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Relative Strength Or Diversification? You Better Choose Carefully

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I'm going to say that you need elements of both, although you're going to want a much bigger helping of relative strength.  Too much diversification can be extremely unhealthy, there needs to be a balance.  Let me give you a quote about diversification from one of the best investors of all-time:


"Diversification is a protection against ignorance.  It makes very little sense for those who know what they're doing."

- Warren Buffett

Mr. Buffett, I completely agree with you.  Conventional wisdom says to diversify, to invest in all areas of various asset classes so that stronger areas can protect you from weaker areas.  But I honestly view it the other way.  I believe the weaker areas are simply killing your stronger investments.  Knowing that the U.S. Dollar Index ($USD) has been rising for 8 years, for example, tells me to avoid energy (XLE) and materials (XLB) stocks.  There'll be a time for those stocks, but it's not now:

When you buy the SPY (ETF that tracks the S&P 500), you most certainly diversify.  But by doing so, a significant amount of your money is being invested in energy and materials.  Look at that chart above.  A chunk of your money is underperforming badly.

In a day and age where we order breakfast and tell our server to "hold the potatoes" (bad example, I would never do that!) or call our cable company and ask them to cancel HBO, why can't we call our broker and say I'd like 500 shares of the SPY, but hold the energy and materials?  Wouldn't that be great?  Then when the XLE and XLB begin to outperform again, we could simply add them a la carte.

Honestly, it's not hard to be a better-than-average investor.  But you have to be willing to gain a little knowledge and do a little homework.  You don't need a PhD.  You don't need 48 hours in a day.  You just need StockCharts.com and a few ChartLists.  Ok.....and maybe me and my fellow bloggers.  I'm not kidding.

Wall Street preys on those who mindlessly buy diversified ETFs.  Since part of your money is spent buying areas of the stock market that Wall Street hates, they're more than happy to short those shares.  Those proceeds from shorting are then used to buy stocks in outperforming areas.  They make a fortune and then preach to us to diversify.

Whatever.

Stick with what is working until it doesn't work any longer.  That probably seems obvious and it is.  Take a look at MSCI, Inc. and the specialty finance group ($DJUSSP):

When the overall market sold off in May, both MSCI and the DJUSSP struggled and consolidated a bit, but check out that relative strength!  And when the buying resumed this past week, the DJUSSP:SPX ratio and the MSCI:SPX ratio both broke out to new highs.  Wall Street tells us the stocks we should own, but we're too busy diversifying to "protect" ourselves.  Look at that chart again.  The DJUSSP is one of the best performing industry groups relative to the S&P 500 and MSCI is one of the best performing stocks relative to its specialty finance peers.  Why not own it and outperform portfolio managers everywhere?

I want you to join me for a special webinar, "The Power of Relative Strength", on Monday, June 10, 2019 at 4:30pm EST.  I am going to cover every industry group and give you my opinion as to whether you should consider buying stocks in each industry.  I'll also discuss a few of the stocks that are currently in my Model Portfolio, including MSCI.  Since I began publicly announcing (on November 19, 2018) my Model Portfolio, which holds 10 equally-weighted and top performing stocks, check out its performance vs. the benchmark S&P 500:

S&P 500:  +6.79%
Model Portfolio:  +39.69%

On May 19th, when my last selections were announced, I added two additional portfolios - an Aggressive Portfolio that holds 10 of the best performing small- to mid-cap stocks and an Income Portfolio that holds large cap, more defensive and income-oriented stocks for those seeking more safety.  Here's how they've performed (and compared to the S&P 500) since that May 19th webinar:

S&P 500:  +0.48%

Model Portfolio:  +7.35%
Aggressive Portfolio:  +7.26%
Income Portfolio:  +3.31%

Relative strength, as a primary focus for stock selection, works and I'll show you how on Monday.

The Monday event is being hosted by EarningsBeats.com and there's a small $7 30-day trial subscription, but it'll be well worth it.  CLICK HERE to register and for more details.  I'd love to have you join me!

Happy trading!

Tom

Announcement from the Author

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Tom Bowley
About the author: co-founded Invested Central in 2004 and served as the site's Chief Market Strategist for more than 10 years. Invested Central provides stock market education and guidance for those interested in making their own financial decisions. During his tenure at Invested Central, Tom co-hosted Market Open LIVE, a national radio broadcast that covered many of the largest markets across the U.S. In addition, he has spoken at various conferences throughout the United States and Canada and has taught thousands of traders across the globe how to trade equities more wisely with an emphasis on managing risk and intermarket relationships. Learn More
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