Here’s a quick rundown of Tuesday’s after-the-close action: JPMorgan’s (JPM) Q3 earnings fell 3% from last year to $1.32 a share, missing estimates by 5 cents. Revenue fell 6.4% to $23.5 billion, falling short of expectations and marking the third top-line decline out of the last four quarters. Shares fell more than 1% late, after closing down a fraction. Intel’s (INTC) 64-cent Q3 EPS beat estimates, though the bottom line declined 3% from last
The stock market is ultimately a mirror of investor sentiment. Another barometer of investor sentiment could be the number of times the ticker symbol for a company is used as a search term. Google Trends provides a tool that helps track search term volume and it appears to be a forward indicator. Much of human behavior is based on conditioning. Our years, months, weeks and days are clearly mapped out. Within that, our hours, minutes and seconds are all accounted for. You wake up, take a shower, make yourself look presentable, have a cup of coffee out of your favorite mug and you’re off to work. You arrive at work and don’t even remember how you got there. Then you can’t wait to get home where you can eat, relax, look at emails and prepare yourself to do it again the next day. I’ve heard it said that by the age of 35 most of us are on auto-pilot for 80% of our lives. Certainly, if there are patterns in human behavior, there might be some portion of this pattern that provides clues about the direction of the market. Now, I’m no advocate of technical analysis for stock selection, but it can tell you when to buy something you’ve already decided to purchase. In other words, it can help with timing. Measures of volume can give you an idea for the level of interest in the market. Volume, is in a sense, a measure of the market’s current emotion. When that volume lingers, it turns into a “mood”, often trending sideways, up or down over a period of time. Some stocks trend up or down in such predictable ways (within a range) over a long period of time that they can now be said to have a “temperament”. Ultimately, the market is also on auto-pilot. One great thing about being human is this gift of metacognition — the ability to think about the very thing you are thinking about. So let’s ask the question, is there a better way to think about the emotion, mood and temperament of the market? If there is, I’m sure Google has the answer. No, really. They do. Google provides a tool called Google Trends. It shows information on the number of searches for a given “search”. What exactly is a “search”? It’s when someone puts in a word or phrase and then clicks “search”. Easy enough, right? The goal of the “searcher” is to find information about the stock price. So these are presumably investors looking to find more information about a stock. This is a measure of investor interest — good or bad. And, it’s a better measure than volume and momentum, because “searches” are not commitments. This is where people go prior to making a commitment; they do research prior to the investment decision. When the number of searches is abnormally high it could be a sign of eminent change. So, in some ways it is a barometer for potential future action, like a voting poll. I cover banks so let’s look at the top 3 banks in size to see if a compelling trend emerges that can help predict entry/exit points. JP Morgan Chase (NYSE: JPM ), Bank of America (NYSE: BAC ) and Wells Fargo (NYSE: WFC ) are all compelling investments. Though my favorite is Wells Fargo, I also like JPM and BAC. Though WFC edged out JPM in net income again in Q2, JPM is still the largest US bank by assets. Here’s a price/net income chart. JPM data by YCharts And, here’s a chart of searches for the term “JPM” over roughly the same time period: (click to enlarge) Source: Google Trends I drew in the red line. The letters mark news events. You will notice that high search volume is negatively correlated with stock price, which suggests investors search for stock more when the price is going down, but can this be used as a forward indicator; does it have any predictive value? The end of month reading on January 2008 shot up above the red line — this was a change of investor emotion, a change in routine — auto-pilot has been turned off. If you looked at this Google Trends chart on February 1, 2008, you would have seen a spike above the red line. If you sold JPM on February 1, you would have also been one of the smartest people in the world. On August 2009, search volume dropped below the red line which was the start of an increase in price, a new trend. You will notice a spike at (“H”) around the middle of 2013. This is when a news story was put out about JP Morgan Chase in Barron’s. The story created a lot of interest in the stock, but did not result in a sell-off. Indeed, the stock has been fairly steady since August 2009. The dashed line at the end of the chart represents a forecast of future search volume for the term JPM. Based on the search volume forecast, JPM will be going up over the next 3 months, though I don’t know how reliable the forecast can be. The next highest bank in terms of assets is Bank of America . Unlike JPM, BAC’s price has not followed net income which explains the low earnings multiple. Here’s a price chart: BAC data by YCharts And here’s a chart of the search term “BAC” over the same time period. (click to enlarge) This is a little trickier because prior to November 2007, there were no searches for BAC. Suddenly, there’s interest. We go from 0 to 100 (literally) from December 2007 to April 2009. Had you sold BAC on January 1, 2008 (search volume passes above the red line) and purchased again on May 1, 2009 (search volume passes above the upper limit), you could have saved yourself an 80% drop in price. Then from May 2009 to May 2011, searches fell again. Only to have a sharp spike July 2011. Had you sold on August 1, 2011 you could have avoided a 50% sell-off. Here’s a chart of Wells Fargo’s price over the past 10 years. WFC data by YCharts And here’s a chart of the search term WFC on Google: (click to enlarge) January 2008 (just after the “N” mark) was a breakout month for WFC in search volume — this is when folks turned off the auto-pilot and the stock became increasingly volatile. If you sold WFC on February 1, 2008 you would have seemed a genius. The chart also provides a buy signal (folks went back to auto-pilot) when it crossed above the upper red line in February 2009 you would have purchased the stock between $8 and $13. A more prudent investor may want to wait until all “search volatility” has dissipated. Sometime around the beginning of 2011 the market returned to its pre-2008 search volume. At the time the price was around $30. Today’s it’s at $52. Incidentally, the dotted line at the end there looks to be telling us that WFC is trending flat, but again I don’t have much faith in the forecast. A few comments: I’ve noticed that the effectiveness of this tool is only as good at the search term. For instance, Citigroup’s (NYSE: C ) ticker is “C”. It would take some time to clean out the noise. Even a search for “C price” or “C quote” yielded mixed results. There appear to be no correlations between Google Trends and short interest. You might think that as searches go up, short interest would follow, but this is not the case. A big news story, press release (earnings report) will provide a false signal, but you can eliminate this with a quick search. If there are no big news stories, press releases, etc, and search volume is going up, it may be time to sell. While you can ask the chart to show news activity, it does not always pick up company press releases. For example, if we look at the WFC search volume chart (see below) for the past 90 days, we see a spike at July 14, which was an earnings announcement. However, the second spike was the sell off on Aug. 24. The next day WFC hit a price bottom. WFC’s price began trending down on August 19, but the search volume for the ticker symbol did not pass the red line until Aug. 23 (Sunday). So, to put some context on this, on Aug. 22, a Saturday, people woke up and instead of going on auto-pilot they checked on WFC’s price. And, on Monday morning, well, we all know what happened on Monday morning. Now we appear to be back on autopilot, but I’m monitoring closely. (click to enlarge) Google Trends provides data on a daily basis. The presentation here is a snapshot, but if you go to the actual website you will see more granular data. I have an email in to Google to see if I can get a raw data file to run correlations, but that may never happen. I will keep you posted. Each stock has its own temperament. This is not a one “rule” fits all. Finally, to all the critics, this is only research in progress. I am by no means calling this a definitive study, but it’s showing some promising signs. AIAB Subscribers : If you have a bank you would like me to research please send a direct message. I’ve also provided Google Trends charts for the top five non-banks for comparison. Disclosure: I am/we are long WFC, BAC, JPM. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Wide diversification and a ‘buy and hold’ strategy are not necessary for success. In fact, there are much better ways to hedge the market, capitalize on upside, and protect yourself from downside. Here is how I diversify my portfolio. Wide diversification is only required when investors do not understand what they are doing.” – Warren Buffett Every couple weeks I list my portfolio along with top-rated stocks to members of Tipping the Scale. I do this because my holdings often change depending on stock gains, valuation, and when new opportunities arise. Soon after my last update, a person noted that I did not own any materials, utilities, and was very light on industrial stocks and ETFs. He continued that for a portfolio of my size, he was surprised I did not prioritize “diversification”. My response is that I do diversify, just differently, and that my intention is not to track the market, but to rather beat the market. With well over a decade of consistency, my bottom line approach has not changed much, having worked very well in all markets. Here’s what I do. Rather than prioritizing industries and sectors of the market to achieve diversification, I diversify by purpose. Each holding in my portfolio fits into one of five categories, my sectors if you will, and thereby having a purpose. That category dictates management style, selection, and activity. Here are the five categories and the weight that each has in my portfolio Category Weight Top rated stocks 35% Dividend & Income Stocks 30% Deep Value 10% Growth & Momentum 5% Cash 20% Top-rated stocks are those that score in the upper echelon of companies covered in Tipping The Scale. Typically these are stock that score 88 or higher, meaning the company had to score relatively high in all 10 categories that TTS tracks. These include business growth, macro outlook, profitability, management vision, valuation, etc. Due to such a high rating, my theory is that “top-rated stocks” are worth holding through volatility, and should not be sold, only acquired in periods of loss until the company’s rating starts to decline. In the first three months of TTS, top-rated stocks (seven stocks with a score better than 90) traded higher by more than 9% versus a loss of 1% in the S&P 500. Therefore, these stocks tend to perform well both in short and long term, which is why they are such a staple in my portfolio. For investors considering my portfolio strategy, 35% of your holdings would be allocated to those stocks where you have the most confidence, and are the best of the best, however it is that you determine “the best”. Dividend And Income stocks provide some balance to my portfolio, as these are typically low beta, safe investments. Seeing as how 40 of the potential 100 points for TTS stocks are tied to business growth, macro outlook, and the amount of short and long-term upside in a stock, large companies with high dividends don’t typically rank as “top rated stocks”. Therefore, I hedge those types of investments with stocks that don’t necessarily have tons of upside or growth (i.e. AT&T (NYSE: T ) or Corning (NYSE: GLW )) but have high yields. These are companies that would rank high in other areas, but just don’t have the growth upside of a top-rated stock. Furthermore, this is where I put REITs like the Vanguard REIT Index Fund (NYSEARCA: VNQ ) and ETFs that have high yields. The key with the dividend and income section is to invest in entities that pay a high yield. The average yield of my holdings that fit into this section is 4.6%. With 30% of my portfolio allocated to dividend and income, that 4.6% yield for 30% of my portfolio translates to a 1.4% yield for the entire portfolio. Not to mention, often times a company that pays a dividend will fit into another category, thereby not considered part of the dividend & income section. A good example is Apple (NASDAQ: AAPL ) and Schlumberger (NYSE: SLB ), which fit into the top rated and deep value sections of the portfolio, respectively. All in all, the yield of my total portfolio is 1.8%, just about equal to the SPDR S&P 500 ETF Trust (NYSEARCA: SPY ). That gives me a downside cushion while also hedging my top rated holdings. With that said, the top rated stocks and dividend & income sections serve as a natural hedge against the other, limiting downside risk in the face of a market correction. The Deep Value and Growth And Momentum sections tend to do the same. Albeit, I don’t worry about how many holdings in each sector are in my portfolio, but by allocating my portfolio based on goals, you end up owning stakes in most industries. For example, energy and financial stocks trade at the lowest multiples and are mostly cheap because of macro-related factors, whether it be oil prices or low interest rates. This gives investors an opportunity to cherry pick top companies in those respective industries, those that have fallen below their worth because of macro-related concerns. My belief is that once those macro-related concerns stabilize, those top companies like Schlumberger, EOG Resources, JPMorgan (NYSE: JPM ), and Goldman Sachs (NYSE: GS ) will be the ones to outperform their peers. However, if those macro factors don’t improve, then not much of your portfolio is tied to such stocks. That said, there is certainly no valuation considerations for stocks included in my growth and momentum section. This is where I own companies like FireEye (NASDAQ: FEYE ), Facebook (NASDAQ: FB ), or speculative biotechnology companies. As explained in a recent blog , this is where I trade stocks based on their score in TTS. This is where I buy momentum stocks when volatility makes them cheap, and then sell when that price gets too high. Notably, if the market turns for the worse, these are usually the first stocks to go lower, and that’s why when owning such stocks it is good to keep a close eye and set stern stop-loss and limit orders. Finally, I keep a cash stake that equates to 20% of my total portfolio, which too fluctuates depending on the performance of the market. Believe it or not, cash is where investors can really hedge the performance of the market, and use volatility to their advantage. Below is a chart that I follow as a way to determine the size of my cash stake. Cash as percentage of portfolio S&P 500 performance 15% bull market 20% 2% to 5% off highs 25% 5% to 8% off highs 30% 9% to 12% off highs 35% 13% to 30% off highs 50% 31% or more off highs We are coming off a five year bull market that has seen very little economic growth, one that I fear has been driven by lower interest rates and multiple expansion. I have said on many occasions that I expect a correction. The problem is that there’s no way to know when that correction will come or how bad it will be. So, when the market starts to dip, I start cutting my growth and momentum stocks. If it keeps falling, I will trim value stocks that are hurt by macro conditions. Finally, if the market keeps going lower, surpassing that 30% from market high levels, I will start cutting dividend stocks. However, unless something changes the outlook for those high rated stocks, I will not sell, not until my price target is reached. With that said, this is a hedge that I have found to be very useful over the years. For one, both times that the market has exceeded a loss of 30% off its high since the year 2000, it continued to dip significantly lower. Therefore, I protect myself from future losses, and by quickly increasing my cash position and removing high beta stocks, while retaining low beta stocks (dividend), my portfolio tends to outperform the market. Then, by decreasing cash and increasing my stake in high beta momentum stocks, my gains tend to outperform the broader market as it recovers. However, the final and most important piece of the puzzle are those high rated stocks, because as I already explained, those stocks consistently outperform the market due to having the total package in those 10 essential categories. All things considered, the buy-and-hold, complete diversification strategy by owning all industries of the market is not a bad way to structure a portfolio, but I don’t think it is the best way, and neither does Warren Buffett. Instead, it is best to determine what you want from a portfolio, and then create it from those goals. Over the years, as my net worth has grown larger, I’ll be the first to say that my appetite for risk has diminished, and where I used to own more momentum stocks, I have since found high yield to be most important. However, the one thing that has not changed is my desire to own as many high quality companies as possible. In any market, those are the ones that thrive, and that’s why I would tell anyone to diversify by owning what’s best, and not to own a little piece of everything. Disclosure: I am/we are long AAPL, GS, T, JPM, SLB, GLW. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.