How You Can Beat Wall Street
By Briton Ryle | Monday, July 31, 2017
It's often said that the stock market hates uncertainty. And I guess we all kind of gravitate to the status quo.
But at the same time, most of us have gotten pretty good at dealing with adversity when it arises. Because the fact is, stuff always happens that we don't expect.
The stock market is the same way. Every year, some pretty crazy things happen in the world that seem like they could push the stock market into a huge sell-off. And really, the "surprise" is usually how well all this crazy news is handled...
In 2014, the Fed ended QE, oil and gold prices crashed, Russia's economy collapsed after it took over Crimea and basically started a civil war in Ukraine, Chinese growth slowed +25%, a terrorist group took over a huge swath of Iraq and Syria, and an Ebola epidemic killed thousands... and the S&P 500 rallied nearly 32% for the year.
In 2015, Greece defaulted on a debt payment, Turkey shot down a Russian plane, China devalued its currency, U.S. corporate earnings started falling for the S&P 500, the Dow Industrials fell as much as 1,000 points on August 24, German bond yields went negative, high-yield bonds collapsed... and the S&P 500 was unchanged for the year.
In 2016, January started with a plunge lower, crude oil fell to $27, Japanese yields went negative, the UK voted to leave the EU, Brazil's economy collapsed, China's debt skyrocketed and growth slowed, the Fed hiked interest rates a quarter-point... and the S&P 500 rallied 13%.
For some, the fact that stocks rallied in the face of such uncertainty is a sure sign that the stock market is a Fed-blown bubble and that individual investors have lost touch with reality.
The stock market always has to assimilate totally unforeseen events. That's how the world works. It's chaotic. There's no rhyme or reason to it. But even that doesn't really get to the heart of the matter. Think about it like this: When Putin invaded Crimea, did you say, "Oh, I'd better not go out to dinner tonight"? Or when the Fed officially ended its bond purchases, did you think, "Darn, now I can't buy that new car"?
Of course not. Because that's not how people live their lives. The fact that ISIS declared itself a country has exactly zero impact on what kind of shoes you will buy.
Fact is, the Ebola breakout was the only event in the last few years that had the potential to change people's behavior. And rightfully so: That was a bit scary.
This is why the stock market usually trades with an upside bias: because populations are growing, so you have more people buying more stuff. The periods in which we buy less are few and somewhat far between.
OK, there's a bit more to successful investing than that. Still, I can't help but wonder why professional fund managers are so bad at it...
Wall Street Fails... Again
Mutual funds simply can't beat the S&P 500 over time. Sure, in any given year, some funds will do better than the index. But they can't maintain that performance.
Check out this table:
In 2013, out of 1,034 large-cap mutual funds, 204 did better than the S&P 500. That's about 1 in 5 — not too bad, I guess. How many of these funds beat the S&P 500 though 2016? Exactly zero.
As an investor, I hope you look at that and say, "Heck, I can do better that." And I agree — you can.
For one, you could just buy an S&P 500 index fund. Such a fund will have a miniscule fee, so your performance will pretty much match the index itself.
Individual investors have figured this out. That's why so many individual investors are simply buying index funds. And it's why so many 401(k) plans are switching to Vanguard.
I think that's great. It shows that individual investors (i.e., you and I) aren't buying Wall Street's guru bullshit anymore. Investors like you are taking matters into their own hands — and doing better.
But there are a couple negatives that indexing creates...
How to Beat the Index
First, as investment dollars concentrate into S&P 500 index funds, those become the only stocks that move.
Also, because indexing spreads money equally among the companies on the index, there's no way to value companies that are growing faster.
For instance, Apple and its 10% annual growth has a lower price-to-earnings than Johnson & Johnson and its 3% growth.
Some are even saying that the trend toward passive index funds means the "death of the stock-picker" because there will be no reward for finding the best stocks out there...
This is where I draw the line. Yes, indexing is great. But stock picking — finding the undervalued, unloved gems of the stock market — is how we are going to beat the market.
Keep it Simple...
It's common to think of a good fund manager as a good stock-picker. But when you run a mutual fund, it simply may not matter if you're good at picking.
Why? Because if you have a fund with 100 stocks in it, does it even matter if 10 of them are huge winners?
The more stocks you pick, the more outperformance will be watered down by the sheer number of stocks you hold. Plus, when you diversify and hold stocks in a wide range of sectors, gains in one sector will be offset by losses in another.
This is why I don't like diversification. Buy just a few of the top stocks in a few winning sectors, and sell them when they stop working. That's how you make more money than other investors.
The Fidelity Magellan Fund holds 170 stocks. And there's a small AthenaInvest fund that holds 10 stocks. That's it — 10.
Guess which fund does better? Yeah, you're darn right, the AthenaInvest fund has averaged 16% a year for the last 10 years.
Pick four stocks that can go up 20% over the next year, and you'll beat 95% of Wall Street pros. And here's a hint: Find something with a nice 4% to 5% dividend, and you're off to a great start.
Yes, in 2017, some unexpected things are going to happen. Don't make your investment profits one of them.
Until next time,
Managing Editor, Wealth Daily
A 17-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.