There are a lot of stock market myths swirling around these days. So I want to take this opportunity to clear a few of them up.
I’m currently in the middle of a nice 10-day vacation, the first three days of which were at Disney World (though that was really more of a vacation for the kids; my wife and I pushed them around in a stroller all day and gave them treats non-stop) and the rest at Anna Maria Island (West Coast of Florida) with my in-laws. I’m actually writing my column this week from our pool bar this morning, but don’t worry—no drinking until the sun hits the pool early afternoon. (OK, maybe noontime …)
As most people at Cabot could tell you, my vacations are usually working vacations—I (like many Cabot analysts) hand off some of my responsibilities when I’m away, but in the past I’ve typically checked in regularly and done at least some writing most days.
But on this vacation, I wanted to clear some time, so for the first few days I was totally off. Sure, I checked the market on my phone a couple of times per day while waiting in Disney lines, but I never opened my laptop once. It was nice.
Of course, this approach has a downside—when I finally did check my email earlier this week, there were 77 emails to respond to! Honestly, I don’t mind responding to emails; I think customer service is one thing that sets us apart from our competitors.
What was a bummer, though, was seeing a whole bunch of subscribers who were fretting about a host of things that I would consider either unknowable or uncontrollable. They weren’t bad questions, but in the market, it’s always important to concentrate only on what really matters—otherwise, the headlines will lead you in all sorts of wrong directions.
So today I will dispel five stock market myths that I’m getting asked about repeatedly these days.
Stock Market Myth #1: You Should Sell Stocks Because the Fed is About to Hike Interest Rates Again
I’ve already discussed some of the follies of timing your stock market action to the Fed’s. Suffice it to say that, for whatever reason, the Fed used to have much more control over the economy and the stock market than it does today—the past couple of rate hike cycles have actually seen the stock market do quite well.
Now, there is a theory called Three Jumps and a Stumble that says the market is doomed after the third rate hike. Maybe that will prove true, but, again, it hasn’t worked that well in the recent past—the Fed’s third rate hike during the 2004-2006 tightening cycle occurred in late 2004, about three years before the bull market ended.
That’s not to say the market can’t have a correction soon—there hasn’t been any real selling since November’s election. But the Fed’s days as a magic indicator for the market are long past.
Stock Market Myth #2: You Should Sell Your Stock Because the Top Brass is Selling Shares
I get this one all the time, and it makes so much sense—if the CEO just sold 50,000 shares, shouldn’t you? No, and the reason is two-fold. First, there’s no great correlation between insider selling and stock performance. Sometimes these officers sell near the top, but more often, they simply sell a chunk every three months to cash in. It’s not predictive, it’s just a way to get paid.
Second, what counts is what institutional investors think of the stock. If the CEO is bullish and buying shares, but Fidelity, T. Rowe Price and others are selling boatloads of stock, guess what? The stock is going down! That’s why it’s best simply to monitor the stock’s action, which will tell you if big investors are bailing out.
Stock Market Myth #3: You Should Sell Your Stock Because It’s Overvalued
Obviously, valuation is important, but for growth stocks, valuation as a timing tool is vastly overrated. In fact, in a bull market, valuation is usually a result of great performance, not the cause of it.
Obviously, a company that’s trading at 100 times earnings isn’t going to stay at that elevated valuation forever—at some point, whether it’s because of a downturn in the market or a hiccup in the company’s growth, the valuation will come down to earth. But that inflection point can be months or (for the biggest winners) years in the future.
In my view, growth investors are better off seeing if the market is healthy and whether the stock is “early stage” or “late stage.” That’s a whole other article in and of itself, but basically, stocks that have made huge runs for a year or more are usually near the end of their intermediate-term runs, so it’s better to focus on stocks that have more recently emerged from consolidations on big volume.
Stock Market Myth #4: The Market is Due for a Pullback after a Big Advance
OK, I admit, this isn’t exactly a myth. But my point is that too many investors are enamored of “the call of the countertrend” (to quote William Eckhardt, a successful trend-following trader). Once the market or a stock has a nice run for a few weeks, I am usually inundated with emails from subscribers asking whether they should sell the stock, or whether they should pare back on many stocks, thinking the market is due for a retreat.
The fact is that short-term timing is extremely difficult. Certainly, it’s best to be more discerning on the buy side after the market’s had a good run, and maybe you want to take some partial profits (selling one-third of your shares on the way up) if things get bubbly. But by constantly anticipating a pullback, investors pretty much guarantee they’ll never ride a major uptrend—and those major uptrends are where the big money is.
Stock Market Myth #5: It’s Good to Buy New IPOs Right out of the Gate
Chris Preston just covered part of this last week in his article titled “Why You Should Avoid the Snapchat IPO”, but I want to broaden Chris’ point: You really shouldn’t be buying any IPO right as it comes public, as there’s no way to tell if it’s going to be a winner or not. That’s more like gambling than investing.
A better method is to wait a couple of weeks (or more) and see how the stock trades. In the vast majority of cases, IPOs that go on to be winners will offer some lower-risk entry points along the way. One name I’ve been watching recently is Alcoa (AA), which split into two companies a few months back.
When AA came public back in late October, it did have a nice initial run, but then built a tidy base for about six weeks. The breakout above 32.5 or so was a nice entry point.
And now I think AA is offering another solid time to buy—after running to 40, the stock dipped to its 50-day line for the first time since its breakout, which usually offers support. Sure enough, AA bounced on excellent volume and has held its ground since. Earnings estimates here are huge (analysts see earnings north of $2 per share this year) and are likely conservative, and I think the stock could be bought around here, albeit with a stop in the 34 area.