Investing Club: The best investors balance a long view with a short focus. Here's how to do it

Published Fri, Mar 25 20222:05 PM EDTUpdated Fri, Mar 25 20223:35 PM EDT

Choppy markets are tricky for long-term investors. You need to stick with the game plan, ride out temporary downswings, bury your emotions. But investors also can't simply ignore the here and now. Russia is at war with Ukraine, gas prices have soared, and the Federal Reserve is planning to aggressively raise interest rates to combat the kind of inflation the U.S. hasn't seen in decades. These are all meaningful events that will impact markets and many companies for months or years to come. The solution: The best investors do both — maintain a long view while also focusing on the shorter term. While those two focal points may seem diametrically opposed and difficult to juggle, balancing them is, in fact, the key to navigating volatile markets. Here are some strategies to help you get into the proper mindset. Lessons from Covid lockdown As we transitioned out of the lockdown caused by Covid, we talked about the need to maintain a so-called barbell style portfolio. On the one end, we had stocks that benefited from stay-at-home dynamics. On the other end, we had stocks that benefited from reopening trends. The thinking was that whatever the latest headline, we would have one group that we could book profits in and another in which we could add to our positions. Fundamentally, we felt every position, regardless of which side of the barbell it was on, had strong underlying fundamentals and an attractive outlook. It just had different time horizons. Put another way, we never want to own a position if we don't have a positive view of the company or the stock's valuation. We are long only investors, meaning we hope all our positions will eventually go higher. We don't bet against stocks with shorts or with options. Tweaking our barbell style In the current volatile market, we can also apply this barbell but in a slightly different way. While we aren't thinking in terms of Covid lockdown versus reopening stocks, we can think in terms of economic sensitivity and duration. Economic sensitivity refers to the impact the strength of the economy will have on earnings. While all companies are inherently tied to the economy — given that the flow of capital is interconnected — some businesses are far more sensitive than others. Duration refers to how far out we have to look before any earnings become material. This may also be reflected in a higher valuation multiple. The further out the earnings are — and therefore the more we have to discount them to get to a present day value — the "longer duration" the stock is. We're not going to have a perfectly clean barbell — we didn't during the pandemic shutdown either — because economic sensitivity and valuation multiples don't have a perfectly consistent correlation. However, what we will attempt do is provide some food for thought that we hope will help members maintain their longer-term views while sharpening their ability to focus on shorter-term dynamics. For the sake of this exercise, let's consider one end of the barbell to be the "long-term view," and on the other the "short-term focus." Doing this will help us better think through which names are more deserving of our attention right here, right now, and which ones we can manage more passively. Long-term view stocks First the long-term view: These stocks will be the more passively managed names and identifying them is what will free us up to focus on those that require more active management. On this side of the barbell is where you're going to place those secular growth names. These stocks have shown an ability to execute and grow through any environment but don't usually see an outsized earnings boost when the economy heats up. They benefit from a strong economy but they don't go from zero-to-60 the way an oil exploration and production stock such as Club name Devon Energy (DVN) might. On this end, we might put names like Club names Alphabet (GOOGL), Amazon (AMZN), Salesforce (CRM), Nvidia (NVDA) and Apple (AAPL). Like we always say about Apple: Own it, don't trade it. So that stock is, of course, going to be among the more passively managed ones when the market environment becomes more difficult to navigate. While we're still monitoring key events, in the short-term the market is going to do what it is going to do but we believe that longer term, these profitable companies — key word here is profitable — will all continue to see earnings grow regardless of what the near term brings. Google-parent Alphabet will continue to gain share in cloud, advertising activity will continue to move away from print and linear television toward direct targeting and YouTube. Amazon will also benefit from cloud adoption, a growing ad business and the ongoing shift toward e-commerce. Salesforce will keeping growing as companies increase information technology investments to compete with rivals. Apple will keep selling the single most important consumer device in the world — the smartphone — while growing its services' revenue streams, generating monstrous free cash flows and buying back shares. The heart of everything from cloud to cars to gaming and graphics will continue to be Nvidia, with its cutting edge hardware and rapidly growing suite of software. The stocks of these companies have taken a hit as price-to-earnings multiples contract. For the most part, however, none has seen underlying fundamentals deteriorate. As a result, the long-term view beats the near-term dynamics. Therefore, we can accept some pain here. Rather than ask ourselves what to do with them on daily basis, we'll take a more passive approach. They aren't bad names and our long-term view remains very bullish. They simply don't have their upside levered to the economy the way an oil company might. In some cases, such as with Amazon and Salesforce, higher multiples have kept some investors away. We'll keep our eyes on these stocks, adding to our positions on pullbacks and and rebuy shares we sold at higher prices. On the flip side, we can trim our positions should we feel greedy or need to raise some cash. We'll still monitor the earnings calls and conferences, read the industry notes and look out for newcomers, but we don't have to sit there constantly questioning our position, wondering when the music will end. In our view, the music in these names will keep playing for years, even decades to come. One last thing to note is that in a market that's volatile but isn't constantly throwing new lows at us, we can do our buying at a given level and step away. We discussed this in more detail previously when illustrating how we build a position . Consider our recent buy of Alphabet shares . During periods of market turmoil, we want to circle the wagons around the highest quality companies at attractive valuations, knowing that even if we aren't going to nail a bottom, longer-term we can rest pretty well assured that we will see higher levels than our purchase price. Put another way, we aren't going after speculative names in this environment, we need the stocks of companies that as a result of their financial standing and revenue resilience are ultimately in control of their own destiny. Year to date, the stock has, on decent volume, seen support come in four times around $2,500 per share. During that time, the company also put out a fantastic earnings release , which came on Feb. 1 after the closing along with an announce of a 20-for-1 stock split and a $10 billion share buyback. By March 4, the day we stepped in, we had already seen two of those $2,500 level buyers step in and the earnings release was in the rear-view mirror. We're never going to nail a bottom but we can target a buy around support levels. With the earnings serving to confirm our long-term view, we took a shot at around the $2,600 level — $2,628.56 to be exact. With our long-term view supported on a fundamentally strong quarterly update, we bought at a level we haven't seen in roughly nine months in a position that has about 4% weighting in our portfolio. We're done for now. We'll let this one do its thing knowing that other than looking for a new lower level to maybe nibble at, this position has been addressed and does not need daily attention. Short-term focus stocks By taking this more passive approach on a handful of names, we free ourselves up to think more critically about the names that do require more attention. These could be problematic positions we need to monitor and manage on a daily basis — such as our PayPal (PYPL), Facebook-parent Meta Platforms (FB), Wynn Resorts (WYNN) and American Eagle Outfitters (AEO) holdings. These are names we discuss daily and monitor like hawks, even if we're not constantly trading them. Some are names that are going to move on every macroeconomic reading, oil price swing, Covid lockdown, or update on Russia's invasion of Ukraine. In addition to those problem positions, we would put the economically sensitive industrials, financials and energy names — including Devon, Chevron (CVX), Nucor (NUE), Haliburton (HAL), Wells Fargo (WFC) and Honeywell (HON) — in the short-term focus camp. All of these names have increased leverage to economic activity. We may not be taking action in these "short-term focus" names every single trading day but they do require more attention. For example, an increase in infrastructure investing? That's Nucor. We have pretty aggressively booked profits in Nucor recently — here , here , here and here — as the stock notched new high after new high. While we still view it as the best steelmaker around and believe it will benefit from infrastructure investments we have to also be mindful that a bridge built today with Nucor steel isn't getting rebuilt again for another century. And as a steelmaker, it doesn't have a high-margin recurring revenue stream to fall back on. We still see more upside to near-term earnings than the market has been pricing in — the reason we took a position to begin with. It's also why we are now ready to let it run a bit before our next sale, not to mention significant buybacks and a growing dividend. However, it isn't going to be earnings growth for as far as the eye like, say, Google-parent Alphabet. As a result, we must actively manage the Nucor position and analyze it daily. So, when commodity prices are on the rise and investors are concerned with inflation, it's a name like Nucor that can push prices through to customers and protect margins that will outperform. Therefore, while we do expect inflation to come down over time, investors need to consider names like this during periods of high inflation, even if it requires more of our short term focus and a more active management approach. Given how strong Nucor has been during the inflation upswing — up roughly 35% year to date 115% over the past year — it's easy to tell that you don't want to have a large position on when the tide turns. The same can be said for Chevron, which we booked profits in — here , here , and here — as commodity prices rallied on increased geopolitical tension. While a move away from foreign energy should certainly provide a longer-term headwind, we have to acknowledge that a geopolitical premium has worked its way into commodity prices and as tensions hopefully ease, that premium will come out. There's also an increased risk that a misstep by the Federal Reserve can push the economy into recession. This would hit energy demand and have an outsized impact on a name like Chevron. Again, a recession is not our base case but it is a risk that has increased given the Fed's need to aggressively adjust policy to curb inflation. In the end, unlike say Alphabet, which is tied to secular growth trends such as cloud computing, targeted advertisements, online shopping, autonomous driving, and artificial intelligence in general, Chevron and Nucor are tied to commodity prices. As a result, while they are certainly going to be in the driver's seat during an economic boom, as commodity prices rise, they are more likely to be standing in the middle of the road, ready to get runover when the cycle goes against you. Before wrapping up our short-term focus analysis, we should note that the potential for getting run over is one of the reasons we're such big fans of Devon Energy's fixed plus variable dividend strategy. We know — and management knows given their hesitancy to increase production — that these elevated commodity prices won't last forever. One look at the forward curve, will tell you that. It's still in what's called backwardation, when prices further out in time are lower than those nearer to the present. However, in the meantime, they're taking advantage by correlating a large portion of the dividend to free cash flows and buying back a ton of stock. So, by the time the cycle eases, shareholders will have been hugely rewarded — and that has certainly been the case thus far with shares up over 40% year to date and more than 190% during the past year. This was the best performing stock of 2021 afterall. Bottom line Whether you are a full-time portfolio manager or an amateur investor, your time is limited. By identifying and separating names with unchanged long-term views from those more highly leveraged to current events, you can better manage your time. Consider our rule of thumb: For every position, you want to allocate one hour per week for homework. If you can identify the longer-term view names, you can perhaps whittle that down to 25 minutes per week — we're talking five minutes per day to check price levels and conduct a quick Google search for news updates — and allocate the other 35 minutes to more thoroughly researching and thinking through the short-term focus names. This is exactly how we do it for the Club. We don't discuss what we think of Alphabet each day. That would be a waste of time. We already know. Instead, we spend the bulk of our time discussing names leveraged to the current environment. We look at how that backdrop may shift in the near term and how we can best address problem positions. We look to build positions when warranted and to trim when the opportunity cost may simply be too great. (Jim Cramer's Charitable Trust is long DVN, GOOGL, AMZN, CRM, NVDA, APPL, PYPL, FB, WYNN, AEO, CVX, NUE, HAL, WFC and HON . See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. 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Traders work on the floor of the New York Stock Exchangein New York, U.S., on Tuesday, March 15, 2022.

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