"Kee" Points with Jim Kee, Ph.D.


  • Things That Take Your Eye Off the Ball
  • How Many Stocks? 


Things That Take Your Eye Off The Ball

The most important thing for an investor to do this week is to avoid the media hype as (1) the US and China resume trade negotiations (Monday), (2) the Federal Reserve announces its interest rate decision (Wednesday), and (3) July payroll numbers get reported (Friday). Bloomberg, for example, had a piece over the weekend titled, “Get Ready for the World Economy’s Biggest Week of 2019,” citing these three events. Here’s my quick take: As for a China/US trade deal, both have a lot at stake, but the current buzz is that China might prefer to wait until the 2020 election (with the hopes of a Democratic win) than deal with Trump, while Trump wants a deal sooner in order to facilitate re-election. That would give China the upper hand, but I’m not so sure. Most world leaders have acknowledged at this point that China doesn’t play by the rules with respect to intellectual property, so China will need to acquiesce on that sooner rather than later. It makes China a less attractive trading partner for all of the countries that it trades with, not just the US, and China certainly needs trade (access to global markets). Time also allows companies to rework supply chains in countries other than China, which would not be in China’s interest. So I’m neutral as to who can wait on a trade deal and who cannot between China and the US. As for the Fed, in a nutshell I think that the Federal Reserve sees the “neutral” rate closer to 2% than 3% these days (3% was the number cited a year ago), but I feel that Trump had made it awkward for the Fed not to raise its target rate last December (2018) to 2.25%-2.5%. It wouldn’t surprise me to see the Fed take that hike back this week, but that’s about all I expect from the Fed. As for Friday’s payroll numbers, this, too, in my opinion has become way overhyped. Unemployment is low, participation rates have flat lined, and GDP growth last week at 2.1% came in a bit above expectations. My advice, from an investment perspective, is to think about this week less in terms of “World Economy’s Biggest Week in 2019,” and more terms of, “things that take your eye off the ball.”


How Many Stocks?

Mutual funds and hedge funds are experiencing a record overlap of holdings in the top 50 stocks (Wall Street Journal), leading many investors to experience more company-specific risk. A general result of modern finance is that higher returns usually don’t come without taking higher risk, although higher risks don’t assure higher returns. In my years as a portfolio consultant, I often saw portfolio managers taking on extra risk by making bigger bets on fewer companies. That begs the question, “just how many stocks should a well-diversified investor own?” If you own too few stocks, then the risk of a single-stock blow up (happens all the time!) contributes more to the risk of your portfolio than it adds in potential return. If you own too many stocks, then the reduction of risk from owning more individual stocks is not worth the foregone potential returns that the portfolio suffers by being too diluted, i.e. it doesn’t really matter if a stock triples if it is only 1 of 5,000 in a portfolio. Of course, financial economics has a lot of statistical metrics and terms used to describe and measure risks and returns and the trade-offs between the two, but that’s the gist of it. So what’s the right number of stocks to hold in a portfolio? When I was in graduate school, I saw numbers cited as low as 12. But the optimal number of stocks in a portfolio seems to be increasing, at least that is my reading of the peer-reviewed research. According to Princeton professor Burton Malkiel, increased volatility means that investors might need to hold as many as 200 stocks to get the same level of diversification that they got with 20 stocks in the 1960s. The bottom line? I see very little research advocating fewer than 50 stocks. To quote Malkiel, “If you think that you can do an adequate job of minimizing portfolio risk with 15 or 30 stocks, then you are imperiling your financial future and the future of those who depend on you” (The Irish Times).