Investors I meet around the country have a common trait. They always talk about buying or selling when they ask about their investments. “Should I buy stock XYZ?” “Should I sell stock ABC?” These are the typical issues. In other words, the investment decisions are seen in terms of buy-sell, attractive-unattractive.
Unfortunately we do not live in a yes-no kind of investment world. The nature of the financial markets changes every day. Every day new information becomes available affecting particular stocks and particular assets. What I am trying to say is that risk changes gradually and continuously.
Risk can be looked at as the probability of making money in the current environment. As risk rises, the probability of making money decreases. On the other hand, when risk decreases, the probability of making money increases.
As far as equity investing is concerned, risk rises when the economy strengthens thanks to generous injections of liquidity orchestrated by the Fed. Commodities and short-term interest rates bottom and begin to rise. Inflation is not an issue, but it will be. This was the environment from late 1998 (low risk) to mid 2000 (when risk reached its peak).
As risk falls, the probability of making money steadily increases. The economic and financial environment becomes the mirror image of the one discussed above. The economy weakens, and analysts begin to raise issues such as soft-landing, V-shaped, or W-shaped recession. Commodities and short-term interest rates decline. Inflation subsides, disappearing from the financial radar screen. In the current financial cycle, risk has been declining steadily since early this year and is now very close to a bottom.
What should investors do as the probability of making money changes? The answer is provided by the way poker players play the game. The players always compute in their head the odds of making money. As the game evolves, the odds change, and their bets are always related to those odds. If they believe they are going to win, they gradually increase their bets. On the other hand, if the odds of winning decline, they bet more cautiously and might even fold.
Investors play the same strategy game. They should gradually adjust the exposure to the stock market depending on the odds they have of making money.
(This Observation appeared in the issue of 11/26/01 of The Peter Dag Portfolio)
George Dagnino, PhD
Editor, The Peter Dag Portfolio. Since 1977
2009 Market Timer of the Year by Timer Digest
To find out more about my in depth views of the markets and my strategy just visit our website https://www.peterdag.com/ where you can subscribe to The Peter Dag Portfolio. You can also call me at 1-800-833-2782 to discuss your specific investment portfolio.
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