Some of the reasons I'm more comfortable trading than buying and holding stocks are nicely outlined below. If you read the entire piece you'll notice that Nick's market approach to sell run-ups moderately and nibble as those run-ups correct, may work very well in 2021 as the market finds a channel and waits for earnings to catch up. The editorial is from Barron's this week. It's a worthwhile read.
I Might Stink at Selling. A New Study Shows I’m Not Alone.
A top Wall Street strategist says we’re six to eight weeks away from an excellent time to sell stocks. But separately, a study on selling shows that even professional money managers stink at it. A notoriously poor market timer, meanwhile, has done it again, getting trampled by bulls last month.
You’ve heard of the Oracle of Omaha? Think of this guy as the Whiffer of Westchester County, N.Y.
Let’s take those in reverse order: Greetings from Westchester.
I had a foolproof market thesis. Stocks were sure to dive in November for three reasons. Virus cases were spiking. There was potential for an election dispute. Plus, stocks looked pricey after soaring while the economy limped — it’s not as if there was any risk of, say, the S& P 500 index posting its best November since 1928. So I shifted some money from stock index funds to cash.
It turns out that low interest rates and good news on vaccines are more important to the market than any of that other stuff. The S& P jumped 11% for the month, the best since you know when. At least I ended up with a half-bonanza, because I am suspicious enough of my judgment to keep from abandoning stocks altogether. And thank heavens for the vaccines.
It turns out that better investors than me struggle with selling decisions, especially where individual stocks are involved. There is a vast body of academic research on stock picking, but little on selling, so a paper that has been circulating for the past year stands out.
The founder of Inalytics, a firm that measures investment skill, along with researchers from the University of Chicago, Carnegie Mellon University, and the Massachusetts Institute of Technology, studied more than four million trades made in nearly 800 institutional portfolios from 2000-16. The traders weren’t ham-and-eggers; their average portfolio size was $573 million.
“A striking finding emerges: While there is clear evidence of skill in buying, selling decisions underperform substantially—even relative to random selling strategies,” the researchers write.
Think of that. People who buy and sell stocks for a living aren’t just unskilled when it comes to selling— they’re the inverse of skilled. These aren’t chimps throwing darts at the financial pages. They are Ivy Leaguers sticking darts in painful places. Poor selling hurts their returns by close to two percentage points a year, on average. Compounded over a career, that’s a fortune.
It will take more research to know why skill in selling is so rare, but there are some early clues. The researchers report that portfolio managers in interviews talk about spending most of their time looking for stocks to buy, and regard selling as something to do to free up money for new purchases.
Perhaps, the researchers theorize, there is an “asymmetric allocation of cognitive resources” at work. That is, the portfolio managers are simply doing far more homework on their purchases than their sales. There is supporting evidence for that in the study: Sales that occurred near company earnings reports, when portfolio managers were presumably paying close attention to fundamentals, were associated with decent returns. Sales that were nowhere near earnings reports were largely flops.
Previous research from the field of behavioral research has shown that investors tend toward what’s called loss aversion. They feel the pain of losing money more deeply than the joy of gaining. That makes them hold losing trades for too long, so as not to give up hope, and sell winners too soon, to keep good news from turning to bad.
The selling study, however, showed something different: Returns were particularly bad when portfolio managers sold extreme performers, both good and bad, with relatively small weightings. It wasn’t tax harvesting at work, because a majority of portfolios were tax-sheltered. The researchers reckon that those particular sales represent managers simply choosing from low-conviction holdings that had done something big, rather than taking a more rigorous approach.
So market timing is hard, and selecting stocks to sell confounds even the best. Now, Michael Hartnett, chief investment strategist at Bank of America, says investors should get ready to do a little of both. Vaccines, he predicts, will bring a mirror image of this past March, when investors reached maximum pessimism.
“If we’re taking a vaccine and emerging from our caves and traveling and going back to offices, there will not be the need for monetary and fiscal stimulus,” Hartnett told me this past week. The rollout of vaccines will be unambiguous good news, of course, but “in this bizarre place called Wall Street, it’s likely to create a moment of peak positioning,” he says.
We’re not there yet. Hartnett says that after another six to eight weeks, or 6% to 8% more upside for the stock market, the time will be right for investors to favor havens. He recommends overweighting cash, inflation-protected Treasuries, and defensive stocks with sturdy dividends, including utilities, consumer staples, and some real estate investment trusts. Gold, he says, will look good, too, after a pause to digest the cash it has attracted of late.
But be prepared to be nimble. Assets like these “obviously work much better if there is a sustained downside,” Hartnett says. “I think more likely what you’re moving into is just a very volatile, fat trading range.”
Good luck to tactical investors who wish to follow that advice. I try to limit my market-timing attempts to one a decade, and to offset the inevitable drag on my returns by writing about my shame for money. The S& P 500 trades at 23 times the record earnings generated in 2019, which indeed seems pricey. But if I sold again now, I’d probably miss out on the best January for stocks since the days of Dutch East India. Even the Whiffer of Westchester knows when to walk away.
