A look back at stocks in 2009. Lessons learned.

I write an article every time I add a security to my portfolio, but lately, all I have been doing is selling. In fact, I started 2009 with a goal to significantly decrease my stock market exposure. At the time, over 60% of my net worth was tied to the stock market. I wanted to cut that percentage down to less than 30%. However, with markets down 40% from their October 2007 peaks, I needed a really good plan to get it done. I didn’t want to miss any of the big opportunities for asset appreciation, which I felt where just around the corner, but I also could not take the risk of loosing more capital as the markets continued their descent down the abyss.

By the end of 2008 things were looking rather ugly both on Wall Street and Main Street. However, remembering that investor’s best friend is reversion to the mean, I was buying certain stocks, even as I was looking to reduce my overall exposure to the stock market. My main reason for wanting to cut down on stocks was my macro economic view, which by that time was increasingly leaning towards a deflationary scenario. As a side note, world recessionary environment has recently improved on the surface, but digging deeper reveals many issues that will take years, if not decades to resolve. In fact, world economies appear to be in even worse shape now than they were a year ago.

One complication was that at the end of 2008, I had accounts, which included many positions that were added by an adviser. I never fully researched them and knew very little about them. To do a decent job unearthing valuable information on this many stocks and to keep on top of them seemed like an insurmountable task. I needed a simple plan that was easy to implement and equally easy to stick to. I knew that I had to sell selectively and gradually, sometimes strategically and at other times opportunistically, but that still did not tell me which positions to sell and when to sell them.

In light of these circumstances, I decided to begin by concentrating on certain industries and sectors, rather than individual stocks. I perceived the more vulnerable sectors to be emerging markets, financials, consumer durables and discretionary, construction and equipment manufacturers, metals and oil related positions, as well as technology and communication.

Once I knew where to look for cuts, I eyeballed simple technical charts for those positions in my portfolio that where within the more vulnerable industries. Where a current price was less than about 25% below what I saw as the next major resistance level, I looked further to check that level against my first order estimate of the position’s intrinsic value. This way, I was able to limit my value research to only a few companies. For those companies, whose intrinsic value roughly corresponded to the resistance level, I put in sell orders just below that resistance level. As orders began to execute, I looked for additional candidates.

All in all I liquidated 32 positions in 2009, with 26 of the sales occurring in the second half of the year. The following table details the positions I sold in 2009:

There are many ways one could measure success relative to a goal. I wanted to reduce my market exposure to below 30% by the end of the year. As that date got closer and as markets continued their march up, I extended my deadline by a month to the end of January. I met that deadline and in that sense I succeeded. Advantages and disadvantages of setting the goal the way I did in the first place can, of course, be debated, but such a discussion would require a wider context and yield few objective results. However, examining how close I was to getting out near the top for each of the securities and where price action has taken them since should provide more useful information from which I can hopefully learn.

To make it easier, I marked those securities in the above table, where I got out within 15% of the 2009 top in green – success. Those, where I missed the top by more than 15%, but where my sale price was less than 10% lower than January’s last closing price in black – neutral and the rest I marked in red – failures. By this admittedly arbitrary metric, which is not normalized to market and also ignores inconsequentially small dividends and interest, six of the 32 security sales qualified as botched attempts at properly setting the sale price. Of course, such mistakes are inevitable, but an even bigger mistake would be not to attempt to learn from them.

Let’s first concentrate on the “reds” and see what I can learn from them. One obvious thing to note is that they are generally clustered closer to the 2009 market bottom in March. This serves as yet another reminder that vast majority of individual stocks are highly correlated to their stock markets. My first lesson is therefore: Attempts at picking stocks that may be inversely correlated to the corresponding indexes rarely succeed.

I sold GLD (SPDR Gold Trust ETF) in February of 2009, believing that inflationary pressures driving the price of gold through 2007 had subsided and would not reemerge for years. As a safe haven and a hedge against future inflation, gold remained at historically high levels in dollar terms through 2008. By early 2009 it was looking expensive vs. most other commodities, as well. I was right for about 6 months, as the price of gold went nowhere, while most other commodity prices improved. However, by August inflationary fears reemerged full force, stock markets rallied to the past October’s levels and first signs of a “statistical economic recovery” emerged.

I anticipated that statistics would show a recovery, but I didn’t believe that economists would blindly and enthusiastically accept and run with it – with few exceptions they did. Most people will believe what they want to believe. I underestimated how much faith people put in headline statistics and how scared investors can get by the likes of helicopter Ben with his re-inflation efforts. Had I waited to sell till the end of the year, I could have almost tripled my money on gold, rather than merely more than doubling it. My second lesson is then: It doesn’t pay to be way ahead of the masses; wait for the “early adopters” to show first signs of loosing faith, before taking action.

I sold GLW (Corning Incorporated) in March of 2009, only two weeks into the rally, taking a quick profit. Had I waited till the end of the year, I would have almost doubled my money, rather than making 35% on it. The reason I sold Corning in March was my expectation that the rally off the market lows would be short-lived and that many other great opportunities would soon present themselves. This failure reminds me that I am no better than the next guy at timing the market, which has a mind of its own. The third lesson is: Buy and sell stocks based on their individual merits under prevailing economic conditions; don’t do it based on short-term market expectations.

I sold CHN (The China Fund, Inc.) in May, took a 15% loss and missed out on an over 50% gain. I did so on the belief that Red China is hiding their true state of affairs and that soon their house of cards would come crumbling down. I still strongly believe that this is exactly what is happening and what will happen. However, inevitable unmasking of the truth leading to disaster can take a very long time to materialize and in the meantime status quo prevails. Getting out of China when I did was probably too conservative. The fourth lesson is: Don’t be too quick to limit market risk, as it will also limit the potential market reward.

In late May and early June I sold AMP (Ameriprise Financial, Inc.) and NSANY (Nissan Motors ADR). The thinking was that their businesses could never be the same – both the business of providing financial advice and that of making cars were pretty much doomed to shrink. Car business and Nissan along with it was really hurting – big losses. Ameriprise’s latest quarterly results were back in black, but far from good.

Then cash for clunkers here and in Japan came rolling along and more Fed purchases of Mortgage Backed Securities during options expiration weeks, obviously intended to boost equities. The list of major world governments’ efforts to boost markets goes on and on. I certainly didn’t expect the magnitude and the length of the market rally that followed. While clunkers did their job directly boosting Nissan’s sales, the equity market’s rise was a triple boon to Ameriprise, lifting its owned portfolio value, its management fees from managed accounts and its stock valuation (along with everyone else’s). Lesson five here is: Expect the unexpected: especially pay close attention to government policy and actions, as they may lead to otherwise unexpected results.

At the end of July, I reduced one of my largest holdings, CI (Cigna Corporation) – a health insurer, as fears over a public option being debated in Congress abated and Cigna approached its major resistance level. For the following 4 months Cigna traded in a very narrow band around that resistance level, breaking out above it at the end of November. Most other health insurance companies were similarly undervalued over the same concerns and I intended to replace those Cigna shares with another health insurer (Humana was looking relatively cheap) after the earnings came in. Unfortunately, Humana started the run up a weak later (quicker than the other insurers) after issuing guidance in line with estimates and I never followed through on the purchase. Lesson six is therefore: When selling one position to purchase another, do so contemporaneously - don’t even try to time the market.

Well, that’s it for the reds – the biggest lessons to be learned, but there is even more to be learned from some of my more neutral sales, like as well. Perhaps, I’ll take them up in the next installment on my blog at StockValues.Org. In the meantime, I would like to wish all of you out there, happy trading!