With The Top 10 Picks In The Stock Market DRAFT, EarningsBeats.com Selects…

We’re one day away from “DRAFT Day”! Every quarter, we select the 10 equal-weighted stocks that will comprise our 3 portfolios – Model, Aggressive, and Income. My background is in public accounting as I audited companies in the Washington, DC – Baltimore, MD metropolitan area for two decades. While most of my teaching generally encompasses technical analysis and how I use it, I still haven’t let go of my “roots” on the fundamental side. Earnings matter to me. I believe that management teams should develop a business plan that works to their strengths and limits the impact of their weaknesses. And the BEST management teams execute their plan to perfection, beating their own expectations and those of Wall Street.

In order to take advantage of this clear competitive advantage in management teams, we created our flagship ChartList at StockCharts.com, our Strong Earnings ChartList (SECL). I believe that management performance and integrity is so important that I won’t select ANY company for our 3 portfolios, unless it’s on our SECL. Currently, we have 390 companies on this ChartList. Roughly 7-8% of them will be “drafted” by us tomorrow afternoon during our “Top 10 Stock Picks” live virtual event. It’s completely FREE and you’re welcome to join us and witness the process that I go through to assess the current stock market environment and then select the stocks in the best position to benefit from that environment. CLICK HERE for more information and to register.

Let’s look at 3 companies that MIGHT make sense in our portfolios and that will be given considerable consideration:

Walt Disney Co (DIS)

It looks like the triple bottom on the long-term DIS chart near 80 has held and a new uptrend has begun. For the first time since 2020, DIS has made a successful 20-week EMA test and then gone on to break out to new high. We hadn’t seen this since the 20-week EMA was tested during Sep/Oct/Nov 2020. Check this out:

That bottom panel is worrisome for sure. The broadcasting & entertainment index ($DJUSBC) has been absolutely horrific vs. the S&P 500 for 3 years now. Can DIS perform well in such an awful industry environment? Will the industry group begin to reverse, with DIS providing leadership? That’s a difficult call. What we do know, however, is that DIS just posted excellent quarterly results. Revenues came in at $23.55 billion, slightly ahead of consensus estimates of $23.41 billion. Earnings were quite strong, however, at $1.22 per share. Expectations were set at just $.97.

Is DIS worthy of a first-round draft pick? We’ll talk about that tomorrow.

Meta Platforms (META)

Many of our scouts are saying that META could be the #1 overall draft pick. Hailing from the incredibly bullish internet space ($DJUSNS), which has been second only to semiconductors ($DJUSSC) in terms of best relative performance to the S&P 500 over the past year, META has had an MVP type of season, leading its industry peers. Here’s the current chart:

META is one of 8 stocks on our Model Portfolio last quarter that still resides on our SECL. There’s a good chance it gets selected in back-to-back drafts. Over the past 3 months, META gained 41.63%, only beaten by Palo Alto Networks (PANW), which gained 51.22%. Not too surprisingly, our Model Portfolio racked up a quarterly gain of 21.87%, which CRUSHED the S&P 500’s gain of 10.08%.

Sure, it’s trendy to say that META is overbought, along with most every other key technology or communication services name. But those who only look at the last year’s STRAIGHT UP move like to conveniently ignore the fact that META dropped 75% the year before during the cyclical bear market. Market makers were able to scoop up this All-Star at dirt cheap prices for their wealthy institutional clients. Maybe those institutions can give the #1 draft pick acceptance speech, thanking everyone who panicked during that manipulation-driven selloff.

What about META’s fundamentals? Well, last quarter the company produced revenues of $40.11 billion, easily surpassing its $38.99 estimate. And instead of the widely-expected profit of $4.83, META blew the doors off that number, instead coming in at $5.33. What’s not to like here?

Let’s see if META has its name called first on Tuesday! Or how about the other 7 Model Portfolio returning starters? Could they be re-drafted? What a great problem to have!

AZEK Company (AZEK)

It’s easy to talk about META, AMZN, NVDA, etc., but our scout team needs to look deeper and take a stand on potential high-flyers from time to time. Yes, their floor might not be nearly as high as a company like META, but the potential to the upside can be staggering for smaller-cap companies. AZEK isn’t part of the scorching-hot technology (XLK) or communication services (XLC) sectors. Instead, AZEK is a $6.6 billion company in the industrials (XLI) sector and designs, manufactures, and sells building products for residential, commercial, and industrial markets in North America. Technically, it’s been an exceptional performer over the past few months:

Like META, AZEK is a relative leader in a leading industry group, building materials & fixtures ($DJUSBD), which I always love to see. The DJUSBD is the 8th best-performing industry group over the past year. But AZEK is also a smaller company and we know that small caps have struggled relative to their larger cap counterparts. Still, it’s hard to ignore the numbers posted by AZEK. Their revenues were $240 million vs. their expected $234 million. And earnings doubled expectations, $.10 vs. $.05. Results like this can change the future projection of earnings, especially when guidance is raised. AZEK raised its Q2 revenue guidance significantly from $381.6 million to a range from $407-$413 million. And then what happens if AZEK beats estimates again?

Is the potential here solid enough to result in a Top 10 selection?

We have our work cut out for us tomorrow. I’ll be secluded for the next 24 hours in our EarningsBeats.com “War Room”, deciding where the stock market may go over the next 3 months and which areas and stocks are poised to benefit from it. If you’re interested, you can find out more information about this FREE event and REGISTER here.

Happy trading!

Tom

Tom Bowley

About the author:
Tom Bowley is the Chief Market Strategist of EarningsBeats.com, a company providing a research and educational platform for both investment professionals and individual investors. Tom writes a comprehensive Daily Market Report (DMR), providing guidance to EB.com members every day that the stock market is open. Tom has contributed technical expertise here at StockCharts.com since 2006 and has a fundamental background in public accounting as well, blending a unique skill set to approach the U.S. stock market.

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The EarningsBeats.com Strategy For Uncovering The New Winners

Earnings and interest rates are always the key drivers to stock market success. There may be other short-term factors that influence price action, but, at the end of the day, rising earnings and interest rates conducive to job and economic growth is what results in secular bull markets.

Organize Your Trading Candidates With ChartLists

While I follow interest rates very closely and consider them when evaluating likely future market direction, it’s really the earnings reports that we follow most closely at EarningsBeats.com. Q4 earnings are not yet complete, but most of the very influential companies in the Dow Jones, S&P 500, and NASDAQ have reported. Our research, including earnings research, is organized into many ChartLists, which I briefly describe below:

  • Strong Earnings (SECL): companies beating both revenue and EPS estimates and meeting other liquidity and performance filters. I view it as a list of companies demonstrating high quality technicals and fundamentals. It’s the ChartList that I trade from most frequently.
  • Strong Future Earnings (SFECL): companies that show excellent relative strength (high SCTR scores) and adequate liquidity that are not already on the SECL. I think of it as a list of excellent companies that simply weren’t able to beat estimates in their prior quarter, but who are trading as though they may do so in the quarter ahead.
  • Strong AD (SADCL): companies showing excellent relative strength (high SCTR scores), adequate liquidity, and rising AD (accumulation/distribution, not advance/decline) lines. The AD lines IGNORES opening gaps and focuses only on price action during the day, with volume being the multiplier. Companies on this ChartList are companies that tend to trade higher into the close, suggesting morning weakness might be bought.
  • Raised Guidance (RGCL): companies that, as the name would suggest, raise guidance – either revenues, EPS, or both. I like management teams that feel confident in their business and raise guidance throughout the quarter.
  • Bullish Trifecta (BTCL): companies that are common to the SECL, SADCL, and RGCL. These companies have produced strong quarterly results, have raised guidance, and show possible accumulation by big Wall Street firms.
  • Earnings AD (EADCL): companies that gain AT LEAST 5% from the opening bell to the closing bell on the day after earnings are reported. I then review every one of these companies and provide my Top 30 – companies that I really want to consider trading in the days and weeks ahead.
  • Short Squeeze (SSCL): companies whose float is heavily shorted. We track those companies with short percentage of float in excess of 20%. High short interest can trigger massive short squeeze rallies.
  • Seasonality (SEASCL): companies that have a history of performing well during certain calendar months.
  • Portfolio ChartLists: every quarter, we provide a list of companies that we “draft” into our 4 portfolios – Model Portfolio, Aggressive Portfolio, Income Portfolio, and Model ETF Portfolio.
  • Relative Strength Industry Groups (RSICL): This is an exclusive ChartList for our annual members that tracks the relative strength of every industry group over the past few years. Trading leading stocks in leading industry groups is how you beat the S&P 500 and this ChartList provides us those leading industry groups.

There are other ChartLists that we create from time to time, but you can see from the above that our research is broad and provides a TON of great information for our members on a regular basis. But before trading anything, it makes sense to evaluate the current state of the market. Is the current rally sustainable?

S&P 500: Is the Current Rally Sustainable?

I say yes. Sure, we’ll have some pullbacks along the way, but right now money is flowing into aggressive areas of the market and that “risk on” environment bodes well for higher prices ahead. Check out this S&P 500 chart with several key “sustainability” ratios in the panels below the S&P 500 price chart:

Is this not obvious? Money continues to POUR INTO aggressive areas. The 6 sustainability ratios above can be summarized as follows:

  • QQQ:SPY – NASDAQ 100 performance vs. S&P 500 performance. The NASDAQ 100 is a much more aggressive index, focusing almost solely on high growth large cap stocks.
  • XLY:XLP – consumer discretionary vs. consumer staples. Two-thirds of our GDP is consumer spending. It just makes sense to see which area of consumer spending, aggressive discretionary vs. defensive staples, Wall Street is favoring. That tells us what the big Wall Street firms are expecting in the months ahead.
  • IWF:IWD – large cap growth vs. large cap value.
  • $DJUSGL:$DJUSVL – another measure of large cap growth vs. large cap value
  • $DJUSGM:$DJUSVM – mid cap growth vs. mid cap value
  • $DJUSGS:$DJUSVS – small cap growth vs. small cap value

Every one of my aggressive vs. defensive ratios is climbing. Personally, I love all the pessimists out there constantly trying to tear apart this bull market. The problem is that many analysts are trying to handpick one or two SECONDARY indicators to determine market direction, which is absolutely wrong in my opinion. We remain extremely bullish if we look at the primary indicator, which is price and volume. Sentiment does a great job of marking market tops and bottoms and my favorite sentiment signal is the equity only put call ratio ($CPCE).

Sentiment Paving The Path To Higher Prices….For Now

Despite the nearly straight-up move that we’ve seen on our major indices since late-October, there is little complacency in the options world. Over the past 11 years, or approximately the duration of this entire secular bull market, the average daily CPCE reading has been in the .60-.65 range. Readings higher than this show an unusually heavy dose of equity put buyers (which coincides with market bottoms or approaching market bottoms), while lower readings suggest an unusually heavy dose of equity call buyers (which coincides with market tops or approaching market tops). While action has been mostly bullish in 2024, the average CPCE reading in 2024 has been .65 – a far cry from the 5-day average readings of .55 and below that typically mark market tops. Check this out:

Those red arrows highlight the very low 5-day CPCE readings and show you where the S&P 500 was at roughly the same time. After reviewing this chart, I’d quickly conclude that this rally may continue until we see options traders start pouring into equity calls. Friday’s CPCE reading was 0.48. If the S&P 500 continues higher through much of next week, it’s possible we could finally get a 5-day CPCE reading below .55 to mark a top. Friday’s 0.48 reading was a good start. Keep an eye on this throughout next week.

What Stocks Are Likely To Lead The Next Market Surge

Well, I believe our Earnings AD ChartList (EADCL) will hold the key. Again, this ChartList comprises 30 names that performed exceptionally well the day after its earnings were released as new fundamental information started to be priced in. I expect many of them to perform very well in the weeks ahead. Most of the companies on this ChartList are leaders among their peers. But others might just be getting started. Let me give you 1 of the 30 stocks featured, and one that might fit this description of just getting started – Allegro Microsystems (ALGM), a $6.1 billion semiconductor company:

ALGM’s relative strength vs. its semiconductors peers has been awful. But is it just starting to reverse higher? The AD line began strengthening a few months ago at the initial bottom and, on Friday, ALGM finally broke above a triple top. Notice that volume that accompanied the post-earnings run. We never have any guarantees of future price direction, but I’d certainly say that ALGM has my attention and is a stock that I’ll be watching as this could be the start of a very powerful advance.

In tomorrow’s EB Digest, our FREE newsletter, I’ll be providing everyone a link to our ENTIRE Earnings AD ChartList. If you’re a StockCharts.com Extra or Pro member, you can download this ChartList right into your SC account. Otherwise, you can view all 30 charts to see which stocks could be our leaders in 2024. If you’re not already a FREE EB Digest subscriber, it’s easy to get started. Simply CLICK HERE and provide us your name and email address and we’ll be happy to send you that Earnings AD ChartList in our Monday EB Digest newsletter. There is no credit card required and you can unsubscribe at any time.

Happy trading!

Tom

Tom Bowley

About the author:
Tom Bowley is the Chief Market Strategist of EarningsBeats.com, a company providing a research and educational platform for both investment professionals and individual investors. Tom writes a comprehensive Daily Market Report (DMR), providing guidance to EB.com members every day that the stock market is open. Tom has contributed technical expertise here at StockCharts.com since 2006 and has a fundamental background in public accounting as well, blending a unique skill set to approach the U.S. stock market.

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The Hoax of Modern Finance – Part 7: The Illusion of Forecasting

Note to the reader: This is the seventh in a series of articles I’m publishing here taken from my book, “Investing with the Trend.” Hopefully, you will find this content useful. Market myths are generally perpetuated by repetition, misleading symbolic connections, and the complete ignorance of facts. The world of finance is full of such tendencies, and here, you’ll see some examples. Please keep in mind that not all of these examples are totally misleading — they are sometimes valid — but have too many holes in them to be worthwhile as investment concepts. And not all are directly related to investing and finance. Enjoy! – Greg


“Those who have knowledge don’t predict. Those who predict don’t have knowledge.” — Lao Tzu

So that there can be no confusion, I want to state my honest heartfelt opinion on forecasting: I adamantly believe there is no one who knows what the market will do tomorrow, next week, next month, next year, or at any time in the future—period.

Hindsight is a wonderful tool to use in order to know why something might have occurred in the past, but rarely is the cause known during the event itself. The prediction business is gigantic. William Sherden, in The Fortune Sellers, claimed that in 1998 the prediction business accounted for $200 billion worth of mostly erroneous predictions. Can you imagine with the growth of the Internet and globalization, what that industry is today? Frightening! As Oaktree Capital Management’s Howard Marks says, “You cannot predict, but you can prepare.”

Dean Williams, then-senior vice president of Batterymarch Financial Management, gave a keynote speech at the Financial Analysts Federation Seminar in August 1981, where he made some almost prophetic comments about investing that are as true today as they were then. He spoke about the relationship between physics and investing, but I have previously discussed that subject. Another comment was, “One of the most consuming uses of our time, in fact, has been accumulating information to help us make forecasts of all those things we think we have to predict. Where’s the evidence that it works? I’ve been looking for it. Really! Here are my conclusions: Confidence in a forecast rises with the amount of information that goes into it. But the accuracy of the forecast stays the same.” Later on, he added, “It’s that you can be a successful investor without being a perpetual forecaster. Not only that, I can tell you from personal experience that one of the most liberating experiences you can have is to be asked to go over your firm’s economic outlook and say, ‘We don’t have one.'” He goes on to talk about using simple approaches versus complex ones, delving into the fact that they also must be consistent approaches. This is a must-read; you can find it from an Internet search on Dean Williams Batterymarch.

Sherden states that the title “second oldest profession” usually goes to lawyers and consultants, but prognosticators are the rightful owners. Early records from 5,000 years ago show that forecasting was practiced in the ancient world in the form of divination, the art of telling the future by seeing patterns and clues in everything from animal entrails to celestial patterns. As Isaac Asimov wrote in Future Days, such was the eagerness of people to believe these augers that they had great power and could usually count on being well supported by a grateful, or fearful, public. I’m not so sure most of this isn’t applicable to today. Sherden did much research into the numbers of people directly involved in forecasting—and this data was from 1998. They are staggering and growing. And let’s not forget that one of the largest-selling newspapers in the country is the National Enquirer. Below are some of the findings on forecasting from Sherden’s book.

  • No better than guessing.
  • No long-term accuracy.
  • Cannot predict turning points.
  • No leading forecasters.
  • No forecaster was better with specific statistics.
  • No one ideology was better.
  • Consensus forecasts do not improve accuracy.
  • Psychological bias distorts forecasters.
  • Increased sophistication does not improve accuracy.
  • No improvement over the years.

A weather forecaster will have an exceptional record if he says simply that tomorrow will be just like today. If I were a weather forecaster, I would tend to err on the side of bad weather instead of good weather. Then, if you are wrong, most will not notice. It is when you forecast good weather, and it is not, that they will notice. Most market prognosticators tend to have a bullish or a bearish bias in their forecasts. Bullish forecasts are generally well-accepted, especially by the Wall Street community, and bearish forecasting is a giant business because it infringes on investors’ fears.

“Given the difficulties forecasting the future, it is very useful to simply know the present.” — Unknown

Barry Ritholtz (The Big Picture blog) recently pointed out how ridiculous the forecasting business has become. In particular, the end-of-the-year forecasts for the next year or the best stocks to own. Here is an example from the August 14, 2000, issue of Fortune magazine by David Rynecki on “10 Stocks to Last the Decade.”

August 14, 2000

  • Nokia (NOK: $54)
  • Nortel Networks (NT: $77)
  • Enron (ENE: $73)
  • Oracle (ORCL: $74)
  • Broadcom (BRCM: $237)
  • Viacom (VIA: $69)
  • Univision (UVN: $113)
  • Charles Schwab (SCH: $36)
  • Morgan Stanley Dean Witter (MWD: $89)
  • Genentech (DNA: $150)

Closing Prices December 19, 2012

  • Nokia (NOK: $4.22)
  • Nortel Networks ($0)
  • Enron ($0)
  • Oracle (ORCL: $34.22)
  • Broadcom (BRCM: $33.28)
  • Viacom (VIA: $54.17)
  • Univision ($?)
  • Charles Schwab (SCH: $14.61)
  • Morgan Stanley Dean Witter (MWD: $14.20)
  • Genentech (Takeover at $95 share)

Ritholtz goes on to say, “The portfolio managed to lose 74.31 percent, with three bankruptcies, one bailout, and not a single winner in the bunch. Even the Roche Holdings takeover of Genentech was for 37 percent below the suggested purchase price. Had you merely bought the S&P 500 Index ETF (SPY), you would have seen a gain of over 23 percent.”

On March 11, 2008, CNBC’s Mad Money host, Jim Cramer, emphatically said it was foolish to move money out of Bear Stearns. He claimed that Bear Stearns was just fine. He was totally wrong. A week later, JPMorgan agrees on March 16 to buy Bear for $236 million, or $2 a share, representing just over 1 percent of the firm’s value at its record high close just 14 months earlier. The deal essentially marked the end of Bear’s 85-year run as an independent securities firm. On Monday, March 17, Bear shares closed at $4.81 on optimism another buyer may emerge. The average target price: $2. Don’t confuse advice from someone in the entertainment business with advice from someone who manages money. In fact, don’t pay attention to anyone’s predictions. No one knows the future!

The Reign of Error

In 1987, a book was written entitled The Great Depression of 1990, by Dr. Ravi Batra, an SMU professor of economics. Sadly, I bought and read that book. Batra was claimed as one of the great theorists in the world and ranked third in a group of 46 superstars selected from all economists in American and Canadian universities by the learned journal Economic Inquiry (October 1978). The foreword was written by world-renowned economist Lester Thurow, who said The Great Depression of 1990 is crucial reading for everyone who hopes to survive and prosper in the coming economic upheaval. The title for one chapter was “The Great Depression of 1990–96.” Not only did he pronounce the beginning of it, he also proclaimed to know the end.

The 1990s saw the largest bull market in history, with the Dow Industrials rising from 2,700 to over 11,000 during the decade of the 1990s. By the end of the decade, we were flooded with books about the never-ending bull market, such as Dow 40,000 by Elias, Dow 36,000 by Glassman and Hassett, and Dow 100,000 by Kadlec. From 2000 until early 2003, we witnessed a bear market that removed most of the gains of the previous 10 years, with the Dow Industrials back down to about 7,350.

“We are making forecasts with bad numbers, but bad numbers are all we have.” — Michael Penjer

 These forecasts were dead wrong; however, I ‘m sure the authors sold a lot of books. The bad news in the stock market did not end after the bear market from 2000 to 2003; by March 2009, the Dow Industrials was below the level of the previous bear by another 8 percent. Agencies whose duty is to make forecasts were almost universally wrong during the 2006 to 2007 period, with forecasts of the economy, the markets, and the world outlook all positive; even the ones that weren’t quite as rosy were only modestly so. The business magazines were the same. How many forecasts do you find yourself reading and listening to? Did you ever research to see if any of them ever turned out to be correct? Or even close?

Finance is not the same as physics, in that no mathematical model can fully capture the large number of always changing economic factors that cause big market moves—the financial meltdown of 2008 is an example. Emanuel Derman says, “In physics, you’re playing against God; in finance, you’re playing against people.” The parallelism between physics and finance has gained support from author Nassim Taleb, who says, “It doesn’t meet the very simple rule of demarcation between science and hogwash.” Whether invoking the physicist Richard Feyman or the late Fischer Black, the use of mathematical models to value securities is an exercise in estimation. Derman further states, “You need to think about how to account for the mismatch between models and the real world.”

“Science is a great many things, but in the end they all return to this: Science is the acceptance of what works and the rejection of what doesn’t. That needs more courage that we might think.” — Jacob Bronoski

Long Term Capital Management (LTCM) was started by John Meriwether, who had a great following along with Myron Scholes and Robert Merton, two famous economists. Together, they grew LTCM into assets of more than $130 billion, using a model they claimed would achieve exceptional returns without the usual risk. That alone should have been all the warning anyone needed. In 1997, their model did not do well, and by mid-1998 they had lost all of it; they had borrowed more than a trillion dollars to make investments. The story ended in September 1998, when the New York Federal Reserve Bank led a group of organizations to step in and bail them out; shortly thereafter, there was no more LTCM. Academics with sophisticated models are a dangerous lot. And here’s the best part—just before the demise, Scholes and Merton won the Nobel Prize for economics for their efforts in financial risk control.

LTCM was not alone; stories of hundreds of funds have gone out of business after short periods of exceptional success. Rogue trades were rampant. Remember Nick Lesson of Barings Bank? How about Jerome Kerviel of Societe Generale, or a host of large banks during the period? The list is long and growing. Enron, WorldCom, and Global Crossing were just a few large companies that went bankrupt, taking their employees’ pensions and investments with them. I don’t recall anyone ever anticipating any of these failures; forecasters never do.

After the inflationary decade of the 1970s, the price of gold was soaring. In the early 1980s, forecasts of gold reaching unbelievable heights were everywhere. They were supported with the facts that gold’s fixed value was released in 1971 and it was free to trade, and trade it did. The Hunt Brothers had bought a large portion of the silver market. No forecaster saw anything but higher prices. I recall buying three 100-ounce bars and wishing I had more money to buy more. You will see in Chapter 11 on drawdowns that gold plummeted in 1981, and it took more than 25 years to get back to its peak. And by 2013, the forecasts of gold going to the moon were everywhere.

At what point will we start to believe that forecasting is a hoax? This book is about the stock market, where the forecasting business is huge. I can tell you this: stock market forecasters are no different than economic forecasters. The ones who get lucky with a forecast are the ones who have yet to be wrong. I think the worst of them are the ones I call outliers (not to be confused with outlaws); these are the ones who, through some stroke of luck, make a forecast about something big and it turns out to actually happen. However, it is rarely in the exact manner of the forecast, but that is soon forgotten as he or she is paraded through the financial media as the guru of the year. They start newsletters, hold conferences, and embark on periods of more and more forecasts because they are now experts. Yet, most rarely make another correct forecast. John Kenneth Galbraith said: “When it comes to the stock market, there are two kinds of investors: those who do not know where it is going, and those who do not know that they do not know where it is going.”

An Investment Professional’s Dilemma

When speaking to investment advisors, I often remind them that they must deal with two realities:

  1. Your clients expect you to have answers.
  2. The market is unpredictable.

Once you have your clients believing #2, then the questions for #1 will be easier to answer. Most advisors, and especially their clients, get caught up in the moment and are easily swayed into believing that some expert actually knows the future. Or that they focus on the recent past and extrapolate that ad infinitum.

“Mind you, you should take economic forecasts—even my own—with a big grain of salt.” John Kenneth Galbraith may have been more right than econometricians like to think when he said that “The only function of economic forecasting is to make astrology look respectable.”

Nobel Prize-winning economist Kenneth Arrow has his own perspective on forecasting. During World War II, he served as a weather officer in the U.S. Army Air Corps, working with individuals who were charged with the particularly difficult task of producing month-ahead weather forecasts. As Arrow and his team reviewed these predictions, they confirmed statistically what you and I might just as easily have guessed: The Corps’ weather forecasts were no more accurate than random rolls of a die. Understandably, the forecasters asked to be relieved of this seemingly futile duty. Arrow’s recollection of his superiors’ response was priceless: “The commanding general is well aware that the forecasts are no good. However, he needs them for planning purposes.” (Peter Bernstein, Against the Gods)

“You don’t need a weatherman to know which way the wind blows.” — Bob Dylan

The book Dance with Chance by Spyros Makridakis (an author who wrote a wonderful business-forecasting book a couple of decades ago) gives a short story about Karl Popper. Popper was a philosopher of science born in Austria. In the 1930s, he leveled a charge against Sigmund Freud, whose psychoanalytical theories had gained widespread acceptance. Popper pointed out that real scientists start with conjectures, which they then try to refute—as well as seeking evidence to support them. Only by failing to disprove their hypotheses, can they prove they were correct. Meanwhile pseudoscientists, as Popper called them, only look for events that prove their theories correct. Theories like this are little more than untested assertions. That’s not to say the assertions can’t eventually turn out to be right, but we can only reach this conclusion once someone has tested them.

“Forecasting the future is much more difficult than forecasting the past.” — Unknown

Forecasting the future of monetary, economic, financial, or political possibilities has a serious flaw in that regardless of if your forecast is close to being correct, or even if it is spot on, the assumption about how the market will react is where the big problem lies. There is a flawed belief that positive events from political, economic, and monetary news will reflect positively on the markets. Conversely, negative news events will reflect negatively on the markets. This simply is not true. You can see that there is hardly any usable correlation to these events and the markets; earnings announcements are a perfect example. How many times have they been positive and the stock market did not react accordingly? The gap between a good economic or monetary forecast and the reality of what the market does is huge.

“There is always a reason for a stock acting the way it does. But also remember that chances are you will not become acquainted with that reason until sometime in the future, when it is too late to act on it profitably.” — Jesse Livermore

The following (slightly modified) comes from Gary Anderson, who wrote the must-read book entitled The Janus Factor. The link between fundamentals and price is elastic, and rarely still. At times, good earnings reports cause the price of a stock to rise, while at other times traders use positive earnings news to sell the same stock. Will a global crisis increase the value of the dollar or send it lower? The linkage between change in the world and change in the market is often ambiguous and sometimes just plain mysterious. In most cases, human beings are clever enough to create plausible stories to account for the market’s response to events, but too often only with the aid of hindsight. There is a constant shift in the fundamental reasoning used to support decisions to buy and sell. The financial media is constantly justifying each move in the market with whatever recent event they can find that supports that move. Fundamental conventions supporting buy/sell decisions can vary from period to period and have no place in rational investing.

We can draw a useful distinction between reasons and causes. Earnings do not cause prices to move, nor do research reports, news bulletins, talking heads, dividends, stock splits, the economy, peace, or war. These factors may be reasons motivating traders to buy and sell, but the direct cause of a stock’s price movement is the buying and selling activity of traders and investors. We focus on causes, not reasons—on what traders do, not why. This is accomplished by measuring price and price derivatives (breadth, relative strength) of price movement.

Gurus/Experts

What would we do without all the experts, gurus, pontificators, purveyors of gloom and doom, and, of course, the perma-bulls and perma-bears?

First of all, a giant industry would be gone, an industry that generates billions of dollars in the USA alone. I’m not going to spend a great deal of time on this, because the website of CXO Advisory Group LLC, CXOadvisory.com , does all the heavy lifting. They have an entire section devoted to GURUS. Here are the two questions they ask at the beginning of that section: “Can experts, whether self-proclaimed or endorsed by others (publications), provide reliable stock market timing guidance? Do some experts clearly show better intuition about overall market direction than others?” They address these questions with a logical and transparent process. After following more than 60 experts and thousands of observations, near the end of the Guru section, they conclude: “The overall accuracy of the group, based on both raw forecast count and on the average of forecaster accuracies (weighting each individual equally) is 47 percent. In summary, stock market experts as a group do not reliably outguess the market. Some experts, though, may be better than others.” Hmmm! It seems like a coin toss, on average, would do better.

Additionally, CXOadvisory.com reviews numerous academic papers, and then does its own backup analysis to determine if the paper’s author and they agree. An excellent piece, when reviewing Charles Manski’s July 2010 paper entitled “Policy Analysis with Incredible Certitude,” categorizes incredible analytical practices and underlying certitude. These four are:

  1. Conventional certitudes (conventional wisdom)—Predictions (indicators) that experts generally accept as accurate, but are not necessarily accurate.
  2. Dueling certitudes—Two contradictory predictions that competing experts present as exact, with no expression of uncertainty (leading to conflicting strong investment strategy recommendations).
  3. Conflating science and advocacy—Developing arguments (assumptions) that support an investment strategy rather than an investment strategy that supports evidence-based arguments, while portraying the deliberative process as scientific.
  4. Wishful extrapolation—Drawing a conclusion about some future situation based on historical tendencies and untenable assumptions (ignoring differences between the historical and future situations, and emphasizing in-sample over out-of-sample testing).

If you have ever watched television, read a newsletter, or attended a seminar, I’m sure the above sounds familiar. People who appear as experts generally aren’t any better than the masses; however, when they are wrong, they are rarely held accountable, and never admit it (generally). They will respond that their timing was just off or some catastrophic event caught them off guard, or worse—wrong for the right reasons.

There is a book by Philip Tetlock, Expert Political Judgement: How Good Is It? How Can We Know?, that deals with the business of prediction. Tetlock claims that the better-known and more frequently quoted they are, the less reliable their guesses about the future are likely to be. The accuracy of their predictions actually has an inverse relationship to his or her self-confidence, renown, and depth of knowledge. Listen to experts at your own risk.

Larry Williams was an active and renowned trader before I even began to show interest in the markets. There is one significant point that Larry has made consistently that needs to be repeated here. If you are going to be mentored by someone, if you are going to read someone’s book on trading/investing, if you are going to sign up for a course of instruction from someone, please make sure they are qualified to teach the subject. This does not always translate into how they trade or invest. Like Larry says in his Trading Lesson 16, Kareem Abdul-Jabbar tried coaching and was a disaster at it; Mark Spitz’s swimming coach could not swim. However, the bottom line is that the best teachers are probably the ones who actually trade and invest, as they have firsthand experience to the nuances of the skill. This argument is not unlike the one between the ivory tower academics and those involved in the real world applying their craft every day. While they may have considerable talent to offer, your chances are probably better with a real practitioner.

Masking an Intellectual Void

My formal education was in aerospace engineering. My education in “The World of Finance” came and continues to come from people in the investment industry I have grown to respect. I hate to list some as fear of leaving someone out, but Ed Easterling, John Hussman, and James Montier are certainly at the top of the list. Are these professionals always correct? Of course not, but they usually admit it and they write in such a manner that they know the uncertainty is always there and yet present valid arguments on a wide range of topics and concepts. The rest of the learning comes for reading literally hundreds and hundreds of white papers in finance and economics. This process caused my concern at the insane use of advanced mathematics, usually in the form of partial differential equations, to supposedly assist in making the point that the paper was addressing. I cannot tell you how many times I thought that most of the math was unnecessary and more often than not the paper would have stood alone without the math. In many instances I think there is an attempt by most to overly complicate their work with mathematics with the belief that it brings credibility to their work. Another reason, and one I certainly cannot prove, is that they also know that most people who read their paper, other than their peers, will not grasp the math and just assume it is valid and necessary.

The senior special writer, Carl Bialik, of The Wall Street Journal, who writes a section called “The Numbers Guy”, is one of my favorite reads. As I was wrapping up research for this book and thinking that I had included enough opinions about things without substantial evidence, I was delighted to find support from Carl for this section on “Masking an Intellectual Void.” On January 4, 2013, he wrote two articles entitled, “Don’t Let Math Pull the Wool Over Your Eyes,” and “Awed by Equations.” Those articles referenced two papers that gave support to my belief in the overuse of mathematics, and how readers of white papers generally were impressed with what they actually did not understand. Research was conducted using only the abstracts of two papers, one without math, and one with math; the catch being that the one with math was bogus, totally unrelated to the paper. Yet the highest percentage of participants who gave the highest rating to the abstract with added math, based on the participants’ educational degree, was as follows:

Math, Science, Technology      46 percent 

Humanities, Social Science     62 percent 

Medicine            64 percent 

Other           73 percent 

I think this shows that those who had a high probability of not understanding the math gave the paper with the bogus math a higher rating, while those who possibly did understand the math did not.

This is just my lame attempt at humor. The financial academics have almost universally used partial differential equations in their white papers; I think, more often than not just to hide an intellectual void. Many times, the difficult math is not necessary, but by including it, they know most will never be able to question their work. Sad, indeed! Incidentally, the equation can be simplified to 1 + 1 = 2.

Earnings Season

For decades, I have watched the parade of earnings announcements and how the media hangs on each one as if it actually had some value other than filling dead air. Figure 5.1 shows the stock price of Amazon back in the 2000-2001 bear market. The annotations are from actual earnings forecasts from analysts. If you yell “buy” all the way down, the odds are good that you will eventually be correct. Hopefully, you will still have some money.

“In our view, security analysts as a whole cannot estimate the future earnings pattern of one or more growth stocks with sufficient accuracy to provide a firm basis for valuation in the majority of cases.” — Benjamin Graham

It seems that the media is so focused on earnings reports that they forget to report the actual earnings. Instead, their focus is on where the earnings came in relative to the analysts’ estimate. After beating up on experts, it is hard to imagine that someone would actually make an investment decision based on an analyst’s (expert) guess as to what earnings should be. These analysts are constantly wined and dined by the companies they analyze, so, in general, I think they are biased, and almost always to the upside. In fact, I think most are really just trend followers, in that they are always forecasting better earnings as markets rise and, once a market rolls over and begins to decline, they eventually begin to forecast lower earnings.

Figure 5.1

When asked what investors’ greatest problems are, the late Peter Bernstein said, “Extrapolation! They believe the recent past is how the future will be.”

Are Financial Advisors Worth 1% of AUM (Assets Under Management)?

“People who need advice are least likely to take it.” — Unknown

Many asset managers hold entirely too many stocks and have become closet benchmark trackers. If they beat their benchmark, they call it alpha, and when they do not beat their benchmark, they call it tracking error. If your investment manager rebalances your portfolio periodically based on a few questions that he required you to answer when setting up the account, here are some things to think about. Usually, the risk tolerance and objective questionnaire is much more involved, but here are two questions typically asked:

  1. What percentage of current income will you need when you retire?
  2. On a scale from 1 to 7, what is your risk tolerance?

Do you honestly believe a person knows the answers to those questions? No way! They will try to answer based on what the advisor has told or suggested to them. The law requires this type of action for advisors, so pick an advisor you think will actually meet your needs and, if you are unsure, can point you in the right direction.

Economists Are Good at Predicting the Market

“The economy depends about as much on economists as the weather does on weather forecasters.” — Jean Paul Kauffman

Just to put this into perspective, the stock market is a component of the index of leading indicators. If the stock market is a good leading indicator of the economy, why ask an economist what the market is going to do? Yet they are paraded daily across the financial media, making forecasts about the markets, political policy, fiscal policy, monetary events, and, yes, occasionally about the economy. When they are correct, they won’t let you forget it; when they are wrong, no one remembers. Many economists are good when dealing with the economy, but rarely are they good when they stray into other areas.

News Is Noise

Here is a humorous attempt to portray some of the daily noise often referred to as news. On Wall Street today, news of lower interest rates sent the stock market up, but then the expectation that these rates would be inflationary sent the market down, until the realization that lower rates might stimulate the sluggish economy pushed the market up, before it ultimately went down on fears that an overheated economy would lead to once again an imposition of higher interest rates.

Rolf Dobelli, writing for The Guardian, on April 12, 2013, in an article entitled “News is bad for you—and giving up reading it will make you happier,” listed these problems with news:

  • News misleads.
  • News is irrelevant.
  • News has no explanatory power.
  • News is toxic to your body.
  • News increases cognitive errors.
  • News inhibits thinking.
  • News works like a drug.
  • News wastes time.
  • News makes us passive.
  • News kills creativity.

He claims he has gone without news for four years and says it isn’t easy, but it’s worth it. Since he wrote for a news organization, I would imagine he is also looking for work.

“If you can distinguish between good advice and bad advice, then you don’t need advice.” — VanRoy’s Second Law

When asked at seminars what is the single most important concept to understand when investing, I respond simply that it is to know thyself. The human mind is a horrible investor, and the use of heuristics does not help. The next chapter deals with human behavior as it relates to the market.


Thanks for reading this far. I intend to publish one article in this series every week. Can’t wait? The book is for sale here.

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A Word and A Chart About and On Alibaba

Alibaba.com is one of the world’s largest wholesale marketplaces.

To be honest, I had never gone to their website until today, even though we bought shares in BABA 2 weeks ago. So, in case you are like me and have not checked them out, they sell a lot of consumer items in bulk. 

And they also sell pretty much everything. For instance, if you want a 1000w off-grid wind power Free Energy System for your home or business, you can get one and find an online description of the supplier, including their annual revenue. Plus, if you want them in bulk, you can order 1000 sets at a reduced price.

BABA has proven controversial a lot, most recently with a lawsuit settlement on monopolistic practices. However, the impact on their revenues is nominal and, in fact, could be a plus, as the company’s stock price trades at just 8x net profits.

Anyway, China overall, has had no shortage of bad press. Yet, before we learned Jack Ma and others bought up to $200 million of BABA stock, the stock looked and still looks appealing to us. If one is looking to be a contrarian to all the bad press, then BABA is a company with solid fundamentals.

Hence, the charts are in focus.

There are a few technical aspects we like to focus on that stand out in the Daily chart.

  1. The new 60+ day low followed by a gap higher leaving a potential long term bottom.
  2. That gap up also reversed the price below the January 6-month calendar range.
  3. Although it continues to underperform the benchmark, it is nearly on par.
  4. Real Motion has a bullish divergence, in that momentum is above the 50-DMA while price trades just below its 50-DMA.
  5. Relative to the China ETFs KWEB and FXI, BABA is doing better.

Now looking ahead:

  1. The 6-month calendar range is support and should hold, while the recent lows is the optimal risk point.
  2. The 50-DMA needs to clear and confirm as a phase change to recuperation.
  3. The January 6-month calendar range high, at 76.69, is another key area to clear.

On these types of trades, risk is extremely important. Finding bottoms is a tricky trade, but when done right, can have huge payouts.

Finally, BABA reports earnings pre-US market opening on February 7th.


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In this video from CMC Markets, Mish looks at a selection of popular instruments, outlining their possible directions of travel.

Mish is a favorite guest in Singapore, where she gets to discuss the macro and how to think about investing in the big picture. In this short clip from Breakfast Bites, Mish talks TSLA.

In this video from Stockpick, Jillian Glickman and Mish discuss economic outlook and current investment picks plus forecasts on inflation

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In this video from CMC Markets, Mish looks at a selection of popular instruments ahead of today’s US Q4 GDP announcement, outlining their possible directions of travel.

Mish makes up a new ETF (not real) called VAIN, but really discusses the basket of stocks that are worth watching in this appearance on Yahoo! Finance.

Mish discusses Alibaba and how the rumors of China’s impending demise might be a bit exaggerated on Business First AM.

Mish talks all about retail and stock pick Abbvie (ABBV) on Business First AM.

Nicole Petallides and Mish dig deep into trends and stocks to watch for next big moves, as we are in full January trend mode on this video from Schwab Network.

On the Monday, January 22 episode of Your Daily Fivefrom StockCharts TV, Mish sees the potential for consumers to spend more money, from self-help to dieting, to makeup to skincare to fashion — pointing out several relevant stocks and how to trade them.

Mish looks at a selection of popular instruments in this video from CMC Markets, outlining their possible directions of travel.

Mish joins Jason Perz on the Against All Odds playlist, where she covers it all talking the mental game of trading, commodities, futures, equities, technical analysis, and macro.

Mish’s Market Minute on StockCharts TV returns, all new! Mish and Geoff Bysshe share how the powerful “Calendar Range” StockChartsACP plugin tells you who and what to believe, when to act, and what to trade. The new year is a big “reset” emotionally, and January sets the tone for the next six months AND the year. Every month is “like an inning in baseball,” financial reports focus on quarters, but analysts think in terms of the first half and second half of the year. How can you harness this knowledge to your benefit? Watch to find out!


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January 30: Breakfast Bites, Singapore Radio & Live in the Market Coaching CMC Markets & CNA Asia First

February 2: Benzinga Pre-Market Show

February 5: Money Show Life with Chuck Jaffe

February 21-23: The Money Show in Las Vegas

February 29: Yahoo! Finance & Your Daily Five, StockCharts TV

Weekly: Business First AM, CMC Markets


  • S&P 500 (SPY): 480 now the pivotal zone.
  • Russell 2000 (IWM): 195 pivotal, 190 support to hold.
  • Dow (DIA): 375 support.
  • Nasdaq (QQQ): 415 support.
  • Regional Banks (KRE): 50 key to hold.
  • Semiconductors (SMH): 184 support.
  • Transportation (IYT): 262 now pivotal.
  • Biotechnology (IBB): 135 pivotal.
  • Retail (XRT): Flirting with 70, which has to clear and hold to stay very bullish.

Mish Schneider

MarketGauge.com

Director of Trading Research and Education

Mish Schneider

About the author:
Mish Schneider serves as Director of Trading Education at MarketGauge.com. For nearly 20 years, MarketGauge.com has provided financial information and education to thousands of individuals, as well as to large financial institutions and publications such as Barron’s, Fidelity, ILX Systems, Thomson Reuters and Bank of America. In 2017, MarketWatch, owned by Dow Jones, named Mish one of the top 50 financial people to follow on Twitter. In 2018, Mish was the winner of the Top Stock Pick of the year for RealVision.

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Your Money And You: This Investment Strategy May Very Well Be Your Best Choice?

Every one of us faces this question as we look to the stock market for a better financial future. Let me first start this article with the understanding that the stock market isn’t your only choice in terms of investing in your future (or your child’s or grandchild’s future). But this article will ONLY focus on the stock market.

Your Choices

There are a number of factors to help you decide which investment strategy is right for you. Your age, investment horizon, and ultimate goals will likely weigh heavily in devising your own personal investment strategy. Beyond that, however, you must consider the level of risk you’re comfortable with. Not all stocks in the stock market are equal-weighted in terms of risk.

Growth Stocks Seeking Capital Appreciation

Stocks dependent on strong earnings and strong future earnings growth might be perfect for anyone willing to take higher risks and have plenty of time (younger age) to recoup losses in the near-term, especially if your strategy will be consistent with additional future investments being made as well as current investments. Growth stocks can generate very strong returns in a favorable environment of low interest rates and strong future earnings, but many do no pay anything out of current earnings (think dividends). As economic conditions change, valuations can drop rapidly with lowered expectations of earnings and growth. You don’t have to look back that far (2022 cyclical bear market) to see how far growth stocks can fall in a very short period of time.

As an example, let’s look at NVIDIA Corp (NVDA), which has gained 236% over the past year, but pays no dividend. It’s been the leading NASDAQ 100 stock, along with six others that have more than doubled over the past year:

  • CRWD: +190.98%
  • META: +181.64%
  • AMD: +157.32%
  • PANW: +140.03%
  • AVGO: +119.94%
  • ZS: +109.56%

As a growth stock investor, it’s these types of gains that make investing fun. But there’s a dark side to this group as well. We only need to look back at the past few years of NVDA performance to understand the roller coaster ride that your growth stock might take your money on:

Right now, I’m sure everyone would have liked to have owned a lot of NVDA. But the same wouldn’t have been said at the end of 2023, when NVDA’s 1-year rate of change (ROC) had fallen close to -60%. Bear markets can be absolutely brutal for growth stocks, because their future earnings growth and earnings growth rates contract with economic activity. And, if that’s the primary factor in growth stock valuations, it’s going to be very painful. Even the 6-month ROC in September 2023 was close to -60%. Imagine that your entire portfolio is situated in growth stocks like NVDA 6 months to a year prior to the start of retirement. Then think about the pain and stress, both emotional and financial, that type of drop would inflict on you. When you consider your strategy, you MUST consider all possibilities, not just the best ones.

Conclusion: Investing in growth stocks should be considered in EVERY portfolio. Even those who have already retired could have a nest egg expected to last another 20 years or more. But you won’t need all of that money in the first year of retirement. A portion of your savings will be needed 10-20 years down the road or longer. This portion could be invested a bit more aggressively as you won’t need this money for many years to come. Historically, growth stocks will typically outperform more conservative investment approaches over periods of 10 years or more. However, determining how much you should invest in growth stocks is based on a number of factors, including age, years to invest, personal risk tolerance, investment purposes, financial goals, etc.

Income Investors Seeking Dividend Yield

This is a more conservative strategy that focuses much more on payments to shareholders out of current earnings and in the form of dividends. These more conservative dividend payers tend to see much more consistency in their earnings picture and much less volatility in their stock price, though there certainly can be exceptions to this general rule. These investment are not usually as highly stressed by shorter-term economic concerns. Utilities and real estate companies quickly come to mind. They are not fully insulated from economic concerns, especially real estate as this group can react to movements in interest rates, but most investors in these two sectors look toward higher income/dividends as a primary reason for investment. To illustrate using a perf chart, let’s compare the price performance of a growth area like technology (XLK) to more income-oriented areas like utilities (XLU) and real estate (XLRE), since the current secular bull market advance began in 2013:

Most technology stocks pay little or no dividend, but you can see that the capital appreciation opportunity is obvious. Many of the big drops in the stock market are felt harder in technology, however. The XLU and XLRE provide much smaller opportunities with capital appreciation as their earnings growth prospects do not fluctuate over the years as wildly as technology companies. But the comparative safety of capital, along with a much, much higher portion of current earnings being paid out by utilities and real estate companies is the preference of many income-oriented investors. Their dividends, many times, compete with an even safer form of investment, U.S. Treasury securities.

Combination of Capital Appreciation and Dividend Yield

For many investors, it’s probably a good bet that owning both capital appreciation and dividend-paying stocks makes a lot of sense. And there are a group of stocks that show significant combinations of both strategies that might appeal to many investors. It doesn’t have to be one or the other. How about the “hybrid” company, one whose dividend yield may be more modest, but the dividend growth rate is strong and fairly sustainable. Here are three stocks that might qualify for this hybrid label:

Proctor & Gamble (PG):

PG is a stock normally thought of as defensive and value-oriented. I’m not sure the chart necessarily agrees with this assessment. Let me start by saying that PG has raised its annual dividend for 68 consecutive years. That’s quite an accomplishment in and of itself, considering the number of secular and cyclical bear markets that PG has endured. And PG hasn’t been a bad grower either. Here’s the price chart:

I’ve changed the chart here to quarterly, since dividends are paid out quarterly. I’ve also lengthened the chart to 30 years, so that you can see the power of capital appreciation AND solid increases in dividends each year. PG has not only raised its dividend for 68 consecutive years, but the AVERAGE increase is 8.6% since 1994. Those dividend payouts have spiked significantly, which tells us that the current dividend payout in 2024 will only continue to increase by a rate that will at least keep up with inflation, if not exceed it. Oh, and then throw in the capital appreciation potential. Nothing is ever a guarantee, but PG has been a very solid investment for a long, long time. If you’re a growth investor, however, the day-to-day movement in PG will likely bore you. Boring isn’t always a bad thing, though, especially when it comes to building financial wealth.

Starbucks, Inc. (SBUX):

SBUX is another long-term solid grower in terms of capital appreciation, but long-term investors might be surprised that its dividend yield is currently 2.43%. The price chart below tells its own story in terms of price appreciation, but check out how quickly the SBUX quarterly dividends have been climbing:

While the SBUX capital appreciation rate has slowed from its earlier years, its ability to generate profits to pay out higher and higher dividends has not. SBUX has an average increase in its annual dividends of 17.76% since the secular bull market began in 2013. In recent years, that average increase has fallen into the high single digits (8-9%), but that’s still a very solid annual increase rate.

Nike, Inc. (NKE):

NKE has been a grower over the years and its annual dividend has increased every year this early this century – through two secular bear markets and 3 cyclical bear markets, which shows the company’s ability to increase shareholder weather – even during the worst of stock market climates. Check out NKE’s capital appreciation over the years:

Despite its underperformance the past couple years, NKE has still been a “10-bagger” over the past 15 years, rising from 10 bucks to 100 over that period. But a rapidly-rising annual dividend, combined with price struggles since 2021, now provides a 1.45% dividend yield. Not only has NKE raised its dividend every year over the past couple decades, but its AVERAGE annual dividend increase has been double digits in all but 2 of those years. During 2009 and 2010, NKE “only” raised its annual dividend 8.7% and 8.0%.

These hybrid stocks do feel an impact from economic activity, but the combination of price appreciation and solid dividends and dividend increases should not be overlooked.

For the past several years, with only minor exceptions (namely, the 2022 cyclical bear market), I’ve suggested sticking with this secular bull market. Betting against these bull markets is a big mistake, in my opinion. The perma-bears just keep digging themselves a deeper and deeper hole. In Monday’s FREE EB Digest article, I’ll provide my argument to derail the most common reason for not investing in the stock market right now. If you’re not already an EBD subscriber and you’d like to see Monday’s FREE article, simply CLICK HERE to register with your name and email address. There’s no credit card required and you may unsubscribe at any time.

Happy trading!

Tom

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Perspective And History Tell Us To Lower Our Expectations For Technology Stocks

No one loves a good bull market more than me. History tells us that we want remain mostly on the side of the bulls. Perma-bears have an awful long-term track record. They’ve called 30 of the last 3 secular bear markets. Honestly, those who cannot ever see anything other than a downtrend ahead should find a new occupation or hobby. Here’s the long-term chart of the S&P 500.

GDP + inflation + innovation = roughly an average 9% annual gain on the S&P 500. Ask yourself a question. How many times have you exited the stock market and wished you had just left your investment alone and untouched? Be honest.

Seriously, how often do perma-bears get it right? Hey, listen, there’s nothing wrong with being bearish from time to time if you’re a shorter-term trader. The stock market moves too far sometimes and rightfully needs to correct. And after years of secular bull market strength, there comes a time when stocks need more than a simple correction and a secular bear market is justified. In my opinion, that’s not now. Talk to me again in 2030. We won’t be in one for a long time as the current 11-year secular bull market rages on. But, even during a secular bull market, the bulls must acknowledge when short-term risks grow and portfolio adjustments should be considered.

I believe now is a good time to lean on perspective and the impact it could have in 2024.

We all know (or should know) that the three aggressive sectors – technology (XLK), consumer discretionary (XLY), and communication services (XLC) – tend to lead most secular bull market advances. But they don’t lead all of them. And there are examples right now that maybe our leaders have led for a bit too long.

The S&P 500 just advanced more than 16% in 41 trading days from October 27th through December 28th. We can use a 41-day rate of change (ROC) to see how often this 16% level is reached or exceeded in this time frame. Check this out:

This type of move typically occurs after a big bear market move lower or after a correction. The 2023 occurrence came on the heels of the July through October correction. These huge gains are not normal and rarely result in similar gains moving forward. We need to pause and allow these gains to be absorbed. Also, election years are weak historically during Q1, which is exactly where we’re situated right now. While I expected a scorching January in 2023 based on a few of my signals, I don’t expect that at all in January 2024. Lows in election years tend to coincide with March.

Currently, the largest sector in the S&P 500 is technology, which represents 28.79% of the benchmark. Discretionary represents 10.84% and communication services totals 8.55%. So these 3 aggressive sectors comprise 48.18%, or nearly half of the benchmark. If these 3 groups simply take a few months to absorb recent gains, we could easily see rotation move into other areas like industrials (XLI), financials (XLF), or health care (XLV). These 3 more value-oriented sectors represent more than 34% of the benchmark. While XLY is in the aggressive sector camp, it actually looks like it could still provide a lift to the S&P 500. More on that below.

Technology (XLK) is clearly the one to watch though as it has the biggest impact on the S&P 500. Currently, from this chart alone, I see significant risks ahead if you’re overweighting technology:

Nothing on this chart looks particularly encouraging for technology. The top part of this chart tells us that technology’s relative momentum was VERY stretched – similar to 2020 – and we know what happened next. It was a lengthy period of average to underperformance vs. the S&P 500.

The middle part of the chart shows that the XLK:$SPX relative strength is at the upper end of its relative uptrend, which makes it difficult to continue outperforming. In fact, it’s probably time to consider weak relative strength ahead. Finally, the bottom panel charts the 52-week relative performance. Money has poured into technology over the past year – again similar to 2018. It wouldn’t be normal for this to continue higher. Once again, this tells me the risk is to the downside and it’s not worth the risk of overweighting technology right now.

I’ll make one last point about the likely relative weakness in technology. Check out this 20-year weekly chart of the XLK:

We’re at the top of the XLK’s 15-year channel, which has been problematic at every point in this channel, with the exception of the after-effects of the pandemic. It just looks like time for a change in leadership for a bit.

So all of this leads me to a big question. If technology underperforms, where should we look for relative strength?

XLY:

The XLY is trading much closer to its lower uptrend line, suggesting strength could easily find its way here.

XLV:

The XLV has been consolidating and, therefore, underperforming the S&P 500 for quite awhile. The recent breakout may be the trigger this group needs to see a lot more money rotating IN.

XLF:

Technically, we don’t usually see this group lead. Given the circumstances of the 2008-2009 financial crisis, the XLF has been a tough place to make money. But I believe the group was undervalued while short-term rates jumped and resulted in an inverted yield curve. 2024 is likely to reverse that condition, which will benefit the net interest margin for banks ($DJUSBK), a significant fundamental tailwind. Should our economy grow in 2024, which I believe it will, it could be a goldilocks scenario for banks – a solid, and perhaps even improving, economy coupled with rising spreads.

It will be very interesting to see how the first quarter of 2024 develops. While I can’t guarantee outperformance or underperformance of any area, I do believe that we can assess risk and make more informed trading/investing decisions.

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Happy trading!

Tom

Tom Bowley

About the author:
Tom Bowley is the Chief Market Strategist of EarningsBeats.com, a company providing a research and educational platform for both investment professionals and individual investors. Tom writes a comprehensive Daily Market Report (DMR), providing guidance to EB.com members every day that the stock market is open. Tom has contributed technical expertise here at StockCharts.com since 2006 and has a fundamental background in public accounting as well, blending a unique skill set to approach the U.S. stock market.

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The Hoax of Modern Finance – Part 4: Misuse of Statistics and Other Controversial Practices

Note to the reader: This is the fourth in a series of articles I’m publishing here taken from my book, “Investing with the Trend.” Hopefully, you will find this content useful. Market myths are generally perpetuated by repetition, misleading symbolic connections, and the complete ignorance of facts. The world of finance is full of such tendencies, and here, you’ll see some examples. Please keep in mind that not all of these examples are totally misleading — they are sometimes valid — but have too many holes in them to be worthwhile as investment concepts. And not all are directly related to investing and finance. Enjoy! – Greg


The Deception of Average

The World of Finance is fraught with misleading information.

The use of averages, in particular, is something that requires discussion. Figure 4.1 shows the compounded rates of return for a variety of asset classes. If I were selling you a buy-and-hold strategy, or an index fund, I would love this chart. Looking at the 85 years of data shown here, I could say that, if you had invested in small-cap stocks, you would have averaged 11.95 percent a year, and if you had invested in large-cap stocks, you would have averaged 9.85 percent a year. And I would be correct.

Figure 4.1

I think that most investors have about 20 years, maybe 25 years, in which to accumulate their retirement wealth. In their 20s and 30s, it is difficult to put much money away for many reasons, such as low incomes, children, materialism, college, and so on. Therefore, with that information, what is wrong with this chart? It is for an 85-year investment, and people do not have 85 years to invest. As said earlier, most have about 20 years to acquire their retirement wealth. and there are many 20-year periods in this chart where the returns were horrible. The bear market that began in 1929 did not fully recover until 1954, a full 25 years later; 1966 took 16 years to recover, 1973 took 10 years, and, as of 2012, the 2000 bear still had not recovered.

Table 4.1 shows the performance numbers for the asset classes shown in Figure 4.1 (LT—Long Term, IT—Intermediate Term). The cumulative numbers in Table 4.1 begin at 1 on December 31, 1925.

Table 4.1Hint: Be careful when someone uses inappropriate averages; or more accurately, uses averages inappropriately.

In Table 4.1, recall how the small-cap and large-cap compounded returns were about 12 percent and 10 percent, respectively. Figure 4.2 shows rolling 10-year returns by range since 1900. A rolling return means it shows the periods 1900–1909, 1901–1910, 1902–1911, and so on. You can clearly see that the small stock and large stock returns depicted in Table 4.1 fall within the middle range (8 percent–12 percent) in Figure 4.2, yet, of all the 10-year rolling periods, only 22 percent of them were in that range. Often, average is not very average. It reminds me of the story of the six-foot-tall Texan that drowned while wading across a stream that averaged only three-feet deep.

Figure 4.2

Another (and final) example shows how easily it is to be confused over what is average. And, of course, this time it is intentional. This example should put it in perspective. You cannot relate rates of change linearly. In Figure 4.3 , point A is 20 miles from point B. If you drive 60 mph going from point A to point B, but returning from point B to point A, you drive 30 mph. What is his average speed for the time you were on the road?

A. 55 mph

B. 50 mph

C. 45 mph

D. 40 mph

Figure 4.3

Many will answer that it is 45 mph ((60mph + 30mph)/2). However, you cannot average rates of change like you can constants and linear relationships. Distance is rate multiplied by time (d = rt). So time (t) is distance (d)/rate (r). The first leg from A to B was 20 miles divided by 60 mph or one-third of an hour. The second leg from B to A was 20 miles divided by 30 mph or two-thirds of an hour. Adding the two times (1/3+2/3 = 1 hour) will mean you traveled for one hour and covered a total distance of 40 miles, which has to mean the average speed was 40mph. Look up harmonic mean if you want more information on this, as it is the correct method to determine central tendency of data when it is in the form of a ratio or rate.

Figure 4.4 shows the 20-year rolling price returns for the Dow Industrials. The range of returns in this 127-year sample (1885–2012) is from a low on 08/31/1949 (of .3.71) percent to a high on 3/31/2000 (of 14.06 percent), a 17.77 percent range.

To help clarify rolling returns, if investors were in the Dow Industrials from 9/30/1929 until 8/31/1949 (the low mentioned previously), they had a return of .3.71 percent. Complementary, if they invested on 4/30/1980, then, on 3/31/2000, they had a return of 14.06 percent. The mean return is 5.2 percent and the median return 4.8 percent. When median is less than mean, it simply means more returns were less average. If you recall the long-term assumptions that are often used in the first part of this chapter (Figure 4.1), you can see there is a problem. The magnitude of errors in assumptions of long-term returns cannot be overstated and certainly cannot be ignored. This variability of returns can mean totally different retirement environments for investors who use these long-term assumptions for future returns. It can be the difference between living like a king, or living on government assistance. Institutional investors have the same problems if using these long-term averages.

Figure 4.4

One of the primary beliefs developed by Markowitz in the 1950s as the architect of Modern Portfolio Theory was the details on the inputs for the efficient investment portfolio. In fact, his focus was hardly on the inputs at all. The inputs that are needed are expected future returns, volatility, and correlations. The industry as a whole took the easy approach to solving this by utilizing long-term averages for the inputs — in other words, one full swing through all the data that was available, and the average is the one used for the inputs into an otherwise fairly good theory. Those long-term inputs are totally inappropriate for the investing horizon of most investors; in fact, I think they are inappropriate for all human beings. While delving into this deeper is not the subject of this book, it once again brings to light the horrible misuse of average. These inputs should use averages appropriate for the investor’s accumulation time frame.

One If by Land, Two If by Sea

Sam Savage is a consulting professor of management science and engineering at Stanford University, and a fellow of the Judge Business School at the University of Cambridge. He wrote an insightful book, The Flaw of Averages, in 2009, wherein he included a short piece called “The Red Coats” that fits right into this chapter.

Spring 1775: The colonists are concerned about British plans to raid Lexington and Concord, Massachusetts. Patriots in Boston develop a plan that explicitly takes a range of uncertainties into account: The British will come either by land or by sea. These unsung pioneers of modern decision analysis did it just right by explicitly planning for both contingencies. Had Paul Revere and the Minutemen planned for the single average scenario of the British walking up the beach with one foot on the land and one in the sea, the citizens of North America might speak with different accents today.

Incidentally, Dr. Savage’s father, Leonard J. Savage, wrote the seminal The Foundation of Statistics in 1972 and was a prominent mathematical statistician who collaborated closely with Milton Friedman.

Everything on Four Legs Is a Pig

Although this is unrelated to investments and finance, it is a story about averages that offers additional support to this topic. Doctors use growth charts (height and weight tables) for a guide on the growth of a child. What folks do not realize is that they were created by actuaries for insurance companies and not doctors. As doctors began to use them, the terms overweight, underweight, obese, and so on were created based on average. So if your doctor says you are overweight and you need to lose weight, he is also saying you need to lose weight to be average. And from a Wall Street Journal article by Melinda Beck on July 24, 2012, “The wide variations are due in part to rising obesity rates, an increase in premature infants who survive, and a population that is growing more diverse. Yet the official growth charts from the Centers for Disease Control (CDC) and Prevention still reflect the size distribution of U.S. children in the 1960s, 1970s, and 1980s. The CDC says it doesn’t plan to adjust its charts because it doesn’t want the ever-more-obese population to become the new norm.” And now you know.

During my last physical examination, I told my doctor about how these charts on height and weight were just large averages created by actuaries for insurance companies, and that I did not mind being above average. The chapter that follows focuses on the multibillion-dollar industry of prediction. I rarely am invited to be on the financial media anymore because I refuse to make a prediction; it is a fool’s game.


Thanks for reading this far. I intend to publish one article in this series every week. Can’t wait? The book is for sale here.

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Ready Yourself for 2024 With Macro to Micro Analysis

For the new year, we have given you an extensive 3-pronged look at the markets.

First, we have the general outlook for the economy and markets through the Outlook 2024. This is the general outlook for 2024, including the recap of 2023 and how the predictions I made then played out. It includes a comparison in inflation and disinflation patterns of the 1970s and now. It also includes all the indices and the general outlook for key sectors and the bonds, dollar, metals, and so on.

Moreover, we look at the Economic Modern Family and their outliers through charts and analysis. Also included are overall trends to watch, plus picks.

One other area I cover in the Outlook 2024 is the teachings of Raymond Lo and how he sees the upcoming Year of the Dragon. Part of my comments on his analysis is based on this statement by Lo:

“Many has the misunderstanding that the Dragon is glamorous auspicious animal and will always bring good luck. To the contrary, Dragon and Dog in the 12-animal system is called the “Gate to Heaven and Hell” or the “Net of Heaven and Hell”.

General Thoughts

2024 could see gains; however, we are agnostic and definitely looking to charts. SPY needs to hold 4600 as our line in the sand, and small caps need to hold over 2000. Plus, in January, we will have a 6-month calendar reset this year with the election; instruments that fail the calendar range lows could set the stage for a broader selloff, while instruments that rally above the calendar range highs can be the bigger winners, at least for the first half of the year. Nonetheless, we have keen eyes on junk bonds, which, despite rallying, have well underperformed the indices. If they hold, great; if not, we take that as a warning.

With the anticipation of Fed lowering rates multiple times, we also want to see Fed Fund rates stabilize and not fall too dramatically, as those could be the signs of recession that we seemingly avoided in 2023. Additionally, we expounded with Daily newsletters.

From Gold and Silver

For last year’s Outlook, I wrote:

Perhaps our biggest callout for a major rally in 2023 is in gold.

Here we are over $2000 and, although gold has not doubled in price, it did rise by 25%.

For 2024, we stay with our call for higher gold prices. I am looking for a move to $2400, provided gold continues to hold $1980.

That statement was from December 1st. To add to that statement:

Trends for 2024 — Gold and Silver start their Last Hurrah.

From 17 Predictions

With certain areas of inflation coming down, although still higher than what numbers suggest, the discussion of the rate hike cycle at the end is controversial. Statistically, there has been a major financial failure at the end of each rate hike cycle since 1965.

Currently, the catalyst for financial stress could be the rising debt, rising spending, geopolitical issues impacting supply chain and a contentious election year. And anything that gooses inflation will stop the Fed from cutting.

January 2024 will see a new 6-month calendar range reset — it will be very important this time, with many predicting the end of the first quarter with a selloff. Although the stats are on the side of a higher market, this year of the dragon suggests some irritation that could turn the market on its side with more volatility.

To be prepared check out our predictions.

From The Vanity Trade 2024: All About Me!

According to Wikipedia, “Self-help or self-improvement is a self-directed improvement of oneself—economically, physically, intellectually, or emotionally—often with a substantial psychological basis.”

In the Outlook 2024, I quote Raymond Lo yet again,

“The Dragon is considered a ‘Star of Arts.’ The industries that will perform better in the Year of the Dragon will be related to the Metal and Wood elements. Metal industries are beauty and skin care; wood industries are media, fashion….”

This got me thinking about the consumer and the habits of 2023 and how they could continue or change in 2024.

With disposable income still quite high, consumers who spent the last half of 2023 in YOLO or revenge spending go into vanity mode in 2024.

Fashion, beauty, skincare, elective surgeries, self-help, diet drugs, and maybe dating stocks do well.

This daily includes lots of picks to put on your radar.


Click this link to get your free copy of the Outlook 2024 and stay in the loop!

Thank you, all my loyal readers, followers, clients and colleagues, for making 2023 so successful. Here is to a VERY HEALTHY, HAPPY and PROSPEROUS NEW YEAR!!!


This is for educational purposes only. Trading comes with risk.

If you find it difficult to execute the MarketGauge strategies or would like to explore how we can do it for you, please email Ben Scheibe at [email protected], our Head of Institutional Sales. Cell: 612-518-2482.

For more detailed trading information about our blended models, tools and trader education courses, contact Rob Quinn, our Chief Strategy Consultant, to learn more.

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Get your copy of Plant Your Money Tree: A Guide to Growing Your Wealth.

Grow your wealth today and plant your money tree!

“I grew my money tree and so can you!” – Mish Schneider

Follow Mish on X @marketminute for stock picks and more. Follow Mish on Instagram (mishschneider) for daily morning videos. To see updated media clips, click here.


Mish and team look at 2023 and make several predictions on commodities and trends for 2024 and vanity stocks in Benzinga Pre Market Prep.

Mish discusses gold, silver and why self care and “all about me” can trend in 2024 in this video from Yahoo! Finance.


Coming Up:

January 2: The Final Bar with David Keller, StockCharts TV & Making Money with Charles Payne, Fox Business & BNN Bloomberg

January 3: Real Vision IP Group Special Presentation

January 5: Daily Briefing, Real Vision

January 22: Your Daily Five, StockCharts TV

January 24: Yahoo! Finance

Weekly: Business First AM, CMC Markets


  • S&P 500 (SPY): 480 all-time highs, 460 underlying support.
  • Russell 2000 (IWM): 200 pivotal.
  • Dow (DIA): Needs to hold 370.
  • Nasdaq (QQQ): 410 pivotal.
  • Regional Banks (KRE): 47 support, 55 resistance.
  • Semiconductors (SMH): 174 pivotal support to hold this month.
  • Transportation (IYT): Needs to hold 250.
  • Biotechnology (IBB): 130 pivotal support.
  • Retail (XRT): The longer this stays over 70.00 the better!

Mish Schneider

MarketGauge.com

Director of Trading Research and Education



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The Top Five Charts of 2023

KEY

TAKEAWAYS

  • 2023 was dominated by mega cap growth stocks, but the fourth quarter saw a potential change as other sectors experienced renewed vigor.
  • Three breadth indicators provided great clarity to the up and down cycles over the course of the year, as extreme readings tended to coincide with major turning points.
  • Interest rates remain top of mind as a pullback in the Ten Year Treasury Yield certainly seemed to provide support to the recent rally for stocks.

The end of the year provides a natural opportunity to look back and reflect on what we learned over the last 12 months as investors. I very much enjoyed thinking about how to tell the story of this market in just five charts, and to be completely honest, the videos below include way more than that!

But as much we love to make things more complicated for ourselves, mindful investors know that simple is often the best approach. So, by boiling down this year into five major themes and using these charts as a starting point to a deeper analysis of each, I found it to be a rewarding and at times eye-opening experience.

You can access the full playlist of the Top Five Charts on our YouTube channel, and you are welcome to ChartList I used during the videos, which you can find right HERE!

Without further ado, here are the five charts I selected, along with descriptions and video links. I hope you can use these as inspiration for your own year-end process and performance review!

Chart #1: S&P 500

As Ralph Acampora told me years ago, “Always start with a simple chart of the S&P 500.” And it’s been a fascinating year to do so, with each quarter providing a unique experience for investors, including plenty of ups and downs.

Looking back, I’m struck by what a sideways market we experienced really through the end of May. The S&P started with a strong January, but subsequent months basically brought retests of previous highs and previous lows, and no real indication of bullishness or bearishness on the larger timeframe.

June’s breakout provided a perfect example of the bearish momentum divergence, as negative momentum into the July high indicated an exhaustion of buyers. I also find myself focusing in on the October low, which caused me to be quite bearish at the time. That was definitely one of my key lessons learned in 2023, especially the importance of recognizing a clear change of character in November.

Chart #2: Ten Year Treasury Yield

Back in January 2023, I was asked during an interview to identify the most important chart to watch in 2023. I answered this chart, the Ten Year Treasury Yield ($TNX), along with the value vs. growth ratio. My thesis was that many investors had not experienced a rising rate environment (including me!), so this could mean some painful lessons as value outperformed growth as interest rates pushed higher.

As the chart clearly shows, the Ten Year Yield going from around 4% to 5%, completing a long journey from almost zero rates not long ago, did not provide the tailwind for value stocks that I expected. What a beautiful testament to the benefits of including macroeconomic analysis as part of a holistic investment approach, but also the importance of focusing on the evidence of price itself. If the charts say growth is outperforming, I’m going to want to stick with growth until proven otherwise.

Chart #3: Market Breadth

Breadth analysis is an essential component to my analytical process, as it addresses the issues related to our growth-oriented benchmarks being dominated by a small number of mega-cap stocks.

This chart includes three different breadth indicators: the S&P 500 Bullish Percent Index, the Percent of Stocks Above the 50-day Moving Average, and the McClellan Oscillator. With the first two indicators at 80% and 90%, respectively, this suggests a potential exhaustion point to the current upswing, similar to what we observed in July 2023, November 2022, and August 2022.

Chart #4: Leadership Themes

I have been thinking of 2023 as the year of mega-cap growth, but this fourth chart that it actually wasn’t about growth over value, but rather large over small. Reviewing the nine Morningstar style boxes, it’s clear that, while growth did indeed outperform value, it was overall more of large vs. small story.

Large-cap growth has outperformed large-cap value by almost 900 basis points (nine percent), but has outperformed mid-cap and small-cap style boxes by around 1300 basis points. Our benchmarks have been powering higher, propelled by the strength of large-cap growth, and one of the most important questions for 2024 will be whether this stretch of domination will continue.

Chart #5: Bitcoin

Higher highs and higher lows make an uptrend. And while Bitcoin ($BTCUSD) did not show that general pattern in the middle of 2023, it started the year strong and certainly ended the year in a position of strength.

Bitcoin has nearly tripled in value since December 2022, starting with a significant rally into an April high. But from March through October, Bitcoin basically was rangebound between 25,000 and 31,000. I remember laying out a game plan, which involved following the price momentum fueling any exit from that range. Sure enough, in October, we witnessed an upside breakout inspired by renewed optimism for a potential announcement confirming new spot Bitcoin ETFs. While that news has not yet arrived, the bullish uptrend shows that investors remain eager for this huge potential catalyst.

During my years in the Fidelity Chart Room, I was often reminded that charts can tell the best stories about market history. And as each new year concludes, the charts can provide a fantastic report card for your performance, a history textbook filled with practical lessons for years to come, and a reminder of the value of technical analysis in helping us identify opportunities and manage risk.

I hope these discussions inspire you to have a thorough review session as we wrap 2023, and an honest assessment of how you can improve your investing toolkit in 2024.

Happy holidays, thank you for making StockCharts a part of your process, and I’ll look forward to more great charts and conversations in the new year!

RR#6,

Dave

P.S. Ready to upgrade your investment process? Check out my free behavioral investing course!


David Keller, CMT

Chief Market Strategist

StockCharts.com


Disclaimer: This blog is for educational purposes only and should not be construed as financial advice. The ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial professional.

The author does not have a position in mentioned securities at the time of publication. Any opinions expressed herein are solely those of the author and do not in any way represent the views or opinions of any other person or entity.

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The Hoax of Modern Finance – Part 3: Fictions Told to Investors

Note to the reader: This is the third in a series of articles I’m publishing here taken from my book, “Investing with the Trend,” in article form here on my blog. Hopefully, you will find this content useful. Market myths are generally perpetuated by repetition, misleading symbolic connections, and the complete ignorance of facts. The world of finance is full of such tendencies, and here, you’ll see some examples. Please keep in mind that not all of these examples are totally misleading — they are sometimes valid — but have too many holes in them to be worthwhile as investment concepts. And not all are directly related to investing and finance. Enjoy! – Greg


Believable Misinformation in Investing

Remember in our previous articles how many of the things we learned when we were young simply are not true? How many things have you learned in regard to investing that also just might not be true? Well…

  • “Buy and hold is the only way to be successful in the stock market.”
  • “Dollar-cost averaging is a good technique.”
  • “Diversification will protect you from bear markets.”
  • “Compounding is the eighth wonder of the world.”
  • “You must remain invested at all times, or you will miss the 10 best days each year.”
  • “Average returns are never better than compounded returns.”
  • “Probability and risk are the same thing.”
  • “Equity asset allocation will protect you from bear markets.”
  • “Economists are good at predicting the market.”
  • “Chasing performance is a common technique.”

The Void of Accountability

How often do you watch economists and market experts in financial media (television, print, etc.) offer strong opinions on the future direction of the economy and the stock market? Do they ever present their track record? Never! In fact, if you pay close attention, you will see that most of the “experts” are gaining something from their appearance. I’m shocked and disappointed at the absolute certainty in which they deliver their prognostications.

Hiding Behind Statistics

Have you placed a bet on the market using the Super Bowl indicator?

The Super Bowl indicator is based on the premise that, if the Super Bowl champion came from the old AFL, now known as the AFC, then the year will bring a downtrend in the stock market, while a winner from the old NFL, now the NFC, will lead to a bull market. Hopefully, you have not made any market decision on this, as that is a classic example of data mining and, even then, with an inadequate amount of data. This is not uncommon, however, as analysts, the financial media, newsletter writers, bloggers, and so on are constantly using data-mined statistics to make or support their hypothesis.

Figure 2.1 is a histogram of the annual returns on the Dow Industrial Average since 1897. The returns on the left are the down years, and the ones on the right are the up years. The up years account for 66 percent of all the years, so, if I were selling you a buy-and-hold strategy or an index fund, I could point to this chart and say, “Look, the market is up 66 percent of the time,” and I would be correct. Is this actionable information? Of course not, it is only observable information. And it is good, because it helps one understand market history and statistics. But you can’t make an investment decision based on this information.

Let’s play a game. First of all, I promise you that it is a fair game; here are the rules: 

  • It will cost you $10 to play the game.
  • You can play as many times as you desire.
  • If you win, you will receive $1 million.
  • There are no tricks.
  • The honest mathematical probability of winning is 1 out of 6. Honest! No tricks!

Figure 2.1

How many want to play?

When I do this during a presentation, most folks raise their hands; a few don’t, but those are the ones that never raise their hand. I then announce that the game is Russian roulette, and ask, “How many want to play the game now?” No one raises their hands. I then ask, “What happened?” I changed your focus from these goofy statistics to the risk of playing the game, and when you found out the risk of playing, you were no longer interested. Most do not realize the difference between probability and risk. This is what you need to do with the market, analyze and assess the risk. Stop paying attention to the daily noise, and know the difference between actionable information and observable information.

You Must Remain Invested or You Will Miss the 10 Best Days of the Year

“You must remain invested, or you will miss the ten best days of each year.” How many times have you heard that? While the fact of this matter is true, it is an impossible task to determine the best days beforehand. Let’s turn it around and ask what happens if you miss the ten worst days each year.

Figure 2.2 shows the S&P 500 since 1979. The line that moves down and to the right is the line represents the “missing the ten best days” argument. Note that this analysis was about missing the 10 best (worst) days per year. Again, the argument is factual; it just isn’t realistic. The line that moves up and to the right is the one that “misses the 10 worst days.” Clearly, missing the 10 worst days gives a drastically better performance than missing the 10 best days. The two lines in the middle are the S&P 500 and the line representing “missing both the 10 best and 10 worst days,” which you can see are quite close.

Figure 2.2

I have done this analysis also using the Dow Industrial Average back to 1885, and the results are always the same. I have done this over many varying time periods, and again, the results are the same. So, the buy-and-hold pundits and the index investing pundits want to scare you into believing their methods are better. A few articles from now, the section “The Deception of Average” should be enough to convince you that there is something wrong with that type of thinking. The best days (worst days) in the market are nothing more than interesting statistical anomalies. The argument that missing the best days would reduce the final return of a buy-and-hold strategy is true, but it also provides no information regarding the question of whether one can time the market in that regard. Somewhat like a strawman argument.

Table 2.1 is the data on the “missing days” conundrum. All data is updated through December 31, 2012. All calculations are based solely on price performance with no adjustment for dividends or inflation. It should be clear that if it were possible, missing the worst days each year would be the better strategy. This might be a stretch, but because missing both best and worst outperforms buy and hold, I think it shows that missing bad market days is more important. It also shows that missing days of high volatility are good. However, the purpose here is to challenge the marketing of buy and hold, which uses the “missing the best days” argument.

Remember, the message is clear and simple: The name of the game is to miss the bad days a lot more than missing the good days. This will play out as this book moves along. Note that most of the best days happen during bad or bear markets, usually tied to an overreaction to a short-term panic decline (you will see this in Table 3.1 ).

Diversification Will Protect You?

The world of finance is locked into the risk category of nonsystematic, or diversifiable, risk, and they do a really good job of it. However, diversifiable risk is a small piece of the big risk pie. There are many trite sayings about diversification, one being: “The only thing going up in a bear market is correlation.” During big bear markets, correlations move rapidly toward one. This also means that most asset classes fail significantly during severe bear markets. The correlations among them move toward one, which means they become more and more correlated. Correlation is one of the primary components of modern portfolio theory. Diversification is a helpful tool, but it should only be employed to the point where its costs equal its benefits. 

You can see in the two charts, Figures 2.3 and 2.4 , that, during up markets, most asset classes are uncorrelated and exhibit significantly different returns. However, in the second chart (Figure 2.4 ), during big bear markets, those same asset classes performed almost identically to each other, which challenges the need for diversification.

Table 2.1: Best and Worst Days

The old saying goes, “Diversification works until it doesn’t.” The asset classes used in these two charts are shown in Table 2.2.

Diversification Works, as you can see in Figure 2.3 over the period from 2000 to October 2007…

Figure 2.3: Diversification Works. Chart courtesy of StockCharts.com

….Until it doesn’t, as you can see in Figure 2.4 over the period from October 2007 to August 2009.

Figure 2.4: Diversification Does Not Work. Chart courtesy of StockCharts.com.  

Table 2.2: Components of the Diversification Charts (Figures 2.3 and 2.4)

Dollar-Cost Averaging

Dollar-cost averaging is simply the act of making like dollar investments on a periodic basis, say every month or every quarter. It is sold as a technique because they want you to believe that no one can outperform the market. There are many papers written on this subject, and I don’t want to dwell on it. Dollar-cost averaging is very dependent on when you start the process. If you start the process at the top of the market, just prior to a large bear market, you will be buying all the way down, and this process could last a couple of years. Your average purchase price would probably be somewhere in the middle of the decline. A quick study of equivalent returns would tell you that the following bull move would need to go considerably higher than just halfway back up for you to just break even. In addition, it is also critical as to what periodic day or week you choose to make the investment. Should you do it quarterly and invest on the first day of the first week of the quarter, or something else?

The bottom line is that this process is subjected to unknown market risk, which can work for you but can also work against you. However, I think dollar-cost averaging is probably better than buy and hold, and it is certainly better than doing nothing, which might also be the same as buy and hold. When I hear someone talk about dollar cost averaging, I usually assume it is because they don’t know what else to do. Anytime you can get someone to periodically contribute to an investment, you have accomplished something of value.

Table 2.3 is a really simple example of how it works using Apple (AAPL) stock from the year 2011, buying $500 of the stock on the first trading day of each month and determining the results on the day of the last purchase in December. You can see that, on the first trading day of December, you had accumulated 16.65 shares of Apple stock at an average price of $361.70 per share. The lump sum example assumes you bought all $6,000.00 on the first trading day at $329.57 per share, which gave you 18.21 shares.

Table 2.3: Dollar Cost Averaging

From this example, the lump sum investment came out ahead, but I think you can see it has a lot to do with the time period for the investment, the volatility of the share prices, and, actually, the day of the month that you make the purchase. Some of the advantages of DCA are the affordability factor and the convenience; it can be set up just like any monthly household budget item or expense, and also something many people need to keep the process alive. The disadvantages are that lump sum investing can give better returns but also worse returns, and the disadvantage is that you won’t know ahead of time. Also, when making numerous DCA investments, the fees are generally higher than lump sum. The bottom line is that it helps people make investments on a periodic basis, which is always going to be better than sitting on the sidelines because you don’t know what to do. Furthermore, dollar cost averaging becomes less effective as an investor ages because of less time for compounding, and free cash is usually a lower percentage of total investment goals.

Jason Zweig, in a Wall Street Journal article on May 26, 2009, spoke of Benjamin Graham’s comments on dollar cost averaging. Asked if dollar cost averaging could ensure long-term success, Mr. Graham wrote in 1962: “Such a policy will pay off ultimately, regardless of when it is begun, provided that it is adhered to conscientiously and courageously under all intervening conditions.” For that to be true, however, the dollar cost averaging investor must “be a different sort of person from the rest of us… not subject to the alternations of exhilaration and deep gloom that have accompanied the gyrations of the stock market for generations past.” “This,” Mr. Graham concluded, “I greatly doubt.”

He didn’t mean that no one can resist being swept up in the gyrating emotions of the crowd. He meant that few people can. To be an intelligent investor, you must cultivate what Mr. Graham called “firmness of character”—the ability to keep your own emotional counsel. (A102)

Compounding is the Eighth Wonder of the World

I think it was Albert Einstein who made the above comment, even though I found no proof that he did. The rest of the quote is: He who understands it, earns it, and he who doesn’t, pays it. I always remind folks that he forgot to include an adjective. Positive compounding is the eighth wonder of the world, which is usually associated with saving accounts and so on. Table 2.4 is a simple example of how one negative year can ruin your retirement plans. Notice that Investment Option B also started out with a phenomenal first-year return of +36 percent, compared to Option A’s return of only +10 percent. Another example of why chasing performance can be very harmful to your wealth.

The investment option B in Table 2.4 would require a return of 16 percent the following year to get back to the 8 percent per year average. Beware of negative returns; they can destroy your financial plans, especially as you lose time to recover the losses.

It is critical for long-term investment success to not track short-term market movements. Instead, one should only try to outperform the markets over the long term. Let’s assume that your investment goal is to maintain an annualized return of 10 percent over the next five years, as shown in Table 2.5. Here are the hypothetical market returns: +10 percent, +10 percent, +10 percent, -10 percent, +10 percent. Those returns look pretty good at first glance, even though one of them is negative. However, the impact on the actual investment return is quite different. 

Table 2.4 Compounding Example 1

Table 2.5: Compounding Example 2

The important point is that it only takes one drawdown over any one-year period to destroy compounded returns. In the above example, it would take a 33% return in year five to return the portfolio to an annualized 10 percent return. This is why most investors’ performance is far less than that of the actual market. Compounding is indeed the eighth wonder of the world, but it is only when the returns are positive.

Relative Performance

First of all, you cannot retire on relative performance. Relative performance is a marketing concept dreamed up by financial pundits who rarely outperform the market.

Figure 2.5 is a table of various asset classes and their relative performance. Keep in mind that each column (year) is totally independent of the other columns, and the asset classes at the top performed better than those at the bottom of each column. You do not know if they both lost money, both made money or if one made money and one didn’t. It is just simple relative performance. And guess what? You cannot retire on relative returns. Normally, this table is displayed in color, so the delineation between the squares is more apparent, but showing the actual data was not the purpose of introducing it at this point.

Figure 2.5: Callan Periodic Table of Relative Returns. Courtesy of Callan Associates.

Often, the Callan Periodic Table of Returns is shown to convince investors that chasing performance is a bad idea, as last year’s top performer probably won’t be the current year’s top performer. You can see that, sometimes, there is a string of consistent top performance; in fact, in Figure 2.5, Emerging Markets was the top performer from 2003 to 2007. If an investor caught onto that trend after a few years, it wouldn’t have been long before it failed miserably, and sadly, the investor, who probably thought they were genius, had been adding money each year and had no money management concepts or loss protection (stop loss) in place. Emerging markets fell to the worst performer in 2008 and have shown exceptional relative volatility since. If there was any real value in this, it is to learn and understand market history.

This is probably one of the most difficult obstacles to successful investing to overcome. It is human nature to want to be invested in the top-performing stocks, funds, or strategies. Yet you rarely know they are top-performing until after they have had a few good years of top performance. In the old days, many picked up the late January issue of Barron’s magazine, when they showed the performance for all mutual funds for the previous year. Just like the Callan Periodic Table in Figure 2.5 , when something is a top performer for a while, it, more often than not, does not remain so.

Style boxes are another dreadful source of performance chasing. A typical style box, created by Morningstar in 1992, is shown in Figure 2.6. This gives investors an orderly classification system for mutual funds, which is unbelievably popular and used extensively to sell mutual funds. Morningstar ranks mutual funds into a five-star scale, which forces a normal distribution because the top 10 percent get five stars, the bottom 10 percent get one star, the middle 35 percent get three stars, and the other two 22.5 percent groups get four and two stars. Research has shown that investors tend to put money into those with high ratings and withdraw money from those with low ratings, usually when they should be doing the opposite. (A55)

Figure 2.6: Morningstar Style Box

In fact, many fund managers are tied to a particular style and measured by how they performed relative to that style. Their benchmark is the style box they have been classified into. If the fund drifts from its designated style, the marketing pressure ensures adherence to the style box. I like to remind investors that when a manager who is tied to a benchmark (style) outperforms it, they call it alpha; however, when the manager underperforms, the benchmark they like to say is a tracking error.

Later in this book, you will see an investment strategy that does not pay any attention to styles or style boxes; however, I can show you a modified style box for a trend-following strategy in Figure 2.7. A trend follower is only concerned about uptrends and downtrends. If you feel that you must involve a style box approach, I recommend the one in Figure 2.7.

Figure 2.7: Trend Followers Style Box

With all that is arguably wrong with financial theory, the next chapter will delve into some mathematical anomalies with using simple “bell curve” statistics, which are based on assumptions about the market that just do not play well and, in fact, are simply erroneous.

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