Keep Your Perspective
It’s the Outliers that Count
New Upleg for Housing Stocks? ---
“Don’t sweat the small stuff.” “Yard by yard, life can be hard; inch by inch, it’s a cinch!” Undoubtedly, most of us have heard our mothers or grandmothers use one of these lines (or others like them) when life is getting us down for one reason or another.
In life, such advice often does the trick—we all have bad days or weeks because of some “small” stuff (your car gets hit and needs work, you have a tough week at work, etc.), but we also realize that life goes on, that we’re going to be here for a long time (knock on wood) and that there are more important things than a speeding ticket or what your boss said yesterday.
It’s that perspective—that today, tomorrow, even this week is just a tiny piece of the overall pie of life—that helps us through some of the tough times that we all have to deal with.
However, that perspective seems to vanish when investors are buying individual stocks. Sure, if you’re steadily putting money into a 401(k) plan, it’s easier to think of the long-term; the money isn’t touchable until you’re in your 60s, and we’ve all been “taught” to stick with our mutual funds for the long-term.
But when you’re an active manager of your own account, it’s common to live and die with every trade. Every big move by a stock or the market seems larger than life; a bad week can mess with your head, and a bad month or two can convince many investors that they don’t have what it takes!
Trust me, I’m not throwing stones—for many years I did live and die with my portfolio’s value, sometimes taking its ups and downs as a measure of my worth as an investor. And I wouldn’t be human if taking a loss or watching a name sink on earnings didn’t cause some distress.
But these days, I really try to think of every trade I make as just one of, say, 1,000 I’ll make over many years. Those 1,000 trades will surely include some winners, some losers, some earnings gaps up, some earnings gaps down, some bad markets, some incredible bull markets, some perfect buys (when the stock goes up right after you click the buy button) and some awful buys (where the stock plunges once you’re in). All types!
When you think this way, it makes it easier to stick with a time-tested system, take things “inch by inch” and not sweat the small stuff—i.e., the occasional 15% loss or a stinker of a week. And that ironically will lead to better performance over time, and fewer down times.
Of course, all of this assumes you’re using a quality system that consistently puts the odds in your favor and produces steady results—like the one used in Cabot Market Letter since its founding way back in 1970. For details on growth investing, click here.
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Investing in stocks is really a game of outliers. If you organize your trades from biggest winner to biggest loser, you’ll see that the middle 60% or 70% of trades will probably cancel each other out. It’s the big losers and big winners that make the difference.
Nobody put it better than Richard Dennis, the aggressive trend-follower (probably overly aggressive) who was interviewed in the original Market Wizards book (by Jack Schwager, published in the late 1980s):
“You should expect the unexpected in this business; expect the extreme. Don’t think in terms of boundaries that limit what the market might do. If there is any lesson I have learned in the nearly twenty years that I’ve been in this business, it’s that the unexpected and the impossible happen every now and then.”
Most investors think in terms of price targets and spreadsheets that calculate risk-reward. And those targets and models tend to give credence to the norm. For instance, going back to 1926, it’s a fact that the S&P 500 has averaged gains of 9.85% per year (including dividends) since 1926.
Thus, when looking at the year-by-year returns, it would make sense that most would be clustered around that 10% figure, say, between 5% and 15%. Makes sense, right? Well, reality is completely different.
Of the S&P’s 87 years (through 2012), the market has actually produced an outright loss in 24 of those years, or just about 28% of the time—more than one year out of four. Conversely, the market has returned at least 20% in 32 years, or just about 37% of the time—more than one year out of three. It turns out the market has delivered a return of between 0% and +20% in 31 different years ... just 36% of the time.
Just to put this into a broad context: Even though the market returns an average of 10% per year since 1926, only one-third of those years returned anywhere between 0% and 20%. The other two-thirds of the time, the market either gained more than 20%, or lost ground completely!
This is clearly the opposite of a “normal distribution,” which dominates most of life. If the average height for an adult man is 5 foot 10 inches, most will be around that level, give or take three or four inches. Same thing with average weights, speed, life expectancy and so on.
But the market’s returns aren’t normally distributed because they’re based on human emotions—which brings me back to Richard Dennis’ comments above. It turns out the “unexpected” moves happen much more than they are “supposed to,” but it’s exactly these kind of moves that will determine your results!
Once you embrace this concept, it can actually prove quite liberating—after all, if you grind it out with two or three months without making any progress, it’s no big deal, because all you need to do is find one or two bigger winners to make all the difference. You don’t have to be right every time.
Thus, tying a bow on this entire commentary, every trade is important, but you shouldn’t stress out about every decision, realizing that a few big winners over a couple of years will make all the difference. Especially during volatile market times, your best move is to take it day-to-day. Follow the system, and you’ll come out in fine shape.
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Right now is one of those volatile market times; not only has the market been gyrating this way and that, but earnings season is in full swing, with many heavyweights releasing reports this week and next. I’m looking for many of the stocks I own or are watching to gap up strongly on earnings.
So far, the early returns are promising.
More than a few stocks have reacted well to earnings (GOOG, BEAV, ARMH, NFLX, etc.), including a couple that have shot ahead after multi-week rest periods. In fact, that’s one thing I’m noticing—many stocks that have been lackluster performers have sprung to life in recent days, as money rotates out of some extended stocks.
On that front, my stock idea for today is actually an exchange traded fund; it’s the iShares Dow Jones Home Construction Fund (ITB), which owns good-sized positions in all the major homebuilders—PulteGroup, Lennar, D.R. Horton, Toll Brothers and the like.
As you can imagine, ITB was a great performer for about a year as the new housing bull market took shape—the fund bottomed out in October 2011 at 8 (down from a peak of 64 in July 2005!!) and began trending higher; it reached 21 in October 2012 and actually recently nosed out to nearly 25 in March.
However, to me, the fund really has been in a loose consolidation since last October; the fund hit 21 at that point, and as of last week, it was trading at ... 21.5. Said another way, while homebuilders were leaders for much of 2012, they really have done little to get excited about during the past few months.
Now, however, I think that may be changing. An analyst upgraded the whole group earlier this week, and ITB, Lennar and other homebuilders bounced up off their long-term 40-week moving averages.
Given my long-term bullishness on the new housing boom (I think there’s years to run in the upturn), the long period of relative listlessness and the big-volume rally, I think you could consider buying a little ITB (or another housing stock) here and look to add shares if you get a profit of a few percent.
All the best,
Michael Cintolo
Editor of Cabot Market Letter
and Cabot Top Ten Trader
Editor’s Note: Cabot Market Letter’s Michael Cintolo has 43 years of time-tested investing strategy behind him when he chooses top-notch growth stocks. He does all the work so you don’t have to!
Mike recently handed subscribers gains of 74% (and climbing) in LinkedIn … and there’s much more where that came from! So take the guesswork out of stock picking, let Mike be your guide.
