Written on 28 June 2013 by Kris Sayce

We won’t say we told you so…OK, yes we will: we told you so.

Over the past few weeks most of the talk around the financial markets has been how bad things are…how the sky is falling in.

‘The yield rally is over’, ‘Sell in May and go away’, ‘Stocks will never go up again’.

Yawn. Let’s get a few things straight: the yield rally isn’t over; buying in May over the long term is actually better than not buying stocks at all; and that’s right, stocks are going back up again.

Our old nemesis, Commonwealth Bank of Australia [ASX: CBA] is now only about 5% from its peak. Odds are investors will begin playing the relative value game again soon, so that the other banks and dividend payers will return to their May highs.

Look, we’re not saying investing is easy. It’s far from that. We’re just saying that the investing environment has changed in recent years. And if you don’t concede that and adapt to it, you’re heading for a world of missed opportunities that could make a big difference to your retirement…

But what exactly do we mean when we say investing has changed? The following illustrations should explain everything. This is how investing used to work:

Source: Port Phillip Publishing

OK. Thats a bit of a simplification. But that was pretty much everything in a nutshell.

Yes, you still had to consider interest rates. After all, the two things that move share prices are earnings and interest rates .

But the actions of the central bank really were a secondary thought. Over the past 15 years, and especially the past five years, that has changed.

Now investing looks more like this:

Source: Port Phillip Publishing

Now it’s not just forecasting earnings, you need to think about the impact that will have on the market…and what impact that will have on the central banks…and what impact that will have on the market…and the impact that will have on earnings.

It’s a vicious circle and a huge bind for investors. The natural reaction is to think, ‘Why bother? It’s all too hard.’

But we take the opposite view. Rather than trying to make sense of the ridiculous, we’re simply turning back the investing clock. We know it’s impossible to guess exactly how the markets will react to a Fed statement or an economic release.

So instead, we’ve gone old school…we’ve bucked the trend by forgetting about central bankers and policy makers. We’ve gone back to analysing individual companies…

Going Old School With Your Investing

If you ask most financial advisors theyll tell you the best place to put your money during market volatility is in the biggest and best blue-chip stocks .

To some extent we cant argue with that. Weve long said that you should have around 20% of your investments in dividend-paying stocks .

That’s great because it means the dividend stocks will pay you to hold them even if you don’t get capital growth. During the past few months we told you to buy more dividend stocks, even though most folks said dividend stocks were a bubble.

However, dividend stocks are the only blue-chip stocks we’d hold for the long-term during a volatile market. Because as the past year has shown you, blue-chip growth stocks aren’t immune from big falls.

It means that investors who invested for the perceived ‘safety’ of blue-chip stocks are nursing some big losses. The better approach is to look at the opposite end of the risk scale.

Doing the Opposite to What You’ve Always Thought

That means looking at speculative stocks. They could be small-cap. mid-cap or large-cap stocks, it doesnt matter.

The idea is that youre looking for the biggest bang for your buck. Think about it: whats the best you can hope for with a blue-chip growth stock? 10%? 20%?

Look, its possible you could double your money with a blue-chip growth stock. But were prepared to bet against that in this environment.

Thats simply because big blue-chip stocks rely more on interest rates, central bank and government policies. They also have an established customer base they need to maintain. Even a slight economic downturn can turn a profit into a loss.

But at the other end of the scale, among the speculative stocks, its a different story. Most of these companies dont have any revenue or profits to lose.

Or if they do theyre still at such an early stage of development that the growth potential far exceeds the risk of a loss.

We’re talking about companies working on a breakthrough in regenerative medicine that ‘turns back the clock’ on your body, or a company that could revolutionise the manufacturing sector and destroy China’s dominance.

Think about it this way. You could either have a bunch of your cash at risk by punting on a 2030% gain on a blue-chip growth stock, or you could keep most of your cash (relatively) safe in the bank and just use a small part of it to punt on high-risk stocks that could bag you a gain of 100%, 200% or 500% .

Dont Vegetate, Speculate

In short, its about risk versus reward and doing what you can to reduce your exposure to central bank influence.

The way we see it, if a medical or technology company breaks through with a revolutionary new idea it will have a big impact on the share price regardless of the broader macro-economic environment.

You cant necessarily say the same thing about blue-chip growth stocks.

We admit this is a controversial view. Most financial advisors will disagree with this approach. But the reality is that investors cant afford to invest in the conventional way in this volatile market. And neither can they afford to avoid the market completely.

The market volatility you see today will still be around in 10 years. Ask yourself, can you really afford to sit out of the stock market for that long? And as for the alternatives, a pile of cash or gold wont build you a lasting retirement fortune .

As we’ve shown you before, the best way to build lasting wealth is to invest in businesses. The only point remaining is in which businesses should you invest?

We’ve stated our view. In a market dominated by central bankers and policy makers the best way to grow your wealth is to avoid the markets most influenced by them.

The best way we can put it is this: Dont Vegetate, Speculate .

Cheers,

From the Port Phillip Publishing Library