by Jason Bodner
November 24, 2020
As quickly as you can, name your favorite:
- Vacation spot?
- Piece of clothing?
And now… what is your favorite stock?
I bet you didn’t hesitate to answer the first seven but struggled for a quick response to that last one. The brain only has so much capacity to recall a list of items quickly. That magic number is 7. Countless psychological experiments confirmed that 7 is the limit of human recall, on average. Hence, 7 is known as “the limit.” That’s why phone numbers are 7 digits, because beyond that they are hard to memorize.
There’s probably another good reason why stocks don’t make it on your personal favorites list: They just don’t make most people feel good. That’s not true for me. Stocks make me feel good. I could name my favorite stock before my favorite movie, but I’d bet stocks are boring for most people. They know they may own them somewhere in a 401 (k) fund managed by someone they never met. And that’s it. But the great irony is that the very things that can make us rich are the things we generally pay little attention to.
For example, say your refrigerator died. You need a new one fast. You hop on the internet and search the types of fridges. You read reviews and watch videos. You research measurements and depths. You must match specifications to know what to replace. You might visit multiple stores. You might talk to multiple salespeople or other customers. You narrow it down to three models. Then you return to the internet for more in-depth reviews. You then go back to the stores to see which one could offer you the best price.
Only after all that deliberation do you pull the trigger. You didn’t want to jump into a huge decision too soon. You wanted to know the best value before buying. But you ordered food in for nearly a week and never factored that in, nor the cost of replacing old food that went bad but wouldn’t if you had acted fast.
By comparison, how much time do you spend researching a stock you plan to buy? I’d bet that if I told you a ticker symbol right now and said it’s a great buy, you’d go buy it without hesitation. Most people wouldn’t even look up any of its fundamentals if they heard that it was a “hot stock tip.”
Refrigerators won’t make you rich, but buying stocks that go up two, three, or even 10-fold or more will. So why do we spend vastly more time researching appliances than we do buying investments? It’s a fascinating phenomenon. The mind focuses on small gratifications but leaves the big ones up to chance.
Fortunately, there are many financial advisors or research services that “do it for you.” That frees you up to focus on fridges, cars, Netflix shows, and other practical or fun stuff in life.
This brings me to market shocks and getting shaken out of great stocks when things get rough.
When the 2020 presidential election reached its conclusion, several COVID-19 vaccine announcements immediately followed. The stock market looked like a rocket launching into space. Every stock went up. Quickly a nasty pattern emerged – a rotation out of growth stocks into value stocks. Companies battered by COVID looked to benefit from a country reopening after widespread vaccination and defeat of the virus. Big tech and growth stocks were suddenly poised to be out of favor as, hypothetically, every American might soon get back on planes, eat at restaurants, shop at malls, and enjoy the good old life.
This can be seen in the Russell 2000 index – full of small cap and value stocks. That index is +16% this month vs. the NASDAQ tech and growth-heavy index +8.6% (Source: FactSet). That’s nearly double.
Suddenly, “stay at home” stocks looked like last year’s news. Many who owned these great stocks must have looked at their portfolios bleeding and started wondering: “Is their time over? Should I sell?”
Those who answered ‘yes’ may be kicking themselves years from now. You see, the massive rotation we saw was likely caused by a mini-quant-quake. Algorithmic traders were crowded into long growth stocks and short value stocks. When you add leverage to that equation, and get a hairpin turn in the opposite direction, you get a mad rush for the exits. When you must sell growth stocks because you are long and they are falling and you must cover short value stocks because they are rising, you intensify the move killing you. Several articles last week came out detailing the woes of quant funds.
You may ask, “Why not just wait?” When professional investors like hedge funds use leverage, brokers control their credit. And when things get uncomfortable, they have the right to make margin calls.
The takeaway is that the market rotation looked to be forced selling of growth and forced buying of value.
The key is to not lose sight of the big picture which is: Big money is buying bigly.
Last week saw another huge week of stock buying:
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
Every sector saw more than 25% of its universe of stocks bought in an unusually large way. This echoes my view that stocks get sold into and bought out of elections. The fact that value stocks have been bought more aggressively while growth is being held back does not mean that one should rush to exit growth stocks. In fact, I’d argue that you should look for deals in that space as others must reduce their exposure.
Focusing on quick trades is like focusing on the fridge instead of your stock portfolio. Don’t miss the big picture. Picking stocks with excellent sales and earnings growth being bought by Big Money is a great recipe for long-term success. Trying to capture the quick chop or avoid short-term pain might cost you in the long run. The amazing Helen Keller may have said it best: “Avoiding danger is no safer in the long run than outright exposure. The fearful are caught as often as the bold.”