The Independent Market Observer

How to Capitalize on a Reversal of Trends

Posted by Brad McMillan, CFA, CAIA, MAI

Find me on:

This entry was posted on Mar 20, 2015 3:11:00 PM

and tagged Investing

Leave a comment

trendsI’m reading a very good book by investor Howard Marks titled The Most Important Thing. I’ll write a full review later, but today I want to focus on one of the book’s key points: the importance of second-order thinking.

Second-order thinking and current trends

Say a company launches a successful new product. First-order thinking would dictate “Let’s buy!” Second-order thinking would ask “Has everyone already bought on this news? Who doesn’t know about this? Who is left to buy?” Based on that line of thought, you might end up selling the stock, despite the exciting new product.

This is the same rationale encapsulated in the Wall Street motto “Buy on the rumor, sell on the news.”

Why do I bring this up? I’ve had several conversations recently with investors who are worried about certain trends—namely, lower oil prices, the strong dollar, and the higher U.S. savings rate. I have to point out that, not that long ago, we were all very concerned about the exact opposite:

  • Consider the rising U.S. savings rate, which is slowing consumer spending growth. Last year, analysts were decrying the fact that consumers were still overindebted and not saving enough.
  • Consider lower oil prices. Last year, it was feared that higher oil prices would strangle the U.S. recovery.
  • Consider the strong dollar. Last year, many said the dollar was on the verge of collapse.

I suspect that our current array of concerns, in most cases, will also reverse in the next couple of years or so. As investors, the question is, how we can take advantage of this?

When trends reverse

Let’s think through some consequences of current trends, and how we may be able to make money off a reversal.

With the strong dollar, there are some obvious opportunities to make potential profit. Consider buying foreign investments in local currencies. Today’s strong dollar means you may get a cheaper price, and if trends reverse, you should get currency gains along with the return on the actual investment. Many European investors are doing the opposite trade right now, hoping to enjoy the same benefits in reverse.

With low oil prices, the path is more indirect. We’ve seen many small and mid-size companies get into financial trouble in the energy industry as oil prices have dropped, and I suspect the advantages will accrue to the larger companies that are now in a position to consolidate and pick up assets on the cheap from those troubled smaller companies. Now might be a good time to consider looking at the largest and most stable companies in that sector.

Finally, the rising savings rate for U.S. consumers is only building support for later spending. Consumer stocks have done well, but rising household net worth and wage income suggests that may well continue. In my view, the short-term slowdown in spending is more of a down payment on faster spending later.

As always, we will see what happens. All of these trends could continue, and for longer than anyone expects. But it’s always worthwhile to think about how things that “everyone knows” may, in fact, reverse. After all, it happens all the time.

                        Subscribe to the Independent Market Observer            

Subscribe via E-mail

Crash-Test Investing
Commonwealth Independent Advisor

Hot Topics

Have a Question?

New Call-to-action

Conversations

Archives

see all

Subscribe

Disclosure

The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly into an index.

The MSCI EAFE Index (Europe, Australasia, Far East) is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.  

Third party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided at these websites. Information on such sites, including third party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.

Member FINRASIPC

Please review our Terms of Use

Commonwealth Financial Network®