Day 86: Psychic Wins Lottery!

The Mother's Little Helper portfolio was up today (+0.08%) for a gain of +$479.96. Overall gain to date: +$21,083.20 (+3.52%). 66 stocks are now in the black, 55 are still in the red. Harman (HAR) was bought by Samsung for $112 per share so the entire position was sold out of the portfolio for a nice gain.

Psychic Wins Lottery is a headline I've never seen, nor have I ever met someone who has seen it. Yesterday I was traveling back to my Bay Area home after a nice visit with Mom. It was nice to take a break from the markets and the blog, until I checked the DOW and saw that the sell off dog had found it's way home and dragged the market down -288.32 points. Ouch!

Remember in a previous post I had expected a pull back before Janet Yellen raised interest rates, but that didn't happen; I got complacent and figured we dodged that bullet. Wrong! While the portfolio was up 5.91% a couple days ago, we're still up 3.52% today, even after that big pull back. Is this it? Is the big one about to hit? I don't know and I don't pretend to be able to predict such things. Maybe it's useful to look at this pullback as a healthy, normal occurrence in the natural cycle of the markets. That's right, the markets aren't crazy, I said this is a natural cycle that should be accepted and appreciated for the health it will bring back to the markets.

First of all some decoding. A Pull Back is a substantial decline in the market that is less than 5%. A correction is when the market falls 10% from it's most recent peak. A bear market is witnessed by a drop of at least 20% from the previous peak.

Pull backs occur all the time, but the ones that get recorded are the 1%+ pull backs and the triple digit declines. With the DOW in excess of 20,000 I think we should get use to triple digit declines because a 100 point decline just isn't that big of a hit to the DOW anymore. Corrections (20%+) have occurred on average almost once a year since 1900. That's about as regular as winter snow and summer sun. Bear markets occur about every three years since 1900, but I'll throw a caveat in just to add some additional confidence. The problem with this statistic is that a lot has changed since 1900 that helps to prevent bear markets. If we measure bear markets since 1946 the rate drops to one bear market about ever five years.

What I find particularly cool is that after looking at 75 years of data, every bear market turned into a bull market. And only 20% of corrections turned into a bear market, so don't get caught up in the hype. Just because the Nostradamus like doom and gloom market psychics and financial news commentators say that a bear market is coming does't make it so. Nobody can predict the markets with accuracy. A 10% or 20% drop in the market is gut wrenching, many investors simply can't stay the course when this happens. The only anecdote is to pull out the books on long term investing and read all that you can about the value and profitability of sticking with your investments long term.

"The only value of stock forecasters is to make fortune tellers look good" - Warren Buffett

Now for some really troubling lack of psychic ability. I have been racking my brain, small as it is, since the launch of this portfolio to figure out how and why my initial tests to find a small portfolio of stocks kept producing ever larger numbers of stocks. There simply shouldn't be 124 stocks in the portfolio. No matter how adept I was at explaining it. Ultimately I concluded that the robust economy was simply producing more likely candidates as time went by. In my second post I wrote this:

"My litmus test weeds out thousands of companies and what's left behind makes the BUY list. Two years ago my tests here at home produced BUYS for about a dozen companies. One year ago it was about 50 companies. Today the BUY list is at 74, with 50 more on "time-out" until they improve. 124 stocks in a portfolio is a lot, I can't argue with that."

Over the past week I've become convinced that something was wrong with my screening as I looked for the companies to place in the portfolio. There are simply too many companies in the portfolio and given the hurdles I placed in their way there should be far fewer companies that are down double digits. An error in logic, math or just stupidity? Regardless of the reason I have to take full responsibility for the error, I just haven't been able to find the problem (remember high school math = D+). While I was in Montana visiting Mom I came up with another approach to finding the my portfolio bug. Shazam! It turns out that what I had done to exclude companies that were overvalued (too expensive today) was actually adding those companies in. When I run my search with the corrected search routine nearly all of the stocks in the red are eliminated which dramatically reduces the number of companies in the portfolio and the overall return is dramatically increased because the drag of the losing stocks is removed. Going forward it's nice to know that I won't make this mistake again.

So I have a big decision. Stick with the portfolio as is because that's what I said I would do, or remove the stocks that shouldn't be there and proceed forward with what should have been the original portfolio. Had I made this error with real money in my own account I would have sold most of the losers early on because I would have set stop losses on every stock. Basically, in real life, the correction would have been made by itself but I would have suffered very real financial losses, albeit with a portfolio that would still be up substantially. The MLH portfolio is a buy and hold portfolio so I can't sell anything. I guess the big question is, should the portfolio be holding stocks that were never meant to be there in the first place?

I hope you'll all post your thoughts on this and let me know what you think is the right course of action.

Stay Invested

Clay Baker