Studies in CAPSology

You might have noticed, over there in the right-hand column, a widget from the Motley Fool’s CAPS website. CAPS hosts an ongoing stock-picking competition, forum, blog community, and other such content. My CAPS score has plummeted nearly 30 points this week, as the market has rebounded somewhat on the heels of the Fed’s discount-window action last Friday. I must admit that the composition of my CAPS portfolio was not a deliberate attempt at weatherproofing, but rather reflects my long-term view that the stock market is due for a major correction, and in such a scenario, it is better to hold large-cap stocks with a few strategic shorts thrown in. The Fed’s action has caused a short-term equities rally, and what seemed like a strategy ready to pay off now looks a tad out of step. But despite the losses, I’ll stick to it for the time being, as I think this rally will be short-lived, and I believe those who expect quick and drastic cuts in the federal funds rate this fall will be disappointed. Corporate earnings, which have been very healthy, will begin to suffer toward the end of this year, and that combined with steady interest rates will put a lot of downward pressure on the stock market for 2008. At least, so goes the theory.

This perspective, however, still has not cured me of my sweet tooth for micro-cap biotechnology firms, and you will notice several small biotech companies in the portfolio, not that I think all of them will end up hitting the big time (surely most will not), but even if one makes a breakthrough, the potential upside is worth the risk, so long as the others don’t completely tank in value.

I should note here that my CAPS portfolio bears little resemblance to my real-world portfolio, which is much smaller in terms of the overall number of companies. Despite the wisdom of professional money managers, my real-life portfolio is heavily concentrated into a half-dozen or so positions. It’s not that I think portfolio diversification is a bad idea—it’s not, particularly for passive investors—but I am relatively young with, God willing, many prime income-earning years ahead of me. It makes sense for me to take on more risk, as opposed to someone nearing retirement age who might need to be more conscious of capital preservation. For my part, I’d rather invest heavily in my best investment ideas, rather than dilute them with holdings that are designed merely to ‘diversify’ my portfolio. Having said that, half of my real-world investments are locked into a crappy 401(k) anyway, so even then, we’re only talking about me actively managing half of my investments. For the record, my ‘active’ investments have greatly outperformed my 401(k), even (especially) during this period of market instability.

Where I find CAPS useful is in its role as a proving ground. I can experiment with different stocks and portfolio allocations, and it gives me an excuse to follow closely a group of 40 to 50 stocks, some of which might eventually make it into my real investment portfolio. If you have any interest in investing, or just like to follow the markets, CAPS is a great way to learn and participate at the same time.