The Problem with Hunches

Woodworking

The Problem with Hunches

Today’s Stock Pick 

I’m a woodworker, but my style of woodworking doesn’t generate much sawdust. I don’t use power tools and I don’t buy lumber. My raw materials are provided by the firewood, mostly oak and maple, that fills my New Hampshire woodshed, and my basic tools are knives and gouges. I’m so committed to my simple tools that I feel like I’m cheating when I pick up a handsaw or a plane, but I deal with it.

I guess you’d say that I’m a woodcarver, but I don’t work with spruce or basswood or any of the other softwoods that are happy to be scooped like ice cream. I also don’t carve little figures of Santa Claus or fishermen or birds or chains, not that there’s anything wrong with those admirable subjects.

My projects mostly begin when I look at a piece of firewood that I’m about to throw onto the fire and I see something in the grain or the color or shape of the wood that suggests that there might be something interesting in there.

I’m not mystical enough (or delusional enough) to suggest that the thing hidden inside the wood actually speaks to me. But somehow the notion takes root in my brain that there might be a tiny chair or a table or a spoon to be found in the chunk of dead tree I’m holding.

Accordingly, I give the piece of firewood a reprieve from the flames, put it aside and go looking for what I thought I saw in it.

 

I don’t even average one project a year. There is too much lawn and garden work when the days are long, and in the colder months, my wife is not fond of the gnawing-rodent sound of a carving knife taking tiny bites of seasoned hardwood, and that irritation eliminates the time we spend sitting in front of the idiot box together.

But the compulsion to create is strong, and I keep at it.

My choice of projects really amounts to a hunch. I suspect—on the basis of absolutely no evidence—that something good will come of the choice I’ve made. Plus, if the project doesn’t turn out, the failure can still serve its original purpose in the fireplace.

Many people like to make decisions based on hunches; sometimes they’re called “educated guesses” and sometimes “feminine intuition.” And there’s some experimental support for the idea that snap judgments often prove quite sound.

The vagueness of hunches only becomes a problem when you start to use them to decide how to put real money at risk.

This happens all the time in the stock market, most frequently when potential investors decide that they know what the stock market is going to do in the future. Or they read about a stock and they just know that it’s going to be a real moon shot.

Right now, the investing world is filled with people who know that markets are just about to fall off a cliff. Maybe they have some evidence (a guy on a cable channel in a really good suit or an astrologer who’s never, ever been wrong), or maybe they just feel it in their bones that things are going to get worse and unimaginably worse.

These people who are prepared for the end of the world as we know it are offset—though not currently balanced—by a group of equally convinced investors who just know that the markets are gathering themselves to spring skyward in a massive rally that will deliver unimaginable wealth to anyone with the sense to see it coming.

All I have to say about this is that when we get a true consensus among investors that things are as bad as they could possible be and they’ll never get any better, that’s when the markets will turn back up. And ditto in reverse for the enthusiastic optimists.

I really hope I’m not harping on this too much. It’s easy to sound like a crank when you’re expressing skepticism.

But the long history of Cabot provides plenty of evidence that markets top when people are at their happiest and markets bottom when people are most depressed. That’s both a historical fact and a demonstrably logical certainty.

So the lesson there is to look at what the market’s doing, not what you’re afraid/hopeful that it will do. Any guess about the future of the market is just a hunch. And while hunches can lead to interesting and useful carving projects, they don’t really have a place in stock investing.

So, what’s the market doing? Well, this chart of the S&P 500 shows the August meltdown, the August/September wedge higher and the September retest of the August lows.

But the most interesting thing is the index’s push back on top of its 25-day moving average. If this move holds up, Cabot’s growth advisories could get a new buy signal as early as tomorrow. (All that needs to happen is for the lower moving average to turn decisively up.)

For those of us who have been watching the market for a while, that seems a little too easy. There’s still a ton of negative news and negative sentiment around.

But we don’t get paid to second-guess our market timing indicators, so we will do exactly what they tell us, and will start recommending a little more buying as long as the market’s medium-term momentum is up. And, as I said above, we’ll keep our hunches to ourselves.

NOTE: On October 14 (that’s a Wednesday), I’m trying an experiment. I’m going to be offering a chance to get a little free stock advice in a webinar called Lunch with the Analyst. At 1:00 EST, I will start off with a short review of what’s happening in the market (essentially what Mike Cintolo and I do in our Cabot Weekly Reviews). Then I’ll run down a few stock recommendations that I think look good.

Then the fun begins.

I will be taking questions from viewers on stocks they own or are interested in. You can send in your questions during the webinar, and I’ll get to as many as I can. If you send a question, please tell me the name of the stock, whether you own it or are just considering buying, and (if you own it) what your purchase price was. And you might also let me know whether you consider this a value, growth or income stock.

If this sounds like fun—I know the price is right (free!)—you can sign up for the webinar by clicking this link right here.

If enough of you take me up on this idea, it may become a regular thing. 

Lunch with Paul Goodwin

My stock pick for today is a Activision Blizzard (ATVI), a stock that was covered in Cabot Top Ten Trader on September 21. I like any growth stock with a good combination of story, numbers and chart, but I was especially interested in this one, because I know World of Warcraft has been a huge earner in China.

Here’s what Mike Cintolo had to say about ATVI in that issue.

“This is a stock we recommended a few months ago, and it just keeps humming along. The latest bit of good news is that Activision’s newest game, Destiny: The Taken King, just set a record for the highest number of first-day downloads in the history of Sony PlayStation consoles. That’s important for Activision because it gives the company a worthy successor to Call of Duty, Skylanders and World of Warcraft, popular games Activision developed that no longer enjoy the same kind of sales growth they once did. Destiny’s record-breaking success should help Activision build on its second-quarter earnings momentum: earnings per share improved 117% year-over-year last quarter, and beat consensus analyst expectations on both the top and bottom lines. Two other new franchises that Activision created—Heroes of the Storm and Hearthstone—have helped spur the company’s recent growth. Along with the Destiny franchise (The Taken King is the franchise’s third installment), those three had a combined 70 million registered players at the end of the second quarter, generating $1.25 billion in non-GAAP revenue to date.

“ATVI shares were barely affected by the recent market downturn. The stock started the year at 20, shot up to 23 in February, and after trading sideways for three months, inched up to 26 in early June. It met resistance there until the stellar second-quarter earnings were released in early August, prompting a jump all the way up to 29. It dipped back down to 26 during the late-August correction, but within a week was back up to 29. Last week’s record-setting news pushed ATVI to another new high at 31. You can buy a little on any weakness and set your losses at around 27, which is the current 50-day moving average.” 

Sincerely,

Paul Goodwin
Chief Analyst of Cabot China & Emerging Markets Report
and Editor of Cabot Wealth Advisory

Comments