Buying the Blood on the Street Is Easy Only in Hindsight

In his latest post, Frank Zorrilla makes an astute observation that the four best-performing ETFs year-to-date were all down several years in a row heading into 2016.

The best performing single ETF’S this year have been KOL (+108%), GDXJ (+107%), EWZ (+83%), and GDX (+72%).

Recent data by Dimson, Marsh, Staunton database, showed median country returns of 8.74% (all years) and 15.94% after three down years in a row, both suggest that you will double the median return of all years if you own a country ETF that is down three years in a row.  It’s a very rare occasion that only happens 3% of the time.

If you take a closer look at this year’s top ETF gainers, you will notice that they were not down three years in a row. They were down 4 or 5 years in a row in the midst of a powerful bull market. Anyone who thought they were a great bargain in early 2014 or early 2015, bought too early and saw another 40% to 60% decline before there was finally a more sustainable relief rally. It doesn’t matter if you just manage your own money or other people’s money. You cannot lose 50% on a position in a bull market and remain in business.

The best performing industries in any given year are usually the ones that surprise the most. What are the type of industries no one expects to substantially outperform? The ones that were down a lot several years in a row and the ones that were up the most several years in a row. In the first case, no one really cares about those industries. They are not simply hated, they are ignored. In the second case, no one believes that their upside run can continue any longer.

There is not one sure recipe for finding the best performing industries every single year. Sometimes, they come from the bottom of the pit. Other times, they come from the top. We have to be flexible and willing to continually adjust to ever-changing market cycles.

Take a look at the long-term charts of the above-mentioned sectors. Each candle represents one year of price action.

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Financial Markets Are Full of Surprises – for Some More than Others

Morgan Housel is out with an interesting post, basically claiming that if you study past history you will learn a lot about history, but very little about the future. The lessons from the past financial crisis are not going to help us with the next financial crises. Life is full of surprises. There is very little we can do to be fully prepared for them. As an ancient proverb goes “when men make plans, gods are laughing”.

He makes some good points. The events and processes that caused the last market correction or bubble are probably never going to repeat in their literal form. Does this mean that studying financial history is futile?

You can learn more relevant lessons that are more likely to pass the test of time if you dig deeper; if you go straight to the source of market corrections and booms – human psychology. When it comes to fear and greed, nothing ever changes. What caused fear of losing and fear of missing out 100 years ago causes the same emotions and reactions today and it’ll cause the same attitude 100 years from now.

The reasons for market corrections might change, the names of the winning and losing stocks might change, but human emotions and psychology are likely to remain the same. One of the best and the most unbiased reflection of human emotions is price action. Technical analysis continues to be an underappreciated tool for risk management, market timing, and equity selection.

What we know with almost 100% confidence is that there will be other big market corrections and bubbles in the future. They will probably be caused by events and processes no one can predict. Most people will react similarly to wild price gyrations. Some will view market crashes and booms as irrational exuberance, others will be prepared better and see in them incredible opportunities.

How is the Boom in Passive Investing Changing Financial Markets

WSJ is out with a post calling stock picking a “dying business” and declaring passive investing the winner.  And the facts about money flows are on the Journal’s side, but as usual, they are greatly exaggerating things by posting data out of context.

Over the three years ended Aug. 31, investors added nearly $1.3 trillion to passive mutual funds and their brethren—passive exchange-traded funds—while draining more than a quarter trillion from active funds

As Howard Lindzon would say “there’s no such thing as pure passive investing, just fifty shades of active investing”. What’s more interesting to me are the potential consequences of this rising passive investing tsunami:

1.The more money flows to passive investing, the faster markets are likely to become. This will lead higher correlations among stocks and more volatility, which means bigger and quicker corrections; it also means bigger and quicker recoveries. Take a look at the bear market of 2000-2002. As harsh as it was, there were plenty of stocks the kept making new all-time highs during that period and delivered some real alpha. Then, compare it to the correction in 2008, 2011, even early 2016. We saw a lot higher correlations during the most recent corrections. Most stocks went down together; then, they recovered together. Is it a big surprise then if leveraged ETFs are becoming the weapon of choice of more and more active traders?

2. More opportunities for savvy stock pickers. A rising wave (bull market) will lift all boats, including the crappy ones, creating multiple great short targets. A swift correction will bring down strong businesses to super-attractive valuations.

3. A decrease in hedge funds’ fees. 1 & 10 might become the new 2 & 20. If you find a great money manager, 2 & 20 is a small price to pay, but the majority of investors are likely to demand and try to negotiate lower fees. Finding a great money manager is like finding the next Amazon before it happened. The trouble is that in most cases, people won’t stick long enough to see a big difference.

The Worst Performers of Last Year Are Crushing 2015’s Best Performers in 2016

If you needed more proof that 2016 is a big mean-reversion year, take a look at the performance of the 10 best performing S&P500 stocks from 2015 year-to-date. On average, those 10 stocks were up 72% in 2015. In 2016, their average return is lagging the S&P500 by being up 4.3%. One of them was acquired in September 2015, so I am showing only 9 for 2016.

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Take a look at the 10 worst S&P500 performers of 2015. On average, they lost about 60% in 2015. Year-to-date, they are up 17%.

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The 9 Hottest IPOs of the Past Year

The IPO pond has dried out in the past year, but it has remained an incredible source of trading ideas. Due to their small float and newness, some new public companies tend to significantly outperform during rising markets and significantly underperform during market corrections.

Here’s a list of the nine hottest new stocks for the past year. Many have already had their run and are due for a pullback. Others are setting up again.

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