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Lessons Learned and What’s In Store: Don’t Get Too Giddy From Your Stock Market Gains

By Michael Brush
Exclusively for InvestorIdeas.com
November 16 2006

With the S&P 500 crossing the 1,400 mark Wednesday for the first time in six years it’s now official: We’ve had one heck of a sweet ride since the gloomy days of summer.

Just a few months ago many well-known forecasters were calling for more serious downside beyond the damage wrought by June and July. Housing market weakness was supposed to spread into the entire economy and spoil the party for good.

Remember that?

But if you’ve been following this column – and the insiders who continued loading up on economically-sensitive names during those dark days – you didn’t get fooled into selling at the summer lows.

Instead, you were buying because we stayed bullish throughout – putting an emphasis on the economically-sensitive names that insiders were picking up.

Many of those stocks were the toughest to buy because they were getting punished the most. But they’ve also been the most rewarding. Our winners like Deckers Outdoor (DECK), Goodrich Petroleum (GDP) and Websense (WBSN) are up 57%, 81% and 50% in a few short months.

Overall, Insiders Corner picks have advanced 11.2% since May 18, which was around the time the market began to fall apart. In contrast, the S&P gained 10% in the same time frame to close at 1,396 on November 15 from 1,262 on May 18.

I’d like to beat the market by more than 12%, but I’ll take these gains for the following reasons.

As scary as things got during the dark days of summer, we didn’t get shaken out. We continued to scoop up the economically-sensitive names that were getting beaten up the most. That’s partly because the insiders were doing so. But it was also because all along I was never really convinced economic catastrophe was just around the corner. Jobs and income growth were just too strong. And in the background, humming economic growth around the globe (leveraged by a weaker dollar) was bound to continue juicing the U.S. economy.
Beating the market by 1.2 percentage points isn’t so bad when you consider that 70% to 80% of managers at actively-managed mutual funds typically under perform the market.
I ran my numbers using all my picks right up through last week. This seems fair, since the comp returns for the S&P 500 included all stocks in the index. But it also means that I include picks put in this column just in the past month. They really haven’t had enough time to perform, and so they drag down results.

Let’s stay humble

Just so I don’t get carried away with hubris, which the market inevitably punishes, I’ll be the first to admit I’ve had my share of disasters in the past seven months.

By far the worst was Pegasus Wireless (PGWC), a company that makes transmitters which can link hard drive video content to your TV.

Pegasus looked like a strong buy in early June, as chief executive Jasper Knabb plowed millions of dollars into the stock. Plus the company had a plausible plan: Get the transmitters into stores in time for the holiday season, with the promise of a big-name electronics retailing partner.

In my defense, my June 8 column on Pegasus included a warning not to go crazy with position size since valuation looked stretched. That’s a good thing, because the stock was a total disaster.

It went into this column at $7.88. It traded at 61 cents Wednesday for a 92% loss. Fortunately, our running policy of cutting losses at 25% saved us from most of the damage.

Lesson learned: Even a compelling insider buy can lead you to serious trouble, so it’s always important to remain diversified and cut your losses before they get too big – at 20% or 25%. (I recently picked up some cheapened Pegasus shares as a kind of option that its devices might sell well.)

The next few months

More of my successes and failures in a moment. But first, what’s next for the market?

It seems like many commentators, investors and speculators have come around to the point of view we’ve stuck with throughout: The economy is fairly robust, which is good for stocks.

Unfortunately, having so much more company now is a bad sign for stocks because the crowd often gets it wrong. To get more of a quantitative perspective on market sentiment, I turned to Jason Goepfert of SentimenTrader.com, a kind of one-stop shop for market technical indicators. His key takeaway: the “smart money” is pulling back while the dumb money is getting boisterous. So be careful.

“We’re now getting indications that those who have a particularly bad trading record have become bullish to a notable degree, while at the same time those groups with a better market feel have pared back long positions,” says Goepfert. “Given historical market performance after this kind of split between the groups, reducing equity exposure seems particularly appropriate.”

Goepfert, however, says it’s too soon to go to cash or start shorting.

One reason to be more positive: We are in the midst of the seasonally bullish time of year, from November through tax day, or April 15. The problem with hanging your hat on this argument is that nothing about seasonality has worked in the past several months. So I’m not so sure I’d count on it now.

Still, I think the economy is sound and probably stronger than many people give it credit for, so I’ll go along with Goepfert. I’m not pulling the plug on long positions right now. I wouldn’t be surprised to see a blow-off correction at some point soon. Still, I think we are in for more gains in the medium term.

What that means for Insiders Corner: I’ll be paying closer attention to valuation and favoring names where insiders are buying after stocks blow up – as opposed to purchases on strength. The already-beaten down stocks may be less likely to lose ground if the market sells off. And they’ll probably post superior gains if the bullish tone continues – given the significant gains for the winners of late.

The insiders seem to agree with this take. In the past few weeks, some of the biggest buys have happened at names that have blown up. We’ll take a closer look at several of them in a few days.

The last seven months

Now here’s a brief look at what worked and what didn’t at Insiders Corner since the market began crumbling in May.

I’ve made 89 picks in Insiders Corner since May 18, which as a group advanced 11.2% as of Wednesday.

Of those, 72% were winners and 24% lost ground. Forty-six percent were up more than 10%, 25% were up more than 20% and five advanced by more than 50%. One doubled -- MasterCard Incorporated (MA) which was in this column on June 8.
Twelve percent of my picks lost more than 10% and three stopped out at 25% -- the mandatory stop loss for this column.

As you’d expect, since the insiders favored these names during the market rout, economically-sensitive stocks in retailing, technology and energy did the best.

Retailers Deckers, Restoration Hardware (RSTO, Steven Madden (SHOO), and Jos. A Bank Clothiers (JOSB) tacked on anywhere from 36% to 57% since May-June when they were added.
Black & Decker (BDK), Goodman Global (GGL), CDI (CDI) and Sealed Air (SEE) popped up in a flurry of buying in economically-sensitive names in early August. They offer building materials and supplies, business services and basic materials. Since Aug. 3 they are up anywhere from 25% to 40%.
Energy names like Goodrich Petroleum and Exploration Co. of Delaware Inc. (TXCO) did well – up 51% and 40%.
Energy and building materials also brought the biggest losers, including Caraustar Industries (CSAR), Abraxas Petroleum (ABP) and Titanium Metals (TIE). These were down 15% to 21%. (Insiders were back at it, buying Caraustar Industries this week, so I don’t think it’s game over yet for that one.)
Ediets.com (DIET) was supposed to advance because of a new marketing push and plans to offer home-delivered meals. Instead it shed 16%, my second worst loser besides the three that stopped out at 25%.

The bottom line: Insiders did a great job of navigating us through the market mayhem this summer. But the few disasters reminded us of the importance of staying diversified and using stops to prevent serious damage – two rules that are easy to forget in a bullish market like the one we’ve been in since August.

Disclaimer
At the time of publication, Michael Brush owned shares of Pegasus Wireless. Mr. Brush is an independent columnist for this web site.
For more on Insiders Corner disclosure, see the disclosure section in About Insiders Corner: http://www.investorideas.com/insiderscorner/. InvestorIdeas.com Disclaimer: www.InvestorIdeas.com/About/Disclaimer.asp. InvestorIdeas is not affiliated or compensated by the companies mentioned in this article.

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