Investment Journalists would make Horrific Fund Managers
Tomorrow I’m going to pack a lunch before I head to work. I’ve learned that I can predict with a high degree of certainty that between 11:30 and 12:30, I’m going to feel hungry enough to benefit from lunch. That isn’t the only forecast I’ll make tomorrow. I’m going to estimate my car ride to the office will take 25 minutes with a 10% margin of error, and that the air conditioning in the office will be set at a temperature requiring something warmer than I’ll wear in the car. There are several other predictions I’ll make before heading to work that will make my day more rewarding, but I’m not going to predict the stock market. That would be a waste of time.
As a former mutual fund manager, I had my finger on the trigger of $50B. I’d head into Manhattan before dawn and determine how best to react if/when certain events occur. I wouldn’t try to predict or make a call about the event. Instead, scenario analysis and if-this-then-that planning kept the fund among the top five performers in its category. This lack of prediction (or predicting various scenarios and reactions) included economic numbers, Fed testimony, earnings reports, everything. After all, if these were predictable, the market would have already built them into prices. So the reaction was what I focused on, that’s where prediction for me was most profitable. I made sure I had a firm understanding of the expectations of others. If a majority of investors was sure of something, then there could only be two outcomes. They could be right, or they could be disappointed; either way, profit was usually found leaning in the opposite direction of the masses. This is the root of the axiom “
buy the rumor and sell the fact.”
Buy the Rumor
The current “rumor” is that the pandemic will not last forever. There are multiple ways it may end; vaccine, therapeutics, a high percent of immunity, or it could die of natural causes. The market has been trading higher based on the eventual return of business without distancing. How coronavirus meets its demise doesn’t matter to the professional or individual investor. They only need to know that it is a widely held belief that it won’t be with us forever. The timing is uncertain, so until there is more clarity when it will disappear, the uptrend in stocks may continue. The clear end to the virus may wind up being the end of the relentlessly positive equity market.
This thinking is, in large part, how successful contrarians execute their strategy. It’s also why forecasters are often more wrong than right. They haven’t accepted that there is the human factor that buys and sells on future expectations. They still retain the notion that believes the market will react off news as though investors were blindsided by the event. We see it on CNBC and other major outlets all the time when one of the regular talking heads is stumped because a company reports higher earnings and the stock trades off, or a payroll number is below the prior period, and the market rallies. These are not people who accept that when an economic release or event comes out as positive as expected, profit-taking usually ensues. Instead, they are professionals with a large audience that expect that if a pharmaceutical company finds a much-anticipated cure, that its stock will always go up. It is far from a given. Rumors, if resolved on expectations, become an opportunity for profit-taking, this tends to change the direction of the stock prices for a period as profit-takers undermine any strength.
Sell the Fact
Once information becomes public, it is by definition too late to be early in taking a position. Contrarian traders or “news” traders like to trade against the tone of the report. This sounds daring, but the market has been building the forthcoming set of facts into prices. If one believes the stock market is currently priced for a perfect scenario, you should consider if it will be more likely to be disappointed, even in the rare case that perfection occurs.
Traders and investors that have gone against today’s economic gloomy forecasts and been long stocks should decide on scenario strategies now, before the eventual full return to work. The market sentiment leading up to the eventual “all-clear” sign on the pandemic has been extremely positive. Even as the rate of infection rotates from state to state, the market has climbed higher. The climb has been dramatic in some industries like pharmaceutical companies in different phases of testing. Holders of these stocks should also pre-think a plan, especially if the market price seems to have built-in a win. Some of these companies, whether they are part of the solution or not, may face severe downward pressure.
Make a Plan
Buy the rumor and sell the fact doesn’t mean to act on any half-baked expectation. It means to buy in anticipation of almost certain news/events to come, and then sell once the news has been presented, preferably with a pre-thought out plan.
It isn’t difficult to forecast the eventual end of a pandemic. The world has a long record of surviving and thriving each and every one. With this in mind, develop a plan. This is true of any Covid or non-Covid related exposure, but it’s especially pertinent today in the Covid stocks. If tomorrow a therapeutic is shown to have complete efficacy, what repositioning will you take? Both the beaten-down sectors such as hospitality and energy and so-called “Covid stocks” like communications and online retail will react sharply.
The resolution of the pandemic should quickly change investors’ buy and sell lists dramatically. Determining now what the lists will look like will reduce hesitation to act later. The headlines of major papers have been telling us the market is overbought since the first uptick after the final March 23 route was completed. We have been in rally mode most of that time. The Nasdaq has even made new all-time highs. If the pandemic abruptly shows signs of abating, the major news outlets will be more positive about the market’s prospects. What are the chances it won’t defy these forecasters again?
Managing Editor
Paul Hoffman
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