It is no secret that many retail investors tend to act on the stock market exactly contrary compared to what they do in everyday live. A special discount or promotion – let’s get it! When stocks fall – panic. When stocks or themes are en vogue, they jump in to not miss the (rolling) train – despite the next coming. Often, this behavior is explained by emotions of fear and greed. However, it goes further than that. There’s a component to it, I call “pseudo-logic”. Why you should be cautious with logic when investing is today’s topic.
Summary and key takeaways from today’s Weekly
– Much of what we read today is based upon fallacies.
– No, the market is not wrong if it’s moving in a direction you do not think is right. Most likely, you are wrong.
– What sounds logic does not have to result in great investment returns. You need to think around the corner to stress-test your logical thoughts.
Just telling you that fear and greed are common in the markets and that many participants behave exactly the wrong way (buying high, selling low) would not justify to write a Weekly. Everyone knows that in theory, despite not practising it. I have the claim on me to deliver just slightly more than such a “wisdom”.
We also know that the human’s brain consists of two halves. One is responsible for emotions, the other for logic (simplified). What I have read about making buying decisions in general is that people buy out of emotions, meaning their decision has already been made subconsciously, and then justified later by logic for a good conscience.
Have you thought about using logic instead of emotions in the context of investing, not only to achieve positive returns at all, but even to achieve above-average results and to beat (outsmart) the market? I mean to justify buying stocks by having good arguments and using logic. Arguments that seem or even are plausible.
Can it work, isn’t it logical?
As logical as it sounds, it should be a guaranteed formula for success – however, it isn’t… Quite to the contrary, if you use “pseudo-logic”.
According to my observations, unfortunately, that’s what many do.
I do not intend to present you a scientific write-up from a psychological view.
In today’s Weekly, I rather want to share with you some personal observations I made over the last years, but especially over the last months. Here or there, I have already written about people just looking at the past performance of a stock to justify their investments and later their prayers for a recovery of their underwater stocks.
You can combine everyday observations, see trends or be indoctrinated by mainstream media to let you think that you have an edge and invest based on these thoughts.
Today, I will show you several examples where logic proved not to be the right tool.
Quite to the contrary. It takes more than just thinking that something is logical to justify a stock investment. You need to think around the corner and question the first logical impression.
By the way, my next research report, exclusive to my Premium and Premium PLUS members (due this coming weekend), features a tech stock where I am also questioning a bit the prevailing “logic”. A few years ago, it was one of the big highfliers as the underlying business had tremendous tailwinds. Subsequently and obviously due to a way too ambitious valuation, the stock cratered and came back to where it started.
Make no mistake about it – the stock has been falling for almost three years! Yet, the founder-led business is as strong as ever.
Plus, it was already profitable from the beginning, generating strong cash flows. Management even made a capital raise near the top to bring in more cash that was not needed for the business. The current status quo is that barely anyone is talking about this business, as growth rates came down.
This reminds me somewhat of Apple‘s stock (ISIN: US0378331005, Ticker: AAPL) in 2018 – no growth, fat net cash on the balance sheet and a valuation that was closer to going out of business than having a dominant role in its sector. My pick has more than 25% of its market cap in net cash, generates strong cash flows and it has a dominant position in its niche.
It is far from going out of business. Time to have a look at it.
During the current correction since early-August most sectors have been falling, however, not necessarily all stocks. My ideas also came down a bit when looking at them all.
On average, all my ideas are nonetheless ahead of the benchmarks.
as per 31 October 2023 market close
If you struggle to find high-quality investment ideas that are not already “priced for perfection”, consider becoming a Premium or Premium PLUS Member, to receive my exclusive research reports with my best and market-beating stock ideas.
Why you should be cautious with “logic”
Although I certainly could deploy (invest) my time at a higher personal return on investment, this is a topic that always comes back to me like a boomerang. Especially, when I scroll through Twitter / X to catch some of the prevailing trends and topics regarding investing in stocks.
I often can only shake my head, because I have in many cases an opposed view – which does not automatically mean I will be right all the time. Far from it. But there are things I have seen or gone through myself already.
This is part of the personal learning process.
At least, I am hoping that people will learn from mistakes and false assumptions. Admitting a mistake is already a huge step in the right direction. However, more often I see the opposite – people deny any wrongdoing of their own and look for an outside reason or excuse for their own faults.
As a famous German investor and stock market guru once said figuratively: investing is like a compensation for pain and suffering – first comes the pain (losses), then the compensation (in the form of returns).
I fully support this view.
“Buy and hope” or “buy and hold and pray” are NOT strategies a serious investor uses. They are a recipe for disaster.
Especially for my newer readers who joined recently: If you haven’t done already, please read more about my views on why buy and hold does not work (see here) and why you should remove your portfolio losers, not your winners (see here).
What I want to discuss today is that using logic is not automatically the path to success.
Or in other words, what sounds logic – a trend, a personal observation of the everyday life, an investment thesis from someone else – does not have to materialize as a great investment. That’s why I have chosen the headline about not trying to outsmart the market.
In every case, the market will outsmart you. What you have to do is to find in which direction the market goes.
Sometimes the clearly obvious does not work.
And the longer it does not work, the higher the likelihood for a washout of those claiming the market to be wrong or not seeing what they see, for whatever reason. Many common wisdoms end in big disappointments this way.
I should add that I am not against logic, being a top-heavy person myself.
More precisely, I am against pseudo-logic. What I mean by that is you can’t form a resilient investment thesis without having checked the fundamentals of the underlying business properly enough. Sometimes it takes more than just to look at the headline figures presented in an earnings announcement. Thinking around the corner and questioning common narratives is what’s needed.
Let’s have a look at some examples.
Wisdom #1: Higher interest rates are good for banking stocks
If this were the case, we’d not be witnessing something like this:
The S&P 500 banks index is not only lower since the FED started to jack up interest rates. It is even lower than it was five years ago… Wasn’t it pretty logic that higher interest rates would increase interest income dramatically?
While this is even true, that’s only half the equation.
At the same time, the costs of deposits are increasing, too, effectively lowering the spread between interest income and expenses (called “net interest margin” or just “NIM”) again. You can look into the results presentations of the banks: the peak in NIMs is already several quarters behind us.
And: all the investment assets outside of loans, mainly bonds and mortgage products, that were gobbled up at max prices and minimal expected returns (leveraged by higher maturities) have suffered tremendous paper losses. While paper losses are not real losses until realized, this has turned the mainstream view completely upside down. How often have I heard that banks will be the big winners…
And no, it does not affect just some small banks no one has ever heard of before.
Just look at the top four US banks – with the exception of JPMorgan Chase (ISIN: US46625H1005, Ticker: JPM), all others are underwater since the rate hike cycle began.
What is even more worrisome is that big banks were net beneficiaries during the last March-crisis when people fled small banks and brought their deposits to the big guys.
Guess what? All their stocks are now close to or even lower than during the March-panic! Some even dramatically lower. Maybe bank stocks are pricing in a recession? Maybe, but shouldn’t they have reacted positively to such an announcement – especially as this figure is far away from a recession?
I doubt that’s a good ground to fish for value. This fish smells…
More or less a year ago, I presented to my Premium Members a report about a somewhat exotic bank I thought would be a big beneficiary. It still has above-average capital return figures, a high cash ratio and comparatively low leverage.
Below you can see the report cover and what the stock did over the last years.
While this rather short adventure brought in a total return of +13.5% with a holding period way below what I am usually out for, it was the exactly right decision to close this idea. I saw issues on the balance sheet and immediately turned risk-off.
As you can see, despite higher interest rates all along, the stock is down by around a third since the framed closing (I sent the update to my members after the Q4 2022 results were published and the stock temporarily ripped higher).
As I continue to cover most of my closed ideas to look for a possible reentry, the last presented results of NTB were rather shocking. Not, if you only read through the headline figures. But what about this:
I pulled the important sentence out:
Period end deposit balances were $11.9 billion, a decrease of 8.7% compared to $13.0 billion at December 31, 2022, primarily due to deposit movements in the Channel Islands and UK, and Cayman Islands segments as customers activated their funds and sought higher yielding products.source: NTB Q3 2023 earnings release, p. 2 (see here)
In other words, the offerings for some people are not attractive or competitive enough. They pulled out nearly 9% of deposits in just nine months. That was 1.1 bn. USD. However, as banks put their money to work, they obviously (!) don’t hold all deposits in liquid cash.
If you look into their books, you’ll see that the bank has 1.7 bn. USD in liquid cash. However, should another such amount be pulled like during the last quarter, management will start to get wet hands.
Although there are some short-term investments maturing, effectively increasing liquidity, this can lead to an uncontrollable event where people start to panic as they did in March 2023 with regional banks. Facts won’t matter then.
10% of deposits for a small bank is not the same as for a big bank.
The bank would then be forced to sell assets, i.e. parts of their bond portfolio, to raise more cash. However, unrealized losses from the long-term holdings are in total 930 mn. USD. And equity on the balance sheet?
922 mn. USD (see below) = could be a tight race.
Don’t get me wrong, I am not saying that this will happen. I either don’t want it to happen, nor do I think it is very likely, maybe 5–10%.
However, I don’t want to have such a low-probability, but high-consequence risk.
Wisdom #2: More solar panels + windmills everywhere = no brainer stocks
I will make the next examples shorter, as you will understand the core message.
Who does not know that wind and solar installations worldwide have been growing for decades? Here are just two charts for illustrative purposes, as I do not even want to have exact figures, as this is a “common wisdom” everyone can observe in everyday life.
Solar and wind stocks likely have been a great bet, haven’t they?
Here’s the Invesco Solar ETF – a vehicle with 1.1 bn. USD in assets.
Maybe, I have only cherry-picked ten years to show that it went nowhere.
Thus, let’s have a look at the maximal available period.
What shall I say? I’ll leave the comments and conclusions to you.
Maybe this was just bad luck. What about wind?
At least +20%. However, over a period of ten years in a seemingly booming business with high ambitions, likely not what many would expect. Note also that the peak was already two years before the FED started to hike interest rates.
What about the max period?
Wisdom #3: Where there is political support, nothing can go wrong
I know that I am risking some of you to laugh by reading this sub-headline.
But seriously, let’s have a look at it. Couldn’t there be a better topic than energy and ESG? We already saw above the performance of the heavily subsidized and supported solar and wind representatives.
As coal and oil for example are much hated and practically cut off from bigger financing, they are likely dying, aren’t they?
First, Big Oil, as they should set the tone for the industry (without fat dividends):
And some coal representatives:
None of them looks like a dying company – all have market caps of several billion USD.
And as said, they not only have to finance themselves, they have big enemies. All this has led to conservative finances, even conservative balance sheets with net cash and underinvested industries with high margins. Ironically, coal in some cases even has become an asset-light business…
We see, political “support” is not always what was intended…
Wisdom #4: Tobacco can hike prices indefinitely
I would not bet on that.
Just mathematics say that it is impossible to sustain. Theoretically, the last cigarette would cost several billions, if the companies would do the magic to sell it to someone to sustain current sales levels.
Thus, there comes a tipping point, when price hikes will have to be disproportionately higher than volumes shrink. And I think we are at this point.
Otherwise, you would not have such juicy “value” charts of the Big Tobacco companies, here with Altria (ISIN: US02209S1033, Ticker: MO) as the best representative as it is a highly praised “dividend king” (a useless title; btw. I have already written about Altria here).
Here are some numbers how Altria developed over the last two decades, as many just judge especially this stock by the company’s past achievements:
|year||cigarette volumes in units|
|cigarette net sales in USD|
|2004||187 bn. (–0.1%)||17.5 bn. (+3%)|
|2009||149 bn. (–12%)||20.9 bn. (+12%)|
|2014||126 bn. (–3%)||21.9 bn. (+0.3%)|
|2022||85 bn. (–10%)||22.4 bn. (–2%)|
|last nine months||58 bn. (–11%)||16.5 bn (–3%)|
Despite all the claims that Altria was one of the best stocks of the last century (this alone shows how primitive the thoughts of some are), you can see:
- in 2004, volumes were even flat and sales rose
- in the following, volumes fell, at times sharply, but sales could be pushed up and later stabilized due to price hikes
- in 2022 both were negative, volumes and sales
- the same over the last nine months, however, the decline is intensifying
The signs are on the wall: what worked in the past, does not work anymore.
I would not bet against the market here!
Other areas to look for wisdoms (to avoid)
You can also check the pretend safe bets on technology companies where one does not understand the business model, or maybe hydrogen, electrification, electric vehicles, copper, lithium, batteries, meat-substitutes and of course – one of my favorite topics – the safety of dividend stocks just based on their past performance.
The longer a dividend has been paid, the better – as they say.
One example even hit the jackpot with an announcement early this week (left), following one in February (right):
The infamous V.F. Corp (ISIN: US9182041080, Ticker: VFC), as you might know from my older writings, is a former dividend king that raised its dividend 50 times in a row. 50 times, every year.
Early this year, just one quarter after the last raise, came the cut – shocking for many.
As resetting by 42% wasn’t enough, they added a 70% reduction on top.
I wrote on Twitter / X that another such cut would come, because the business is weak, not generating enough free cash low, while having a way too high debt load.
My honest opinion: they could have axed it completely.
Much of what we read today is based upon fallacies.
No, the market is not wrong if it’s moving in a direction you do not think is right. Most likely, you are wrong.
What sounds logic does not have to result in great investment returns. You need to think around the corner to stress-test your logical thoughts.
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