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Does Talking To Smart People Help Your Market Returns?

One of the smartest posts I’ve read this year was written by Chris Dixon – “What the smartest people do on the weekend is what everyone else will do during the week in ten years”:

Business people vote with their dollars, and are mostly trying to create near-term financial returns. Engineers vote with their time, and are mostly trying to invent interesting new things. Hobbies are what the smartest people spend their time on when they aren’t constrained by near-term financial goals.

Talking to smart people that are considered experts in their fields could give you a profound insight into future trends, but how actionable is the information you receive from them?

This morning, Howard Lindzon explained how he was convinced by a bunch of smart people to sell his Netflix ($NFLX) position just before it doubled:

I have no position in Netflix. I put one in in December (on the Stocktwits stream) when the stock was in the 90′s and went to hang with some very smart people who had me convinced the Disney Deal was going to kill them. I let outside opinions influence (people I trusted that were super smart) the price and catalysts that were the reason for my investment in the first place. Now the stock has doubled. The catalyst may or may not be fully priced in, but Netflix is dominating on engagement and eyeballs.

This is a typical example of how knowing too much could hurt you – being too smart for your own good in a way. Also a reminder that if you don’t know why you are in a stock, you won’t know when to exit – meaning that you are likely to exit when you get scared, which usually is the worst possible time to do so.

From another side, I know people who have been bullish on Tesla ($TSLA) months before the electric car maker started to appear in the main-stream press and people to rave about its stock. Here is a screenshot of an email conversation I had with Dustin Schneider (who is one of StockTwits’ hackers behind the curtains) in September 2012:

Listening to geeks (engineers, industry experts, marketing gurus, experienced angel investors and venture capitalists, insightful visionaries and futurists) is always…smart. They see and talk about future big trends before anyone else. Blindly acting on their recommendations in the stock market….is a whole different situation. I always like to repeat to myself that it does not matter how smart you are or how incredibly genious your investment thesis is. Unless and until the market agrees with you, you won’t make a cent. The beauty of the stock market is that you don’t need to be first or original in order to make money.

Nasdaq 100 Rebalancing – When The Losers Become Winners

Most investors are urged to index or in other words to invest in popular market benchmarks like $SPY and $QQQ, which are low-cost ways to achieve average market return. There is no arguing that over the very long-term, indexing has delivered decent returns, but very few people ask themselves why this has been the case.

There are two main reasons – rebalancing and momentum. For example, Nasdaq 100, which consists of the 100 biggest non-financial stocks listed on the Nasdaq Stock Exchange, rebalances its holdings once a year (the majority of the changes happen in December each year, but there are sporadic changes during other months too). Basically some the biggest losers of the year are replaced with some of the best performers that are not yet members of $QQQ. Over the long-term, this approach has helped to get rid off smaller-cap stocks that are in a downtrend and keep winners in their best growth years – a form of simplified, long-term trend following if you will. Of course, it is not a perfect approach, because no matter how much Apple, Microsoft or Cisco Systems drop, they will remain in the index due to their enormous size.

The curious thing is what happens in the immediate months after the rebalancing. The results might surprise you:

As you can see, both the new stocks and the removed stocks have substantially outperformed the index itself, as the losers have done so by a much bigger margin. This is not a one year phenomena as this study by Ryan Detrick, who is a Senior Technical Strategist at Schaeffer’s Investment Research, clearly shows:

12 Market Wisdoms from Gerald Loeb

1. The most important single factor in shaping security markets is public psychology.

2. To make money in the stock market you either have to be ahead of the crowd or very sure they are going in the same direction for some time to come.

3. Accepting losses is the most important single investment device to insure safety of capital.

4. The difference between the investor who year in and year out procures for himself a final net profit, and the one who is usually in the red, is not entirely a question of superior selection of stocks or superior timing. Rather, it is also a case of knowing how to capitalize successes and curtail failures.

5. One useful fact to remember is that the most important indications are made in the early stages of a broad market move. Nine times out of ten the leaders of an advance are the stocks that make new highs ahead of the averages.

6. There is a saying, “A picture is worth a thousand words.” One might paraphrase this by saying a profit is worth more than endless alibis or explanations. . . prices and trends are really the best and simplest “indicators” you can find.

7. Profits can be made safely only when the opportunity is available and not just because they happen to be desired or needed.

8. Willingness and ability to hold funds uninvested while awaiting real opportunities is a key to success in the battle for investment survival.-

9. In addition to many other contributing factors of inflation or deflation, a very great factor is the psychological. The fact that people think prices are going to advance or decline very much contributes to their movement, and the very momentum of the trend itself tends to perpetuate itself.

10. Most people, especially investors, try to get a certain percentage return, and actually secure a minus yield when properly calculated over the years. Speculators risk less and have a better chance of getting something, in my opinion.

11. I feel all relevant factors, important and otherwise, are registered in the market’s behavior, and, in addition, the action of the market itself can be expected under most circumstances to stimulate buying or selling in a manner consistent enough to allow reasonably accurate forecasting of news in advance of its actual occurrence…….The market is better at predicting the news than the news is at predicting the market

12. You don’t need analysts in a bull market, and you don’t want them in a bear market