The Advantages of SweetSpot Investing
Contrarian Is Best
Contrarian investing, or going against the majority of investors, is known to be a superior investment strategy. Over time, betting against the crowd is more rewarding than betting with
it. But timing is everything. In
the fall of 1928, a smart investor correctly saw that the stock market had become seriously overvalued as investors chased
ever-higher stock prices. He was so sure of himself that he committed his capital
to shorting the market, betting that it would come down. He was right that the
market was overvalued, but he was a year early. By the time the stock-market
crash arrived one year later, he was unable to capitalize on it. He had
been left penniless by his short positions, which required more than his net worth to cover. SweetSpot investors take a contrarian position but not until after the weak holders who could move
prices against them have already fled the scene...
Low Risk, High Reward
Investing is seen as a trade-off of risk for reward. The conventional
wisdom is that you must assume greater risk to see bigger returns. Or, you must
accept a lower rate of return in order to safeguard your principal. Is this universally
accepted relationship between risk and reward unavoidable? No. The "sweet spot" is a documented phenomenon, a
point in a market cycle where investors can position themselves for outsized gains while taking on minimal
risk. Call it the exception that proves the rule... What has been missing until now is a methodology for identifying the
sectors that are most likely to be at or near their sweet spots at any given time.
Most people who have an opinion on the subject of sector investing think of it as a high-risk proposition. It’s true that individual sectors often are more volatile than the overall market,
and volatility is a commonly accepted measure of risk. But what if you hold a
diversified basket of nine or more sectors? Depending on how closely the
price movements of your sectors correlate to each other, the resulting volatility may be lower than that of the market
itself. Back-testing showed that SweetSpot investors can expect to see half as many
double-digit price drops as the market while enjoying almost twice as many double-digit upmoves. So
as a group, SweetSpot sectors tend to be less risky than the market.
At the same time, SweetSpot's returns have been stellar.
One of the biggest hazards in investing is the tendency to be drawn into popular investments, paying too much for the
privilege. SweetSpot investing avoids this risk. The
sectors we're buying are not always at their lows, but they’re certainly not at their highs. It's hard to fall off the floor, but be careful
when you're scaling that peak... We buy at a low price, and root for our sectors to bounce hard off the floor. Low risk, high reward...
Understandable
The best time to invest in the stock market is at the bottom of a down market -- prices only go up from there. The bottom of a down market occurs when just about everyone who is going
to sell has done so. What better candidates are there to be experiencing
the bottom of a down market than the three sectors that have seen the most selling in the last year?
It makes sense that risks would be relatively low after sectors have seen prolonged selling (but not
before!). Selling pressure is what drives prices down -- in SweetSpot sectors the supply of sellers who
could create such pressure is depleted.
Simple and Easy
Warren Buffett was once asked to identify the key to his investment success. He replied, "It's simple, but it's
not easy."
So far, SweetSpot’s returns compare favorably with the returns of Warren Buffett’s holding company, Berkshire
Hathaway. But unlike Mr. Buffett's approach, SweetSpot is simple and it's
easy. Not just Warren Buffett but many financial professionals, retirees, gamblers, and dabblers spend countless
hours all year long trying to beat the market. Practically everyone (except Mr.
Buffett) fails. SweetSpot investors trade once each year, executing a strategy that
consistently beats the market, and one that also pays a dividend most other investors don't receive: time. The rest of the year we can concern
ourselves with other matters, confident that our assets are well deployed.
It Beats Our Other
Options
Investing in diversified mutual funds pretty much guarantees mediocre results.
Surely, some fund managers beat the market, but as a group they are no more likely to continue doing so than poorly
performing fund managers are to start doing well. Most fund managers are
people, subject to the laws of human nature just like the rest of us. History
is replete with wunderkind money managers whose performance suffered after their success became widely known and they
found themselves on the spot.
Managed mutual funds have underperformed the broad market over time. A 2005 study
by Standard & Poor's showed that in the first five years of the millennium, the S&P 500 beat
62 percent of all large-cap funds; the S&P MidCap 400 beat 81 percent of mid-cap funds; and the S&P SmallCap 600 beat
73 percent of small-cap funds. These numbers don't even factor in the sales fees that some managed funds
charge, which would make the contrast even more stark.
Perhaps even more startling is the finding of other studies that most investors fare much worse than their
already sub-par mutual funds. Chalk it up to the human tendency to buy in at a high price and sell out at a low
one... Yet SweetSpot has consistently beaten the S&P 500, which has beaten the funds, which have beaten most
investors, and it's beaten them all by a wide margin. It's hard to beat that...
It Hasn't Mattered What
the Market Is Doing
The worst bear market since the Great Depression began in the spring of 2000 and lasted for three years. In 1999, the blow-off year of the 1990s stock bubble, few investors were fleeing anything. In
January 2000, the SweetSpot methodology gave us a hint of what was to come -- it found that investors had shunned only
two sectors the previous year: food & agriculture and medical delivery.
At the time, SweetSpot employed a sell signal that was activated in January 2001, prompting us to sell medical delivery for
a big gain (while the market was down). Food & agriculture was
sold at the end of the full three-year holding period, for a gain of 24% versus the market’s 36% loss
during the same period.
As long as our assets are well deployed, it shouldn't matter what the market is doing.
Let's add that to our list of things not to worry about.
We’re Being Spotted
a Lead
We measure our performance against the market’s, but it can be fun to look at how we’re doing against
the shlubs who are out there actively buying and selling. Every time they make
a trade, they’re incurring “friction” costs: commissions; SEC
fees; the time value of taxes paid on profits; and the value of time spent trying (and failing) to gain an advantage. There is also this significant (if unquantifiable) cost: The emotional toll of the stock market’s roller-coaster ride.
Up! Down! I’ll be rich! I’ll be ruined! Add it all up,
and they’re spotting us a big lead.
We Found a Niche
Nobody is trading SweetSpot ahead of us, because few people know about it. And
few people want to know about it. Investment professionals will
tell us they would never consider a strategy that has them trading on one day each year and then holding for
three years. They wouldn’t be able to justify their fees; they need to be able to show they're working hard for your money. Individual investors
aren't too interested either (yet) – they hear the word “sectors” and shy away because they
“know” about the risks of sector investing. SweetSpot has no
competition – the only “herd” we can see is the one stampeding out of the sectors we're about to buy...
We Are Our Own Clients
In December 2004, a financial adviser familiar with SweetSpot asked how the strategy fared in 2002, playing
an apparent game of “gotcha!” The answer to his question was that
in 2002 the SweetSpot funds we held were down 8% collectively (not that this mattered – every one of
them was sold for a gain). The market, however, was down 22% in 2002. Given
that, the adviser was then asked, wouldn't he be happy with an 8% loss?
His response:
“Yes -- On a relative basis the strategy did well. But go tell a
client that you lost 8% that year. Clients are more concerned with absolute performance,
believe me! I don’t mind beating the market on a relative basis but a lot
of clients don’t want to lose any money at all. Their expectations may
be unrealistic but they could still fire you even if you only lost 8%.”
Let's be glad we don’t have to deal with clients who would fire us for doing the right thing (would they?). With SweetSpot, we are our own clients.
Armed with facts, we're not trying to sell ourselves anything and we have our own best interests at heart. (The financial
adviser has since begun investing his own money in SweetSpot, but he has not shared the strategy with any
of his clients. "They like to trade," he said....)
The Zen of No Action
Suppose you enjoy the art of Japanese flower arranging. As a SweetSpot
investor, you can engage in that activity to your heart’s content. You'll feel secure in the knowledge that, at
the same time you’re arranging flowers, you’re also putting forth the effort required to enjoy superior investment
returns. And what if someone wants to buy your beautifully arranged flowers? Well,
now you're moonlighting...
What’s your time worth, anyway? Arguably, it’s priceless -- it
cannot be bought or sold -- we all have the time that The Powers That Be give to us, and no more. Whatever the value of your time, add it to the returns of the SweetSpot Investment Strategy.
By early 2003, stocks had been so weak for so long that most investors had soured on the market. SweetSpot investors sold a lot of their investments along with everyone else, their pain thresholds having
been reached. But several of these investors didn’t sell any of their SweetSpot funds. They wanted
to sell them but decided instead just to stick with the program. They knew how long they were supposed to
hold their SweetSpot funds, whereas they were free to use their judgment in deciding to sell their other investments. For
about three weeks those investors felt pretty smart for having dumped their (non-SweetSpot) investments. Then
in March the market reversed upward, but it wasn’t until May or June that getting reinvested seemed to make sense.
Only their SweetSpot holdings benefited from the entire move up from the bottom. Action, schmaction....
Live a Good Life
In The Art of Living, the ancient Greek philosopher Epictetus stressed the importance of devoting our time and energy
to what matters, and to those matters we can affect. We must be vigilant against
our tendency to worry about things over which we have no control. And if ever there were something that is not within
our control, it's the short-term gyrations of the stock market.
SweetSpot investing gives us the opportunity to cast out the fear and greed that drive us to take impetuous
action. When we indulge these emotions, we are spending our time unproductively
at best and counter-productively at worst. Once we recognize these forces for
what they are, we can put them aside and direct our time and attention to what matters.
We are free to ignore our investments while still taking responsibility for our financial well-being. As for figuring out what is worthy of our attention, we may want to read The Art of
Living. We'll have the time, after all….
