Stocktake: Momentum bodes well for stocks

Momentum bodes well for stocks After a rip-roaring rally, is it time for a market pullback?

It has not been a run-of-the- mill bounce: stocks are very overbought. The S&P 500 last week traded 6 per cent above its 50-day moving average, something not seen since early 2012. Some 82 per cent of stocks traded above their 50- day average, the highest reading in 2015.

In bull markets, however, overbought indices usually become more overbought. Data from market strategist Ryan Detrick shows stocks have enjoyed above-average one-month gains following similarly strong rallies over the last six years. Additionally, not since early 2009 and late 2011 – both major market bottoms – have stocks gone from severely oversold levels to overbought levels so quickly, Detrick adds.

There is also the question of seasonality – since 1950, November and December have been the two strongest months for stocks. Results have been even better following extremely strong Octobers, notes Detrick. Don't assume that what goes up must come down. If there is a pullback, momentum and seasonality suggest it will be a short-lived affair. Cool during market panic Anyone relying on the media to make sense of August's market correction would have been under the impression that all hell had broken loose and that investors everywhere were in a state of absolute panic. Recent figures from fund giant Vanguard suggest otherwise, however.

On August 24th – the height of the China-induced panic, when global markets plunged – just 0.37 per cent of Vanguard clients made changes to their portfolio. Over the course of the week, about 0.5 per cent of clients chose to trade in response to the crisis, Vanguard estimates.

Now, this doesn’t mean there wasn’t a panic. There was – the market plunge was swift and steep, volatility went through the roof and the number of Vanguard clients spooked into selling rose to levels seen during past panics.

Rather, the point is the headlines suggest everyone is selling up and fleeing the market, but that is actually true of only a tiny percentage of investors. Most people do the right thing – that is, they do nothing. Gross goes from bad to worse Things are going from bad to worse for Bill "bond king" Gross. Ousted from fund giant Pimco in 2014, Gross received a $500 million investment from George Soros's investment firm shortly after moving to Janus Capital Group, but reports last week indicated Soros had bailed out after a year of underperformance.

All investors should reflect on Gross’s decline. You can argue Soros was impatient, that Gross’s recent underperformance means nothing against a lifetime of big returns. Still, Gross also underperformed in his last years at Pimco. Has he lost his touch? Maybe Gross misses the wisdom of his former Pimco colleagues? Was he lucky in the first place, the beneficiary of a multi-decade bond bull market? Perhaps he is skilled, but Soros is rightly worried that Gross’s legal battles – he is suing Pimco for $200 million – will distract him?

All the above arguments can be made. Ultimately, the “luck or skill?” question is almost impossible to answer. Besides, even if you know for sure your money is with a skilled active manager, all kinds of external factors – office changes, legal tensions, whatever – may hit future performance. As Gross’s case shows, you just never know.

Earnings 'trap' questioned Looking for a novel investing strategy? Here's one – buy stocks that miss earnings estimates. Hedge fund titan Stanley Druckenmiller praised high-flying Amazon last week for eschewing the short-term earnings game, noting it has missed quarterly estimates in nine of the last 19 quarters. In contrast, he says IBM cares too much – it has missed earnings in only three quarters since 2006, despite suffering 14 consecutive quarters of falling revenue.

Short-term earnings say little about corporate health – firms can beat estimates by lowballing estimates, buying back stock, cutting R&D spending and all kinds of other ways – and clued-in investors know this. A 2009 study found companies that just beat estimates by cutting spending on important factors went on to underperform firms that missed estimates but didn’t cut spending. A 2013 McKinsey report came to a similar conclusion: companies spend too much time trying to manage earnings, and are seldom rewarded for playing the “consensus earnings trap”.

In other words, the Amazon approach – “they don’t give a damn”, says Druckenmiller – may be the best one.