Stormy Markets Reveal Great Managers - Forbes

Navigating a stormy market. 

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After a rough week, many investors are asking whether to buy the dip or sell before things get worse. Wayne Himelsein has navigated two crashes and many storms over the last 18 years and still nearly doubled the S&P 500's return. Wayne says its easier to find great stocks in choppy markets than in bull markets and uses his recent purchase of MarketAxess Holdings (MKTX) to explain.

Ken Kam: Wayne, is it easier or harder to find winning stocks when the market is stormy?

Wayne Himelsein: The reality is that choppiness helps me to identify new stars. It’s somewhat like life in general. When things are great in our lives, and humming along, we don’t take the time to attribute the drivers of our happiness.

But when we’re going through a rough patch, the little things that make us happy jump out, as if our senses are suddenly more acute to what it is that we really want, more so, need in our lives.

So it is with stocks. When the market is humming along, many stocks look good and it’s hard to separate good performance from the broad-based bull market. But as soon as the market shows some weakness, we can more easily notice differentiated behavior, and more clearly see the characteristics that attract us.

Kam: I share that viewpoint, as with my business of evaluating managers, it's during the worst market environments, that I can see the talented managers stand out from those who had just been lucky.

Himelsein: Its funny you say that because when I first started trading stocks, my mentor used to say that a bull market doesn’t make a manager, only bear markets do. Anybody can buy on dips in a bull market and look smart as that stock turns up and makes them a handsome profit. But the bull market is your tailwind.

It’s exceedingly more difficult to trade stocks when markets are falling for more reasons than you’d think. When the “buy on dips” method fails, our entire framework is turned upside down. If we buy a stock that’s dropped and it proceeds to drop much lower, we lose trust in our ability to buy, and with that, we can spiral out of control.

Hearing this in my early days on Wall St, I started to spend more time and go deeper studying how stocks behave when markets are falling. I perceived this to be a greater edge because it was harder to do. And in doing so, learned more about “drop behavior” to identify the characteristics I like. Right now, the stock that demonstrates this best is MarketAxess Holdings [MKTX].

Kam: What exactly did MarketAxess do in this recent market drop that stood out to you?

Himelsein: MarketAxess had a very interesting week in two ways. First off, it was positive over the last three days while the market (the S&P 500) consistently fell. So, quite literally, up up up during down down down. And these were not just little downs, but somewhat heavy S&P down days on Thursday and Friday. MarketAxess didn’t care.

I’ve talked before about this characteristic of opposing behavior, of doing well in the face of adversity, but there was much more to it this time. Just one week prior, on July 24th, MarketAxess came out with slightly disappointing earnings result, sending the stock falling, on a single day gap-down move, from about $370 to about $335, or just under a 10% drop.

This was ugly, but only for the day. For what happened next, on July 25th, and then the 26th, was a bit of a recovery, to the tune of about 4%. But then something more beautiful transpired, namely, the wonderful opposing behavior last week, including its gains on Wed, Thu, and Fri, while the market experienced some bigger than average down days.

Kam: Okay, so I think I understand where you are going with this. You like it both because it did well while others didn’t, and because this activity followed its own not so great news?

Himelsein: It’s not just that, it’s that the stock made its down move, and is now screaming to the world, “I’m done”. The 10% was all it could fall, for immediately afterward, it established that level as its baseline, and even in the face of a falling market, would not budge one more penny lower. In fact, it had to gain while the market dropped, demonstrating that the sellers of other stocks were taking their proceeds and buying MarketAxess.

Usually, when a stock gaps down after a bad earnings announcement (think Netflix), a surrounding falling market will take it down even lower. Its weakness begets further weakness alongside the pressure of the market. But when a stock is done falling, when literally everything you can throw at it including a surrounding storm, cannot push it lower, and in fact inches it higher, it is a sign of pure and unadulterated demand.

Kam: I understand. You love that differentiated behavior, seems like its very revealing for what you like to see. What else do you like about it?

Himelsein: Yes I do, and to be clear, it’s not just that it behaved well last week, it’s that it did that precisely when you would expect that it would not have. So this, if you will “dislocation”, in expectation vs outcome, tells you more. A scream will be more easily heard in a quiet crowd than at a rock concert.

In addition to the very recent view, I will step back with a wider lens, and share my appreciation of its wider attractive behavior. This stock started its bullish run in early 2013, then took the year 2014 to breathe, building a base with which to explode off and explode it did, running powerfully up for the next two years from January 2015 until the end of 2016.

Then a really interesting period of consolidation began. From early 2017 until late 2018, it effectively went nowhere, just gyrating up and down in giant waves, for a two year sideways move. But then, in February of this year 2019, it broke out. It stepped on its two years of consolidation and re-entered a bullish run. And since then, it’s just been climbing.

Until, of course, the earnings gap down on July 24th. The good thing is, we already know what happened after that. Putting all this together, we have a good long term trend, with a minor interruption by a fundamental event, but then immediately followed by the characteristics of strength; thanks, ironically, to a few days of a falling market, that enabled this insight.

My Take: The current bull market is already the longest on record. With Brexit, a trade war, and the 2020 election on the horizon, this is a good time to prepare for the eventual end of this bull market.

Wayne Himelsein started his model fund at Marketocracy in September 2000 to implement his approach to selecting stocks from the S&P 500 that are likely to outperform. Over the next 12 years, Wayne's model averaged 11.05% a year while the S&P 500 averaged 1.29%.

If you don't have enough time to recover from another 12 year period when the market averages just 1.29% a year, it makes sense to choose a manager who has delivered good results even in bad market conditions.

Click here to learn more about Wayne, the stocks he has been buying recently, and sign up to be notified when he updates his views.

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https://www.forbes.com/sites/kenkam/2019/08/04/stormy-markets-reveal-great-managers/

2019-08-04 16:41:00Z
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