positioning in a trendless market…

…that is, in the kind of market we have now.

At stock market bottoms, like the epic one we saw in March 2009, the most highly economically cyclical stocks and the ones with the weakest capital structures (i.e., the most out-of-control debt) are invariably the ones that are the most beaten down.  Because of this, they’re the ones that react the most positively to the first rays of hope that the worst economic news is behind us.

As the market and business cycles mature, leadership gradually shifts from these “value” names to secular growth stocks.  The latter are the least cyclically sensitive and are ones whose investment merit consists in their ability to grow earnings (1) faster than the consensus expects and (2) for a longer period of time than is generally recognized.

Entering year seven after the bottom, we’re deep into the growth stock period.  Dyed-in-the-wool value investors will doubtless be poring over the financials of oil and other commodity production companies.  But the strength of the market will be in technology, social media and Millennial-oriented stocks, I think.

A flat market gives us more time to search for them.

We should also be considering what is likely to happen once this up-one-day, down-the-next period is over.  My view is that the current doldrums are being caused by higher-than-normal valuation, not by perceptions of an upcoming economic slowdown.  If I’m correct, as time passes and company earnings grow, price earnings ratios will gradually shrink.  This will restore more attractive valuation  …and the market will begin to rise again.  When this will happen–and what occurs in the meantime–is less clear.  My answers are “late summer” and “nothing much.”  Alternatives might be “after the first Fed interest rate increase” and “the market goes down 5% – 10%.”

In the current market climate, there’s an easy way to check if my portfolio positioning is in line with my theorizing.

On up days in the market, my holdings should do at least as well as the market; on down days my portfolio will likely underperform.  Conversely, if I have a defensive posture, I should outperform on weak days and underperfrom on strong ones.

The portfolio from heaven will outperform around the clock.  A portfolio potentially in need of overhaul will underperform no matter what.

I normally don’t advocate analyzing portfolio performance on a day-to-day basis.  That’s because there’s often a lot of noise in daily price movements.  And short-term trends may make sense to day traders but no one else.  So there’s a risk that we get shaken out of long-term winning positions by getting scared by meaningless short-term craziness.

Still, in the current market circumstances–and if we don’t get emotionally caught up in the price movements–we have a chance to observe over a short period of time whether our portfolios have the structure we intend them to have.