Things You Know Aren’t Always So
What Works Most of the Time Can Cost You Money
An Emerging Blue Chip in the Energy Patch
“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”—Mark Twain
When Jesse Livermore wrote that investors are their own worst enemies, I think he had something like Mr. Twain’s quote in mind. Sure, panicking out of a stock or buying a stock only because it’s been soaring are investing sins, but they’re relatively easily corrected. Those are things we all do even though we know we shouldn’t—hey, we’re human, and we all fall to temptation at times.
But the hard part for me as an advice-giver is to get investors to recognize that many of the things they “know” for sure are simply not true. And it’s these deeply held beliefs that cause investors to act against their own interests.
My favorite example of this going back many years is insider selling—every now and then Yahoo! Finance or some other outlet will have a headline saying such-and-such officer sold 100,000 shares of XYZ stock. It’s only logical that this would be a bad thing. Why else would the high-level employee be bailing out of so many shares?
Yet, in all my studies, I’ve yet to see one that “proves” that insider selling leads to worsening stock performance. I’ve looked high and low for it, but it turns out just about all the big winning stocks through the years have had lots of insider selling, especially the young, innovative firms that have recently come public.
Another favorite bad idea is the calendar. I can’t tell you how many times during a year I hear things like, “The summer is usually bad” or “September and October are always bad” or, on the flip side, “The market usually does well around Christmas.” Well, on average, yes, these sayings are true … when averaging the past 30 years! But it turns out even September (historically the worst month of the year) has averaged a return of (are you ready for this!) -0.4% since 1971. Hardly a panic-inducing statistic.
One of my biggest pet peeves on a longer-term basis is that so many people “know” that the economy is now in a permanent “new normal” of slow growth. There was an op-ed in the New York Times just this week (dubbed, “When Wealth Disappears”) that goes on about how America’s golden age is in the past, and economic forecasts are far too bright. The message: Prepare for decades of slow growth and stagnant standards of living.
Many investors have been hearing these stories, which is one reason bonds and bond funds yielding 3% or 4% remain so popular. But this is all bunk—heck, these are the same people who told us in 1999 and 2000 that rapid economic growth was going to continue forever! How did that prediction turn out?
The fact is that after more than 10 years of blah performance, the odds are better that we will see some great up-years during the next decade. I did my own study on this: As of last November, the Dow Industrials had advanced a total of 14% during the prior 13 years. Since 1920, every time the Dow had a 13-year return this low, the following five years returned an average of 68% (11% per year). Not spectacular, but not nearly as bad as all the worrywarts predict.
I think the reason behind all these misconceptions is that the market is really a contrary animal. Famed “Turtle” investor Richard Dennis said in one interview that the big trick of the market is that strategies (or, if you prefer, methodologies) that work a high percentage of the time often don’t work well in the long run.
That seems counterintuitive … and it is. But what he meant was that one tactic—say, selling rallies and buying dips—might work a high percentage of the time because the market spends more time gyrating than in strong trends. That was obviously true in the choppy years of 2011 and 2012, but even in 2010, when the S&P 500 returned 12.8%, there were six months of up-and-down performance (including the Flash Crash in May).
Thus, selling rallies and buying dips might work, say, 60% or 65% of the time. So why not do it? Because when it works, the results are relatively small. But when it doesn’t work (when the market trends), you can lose big (either getting stuck with a big loser or miss out on buying a big winner). The result might be 60% winning trades and 40% losing trades … but the average loss might be three or four times bigger than the average win.
Obviously, this is a very general statement; I’m sure there are many good overbought/oversold traders out there. But the point is that many of the tactics that work most of the time and, because of that, also “make sense” to the average Joe, become known and accepted to many. It’s only after a couple of years of following these feel-good methods that they realize they don’t work that well.
While making money (and keeping money!) isn’t easy, it’s not as hard as many people believe. For the vast majority of strategies, the goal is to lose small and win big. Obviously, there are limits to how many losses you want to take—you don’t want your portfolio to die the death of a thousand cuts—but if you keep the losses small and just hit a few doubles and triples, with the occasional homerun, you’ll make good money. Most investors “know for sure” that booking lots of quick profits is the way to go, but as Mr. Twain said, it just ain’t so.
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As for the current market, there’s no question that action has deteriorated over the past couple of weeks, at least for growth investors. It’s not a disaster, and yes, it’s possible this is a short-term retreat caused by our fearless leaders in Washington, D.C., which might end if/when they strike a deal.
But after a relatively smooth ride from the late-June market low, many growth stocks have come under pressure in recent days. On a long-term basis, I don’t consider this abnormal yet, but short- to intermediate-term, I’m less sanguine. I’m not predicting anything, but it only makes sense to expect some potholes given the prior big advance, as well as the uncertainties in Washington.
That said, there are still many stocks acting well, and when buying, I’m focused on names that have recently emerged (say, since the start of September) from multi-week (or multi-month) consolidations. Indeed, many of these “fresher” stocks are holding up very well, while the big leaders of the past three months are encountering some selling.
One name that fills the bill is Continental Resources (CLR), a leader in the newly strong energy group. The story isn’t complicated, as the firm is the largest leaseholder in the oil- and natural gas-rich Bakken shale region of the western U.S. and Canada with 1.2 million acres. And it’s drilling like mad; production is expected to rise 40% this year, and management is targeting growth of nearly 30% in 2014, with more to come after that. The company also has a new, exciting play in Oklahoma, which is small, but initial wells have been excellent (second quarter production tripled from a year ago in this area). Analysts see earnings up 64% this year and 31% in 2014.
Just as important, CLR (along with many energy explorers) recently popped out of a huge basing area on big volume. CLR topped out back in early 2012 and spent the next year and a half correcting and consolidating. But it finally broke loose from that range in early September, and has rallied from 100 to 115 since. This week’s pullback has only brought shares down to their 25-day moving average before finding support.
While CLR isn’t likely to double or triple from here, I think it’s an emerging blue chip in the energy sector, and coming off such a huge rest period, the path of least resistance is now up. It looks buyable around here, but I advise a stop near 100 in case the market develops the flu.
All the best,
Editor of Cabot Market Letter
and Cabot Top Ten Trader
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