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Guru Investor / John Reese3/21/2008 12:01 AM ET

In tough times, stick to your strategy

You can't make money in the market based on what your stocks did yesterday. I'm rolling over half my portfolio based on what they'll likely do next.

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More interest rate cuts, $110-a-barrel oil, the buyout of once-revered Bear Stearns (BSC, news, msgs) -- the last couple of weeks have been wild ones on Wall Street, and the market has reacted as you'd expect. Day-to-day swings of 2%, 3%, even 4% in the major indexes have become a lot more common of late, with intraday volatility even greater.

Big swings in the market can cause many investors to start getting goofy, playing hunches and jumping in and out with each day's emotional overload. Every big "up" day is seen as the potential start of a new bull run, and every big "down" day is seen as a sign that disaster is near. And the higher the emotions run, the worse decisions people tend to make.

That's why I'm sticking to my guru-based investing system. So, just as that system requires, I'll be rebalancing my portfolio today (I rebalance every 28 days). And not surprisingly, given all the recent movement in the market, the five guru-based computer models I'm using for this contest are finding a number of good new values. In fact, I'll be replacing half of the 20-stock portfolio.

Two of the stocks I'm selling -- Chico's FAS (CHS, news, msgs) and American Eagle Outfitters (AEO, news, msgs) -- are retailers, a group that helped me get off to a fast start in January and February in Strategy Lab. But while some retailers continued to help me over the past month -- Bed Bath & Beyond (BBY, news, msgs) was up about 6.6% as of Thursday afternoon -- these two got hit hard, as in double-digit-decline hard, and my models are now finding better prospects elsewhere.

The losses from American Eagle and Chico's were tempered by some nice gains from NewMarket (NEU, news, msgs), a specialty chemicals maker, which jumped about 10% after I added it in my last rebalancing. While it's been a strong performer, my models think there are now better opportunities in the market, so I'm taking the profits on it.

Don't hold the losers

You might be wondering why I'm cashing out of several losing positions even though many have only been in my portfolio just four weeks. Why not wait to see if they bounce back, particularly given the fact that I preach long-term investing?

That's a very good question and one that really gets to the heart of my guru-based investing system.

My models are designed to identify the best values in the market -- based on a stock's price and underlying fundamentals -- at a given time. By cashing out of American Eagle and Chico's, I'm not saying that these stocks aren't going to turn around; in fact, they still get pretty good scores on some of my models. But since my last rebalancing, other firms have simply passed them by, either because Chico's and American Eagle's fundamentals have dipped or because those other stocks have improved.

At this point, the newbies more closely fit the profiles of stocks the models targeted, which means they have better prospects for growth than the stocks I'm selling.

The same concept is true for the winners I'm selling. NewMarket may well continue to climb (it also gets high scores from some of my models), but, looking at a broad range of fundamentals, my models think other stocks are now better positioned for bigger increases from this point on.

Essentially, my approach requires that you wipe the slate clean each rebalancing. How a stock performed last month or the month before isn't relevant anymore; what is relevant is how it is positioned now.

Yesterday is history

In a way, it takes the mentality of a closer in baseball. They say that closers -- the relief pitchers whose job it is to secure leads late in the game -- need to have short memories. If they blow a lead and their team loses the game one day, they can't take the pitching mound thinking about it the next day. You can't win yesterday's game by what you do today. Instead, you refocus on where you are now, and you do what gives you the best chance of winning given the new circumstances you find yourself in.

In the stock market, that means being able to periodically reassess which stocks best fit the proven, fundamental-based, long-term approach you're using. And because a stock's fundamentals and price change frequently, that, in turn, means that I might not hold a particular stock for the long term.

I will, however, always hold the stocks that best fit my long-term strategies' criteria, because those are the stocks that I've found are most likely to make future gains. That notion of sticking to a strategy for the long run, rather than sticking with individual stocks based on hunches or the desire to make up losses, is my definition of true long-term investing.

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John ReeseGuru Investor John Reese

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