I recently finished an interesting book called The Invisible Gorilla. It has nothing to do with gorillas—it’s about the tricks our minds play on us. The name comes from an experiment the authors did in which viewers were asked to count the number of times people passed a ball. If you haven’t seen it, I recommend watching the video on their website (be sure to watch the video before reading the text underneath it).
That particular video demonstrates what the authors call “the illusion of attention”—we can miss things that are right in front of our eyes, even when we think we’re paying attention. However, the book also explains five other “everyday illusions” that are just as interesting: the illusions of memory, confidence, knowledge, cause and potential.
The authors’ discussion of each illusion reveals fundamentally wrong assumptions about the way our brains work, and the book is definitely worth reading if you’re interested in that sort of thing. One of these illusions—the illusion of cause—is particularly relevant to investors. The illusion of cause refers to the tendency we have to make causal connections between related facts. We do this often, and sometimes without realizing it. As the authors write: “Our understanding of our world is systematically biased to perceive meaning rather than randomness and to infer cause rather than coincidence. And we are usually completely unaware of these biases.” The authors’ most amusing example of the illusion of cause comes from the fictional town of Springfield, home of the Simpsons. They write:
“A conversation between Homer and Lisa in an episode of The Simpsons provides one of the best illustrations of the dangers of turning a temporal association into a causal explanation. After a bear is spotted in Springfield, the town initiates an official Bear Patrol, complete with helicopters and trucks with sirens, to make sure no bears are in town.
“Homer: Ahhh … not a bear in sight. The bear patrol must be working like a charm.
“Lisa: That’s specious reasoning, Dad.
“Homer: Thank you, honey.
“Lisa (picking up a rock from the ground): By your logic, I could claim that this rock keeps tigers away.
“Homer: Ooooh … How does it work?
“Lisa: It doesn’t work—it’s just a stupid rock. But I don’t see any tigers around here, do you?
“Homer: Lisa, I want to buy your rock.”
Obviously, most of us are a bit brighter than Homer Simpson. And our brains’ tendency to make causal connections can be very helpful—if you get sick every time you eat a banana, it’s healthy to assume you’re allergic to bananas. If you’re in the woods and a group of birds suddenly takes off, it makes sense to look around for a predator that may have spooked them (assuming it wasn’t you). However, we can get carried away very easily, without noticing it. And seeing causal connections where there are none can lead to bad choices—there are now a significant number of people who believe that vaccines cause autism simply because autism tends to emerge around the same age at which children are vaccinated (even though no scientific study has ever found such a link, and multiple studies have found no correlation at all).
Unless you consciously avoid doing so, your brain will make this kind of jump in all sorts of situations. For investors, financial news headlines are constantly inviting you to assume causation. While financial journalists might know better than to write “The Dow Fell Because of Rising Oil Prices,” writing “The Dow Fell Monday as Oil Prices Surpassed $100 a Barrel” simply invites you to make the connection yourself.
On any given day, there are plenty of such headlines: “Syria Protests Spread, Authorities Pull Back,” “Gates Visits Russia as Putin Decries UN Action on Libya,” “Futures Rise as Japan Cools Reactors” and “Wall Street Stocks Close Higher as AT&T Deal Offsets Rising Oil Prices.” Those are all real headlines from last week. In some cases, there are actual correlations, but all too often, that “as” in the middle of a headline is a way of signaling that you can’t actually prove a causative effect between the two facts.
Nevertheless, investors can easily infer that stocks went up or down because of the second factor mentioned—and all too often do.
Unfortunately, looking for reasons why the market or a stock moved is nothing more than a distraction. Thinking that the market fell because of an earthquake might make you feel better, but, to paraphrase my college geology teacher (who told us that “earthquakes don’t kill people, buildings do”), earthquakes don’t make the market fall, people selling stocks do. There’s never a single reason for a market or stock decline. The primary reason why investors sell is because they think a stock is going to go down more in the future. Their reasons for believing that are usually myriad.
So looking for reasons why stocks and markets are falling—or going up, for that matter—is never going to help you make any money.
There’s only one thing you need to pay attention to in order to make money, and that’s if and when investors think a stock is going to go up in the future. That’s the only thing that drives buying, and buying drives stock prices higher—it’s a virtuous cycle. Thankfully, you don’t need to poll every investor you know to see if they think a particular stock is going to go up in the future (in fact, that’s probably a terrible idea) because the market already does that for you.
When investors are buying a stock, you’ll see the evidence in a rising chart. Same goes for the market. As Cabot Market Letter and Cabot Top Ten Weekly Editor Michael Cintolo wrote in the latter newsletter on March 18:
“Right now, the novice investor will focus on the news, on CNBC, on what the ‘experts’ are saying. But the experienced, successful investor will focus solely on the market and leading stocks—you almost have to be a bit of a robot at times like this, making sure to keep your emotions in check while others are reacting to every news item.”
Following this advice—ignoring news, and buying and selling based on what the charts are telling you—is actually a whole lot easier than tracking and analyzing every news story that could affect the market or a stock. But it’s made a lot harder for most investors by the urge to look for reasons and assign cause. It’s not your fault: you’re only human. But if you can learn to notice, and check, that urge, you’ll be ahead of the 90% of investors who are worrying about those things.
Today, looking at the market tells us one thing: investors are getting less scared. After breaking through them in mid-March, the major indexes have returned to their 50-day moving averages in recent days, showing you that there are more buyers than sellers right now. The sellers might be louder—and the headlines about Libya, Syria and nuclear disaster are very loud indeed—but the buyers are in control of the market.
Last week I suggested a stock for your watch list—Electronic Arts (Nasdaq: ERTS)—that I thought might be a good buy if it could hold up until the market turned. It did just that, and then last Thursday, it took advantage of an up day in the market and Game Stop’s (NYSE: GME) solid earnings announcement to break out toward 20. It will probably consolidate a little around there before moving up again, but this looks like a pretty good buy point to me.
A similar-looking chart is that of the otherwise very different Sensata Technologies (NYSE: ST). Sensata made a much larger advance than ERTS over the last six months, but it resisted the February-March correction just as well nevertheless. That tells me that there is very little selling pressure in this stock, even after a 75% advance. I last saw the stock recommended in mid-February, in both Cabot Top Ten Weekly and Personal Finance. The latter recommendation, by Elliott Gue, was quoted in the February 16 issue of the Dick Davis Investment Digest. He wrote:
“A world leader in the manufacture of sensors and controls, Sensata Technologies Holding went public in March 2010. [The company’s] products are key components in automobiles, heavy machinery and heating, ventilation and air conditioning (HVAC) equipment. The automobile market accounts for more than 50% of Sensata’s total revenue and should drive future earnings growth. Car sales in the U.S. and other developed markets are recovering gradually from the Great Recession. But Sensata’s growth story doesn’t hinge solely on this cyclical uptrend. Stricter safety and emissions regulations, not to mention consumer demand for advanced features, require manufacturers to outfit their automobiles with increasingly complex electronic systems. ... Sensata estimates that the number of sensors in new cars grew at an annualized rate of 7% from 2004 to 2008. [Furthermore,] as the vehicles available in developing countries increase in complexity, demand for sensors and controls will expand at a much faster pace than car sales. The growth potential is astounding: The average Chinese car contains about USD10 worth of sensors, compared to USD25 in the typical Western car. Sensata recently acquired the automobile sensors unit of industrial giant Honeywell International (HON), further expanding its share of this key end market. The HVAC market [isn’t bad], either. As more emerging-market consumers can afford air-conditioning units and modern appliances, demand for Sensata’s products will only increase. In 2010, developing markets accounted for 19% of sales. With two manufacturing facilities in China, Sensata is well positioned to sell to the local market. Buy Sensata Technologies up to 32.50.”
Though it’s been over a month since that recommendation, Sensata’s resilient, sideways base-building action since then makes me think the stock is still a good buy here for investors ready to put some money back to work.
Click here to learn more about Sensata and other top stocks featured in Dick Davis Investment Digest!
Wishing you success in your investing and beyond,
Chloe Lutts
