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Confessions of a Money Manager: Beware 'hot' stock sectors

Ray Unger  —  5/16/2008 10:45 am

One trader said to the other, "You know that can of sardines you sold me? They tasted awful!" To that, the second trader replied, "You fool, those sardines weren't for eating, they were for trading!" Unfortunately, sometimes investors fall for this kind of trading mentality.

Conceptually, we know we should buy quality goods, but how can we tell the rainbow trout from last week's smelly fish? Good question. Let's start with a few simple thoughts.

1. Don't chase last cycle's winner. Now this is a tough one to follow, especially if you own a winner. Those who held tech stocks during the late 1990s made a fortune. But you had to be incredibly smart or lucky to sell at the highs to keep those profits. What some did, however, was adhere to a clinical approach to investing -- rebalancing. That means shaving back those stocks or economic sectors that bulge out of our proportional guidelines we set for ourselves. Unfortunately, what often happens is that we buy more of what's performed the best. That increases our risk. That's what happened to tech investors in 2000, to real estate investors in 2006, and could be happening to today's energy and commodity investors.

2. Look at your fellow investors. Investments actually have personalities. That's right. They reflect the people who buy and sell them. Moreover, these personality traits change. It wasn't that many years ago, for example, that oil and natural gas futures were bought and sold mostly by producers and consumers with a few speculators thrown in to provide liquidity. Today, speculators dominate that market and they trade in the billions based on the latest sound bites heard on news outlets. If you're a speculator, you're in your element. But if you're not, your risk meter should be flashing red.

3. Investigate the substance of the investment. The Internet has clearly hurt the telemarketing hucksters who push "opportunities of a lifetime" on unsuspecting investors every day. They e-mail or send fax sheets or call us on the phone with investment ideas that are sure to double or triple in short order. One of my clients was so hot to buy one of these ideas that I went to the Internet and found that the company had virtually no sales, or little prospect for near-term earnings. I called the company and asked to speak with the president. He was kind enough to tell me that a stock promoter "pumped up" his stock and warned me not to invest. Over the next several months the stock settled back to where it was. The touting broker probably left the scene.

4. See if there are income opportunities available. If you don't own what's been hot in the market and you just have to buy in, then look for an income-producing alternative. Gold, for example, had jumped to over $1,000 an ounce after languishing for more than two decades. If you just can't resist it, try buying a gold-oriented mutual fund like First Eagle SoGen Gold Fund (FEGIX $24.70). Last year it paid shareholders $1.80 in cash because it owns shares in gold mining companies that pay dividends. Likewise, if you want to speculate in oil and gas, buy an energy trust like Enerplus Resources (ENR $47.12). Its May distribution was 41 cents a unit. That's an annualized yield of just over 10 percent. The same applies to real estate -- buy REITs that pay dividends.

5. Remember yesterday's "hot" idea. Sometimes I think investors take amnesia pills before they invest. They jump from one bubble into another without batting an eye. Do any of them remember how hot technology was in the 1990s? How hot real estate was just a few years ago? Do any of these investors think the oil and commodity price run-up has any similarity with tech or real estate? I guess not.

If you follow the traders, good luck. You'll need it. If you allow the traders to concoct the investments in your portfolio, over time it will almost certainly have a fishy odor.

Ray Unger is chairman of Forward Investment Advisors in Madison. He can be reached at 833-9400.

Ray Unger  —  5/16/2008 10:45 am