By Kevin Cook from Zacks.com

14 September 2017

 

Investing can be a jungle, a battlefield, even a nightmare if you don’t follow sound principles of diversification and risk management. The good news is that in the age of the Internet, the self-directed investor has been given access to the research and tools of the professionals.

The better news is that if you follow the main currents and rules of the global investment machinery, you can ride this bull market close to the top with amazing profits in hand.

While many investors fret about the next correction, they are missing some secrets about Wall Street that have been proven time and again.

Today, I offer you five of my favorite secrets that most investors ignore at their peril…

Secret #1: $66 Trillion Says “They Have to Buy”

What is the business of institutional investors who manage other people’s money? It is to deploy that capital. Lots of different equity portfolio managers [PMs] have mandates and performance benchmarks that create certain behavior, such as being long stocks even when the market is peaking.

I am not even addressing how analysts or brokers work on the Street. I’m just talking about fund managers having a bias to buy stocks, not short them. How strong a force is this bias? Trillions strong. The creation of employer-sponsored retirement savings plans has been one of the biggest contributors here.

According to CME Group, the global total of assets invested in equities is roughly $66 trillion. The biggest coffers are held by pension funds, mutual funds, and insurance companies, with hedge funds only collectively breaking the $3 trillion AUM (assets under management) mark this year.

Throw in private equity, university endowments, and sovereign wealth funds and it’s easy to see where that $66 trillion comes from. And it is their primary business to put this capital to work, mostly in equities.

Easily another $10 trillion sits in cash, money market accounts and short-term bond funds. And this is all money “on the sidelines” that could help PM’s do their primary job: buying stocks.

Secret #2: Benchmarks Say “They Don’t Have to Sell”

In this secret, I exaggerate (only slightly) to make the point about the pain tolerance of the aforementioned groups whose job it is to buy stocks with other people’s money. It’s easier to watch stocks lose 30%, 60%, even 90% when it’s not your money.

Do you know what the greatest risk is for a fund manager? It’s not losing money or clients. It’s underperforming their benchmark (most commonly either the S&P 500 or the Russell 2000). So if stocks are peaking and then turn down, who knows if it’s the top? What if the index surges higher again?

For the most part, they can handle the 20% downturn. But they can’t miss the last 10% of upside, especially if they’ve struggled in their stock-picking at all that year and are at risk of underperforming their peers or benchmark.

Secret #3: The Tech Cycle is Bigger Than the Fast Money

This one is simple: money doesn’t leave the markets, it just moves around, often at light speed. Especially when interest rates are near 1%. Especially in an expanding global economy when equities still offer the best risk/reward compared to other asset classes.

But the old rules about sector rotation don’t apply anymore as the economic cycle is not driven as strongly by the “boom and bust” nature of industrial manufacturing and real estate.

Today, long-term investors are focused on the transformational technologies of the cloud, mobile, ecommerce, automation and machine learning, and biotech breakthroughs in cancer research, as Gilead Sciences (GILD) just affirmed with their $12 billion purchase of Kite Pharma (KITE).

So it’s easy to get fooled by the “risk-on/risk-off” movement of stocks by hedge funds and “algo” trading and forget that these long-term technology trends will be driving economic growth for decades, even if a recession unfolds before 2020 (doubtful now).

Secret #4: In a Market of Stocks, Winning = Following the Big Money

What drives stocks higher? Two words: earnings growth. Investors buy companies or shares to capture a future stream of growing cash flows at some discount today. Earnings matter as the primary motivation, but really it’s the actual buying of a stock that is required to move its price higher as demand outstrips supply.

And who does the kind of buying where demand outstrips supply? The institutions we discussed earlier. All these bigger players are also “fed” money by smaller ones like banks, brokerage and independent wealth managers, and family offices.

And they don’t care about the P/E ratio of the S&P 500. They are focused on the long-term potential of their investment thesis in given companies and industries.

When you pick a good stock, you are rewarded when what you saw as a growth or value opportunity is slowly (or suddenly) recognized by these “whales” of the investing ocean.

I know because I’ve followed many of the best hedge fund managers in the world for years. And sometimes they “follow” me like when David Tepper of Appaloosa, Dan Loeb of Third Point, and Andreas Halvorson of Viking Global all started new positions in Alibaba (BABA) in Q2 of this year.

Secret #5: They Do Deep Homework and Hang On

Since lots of these “whales” do their own research, they get to know companies inside and out. After a starter position of 1-2% in a company they really like, they’ll make another trip to visit with the CEO, walk the facilities, and talk to suppliers and customers.

And if you think about it, you can see why the whales are true investors and not “swing traders” or even “position traders” with time horizons measured in months. They take significant stakes in companies at early stages because they know that small and mid-cap enterprises are the ones with the biggest growth potential, where they can ride the opportunity to a double or triple in value.

Many institutional funds and money managers that I follow are taking significant stakes in technology and healthcare companies with a three to five year view.

We just want to take a piece of that growth trajectory. And we make sure our timing is sound with the Zacks Rank on our side. Whale-sized interest plus earnings momentum is a big win-win.

This article by Kevin Cook was originally published at Zacks.com.




Download Preston and Stig's Free Checklist

Download Preston & Stig's free stock investing checklist. Their checklist was developed after spending countless hours studying billionaires like, Warren Buffett, Carl Icahn, and Ray Dalio. With their checklist, you can find safe picks that protect and grow your principal. Additionally, Preston & Stig read a lot of books and write executive summaries for each book they finish. If you download their checklist, you will be added to their monthly e-mail list where they send their book summaries. There are never any advertisements...ever. Here's an example of one of their executive summaries, based on the book written by Billionaire Charlies Koch.