Predicting the Market Proves Fruitless, Just Read the Chart

Lots of analysts work hard at trying to figure out what equity markets are going to do.  These people pour over interest rates, unemployment figures, inflation (both producer and consumer), GDP growth and a trillion other statistics to try to predict how the U.S. and global economies will perform in the short, medium and long terms.

It’s a fun exercise.

The trouble is that, to quote George Bernard Shaw, “If all the economists in the world were laid end to end, they still wouldn’t reach a conclusion.” 

If you listen to the shouting heads on financial TV shows, you can hear just about any opinion you want, from reassuringly rosy to depressingly dire, although the pessimists are certainly in the ascendant at the moment.  Large institutional investors actually make investment decisions based on this data-heavy guesswork, shifting their allocations to regions, countries, sectors and stocks to take advantage of what their crystal ball tells them.  Some of them even make money at it.

There are also many analysts who base their investment recommendations on statistical trends in the companies themselves.  These fundamental analysts look at trends in the company’s revenues and earnings, using these numbers to generate a swarm of statistical measures (and their acronyms), including return on investment (ROI), return on equity (ROE), return on assets (ROA) and their accompanying ratios (and their acronyms), like price to earnings (P/E), price to earnings growth (PEG), and price to free cash flow (PFCF).

These analysts evaluate a stock primarily for its cheapness, figuring that an undervalued stock will eventually be discovered by investors, who will then bid it up to its fair market value.

Read the chart
If there is one way in which the Cabot approach to growth investing (as opposed to value investing) differs from that of most advisors, it is that we pay more attention to what investors are actually doing.  We do that by looking at the chart that shows price movement, moving averages and volume.

Leaving out the double bottoms and tops, heads and shoulders and other classic chart patterns, here are a few basic principles of chart reading. 

  • Stock with rising price on increasing volume = bullish.  This shows that an increasing number of buy orders are being processed, indicating a positive change in investors’ appetite for the stock. 

  • Stock with rising price on decreasing volume = caution.  A stock that is rising for a few weeks, but has falling volume, is losing momentum.  You need to be careful about buying into such an advance.

  • Stock with falling price on increasing volume = warning.  Once a stock starts to decline, investors can get nervous and sell, swelling the volume and accelerating the drop.  If volume is higher than average, it may also indicate institutional involvement in the flight.  A big decline on volume that’s triple a stock’s average is a classic sell signal.

  • Stock with falling price on decreasing volume = mildly hopeful.  This can be a useful signal in deciding whether to sell a declining position.  If volume is dropping, especially if the stock is near a price support level, a downmove may be losing steam.  You don’t want to ignore your loss limits, but if a call is marginal, this can be a good clue.

Remember that high-volume trading often indicates moves by institutional holders, and that they’re the ones who really control the market.  They also tend to take time to enter or exit positions, so intense buying (or selling) tends to persist.

It’s always useful to go back and look at the charts of stocks that have made big moves, either up or down, looking for the volume clues. 

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If you pay much attention to financial markets, you will be deluged every day by statistics.  These numbers reflect the continuing sorry state of the U.S. housing market, the anemic growth of the U.S. economy, unemployment, savings, bad mortgage debt, etc.  There are so many numbers, in fact, and politicians and commentators are so good at spinning them, that we become reluctant to pay much attention. 

Leaders can come to rely on the abstractness of statistics.  Joseph Stalin, a man who routinely purged his enemies (and potential enemies) in their thousands and millions, famously remarked that “A single death is a tragedy; a million deaths is a statistic.”

On the other side of the coin, George Bernard Shaw commented hopefully that “It is the mark of a truly educated man to be deeply moved by statistics.”

It’s hard to know what to think about lots of statistics, especially tragic ones.  It may be, as Stalin believed, that big numbers numb us to the importance of horrific occurrences.  Alternatively, perhaps education can train our imaginations to recognize the human consequences that lurk behind the bland numbers.

Grand Theft Auto (No, Not the Game)

I recently saw a newly-updated list of the most-frequently stolen cars in the U.S. that spoke volumes to me about the present state of the economy. 

It used to be that the most-stolen list would tell you what the hottest cars were, with Corvettes, Lexuses and other expensive wheels trading places from one year to the next. 

Not this year.  The top target for today’s car thieves is the apple of the tuner-car enthusiast’s eye, the 1995 Honda Civic, followed by the 1991 Honda Accord.  The venerable 1989 Toyota Camry occupies third place, followed by the 1997 Ford F-150 pickup and the Chevy C/K 1500 pickup.

It’s not until you get to the sixth spot on the list that you get anything that might be considered upscale (the 1994 Acura Integra) and the seventh position before you get any model from the 21st  century (the 2004 Dodge Ram pickup). 

The list rounds out with the 1994 Nissan Sentra, the 1988 (’88!) Toyota pickup and the 2007 Toyota Corolla.

The reality behind this list of woe is that car thieves are a practical lot who know their customers very well.  And their customers are either just folks looking for good, reliable transportation, or chop shops trying to keep their customers’ aging wheels on the street.  In tough economic times, anybody who owns a 1988 Toyota pickup is a potential customer for a new (used) catalytic converter, front fender or rear-view mirror.  The need to keep a high-mileage beater on the road trumps the desire for a flashy new set of wheels, and grabbing a vintage sedan that can be broken up for parts in an hour or so is a lot less risky. 

I still have a few questions I’d like to ask about how the Most-Stolen list was put together.  For instance, was the list constructed on the basis of absolute numbers, or was it weighted to find the makes and models that suffered the highest percentage of loss?  Also, it used to be that the big cities of the Eastern seaboard were the hot spots for car theft; has that changed, too?

Mark Twain said there were three kinds of lies: lies, damned lies and statistics.  Reading the reality behind statistics can help to keep them honest.

Sticking with an automotive theme, my investing idea in this issue is America’s Car-Mart (CRMT), a used-car company with 92 locations in eight states: Alabama, Arkansas (34 locations), Indiana, Kentucky, Missouri, Oklahoma, Tennessee and Texas.  Using the tag line “Drive Easy,” Car-Mart specializes in what it calls “affordable vehicles for hard working people.”  Since its founding in Rogers, Arkansas in 1981, the company has targeted people with limited or bad credit, putting them behind the wheel when they might have been turned away at other dealerships.  Three-quarters of Car-Mart’s locations are in towns with populations of 50,000 or less.

Car-Mart’s emphasis on the lower end of the automotive economic spectrum carries through to its policies.  If customers see a car they want, but are short on cash, many locations allow them to put the car on layaway for six weeks so they can get the down payment together.  The buyer’s protection plan offers a five months/5,500 miles warranty.  And Car-Mart’s Web site emphasizes that they will trade for anything of value, from electronics and household appliances to farm animals.

America’s Car-Mart isn’t what you’d call a blue-chip company, but catering to the low end user has its rewards, especially during hard economic times.  The company’s second quarter results featured an outstanding 333% increase in earnings on a 29% rise in revenues.  This is an uncharacteristically robust gain, and not like any other quarter in the company’s history. 

The stock has attracted lots of attention by soaring from a January low of 9 to 20 in recent trading.  That’s a more than 100% rise in less than six months and the stock’s highest trading level in more than two years.  Economic stimulus checks put cash in buyers’ pockets, and there’s evidence that some higher-end customers are trading down. 

It’s easy to be skeptical about CRMT, but its down-market orientation and the fact that it finances 90% of its sales through its own facilities makes it less vulnerable to the credit crunch that’s hitting new car sellers.  Even at its current highs, the stock’s P/E ratio is still a very reasonable 15 and annual sales are well over the company’s market cap. 

And those volume clues I told you to look for on the chart?  Well, following the company’s announcement of its excellent earnings, the stock–which usually averages a trading volume of 195,000 shares a day–hit volumes of 1.2 million and 1.6 million shares.  That’s a positive sign, and it may well signal greater gains to come.

Editor’s Note: If you’ve been following our advice about how to weather the recent slump in global stock markets, you should have a lot of your growth stock money sitting safely on the sidelines.  Cash is your friend when the bears are on the rampage.  But if you’re growing impatient and need a way to keep your investing mind occupied, just do what gardeners do in January: build a watch list.  Cabot China & Emerging Markets Report can help you prepare to grab the leaders of the next bull market in the hottest economies in the world.  Just click on the link below to start a no-risk trial subscription.


Paul Goodwin
For Cabot Wealth Advisory


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