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Different catalysts matter for the different time frames. In short-term perspective, price momentum is the most powerful catalyst. Short-term could sometimes be a couple years in the market. Here are a few wise words, written in 2004, by someone who has been on both sides of the table – as a shareholder and company owner:

For years, a company’s price can have less to do with a company’s real prospects than with the excitement it and its supporters are able to generate among investors. That lesson was reinforced as I saw the Gandalf experience repeated with many different stocks over the next 10 years. Brokers and bankers market and sell stocks. Unless demand can be manufactured, the
stock will decline.

If the value of a stock is what people will pay for it, then Broadcast.com was fairly valued. We were able to work with Morgan Stanley to create volume around the stock. Volume creates demand. Stocks don’t go up because companies do well or do poorly. Stocks go up and down depending on supply and demand. If a stock is marketed well enough to create more demand from buyers than there are sellers, the stock will go up. What about fundamentals? Fundamentals is a word invented by sellers to find buyers.

Price-earnings ratios, price-sales, the present value of future cash flows, pick one. Fundamentals are merely metrics created to help stockbrokers sell stocks, and to give buyers reassurance when buying stocks. Even how profits are calculated is manipulated to give confidence to buyers.

Jump over to read the whole story. It is well worth it.

Source: BlogMaverick

There are two ways to learn in life – through your own mistakes and through other people’s mistakes. The former is usually more effective. Nothing beats self-discovery but you better be willing to learn from other people’s experience too. The latter improves the odds of survival and accelerates your learning curve. It makes sense. We don’t need to invent the hot water every decade.

Over the weekend, Howard Lindzon shared his frustration with hedging. Go read it. Howard is a market veteran, who has been through any market you could imagine; meaning his intuition and lessons count for something.

Here is my perspective on hedging.

In bull markets, hedging your long high-beta equity positions by shorting the indexes is rarely a good idea. Bull-markets are low-correlation “markets of stocks”, where sector rotation could keep the indexes afloat while industries are correcting under the surface. While energy and tech are lagging, consumer discretionary and finance could lead. When the latter take a break and consolidate, the former take the lead. In bull markets, indexes could trade sideways or continue climbing slowly while individual high-beta stock correct, one by one. Shorting the indexes via put options does not deliver proper protection.

As the saying goes, in bull markets, you need to be long or on the sidelines; in bear markets, you need to be short or on the sidelines.

There is time for everything.

When volatility and correlation start to rise, when momentum stocks as a group begin to underperform, all of a sudden shorting indexes becomes a good way to hedge.

Circuit City was the best performing stock of the 80s. It is bankrupt today. Best Buy drank their milkshake in the 1990s. Amazon killed them in the 2000s.

$DELL won the 90s. It is likely going private at 75% below its highest point.

Green Mountain Coffee ($GMCR) and Monster Beverage ($MNST) – formerly Hansen Natural, were the best performers of the 2000s. The former is trading 60% below its all-time high, the latter is about 40% below all-time high.

And yet, some of the best performers of the 2000s, have done incredibly well since 2010.

In the first decade of the new century, Panera Bread ($PNRA) gained 1600%, Middleby Corp. ($MIDD) gained 1700%, Sirona Dental Systems ($SIRO) gained 2600%. They haven’t done too poorly since 2010:

Sooner or later, all trends end – some more abruptly than others. This is not to say that momentum does not work as an equity selection system. It just does not work all the time. The rule of thumb is that the best performers of the past 6 months to 3 years, tend to outperform in the next 6 months to 3 years. Anything beyond that, usually leads to mean reversion.

Why some stocks experience much deeper mean-reversion and others consolidate mostly through time?

The stock market is a forward-looking mechanism that discounts pro-actively, often 6 to 18 months into the future. Price momentum usually leads earnings and sales growth in the first phase of any long-term stock market trend. Then, if fundamentals don’t catch up, there’s a mean-reversion.

The market is not stupid. It makes an assumption, sometimes based only on a good story, other times based on real fundamentals; it discounts that assumption pro-actively, but in the same time it is expecting positive feedback in terms of actual earnings and sales growth. If the latter don’t come, a correction follows. If earnings and sales growth numbers confirm and exceed market expectations, the trend continues.

Most stocks don’t manage to live up to market expectations about them. This is why market history is full of thousand of examples of stocks that made 200-300% return in a year or two that then gave back most of it. There are very few stocks that manage to keep up with market expectations in the long run.