E-mail this article Printer-Friendly

When boredom is an investor’s best friend

A confirmed contrarian explains his approach to the market, and why only those who follow a dull strategy will wind up with exciting results.

He refers to himself as the “Maui contrarian.” He has taken a dim view of the economy and the markets since long before the current crisis first surfaced in the middle of last summer.

Events have certainly not proved him wrong. And Mr. Irwin T. Yamamoto is not about to surprise his readers with a happy outlook on 2008, either.

In the latest issue of The Yamamoto Report, the editor explains his approach to the market in some detail. It does not really involve investing in stocks at all, except, perhaps, very late in the game. First and foremost, it calls for a high degree of boredom.

This article was written in January, but since Mr. Yamamoto has not altered his portfolio one jot over the past year, we can safely assume that nothing has changed in the ensuing weeks. Nor have his tart observations lost any of their sting.

A boring 4 to 5 per cent

“My investing strategy consists of two main elements,” says Mr. Yamamoto. “They are defensive in scope. Yet this portfolio will be able to offer offensive fireworks of its own.”

His strategy begins with cash, and lots of it. If you had started your portfolio on January 1, 2008, it should be fully invested in a money market account. “Granted, it sounds boring,” he admits. “Still, your account will yield anywhere from 4 to 5 per cent risk-free.”

You would also avoid jumping into equities at premium prices. “Considering the current price levels of the market and the anticipated decline in future corporate earnings, stock prices are not cheap. And the availability of cash allows you to take advantage of the upcoming bargains.”

Since this was written, we have certainly seen some erosion in the market. But there are still plenty of corporate earnings reports to come in, and the available evidence suggests they are not liable to be encouraging. You are not likely to find many observers who claim that all the bad news is in.

That’s why the second part of the strategy is pure bear.

Contrary to the index

The Rydex Ursa Fund (RYURX) offers results “that inversely correlate with the performance of the Standard & Poor’s Index,” explains Mr. Yamamoto (ursa is the feminine form of the Latin word for bear). “It invests in financial vehicles with economic characteristics that will likely perform opposite to those of its underlying index.”

When the S&P 500 goes down, the fund goes up, and vice versa. Not only does the fund run contrary to the index, it runs contrary to the way most investors act, which is just fine with Mr. Yamamoto.

“Most market participants buy on technical strength or momentum. They purchase securities at yearly highs or multiyear highs. Even record highs. Not me,” states the editor. “I am a contrarian.” We gathered that.

Collect shares when the crowd is dumping them, he declares, and unload them when everybody loves them.

A businessman and the kitchen sink

“I’m a businessman pure and simple,” says Mr. Yamamoto. “Buy wholesale, sell retail. Each day, I search for a fire sale. I study the 52-week low list.

“If you throw out the kitchen sink, don’t be surprised to see me in your neighborhood.”

So purchasing individual stocks isn’t out of the question for those who are able to stick to the discipline of being a true contrarian and buy them when they’re really, really low.

But Mr. Yamamoto’s basic plan consists in switching money from one’s money market plan into the Rydex Ursa Fund. The prime time for doing this would have been more than six months ago, when the market was soaring. Still, let’s examine the strategy in full.

When the champagne overflows

The plan is to deploy 5 to 10 per cent of your cash in the fund as stock-market averages achieve new highs, or record highs. “Buy the Ursa Fund when the sentiment indicators such as Investor’s Intelligence, Market Vane and the American Association of Individual Investors reach extreme levels of bullishness,” advises Mr. Yamamoto.

The better things are, the better the bear fund looks. “As the good news on equities and the economy appears in the headlines, add the fund to your portfolio,” he urges. “When champagne overflows on Wall Street and Main Street, you’ll find Ursa on the bargain counter.

“Later, when stocks tumble in the midst of bad economic news, traders will be able to sell Ursa into strong rallies. It won’t take too big of a bounce for a profitable trade. Remember, contrary investing gave you a low entry price.”

Although the champagne is clearly on hold on Wall Street or Bay Street or any other exchange street these days, that does not mean that the bear fund is necessarily past its sell-by date.

Bear cycle and recession overdue

“Long-term investors should always keep a core position in Ursa since a bear cycle and a recession are overdue,” states Mr. Yamamoto. You might have a 15 per cent position, or even 20 per cent. But your trades must be executed at the high end of the stock market’s trading range.

A year ago, when one leading advisory service called Mr. Yamamoto asking for his top pick for the year, his answer was a bank money market account and the Rydex Ursa Fund. This past December, when another service asked the same question, he had the same answer.

There are even more aggressive funds out there, he adds, specifically the ultrashort ones. “But if you go into them at the wrong time and at the wrong time, your portfolio could get decimated. If done correctly, Rydex Ursa allows you to stay within striking range until the bearish cycle enters the scene.”

But there are people for whom the fund will never be right, adds the editor. If you’re a conservative investor, stay in a money market account and out of bear funds. They are for more aggressive investors who have a high tolerance for risk.

Nonetheless, these investments will find a “fertile environment” in the coming business climate, says Mr. Yamamoto. He has already begun to enjoy the fruits of this fertile environment, as his portfolio has sharply increased in value while the markets plummeted.

The most constructive thing

Mr. Yamamoto can find a bit of blue sky on the horizon, but thunder and lightning are never far away.

In the long run, oil will undoubtedly be in high demand for the next growth cycle. In the meantime, the supply and demand equation simply didn’t justify the $100 a barrel price it achieved, and an economic slowdown will keep a lid on prices.

As for gold, it’s only a matter of time before it surges above $1,000 an ounce, but it’s presently overbought. So look for a short-term drop.

Silver, on the other hand, looks appealing, and its price has been going up. But remember, it’s an industrial metal, says the editor. A business downturn will hurt it, too.

“The economy is in the midst of a long unwinding process,” concludes Mr. Yamamoto. “The most constructive thing to do is nothing.” The process should be allowed to run its course, he adds, without any artificial interference (though he does not say so, we can be pretty sure he is referring to the Federal Reserve Board and other noted interferers).

“Granted, the journey won’t be an easy one.” But the price must be paid for excess in the financial system and an over-leveraged economy. The medicine must be taken now.

And one way to solve the crisis is for investors to be bored and the authorities to do nothing. It may even be the right way, but we’re guessing it won’t happen to Mr. Yamamoto’s satisfaction. They’ve just got to try and shake up the champagne on Wall Street.