Known Unknowns vs. Unknown Unknowns
With the Presidential election coming next Tuesday, I’ve been thinking a lot about upcoming events in the stock market and how they fall into a few unique categories. (These categories actually came from Donald Rumsfeld way back in 2002, but I’ll leave that discussion for another day.)
First, you have the “Known Knowns.” These are things you know that you know. For instance, you know that the election results are going to be tallied shortly after next Tuesday, November 8.
Then you then have the “Known Unknowns”—those things that you know you don’t know. For instance, you don’t know what the results are going to be for all the Senators, Governors, House members and, of course, the President.
Third are the “Unknown Knowns,” which can be a bit hard to wrap your head around. These are items that you think you know but you really don’t. For instance, someone might think there’s no way that such-and-such a ballot measure can pass—but in reality, that’s a belief, not a known truth.
And lastly, there are the “Unknown Unknowns,” which are the things that you don’t even know you don’t know. These include events that come out of the blue, like earthquakes.
That brings me back to the election, an event that’s on the minds of more than 150 million likely voters, plus the vast majority of investors. It’s a highly visible event, but the outcome is unknown, which has led to all sorts of positioning, hedging and predictions from pundits.
I’m not smart enough to tell you who’s going to win the Presidency and what the makeup of Congress will be, never mind what actions they’ll collectively take in 2017. But I do know stock market history, and it turns out, a Known Unknown like an election outcome rarely changes the market’s major direction.
I wrote about this just over a month ago in Cabot Growth Investor, looking at numerous past elections and other events to see how the market reacted. Here’s what I wrote:
“If the election looks like a tossup (i.e., uncertainty), you’ll often see the market sell off a bit before Election Day.
“After the election, there is often a brief, one-?to five-day reaction. The reaction can be very sharp if the outcome was unexpected; Brexit was a perfect example, as was the six-day, 10% plunge in the Dow when Truman beat Dewey in 1948. (Dewey was considered a huge favorite.)
“However, following these brief shocks, the market almost always continues its major trend. For instance, stocks fell a few percent immediately after the 2012 Presidential election, but six weeks later, blasted off into?a powerful bull market. In 2000, there was lots of volatility as the election results were heard in the courts, but the major downtrend that started in March 2000 resumed as time passed.
“Brexit, of course, was painful for two days, but then the market’s longer-term uptrend reasserted itself. And while the 1948 example led to a long sideways period, that simply continued the tedious trading environment that had been in place since 1946!
“Long story short, the election will have an impact on the stock market! But unless it’s super-close or there’s a major surprise in the results, there’s usually not a huge reaction—and then, even if there is, the market’s prior trend reasserts itself (in today’s case, that would be higher).
“Thus, you should just stick with the action of the market and your stocks, and avoid the temptation to invest based on polls and elections.”
My point here is that the stock market is generally going to do what it’s going to do over time. History is filled with “big events” that seemed sure to change the direction of the stock market but, after a few days, were generally forgotten as the market returned to whatever it was focusing on before.
Certainly, the stock market could have a vicious reaction one way or the other, but gaming the initial reaction is (a) hard to do and (b) not likely to change the market’s major trend. Keep that in mind with any euphoria or panic that occurs as the results are tallied next week.
Stalking Recent Earnings Winners for New Leadership
That’s not to say I’m ignorant of the uncertainty that’s out there. But while uncertainty brings risk, it also offers opportunity. As a trend-follower, I’m not advising much new buying right now—a small position here or there is fine, but I’m mostly focused on holding any resilient stocks I own with a good helping of cash as I wait for the fog to lift.
That said, the selling pressure on the stock market is providing an opportunity to uncover the leaders of the next uptrend. Today, my favorite stocks are recent earnings winners. There have been a surprising number of them considering the market environment, and most are holding their gains, which is another encouraging sign.
Netflix (NFLX) is an obvious one—it looks like it’s re-emerged as a liquid leader as big investors are anticipating a major boost to the bottom line going forward after more than a year of heavy investment. (It reminds me of Amazon’s situation two years ago, when the stock began its huge run as profits finally ramped up.) After a big, year-long rest, NFLX exploded higher two weeks ago and has held those gains since. It should be on your Watch List, if for no other reason than to get a read on how institutions are treating growth stocks.
Proofpoint (PFPT) is a mid-sized leader in the cybersecurity space; its products cover the gamut though it’s well known as the leader in email security. It’s not an incredibly liquid stock ($45 million of dollar volume per day), but revenue growth is accelerating and the company has leapt into profitability during the past two quarters. PFPT hasn’t made any net progress for three months, but it spiked back toward its highs two weeks ago and, while volatile, could emerge once the market gets healthy.
And the third stock is one I liked so much that I added it to Cabot Growth Investor’s portfolio last week! I’m very familiar with the company, which came public less than a year and a half ago, and it broke powerfully out of its post-IPO range on earnings. Fundamentally, it checks nearly all the boxes I look for—steady, consistent revenue growth, huge profit margins, solid earnings expansion. And after third-quarter results, management actually upped their longer-term guidance, giving institutional investors the go-ahead to pile in.
If you want the name of this stock and (more importantly) want to be on top of the leading stocks once the market gets going, the best way to do that is to give Cabot Growth Investor a try.
