4. The improvement in unemployment has stopped. There were signs of a recovery in the job market in the first quarter and the unemployment rate dropped below 10%. May figures showed improvement in unemployment slowing as the economy added only 58,000 private-sector jobs. The carefully watched ADP data numbers confirmed the problem. Weekly initial jobless claims are still above 400,000 most weeks, a sign the June unemployment figures are likely to be poor. One of the worst drags on the economy — long-term unemployment, which is measured by those out of work for more than 26 weeks — has risen to over 6 million people. Most of these are close to the end of receiving unemployment payments, which means in a large sense, they will cease being consumers at all.

5. Housing prices are still falling. Americans counted on home equity to fuel their lifestyles in the 2004 to 2006 period. That ended as home prices fell sharply into 2010. S&P Case-Shiller data shows that home prices in the 10 largest and 20 largest cities continue to drop. Economist Robert Shiller expects the slide to continue into 2012. Over a quarter of U.S. mortgages are underwater, which means most of their owners cannot afford to sell them even if they need to as a way to cut living costs.

6. GDP rose less then 2% in the second quarter. It’s the most comprehensive single measurement of the economy’s health, and more and more economists have revised estimates for second-half growth down. The problem may be long-lived. The IMF just issued a report which said U.S. GDP growth will probably be below 3% through 2016.

Beyond those six negatives, there are not many reasons left to support an ongoing market rally. Instead, the signs say a sell-off is probable.

The “Bargain Stock Monitor” is one of three market statistics used as performance expectation analyzers for portfolios that are designed and managed using the Market Cycle Investment Management (MCIM) methodology.

It is derived from the month end Investment Grade Value Stock Index (IGVSI) “watchlist” screening program, which identifies IGVSI companies that are trading at least 15% below their 52-week highs.

The “15% down” break-point allows you to keep your eye on “Bull Pen” items. (You really need to be familiar with the selection rules to get the most from the BS Monitor – chuckle – and from the Watch List program.)

The fewer IGVSI equities at bargain prices, the stronger the stock market and the more “smart cash” you should be accumulating in the equity asset allocation “bucket” of your investment portfolio. As the list of bargain stocks grows (indicating market weakness), portfolio “smart cash” should be finding its way back into undervalued securities.

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The 2011 monitor documents the rally that began in March 2009. At year end 2010, barely 2% of the entire IGVSI universe were at bargain price levels — only 7 stocks. April’s “6″ tied for “lowest-month-end-number-ever” honors, and clearly showed the continuation of a bubbling out of control rally.

The April 30 number demanded continued “Buy Side” patience — May & June have showed you why!

Finally, a buying opportunity in IGVSI equities! In spite of some serious month end bargain hunting (or, possibly, window dressing), the month end “monitor” showed the weakest market conditions in ten months — but still not a big-deal market correction.

The number of IGVSI bargain stocks doubled in May and re-doubled in June.

Those of you who heeded earlier “bubble” warnings (on the IGVSI website) and took your profits, should have repositioned some of your “smart cash” over the past six weeks or so. As for me, I’m rubbing my hands together in excitement, hoping that the market weakness will continue for another few months — in the long run, corrections are a good thing.

If you did not take your profits by the April peak, one of these things happened: (a) You were greedy, and continued to ignore MCIM profit taking guidelines; (b) You didn’t have profits because you failed to make new equity purchases during the last correction; (c) You didn’t want to be burdened with those short-term capital gains that will surely disappear — yet again; (e) You thought that the rally would last forever.

If you locate yourself in the previous paragraph, you should still have unrealized profits that you should be taking — have you figured out yet that “total realized return” is a much better number to focus on than the unrealized variety?

On the “income” side of your portfolio, you should notice significant value gains after the third month of an income CEF rally — particularly in the municipal variety — there have been profit-taking opportunities there as well.

Adding the phrase “like a girl” to the end of whatever you were saying was a put-down, an insult, something to come to fisticuffs over. Little boys the world over hated being told that they, for example, “threw like a girl.” I’m not defending the statement, I certainly don’t agree with its intent, but hey, that’s been the case from the playground on up.

As far as women are concerned, investing belongs in the same category as childbearing, socializing, fundraising, community organization, and consensual leadership. It’s something that women may approach with trepidation, but the reality is they can be darn good at it.

California professors of behavioral finance, did a study of the investment activities of men and women and found that men traded 50 percent more frequently than women. They were ALSO less apt to learn the lessons of former investment mistakes. The professors more kindly called it male “overconfidence.” Whatever the official diagnosis, it costs money. As a result of this affliction, the returns to men’s portfolios trailed those of women’s.

It’s important to recognize that in the study everyone was already an investor. However, what about all the women who may have saved money, but never invested it? The women who suffer from investment “stage fright,” making them unable or unwilling to undertake an activity they may in fact be great at? What I often hear from my women clients, would-be stars wilting in the wings, is that there are too many lines to learn and they cannot follow the plot. “I don’t understand how investing works and I don’t have the ______? to figure it out.”

You need to know very little to be successful at investing. In fact, the sooner you accept that you (as well as the stockbroker or the advisor) cannot know or predict how investment markets will perform, the simpler and more rational the investment process becomes.
The EMH of Investing

Call this humility—something that most women get. Fully tenured professors of finance and Nobel Prize winners call it something else—the efficient-market hypothesis (EMH).

Women and investing

So how exactly do women invest? Check out just a few of the characteristics of female investors that distinguish them from their male counterparts.

Women spend more time researching their investment choices and tend to take less risk than men do. This prevents them from chasing “hot” tips and trading on whims — behavior that tends to weaken men’s portfolios. Women are also more likely to seek out information that challenges their assumptions, rather than only relying on data that confirms what they already thought.

One study found that men trade 45% more often than women do, and although men are more confident investors, they tend to be overconfident. By trading more often — and without enough research — men reduce their net returns. But by trading less, women produce better returns and also save on transaction costs and capital gains taxes.

Women have less testosterone than men do (not a surprise, we know). New and continually unfolding science points to the possibility that testosterone is responsible for herd-like risk-taking behavior from men in the financial markets. That makes a lack of it a decided asset.

With this approach, all the impediments that keep many women from investing—no time, no interest, no technical skills—don’t really matter. You are free to grab the remote from your partner, switch off the investment noise on MSNBC and instead watch American Idol, all the while knowing that you are making money.

You, too, can be wise, without having to be smart.

Periodically, the stock markets go through a mid-cap and small-cap excitement. We are in such a stage currently. Over the last one year, the small- and mid-cap indices have outstripped the large cap indices by wide margins. This performance is also reflected in the typical mutual fund as well. The average large-cap focused funds are up while mid and small cap funds are up much more. There’s also no shortage of analysts proclaiming that the smaller companies is where the action is.

However, as always, investors need to be extremely wary of this space. Volatility and liquidity have always scuppered investors’ gains in this space, mostly because by the time the mass of investors notice the action, things are already over the hill. You can make money in these stocks, but you need to be careful.

So let me give you a different perspective on small and mid-cap performance. The Small Cap Index may have risen 200 per cent from the bottom in March 2009, but to reach that bottom, it had fallen to one fifth its value. It takes a lot more than a 200 per cent gain to wipe out that kind of a fall.

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As cautious investors know, these stocks rise a lot more than the large caps and then they fall a lot more too. This means that we need to have slightly different ground rules for such stocks. Here’s how I think you should approach this space. The most important thing is that smaller companies should never be a major chunk of your portfolio. Everything depends on your personal risk profile but I doubt whether anyone should have more than 20 or 30 per cent of their equity portfolio in small caps.

Secondly, this is one area where investing through an open-ended mutual fund dedicated to smaller companies makes even more sense than otherwise. There are not too many investible large-cap companies in but hundreds of smaller ones. The quantum and quality of information about many of these is several orders of magnitude poorer than large-caps.

There could be a few hidden gems in that long tail but there’s a lot of garbage as well. Since investors are eternal optimists, they firmly believe that they’ll get that one gem that will turn out to be the next blockbuster. But let’s face it. The chances of doing so are not great. Choosing the right stocks at the right time is simply too large an exercise to be feasible for the individual investor. When the markets start tanking, investing through a fund can also provide better liquidity. In small and mid-cap stocks, trading volume dries up very quickly in a negative phase. If you have invested through an open-end fund, you can always get out at a day’s notice, no matter what.

At the end of the day, it’s good to hear about smaller stocks doing well, and there’s no reason why any investor cannot participate in the gains. However, the risks are higher and the traps are well-hidden. You need to go into this with open eyes and open ears.

How much financial bloodshed is necessary before we realize that there is no safe and easy shortcut to investment success? When do we learn that most of our mistakes involve our very own greed, fear, and unrealistic expectations?

Eventually, successful investors begin to allocate assets in a goal directed manner by adopting a realistic investment methodology — an ongoing security selection and monitoring process that is guided by realistic expectations, selection rules, and management guidelines.

If you are thinking of trying a strategy for a year or so to see if it works, you’re due for a smack up alongside the head. Viable strategies transcend cycles, not years, and viable equity strategies consider three or four disciplined activities, the first of which is selection.

Most strategies ignore one or more of the others.

How should an investor determine what stocks to buy, and when to buy them? Will Rogers summed it up: “Only buy stocks that go up. If they aren’t going to go up, don’t buy them.” Many have misread this tongue-in-cheek observation and joined the “buy anything that is rising” club. I’ve found that the “buy investment grade value stocks lower” approach works better.

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A Google search produces a variety of criteria that help to identify value stocks, the standards being low price to book value, low P/E ratios, and other fundamentals. But you would be surprised how the (self serving)definitions can vary, and how few include the word quality.

In the late 90′s, it was rumored that a well-known value fund manager was asked why he wasn’t buying dot-coms, IPOs, etc. When he said that they didn’t qualify as value stocks, he was told to change his definition — or else.

How do we create a confidence building stock selection universe? Operating on blind faith with one of the common definitions may be too simplistic, particularly since many of the numbers originate from the subject companies. Also, some of the figures may be difficult to obtain quickly, and it is essential not to get bogged down in endless research.

Here are five filters you can use to come up with a selection universe of high quality companies, and you can obtain all of the data inexpensively:

1. An S & P rating of B+ or better. S & P is a major financial data provider and its “Earnings and Dividend Rankings for Common Stocks” combine fundamental and qualitative factors into a letter ranking that speaks to the financial viability of a company.

Potential market performance (a guessing game anyway) is not a consideration. B+ and above ratings are considered investment grade. Anything rated lower adds an extra element of speculation to the portfolio. A staff of thousands does your research for you.

2. A history of profitability. Obviously, a company with a history of profitability is a less risky investment than an unproven, start-up, or losing enterprise. Profitable operations adapt more readily to changes in markets, economies, and business growth opportunities. They are more likely to produce profit-taking opportunities for you.

3. A history of regular dividend payments. The payment of dividends, and periodic increases in the rate paid, are signs of economic viability. Companies will go to great lengths, and endure great hardships, before either cutting or omitting a dividend.

There is no need to focus on the size of the dividend itself; equities should not be purchased as income producers. On the other hand, companies who enrich their officers and don’t reward investors should be avoided.

Additionally, dividend cuts are a clear indication of financial stress within the company.

4. A reasonable price range. Most Investment Grade Value Stocks trade between $10 per share and $100. If you have a seven-figure portfolio, price may not matter from a diversification standpoint, but in smaller portfolios, a round lot of a $40 stock may be too much to risk in one position, all at once.

An unusually high price may be caused by a high degree of sector or company speculation while a single digit price may be a warning signal. With no real structural size limitations, I feel most comfortable with a range between $10 and $90 per share.

5. A NYSE Listed Security. I’m not sure that the listing requirements for the NYSE are still more restrictive than elsewhere, but it is helpful to be able to focus on just one set of statistics. Market Stats, Issue Breadth, and New Highs vs. New Lows are reported separately by exchange.

Your IGVSI selection universe will become the conscience of your equity investment program — allowing no room for creative adjustments to the rules and guidelines you’ve established. You will be able to focus on diversifying properly and on identifying stocks that are ready for purchase.

Always keep in mind that you want to sell each equity at your target profit ASAP. What, you say, what are targets? Well, security selection is just one part of the process.

You’ll want to establish appropriate diversification, buying, and selling rules as well. For example, I never consider buying a stock until it has fallen at least 20% from its 52-week high. Your actual “buy list” should change every day in symbol, # of issues, and day-limit price.

You will need to apply consistent and disciplined judgment to your buying activity so you don’t violate a formalized set of diversification rules as to sector, individual issue, global interest, etc. And then the absolute most important function of all — profit targeting.

Never, ever, say “no thank you” to a net/net profit of 10%, or less under certain circumstances, and you’ll be able to do it again, and again, and again.

One other observation, as IGVSI stocks gyrate above and below your purchase price (as they absolutely will), you can be confident that it is merely the nature of the stock market and not an imminent financial disaster — and that should help you sleep nights.

At least ten hands shoot into the air as the discussion turns to stock selection. The speaker smiles, responds to each, and observes: “You really need to know the depth of the water, its temperature, tides, and currents before you dive into the river — and then, what kind of predators are in there?”

Flying low over coastal South Carolina, I’m probably the only person on the plane who sees the meandering rivers and tidal creeks as a history of stock market cycles. How does one navigate these complex connections without getting lost, running aground, or being attacked by alligators?

How does one select equity securities in a manner that consistently avoids the risks of volatile markets, fickle investors, abusive regulators, regressive tax codes, and brainwashed investment gurus? Along with self-confidence and experience, it takes some management skills that most investors fail to sharpen before they launch their boat — planning, organizing, and controlling.
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Here’s an overview, and it is expected to provide structure and provoke thinking while skimming over most of the detail and explanation that can be found in the “Brainwashing” book.

The investment planning stage is too often ignored by the young and the new, and too often over cooked by the older and beaten up. Most of the confused indecisiveness is due to constant media hype and an endless bombardment of data, news, software solutions, electronic tools, and expert opinions. But most actual investment errors are caused by invalid expectations, fear, greed, and lack of discipline.

Markets have been and always will be volatile while tracking higher and lower, predictably and unpredictably at the same time. If you can’t embrace the market cycle and use it to your advantage, you will have trouble becoming a successful equity investor.

Planning involves two basic determinations: Can I afford to take the risks associated with investing in the stock market? Am I preparing effectively to meet my retirement income needs from the income bucket of my portfolio? Clearly, if you do not hold any securities whose primary purpose is income generation, you are overlooking a key element of portfolio development, and need to plan better.

Another “planning” necessity is defining and identifying a risk-minimizing equity selection universe. First of all, market price volatility is not a risk element — it is the very nature of equities. The real risk is the actual financial demise of the company you are partnering up with when you buy its common shares. Clearly, the fundamental quality of the companies you buy is an important consideration.

Investment Grade Value Stocks (you need to google this one) come to mind as a kind of pre-screened, or cookie-cutter collection of the best American multi-national companies. Well known foreign company ADRs can be examined internally for fundamental quality as well. Unfortunately for the lazy, there are no mutual funds comprised solely of IGVSs — and Market Cycle Investment Management mirror portfolios are yet a glimmer in an old man’s eye.

An overpriced, highest quality in the world, selection universe provides little investment opportunity — because? Because the “traders” are correct. The only reason to buy a stock is to sell it (as soon as possible in my book) for a reasonable profit. The higher prices are, the less likely it is that additional gains will come along quickly, and just what is a “reasonable profit”?

Managing your investment portfolio requires that you rein in your emotions with rules for both buying and selling. Operational simplicity is essential. Disciplined compliance with the rules you establish is less simple and a whole lot more essential. In order to succeed, you need to identify and immediately quash anything that looks, sounds, tastes, or smells like hindsight.

In equity investing/trading (one and the same), a lower market price is an opportunity for buying and a higher price an opportunity for profit taking. The number of individual issues within the equity bucket of a portfolio should rise during falling markets because more stock prices are entering an acceptable “lower price’ buying zone.

The objective of the exercise is to have cash available for buying during every downturn — can’t happen unless you have the courage to take profits when prices are rising. Yes, you are expected to feel stupid in both exercises. When you feel like you “sold too soon”, the bubble buster is just around the corner. When you know you re-entered the market too early, the rally is just over the horizon.

The fact that your holdings move (forgive the use of this emotionally charged, designed to make you lose money unnecessarily, buzz word) “underwater” while the stock market corrects is irrelevant so long as they retain their quality, profitability, dividend payout, etc. You need tools that allow you to make this determination. The S & P monthly stock guide comes to mind.

The controlling process of investment management makes you consider the declining market-value inevitability upon your initial investment in any security. The organizing element keeps you diversified by security and by sector — all the diversification you really need with IGVSs, which are generally multinational entities.

Buying rules should be somewhat complex so you don’t just go out and buy everything — always a mistake. With some experience, you’ll find no need to buy anything until it’s down at least 20% from its 52-week high. Note that at this purchase price, the market value can rise 10% without establishing a new 52-week high — very important psychologically.

Selling rules should be ridiculously simple, written in stone, unquestionable by anyone, and understood by your financial professional — if not by the SEC (call me if you really want a good laugh/cry about regulators).

Ten per cent is a reasonable profit level; even less is fine if buying opportunities are plentiful.

No equity investor (trader, speculator, whatever) should ever allow a reasonable profit to go unrealized. No intelligent body of human beings should allow their elected representatives to perpetuate a tax code that encourages loss taking more than it does profit taking, or that considers investment income of all kinds “unearned”.