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Investor Psychology

Stop Leaving Money on the Table

By Elliott H. Gue, on Jun. 11, 2014

On June 10, 1978, legendary racehorse Affirmed fended off Alydar to win New York’s Belmont Stakes by a head and become the 11th horse in history to win horse racing’s famed Triple Crown.

Winning the Triple Crown–the Kentucky Derby, Preakness and Belmont Stakes–is one of the toughest feats in sports. In fact, Affirmed is the last racehorse to attain the Triple Crown.

Many had hoped that California Chrome would finally break the 36-year long drought of Triple Crown winners.

The race shattered previous betting records for the Belmont, and the California-bred colt’s odds hovered near 3-to-5 in the minutes leading up to the race. But the heavy betting on California Chrome stemmed from emotion, not reason.

Odds of 3-to-5 imply a more than 60 percent probability that California Chrome would win the Belmont Stakes, a race also known as the “Test of Champions” for its history of foiling Triple Crown bids.

And California Chrome was the 13th horse since Affirmed in 1978 to win both the Kentucky Derby and Preakness; in other words, an average of one horse every three years has entered the Belmont Stakes with a shot at the Triple Crown. None have managed to win.

The Belmont Stakes is also the longest race of the Triple Crown jewels at 1.5 miles, compared to 1.1875 miles for the Preakness and 1.25 miles for the Kentucky Derby.

Heading into this event, most 3-year-old horses have never raced more than 1.5 miles. That’s a lot to ask of any horse, especially when you consider that a Triple Crown winner must cross the finish line first three times over a five-week time frame.

And don’t forget that California Chrome faced 10 of America’s best 3-year-olds on Saturday. The eventual winner, Tonalist, last raced on May 10, 2014, winning the Peter Pan at Belmont and didn’t run in either the Kentucky Derby or Preakness; the colt was far fresher and better-rested than California Chrome–and its showed.

In light of these challenges, no reasonable person would conclude that California Chrome had a better than 50-50 shot at winning the Belmont. The logical conclusion: Most of the betting was driven by pure emotion, not an analysis of the facts at hand.

The appeal of California Chrome’s story had me pulling for him to win the 146th annual running of the Belmont Stakes. But the facts didn’t support the odds; many quality horses in the field were ignored at the ticket window, giving contrarian bettors a higher-probability shot at a bigger payout.

I’m not much of a gambler, but I do enjoy the occasional punt at the track. I placed bets on each of the six horses that had a better than 30-to-1 odds of winning. That $12 ticket paid out over $20, thanks to Tonalist’s win at roughly 12-to-1 odds.

California Chrome finished fourth in a dead heat, leaving many bettors disappointed–and a bit poorer.

The same lesson from the sport of kings applies to the stock market: Rather than focus on facts, many investors cave in to hype and emotions when placing their bets. In either realm, there’s no faster way to lose serious money.

The good news: Emotion and hype create profitable opportunities for investors who look beyond the headlines. If you’re willing to lean against the crowd, you can book sizable gains in under-the-radar names that aren’t on the front cover of financial magazines or in the headlines on CNBC.

Don’t Believe the Hype

Every week, a steady stream of marketing pieces for financial newsletters cross my desk. Given the sheer number of fear-mongering pitches, these scare tactics must work.

The vicious 2007-09 financial crisis and Great Recession scarred many investors, making them susceptible to fear-based pitches.

Laughable predictions such as the demise of the dollar’s status as a reserve currency, the bankruptcy of the US federal government and a new economic downturn to rival the Great Depression continue to gain traction with many investors.

But there’s one problem with all this negativity: The permanent bears haven’t made a dime for investors, though they’ve likely made a mint off of them.

The S&P 500 closed at an all-time high this week, up more than 130 percent since 2009.

Calls for a second Great Depression appear increasingly ridiculous. Although a frigid winter dented US economic growth in the first quarter, the world’s largest economy has bounced back with a vengeance.

Source: Bloomberg

The Institute for Supply Management’s monthly Purchasing Managers Index (PMI) for the manufacturing sector is an economic indicator on which I’ve relied for decades.

Readings greater than 50 imply an expansion in economic activity, while values above 55 usually correspond with economic growth of at least 3 percent.

The current PMI of 55.4 represents a strong recovery from the weather-induced January reading of 51.3.

Emerging from the Doldrums

The PMI New Orders Index measures the pace of incoming orders for manufacturers. A surge in orders typically precedes a jump in manufacturing output; economists usually regard the PMI New Orders Index as a leading indicator for the economy.

At almost 57, the New Orders Index suggests that manufacturing activity should continue to strengthen this summer.

Investors likely don’t need to be reminded of the Halting Recovery that followed the Great Recession.

From 2011 to early 2013, PMI bounced from the high 40s to the low 50s, buffeted by a series of headwinds that included the EU sovereign-debt crisis, a weak domestic housing market, tax increases, new government regulations and the uncertainty engendered by a contentious presidential election.

The US economy also endured an extensive period of deleveraging in the wake of the epic credit bubble that set the stage for the financial crisis.

In late 2008 and early 2009, household debt stood at more than 95 percent of US gross domestic product (GDP); this ratio has tumbled to about 77 percent, the lowest reading since 2002.

These factors imposed a rigid speed limit on the US economic recovery and expansion. Although economic data never deteriorated to the point where the risk of recession reared its ugly head, the US has experienced the weakest recovery from an economic downturn in the postwar era.

Longtime readers know that I don’t whistle past the proverbial graveyard.

But despite what you might read or hear in the sensationalist financial media, the biggest risk today is to the upside–and you don’t want to miss out on the sectors and industries that are best-positioned for big gains.

Morning in America

With PMI data generally climbing higher since mid-2013, the US economy appears to have entered a normal growth phase that should last for at least two to three years.

Our basic outlook calls for US GDP to expand by about 3 percent annually, supporting solid returns for the stock market.

Roger Conrad and I recently recorded a Free Video to counteract the fear-mongering that continues to predominate in the financial media. These arguments are ill-founded and, even worse, duped investors real money in terms of missed opportunities.

Our Three-Step Program

I’ve always followed three simple steps for generating real wealth in the stock market:

  • Analyze macroeconomic trends and gauge the risk of a significant slowdown;
  • Identify sector- or industry-specific developments that will drive above-average growth for companies with exposure; and
  • Look for flaws in the conventional wisdom that moves the market and take contrarian positions when they make sense.

These simple strategies have helped Capitalist Times Premium’s Wealth Builders Portfolio to trounce the S&P 500 this year.

Source: Bloomberg, Capitalist Times Premium

Our Wealth Builders Portfolio holdings are up an average of 8.4 percent in 2014, compared to the 5.5 percent gain posted by the S&P 500 over an equivalent holding period.

We’re particularly excited about the master limited partnership (MLP) that we recently added to the model portfolio.

This name–which yields almost 7 percent–caught our eye at the National Association of Publicly Traded Partnerships’ recent MLP Investor Conference in Jacksonville, Fla.

The partnership receives scant attention on Wall Street, but the firm plans to enter exciting new markets over the next few years that will accelerate cash flow and distribution growth.

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