Q2 2016 Saw The Greatest Corporate Earnings Gains Of All Time

Our markets moved ahead in Q2 with the usual reason being given: more companies than not "beat the estimates" of Wall Street analysts. However -- it has now been 18 months since more companies reported higher earnings than the quarter before. That news was lost in the noise from Wall Street and its cheerleaders who whispered among themselves, " Yes, their earnings declined," but then shouted,"However, they beat our[recently lowered yet again]"estimates" of what their earnings might be!"

My concern is that such folderol sooner or later comes home to roost. That's why we mix income and capital gains with protective positions. I don't know when the next decline will begin. I'd be delighted if it didn't happen at all -- but I've been around this tree often enough to know that only happens in traders' dreams.

Steady as she goes is our mantra, and long-term is where we expect to take our profits. As a result, we use diversification, trailing stops, cash if appropriate and just a soupcon of common sense and adherence to the Walter Gretzky principle.

How Do We Sidestep Catastrophe?

Diversification is one key, of course. But I don't personally subscribe to the crux of Modern Portfolio Theory (MPT) that says we need to diversify x% into 10 or 12 categories, all of which are always-long positions among various types of equity and fixed income.

Staying fully invested (but "diversified"!) during down markets since (the mantra goes) "No one can know when the market will decline" just sets one up for a rollercoaster ride; when the markets are up, you are up and when they are down you are down. It is little solace that you are well-diversified if all 6, 10, 12 or however many categories you have your investments spread among are all down, albeit to varying degrees.

Instead, for ourselves and our clients we use the core MPT theory during recoveries and during clearly-defined up-markets but not in mature bulls and established declines. Then -- now -- we are willing to use the smartest long/short and liquid alternative funds.

We also use trailing stops so as to remove some of the emotion involved in investing. As a professional investor, even I am subject to emotion. I spend a great deal of time researching mutual funds, closed-end funds, stocks, bonds, option strategies and so on. Having invested that time and selected what I believe are the best choices, without the discipline of trailing stops I might make excuses for the companies whose stock I worked so hard to select.

Next, we are not abashed about having a cash cushion when common sense and the markets themselves dictate the wisdom of doing so. As our trailing stops execute, we stop and ask, "Is this just a sector rotation and, if so, where should we place the funds freed up by these sales?" or "Is everything else looking weak as well, in which case we are happy to avoid losing money in cash equivalents.

Rather than create a passive portfolio of funds or ETFs that goes with the flow of the markets we try to follow the wisdom of hockey great Wayne Gretzky: " A good hockey player plays where the puck is. A great hockey player plays where the puck is going to be."

One example of this approach right now, for us, are the REITs and closed-end muni bond funds we have moved to in 2016. Come September 19, for the first time since 1999, the S&P will add a new sector to its benchmark S&P 500. Real estate companies will be split off from the Financial Sector, leaving mostly banks and insurance companies in that part of the benchmark (although mortgage REITs will remain with the Financials.)

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Disclosure: I am/we are long GG, GROW.


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