SMSFs: get a cocktail, lie back and contemplate the future

In part seven of how to run an SMSF for newbies, we set up an Excel spreadsheet to focus your mind, so while everyone else is being distracted by portfolio optimisation, the efficient market hypothesis, the capital asset pricing model, Black Scholes, tapering, Syria, the Fed, Rudd, Abbott, yield curves and GDP, you're going to cut through the crap and concentrate on the only thing that matters to your SMSF, what stocks you hold and when.

You're also going to stop talking about "the market", average returns and diversification because you don't need to. If you focus on getting stocks right, the market will look after itself. You will not be making a lot of stock decisions based on the market, you will be making a lot of stock decisions individually that incidentally but efficiently translate into a market view without you even having to have one.

So, stock picking, how do you start doing that? Let me make it simple.

The last thing you start with is the PE or yield, or the chart, with cheap or expensive or the trend, in fact, for now, you don't even look at the holy grail, return on equity. In fact you're not interested in stocks at all.

At this stage what you need to do is grab a couple of cocktails, someone half intelligent and go and lie down by the pool, put on your sunnies, lie back and ask yourself this simple question: "What's going to happen next year that nobody expects" because that's where the money is.

Let me explain. At the end of any investment period, the end of the financial year for instance, you can produce a list of the 10 best performing stocks and the 10 worst performing stocks in the ASX 200 or the ASX 100 and list them in order of total return. When you see that list, what you will realise is that despite all the high-brow debate, financial theory, complications, opinions and incessant blah blah blah that absolutely the only thing you needed to know last year was what was on that list and that the only thing you need to know this year is what is going to be on that list.

How do we predict that? Simple. Over any period the stocks that move are not the stocks that do what they were expected to do but the stocks that do things that weren't expected. That's what you have to work out.

If BHP hits its consensus forecasts it won't be on the list. Share prices move on new information and by definition unexpected information, on surprises rather than on expectations. There is no money in consensus forecasts, in consensus PEs and yields, in what is expected and what is already discounted in the share price. The consensus doesn't move share prices, so don't waste your time poring over it, what moves share prices are changes in consensus and your job is to predict the unexpected events, themes and trends that will change consensus forecasts, change expectations and change share prices.

At this point it is not about stocks, think about the themes. Don't waste your time reading about yesterday, read stuff talking about what will happen, not what did happen. The future is where the money is, not in the past. Not in what everyone knows but in what everyone doesn't know. So ask yourself, "What does everyone expect?" and having answered that, ask yourself "Where are they going to get it wrong?"

So your job for the next week is to pour your cocktails and lie back and imagine, if you could go back now to the first of July 2012 and leave yourself a tip or two written on a Post-it note plonked anonymously on your own trading screen, what would it say? "The $A will fall" perhaps, or "Mining capex will peak" or "Interest rates will fall and banks will become proxy term deposits". Now ask, "What would next year's Post-it notes say?" What themes and events can you think of that will appear or persist beyond the expectations of investors this year that will surprise the market and make you money.

That's where the money is. In Post-it note predictions. The answer is in that cocktail.

Next week we'll tell you how to structure the thought process and take a crack at some predictions of our own to get you started.

Marcus Padley is a stockbroker and the author of sharemarket newsletter Marcus Today.