A few days ago, I told you that the markets looked frothy.

The P/E ratio of S&P 500 stocks is the highest since the dot-com bubble.

Also, the Federal Reserve warned Thursday that a “repricing” event could come in the future.

I don’t expect this event to occur in the weeks ahead.

But I do have my trailing stops in place – as always.

In the meantime, there’s a bullish case for stocks to run higher.

Why?

It’s all because of a report update from Goldman Sachs.

Companies are about to drive their stock prices higher.

How will they do it?

I’ll break it down for you.

Cash is King

It’s been quite a year for public companies.

Last year, firms played as much defense as possible by drawing on credit lines and issuing new debt. With interest rates low, it made a lot of sense to take on this risk.

But now, a year later, corporations are flush with cash.

What are they going to do with the money?

Well, take a look at what Apple (AAPL) and Berkshire Hathaway (BRK.A) are doing for clues.

Back in 2007, Apple unveiled the iPhone. At the time, its market capitalization stood under $75 billion.

They’ve done pretty well, thanks to this device. Today, the firm has nearly $200 billion in cash on hand.

A company like Apple has a few options if it wants to return profits to its shareholders.

It could increase the dividend and return cash to investors every quarter…

Or it can engage in a stock buyback to increase equity value.

A stock buyback is a term for an event where companies purchase their own stock on the open market.

Buybacks reduce the number of outstanding shares on the market.

This increases the ownership stake of investors.

As a result, share prices will increase due to the reduced number of available shares. Think of it as a way of the company reinvesting in itself.

Apple’s not the only company buying up stock.

Berkshire Hathaway has spent $6.6 billion on stock buybacks during the first quarter. It spent $9 billion in both the third and fourth quarters of 2020.

Eli Lilly (ELY) announced a plan to buy back $5 billion in stock.

Netflix (NFLX) authorized $5 billion in buybacks set for the second quarter.

And JPMorgan (JPM) said last December that it would repurchase a whopping $30 billion in its own stock. Through the first three months of 2021, it bought $4.3 billion in its own stock.

Here’s the thing.

We’re just getting started with this trend.

Goldman Sachs predicts that we’re on the verge of a “buyback bonanza.”

Behind Goldman’s Numbers

According to Goldman Sachs strategist David Kostin, we could see a 35% jump in share buybacks this year. He also projects a 5% jump in buybacks next year.

Companies are flush with cash. And from January 2021 to April 2021, U.S. companies spent an incredible $484 billion buying their own stock.

That figure is double the pace of buybacks during the same four months of 2020.

Buybacks in April totaled $209 billion, according to MarketWatch.

That is the second-highest monthly total on record. The record came in June 2018 after the passage of the Tax Cuts and Jobs Act.

Goldman Sachs isn’t the only group expecting this buying frenzy.

Last month, State Street Global Advisors analyst Michael Arone predicted a 30% rise in buybacks this year. He expects about $800 billion going back to shareholders through these purchases.

Why Buybacks Matter

A lot of people might speculate that huge cash hoards on balance sheets would be better used to buy other companies.

But in the post-pandemic world, I’d argue that firms are trying to determine what the future holds.

What will this economy look like in 18 months?

Yes, they probably should have a lot of cash set aside for a rainy-day fund. Airline companies are notorious for buying back their stock and never having cash flow for emergencies.

But corporate boards expect a lot of regulatory changes.

There is talk of higher taxes on corporations, and thus their shareholders. The Biden administration is proposing a big hike on corporations. To pay for a $2.3 trillion infrastructure package, the White House wants to hike corporate taxes to 28%.

And many executives do receive bonuses based on the performance of their stock.

So, right now is the time that many firms will put that cash to work and give it to the shareholders.

This trend will likely push the S&P 500 higher. And we’re not going to get in the way. As I said Friday, I’m happy to let this market run higher. Valuations might be stretched, but buybacks are just another way that stocks can continue this rally.

I sleep better at night knowing I can eke out additional gains and have my trailing stops in place in the event that it all goes sideways. I’ll be back tomorrow to talk about a big trend in the auto sector, and a new momentum play.

I’m starting to feel sorry for Federal Reserve Chair Jerome Powell.

Don’t get me wrong. A lot of our economic problems start and end with the U.S. central bank.

Powell has been testifying before Congress. He’s given speeches after each central bank meeting.

And he’s giving interviews and speaking at economic conferences.

He’s regularly downplaying the threat of inflation, never raising serious concerns about the stock market or rampant speculation.

He’s been talking about the need for more stimulus and monetary support like low-interest rates to ensure a stable recovery.

Yet almost every time he turns around, someone undercuts his message.

This week, many of his allies offered serious contradictions to the Fed’s plans for the economy.

I want to talk about what this means for your money.

And I’ll show you why we are not panicking.

Spooky Statements

In March, Powell spoke after the Fed’s two-day meeting on monetary policy.

He offered a very dovish take on interest rates and the central bank’s vision for the U.S.

At the time, the U.S. 10-year bond’s interest rate was rising fast.

Despite ongoing concerns about inflation and a red-hot economy, Powell didn’t flinch. The Fed chair recommitted to keeping interest rates near zero into 2023. 

The markets cheered the decision. Stocks continued to rally through April. And Powell continued to show his commitment to maintaining current policy.

But other people have different opinions. And those opinions matter. One very important voice is Treasury Secretary Janet Yellen.

This week, Yellen, the previous Fed Chair, suggested that rates should rise sooner. At an economic forum hosted by The Atlantic, she said the following:

“It may be that interest rates will have to rise somewhat to make sure that our economy doesn’t overheat. Even though the additional spending is relatively small relative to the size of the economy, it could cause some very modest increases in interest rates.”

Talk about a contradiction. The markets listen to Yellen. She oversees the money supply. Her agency advises Congress on fiscal policy (taxes, trade, and domestic and international finance.)

And, did I mention that she was the previous Fed Chair?

Stocks tanked after her statement.

And Yellen, perhaps realizing that she might have overstepped, quickly changed course. A day later, she told The Wall Street Journal that higher rates were not “something I’m predicting or recommending.”

The damage was done, though. You probably won’t hear her talk about interest rates again in public this year.

Yellen is only one person who has contradicted Powell’s messaging. It’s happened among other members of the Fed. Warren Buffett talked about the threat of inflation at length last weekend.

No one believes Powell right now about interest rates and inflation. Still, he continues to parade his message. How long can he hold this fairy tale together? That remains to be seen.

But behind the scenes, the Fed has just issued a huge warning sign. It offers a staggering view of what may come if the central bank has to raise rates sooner than later.

Stability In Tough Times

Yesterday, the Fed released its semiannual Financial Stability Report. This report analyzes asset prices and sentiment in the market. The Fed says that the markets are stable.

However, the bank is worried about valuations.

Investors have been buying everything hand-over-fist since last March. They’re buying stocks, corporate bonds, non-fungible tokens, and cryptocurrencies. We’ve also seen a huge run on special purpose acquisition companies (SPACs).

The trillions of dollars pumped into the economy over the last year have fueled rampant speculation.

Powell admitted that valuations are high. He says they remain justified in times of low-interest rates.

But Fed board member Lael Brainard’s statements about the report should raise red flags. Brainard talked about the importance of safeguards and the need for banks to increase capital requirements.

These are the types of things that central bankers said while the house was burning down in 2008.

This report suggested that a “repricing event” could occur – meaning that stocks would radically rise and fall.

Repricing would better reflect the company’s fundamentals and the reality of their debts and vulnerabilities to the pandemic.

And we know right now that the market is extremely frothy.

I have shown this chart before. It bears repeating.

Historically, the S&P 500 P/E Ratio is trading at 88% higher than its historical mean. This is the highest level since the dot-com bubble.

It is also two standard deviations away from its mean. The possibility of a snapback and massive shift in valuations could come anytime.

That’s why we’re prepared.

Here is Our Secret Defense Against a Downturn

At TradeSmith, we’ve built tools to help investors manage individual stocks. Through TradeStops, we provide custom trailing stops for each tracked public company.

But we also have a “kill switch” for the market.

Take a look at this chart. It’s our way of knowing when to be active in the markets… and when to get out and move to cash.

You can see last February, right before the worst of the crash started, this market’s health turned red and the S&P collapsed. But we knew at the exact moment when to exit the markets.

Are we facing another correction? Recent statements would suggest a “re-pricing” may happen for the market. Many pundits, economists, and other voices have suggested that rising rates would hammer equities.

It may come at any time.

But we’re not exiting stocks yet. And we’re sleeping well at night.

We’ll use our signals to guide us to higher prices, should they come. If and when this signals red and it’s time to walk away, you will hear from me right away.

Today, I’d like to wrap up our Cognitive Bias series.

Over the last two weeks, we’ve tackled your greatest enemy in the markets.

No. It’s not hedge funds.

It’s not Wall Street bankers.

It’s not some politician or central banker who can’t keep their mouth shut.

It’s your subconscious.

Benjamin Graham was the author of the finance classic The Intelligent Investor.

He was also a major influence on Warren Buffett and other value investors.

Pointing to the irrationality of investors, Graham has a classic quote. “The investor’s chief problem – even his worst enemy – is likely to be himself.“

Taming your biases is the single most important action to take as a buy-and-hold investor. Let’s look at one more bias that could impact not only your portfolio in 2021, but also your tax returns.

The “Effect” on Your Portfolio

The final boss in your cognitive bias lesson is a doozy to say…

Disposition Effect Bias

Dispo-what?

This is a fancy way of oversimplifying different investments in your mind.

We link this bias to the habit of labeling different investments as winners or losers.

We see this bias in conversation every day. Apple, for example, is widely viewed as a winner. It’s the world’s largest tech firm. It keeps going higher and higher…

But what do a lot of people do when Apple reaches all-time highs?

People sell the stock. They’re eager to capture profits.

Yet they completely ignore the fact that this is a growing company… an incredible company… and that it expects profits to rise even higher.

So, they’re selling their winners too early.

And what do people do with their losers?

Well, people don’t like to admit when they’re wrong. When their stock drops, they might ignore clear signals to sell. Instead, they’ll hold onto their losing stock in hopes that it will bounce back.

But if a stock hits negative momentum – there are many sellers and no clear indicators of a rebound – it will go lower. This produces greater losses in the process.

It ties directly to the loss aversion bias that we discussed two weeks ago. People do not like to lose money. As I noted, a person is more emotional about losing $10 than they are about winning more than $20, according to economist Daniel Kahneman.

That’s a powerful mental block to overcome. And it can impact more than just your portfolio.

The Impact on Your Taxes

I don’t spend a lot of time talking about taxes. But, I have to say, it’s very important to consider this issue when talking about your portfolio.

As you know, there are two different structures for capital gains taxes.

The first is short-term capital gains. These are the taxes that you pay on investments or trades that last less than 12 months.

Next are long-term capital gains. In the United States, the IRS classifies these investments differently. Long-term assets are those held for 12 months or more.

It doesn’t seem like too much of a difference.

But the difference between holding a stock for 11 months and 13 months can be pretty jarring at tax time.

If a married couple making a combined $250,000 sells Apple stock for a $5,000 gain after holding it for 13 months, they will pay a 15% tax on those gains. That’s $750 in taxes.

The IRS taxes short-term investment gains as ordinary income. So, if that couple sells Apple at a gain of $5,000 after 11 months, they’ll pay a different rate. Since this gain would fall in the 24% bracket, they would pay $1,200. That’s a $450 penalty for selling.

Why do I bring this up?

Because Disposition Effect Bias may drive you to quickly sell stocks that are winners. You must also consider the tax implications of selling. Not only could you be selling stocks that are poised to run higher, but you also might be giving Uncle Sam a bigger chunk than you should.

How to Avoid This Bias

There’s a solution to avoiding Disposition Effect Bias.

Stop holding onto losers. Stop selling your winners too early.

I know that sounds simple… because it is.

If you want to do the deep dive into the psychology behind this, you can. You can read the 1985 research article, “The Disposition to Sell Winners Too Early and Ride Losers Too Long: Theory and Evidence,” by Meir Statman and Hersh Shefrin.

But that might put you to sleep… and you might miss some great trades.

Instead, you can do what I do. I use TradeSmith Finance to track my portfolio, and I wait for the signals to tell me what to do. Our technology can’t make it easier.

If my stocks are in the Green Zone, even if they’ve run up 30% and I’m tempted to sell, I listen to the signal.

I’ve mentioned Apple several times. It is right there, in the Green Zone. Despite all the noise around the market and the stock, if I own shares of Apple, I can take comfort in riding this stock higher.

If my stocks are dropping and one falls into the Red Zone, I sell my losers. Even if they are the coolest company in the world.

Take Virgin Galactic (SPCE). It’s a really cool company. Yes, they might be putting wealthy tourists into space.

But this stock is in the Red Zone.

It’s very important to have rules.

They help eliminate the emotions that can wreck our portfolio.

As I conclude this series on cognitive bias, I invite you to send me a note. Do you have questions or stories about your experiences with stock market emotions? Let me know at [email protected]. I’d love to read them. I’ll even take a few, with your permission, and respond to them in TradeSmith Daily.

For two weeks, I’ve been sharing cognitive biases that can negatively impact your investing.

Bias drives underperformance in the markets.

It stunts our ability to discover new opportunities.

And it makes us frustrated.

When we fail to tame our biases, the odds of us making the same mistake increase.

Today, I want to talk about a sensitive topic.

If you’re serious about making money in the markets, we have to talk about confirmation bias.

Defining Confirmation Bias

We all have deeply held beliefs. They might be political. They might be personal. They might be a set of rules we follow.

They might shape our worldview.

One of the most important things to remember is that other people don’t think the way you do. They process information differently.

They adhere to other beliefs, structures, and biases.

Market participants do the same.

Confirmation bias describes how people favor information that conforms to their existing beliefs.

What happens here is simple when it comes to money.

Investors tend to seek specific information that “confirms” the things they believe or want to happen. They will ignore any information that refutes these beliefs.

For example, imagine that you’re convinced that a trend is inevitable.

An excellent example of this is “The Death of Physical Retail.”

For years, media outlets and financial newsletters have warned about Amazon. They’ve repeated time and again that malls are going out of business.

Some so-called “experts” have warned that brands like Abercrombie & Fitch (ANF) and Gap Inc. (GPS) might find themselves filing for Chapter 11 one day.

Based on the media reports, you might be steadfast in a belief that both will go bankrupt in the future.

As a result, you might search for news or information that confirms your bias.

You read bearish analysts and bearish articles on both stocks.

You seek information that backs up your belief that both retailers will go out of business.

And, you ignore the articles that suggest these companies are healthy.

You miss positive sales reports. You ignore optimism about the reopening trade. You ignore news from their landlords that they’ve been paying rent.

What happens as a result?

You miss out on a 106% return on Gap Stores since Sept. 8, 2020. And a nearly 200% gain on Abercrombie & Fitch since June 9, 2020.

Why these returns and these specific dates? These were the dates when both stocks entered the Green Zone within TradeSmith Finance.

Here’s How to Tackle Confirmation Bias

If you’re very opposed to investing in a company because you’re opposed to its business practices or mission, that is OK. Or maybe the company took a political stance you didn’t like, or it sells a product that offends you.

But I want to explain that the markets will never give us the satisfaction of morphing to our views.

This lesson can be hard to learn.

But an action plan to address this bias is quite simple to employ.

First, if you’re conducting research, you must broaden your horizons beyond one or two voices.

Everyone has their expert. And it’s essential – especially if you read newsletters – to find someone you want to read. There are many voices out there, and finding someone who meshes with your risk and investment strategies is very special.

But you need more than one person. TipRanks, for example, is a helpful platform that gives you a breakdown of many different voices.

It will tell you the price targets and recommendations of every analyst that covers a stock. It will offer insight into what that company’s executives are doing (in terms of buying or selling the stock). It will disclose which hedge funds own the stock. And it provides a mix of different tools to measure the technical and fundamentals of each company.

Of course, there are also several well-respected newsletters and gurus that we partner with too.

Follow many voices. Get your hands on analyst reports. And recognize the difference between analysis and hype. Anyone who says that a stock “WILL GO” to a specific price should be ignored.

No one can predict the future.

Next, you need to have systems in place that can help override those cognitive biases. Something as simple as TradeSmith Finance, which eliminates all the noise.

The platform brings it down to a clear signal: Green Light, Yellow Light, Red Light.

Buy, Wait, Sell.

You saw it with Abercrombie and Fitch and Gap. Anyone who believed that these companies would collapse missed out.

Finally, take a little time today and examine your portfolio. I want you to really think if any stocks you own have been shaped by confirmation bias.

If so, start doing research. Read the investor presentations. Read more than two blog posts with rosy headlines. And check to see if the stock is still trading in the Green Zone on TradeSmith Finance. Even if it’s rated a sell, the good news is that the markets are at elevated levels.

So you should see good returns if you’ve been holding anything in the sell zone.

I’ll be back tomorrow to wrap up our insights on cognitive bias.

And we’ll be looking for more opportunities as we move deeper into May.

You only need to open your eyes to see that prices for nearly everything are rising.

Raw material costs continue to explode.

After the COVID-19 shutdown in March 2020, companies pulled back on manufacturing.

Now, a year later, we’re witnessing a huge strain on supply chains. We have a shortage of commercial truck drivers (a problem that existed years before COVID). At the end of 2018, there were an estimated 60,000 drivers needed, according to the American Trucking Association. And the problem has only gotten worse.

This factor will impact almost every product’s price and its availability in the coming months.

We also have a global shipping-container shortage.

Ocean freight stocks have ripped higher in April. For example, shares of Star Bulk Carriers (SBLK) popped 12% yesterday. It’s up more than 40% since April 1.

Lumber prices are out of hand. A huge collapse in sawmill capacity helped drive futures prices up more than 50% in 2021.

Corn prices continue to rise, and they are likely to head higher, due to significant bottlenecks in freight ahead of the 2021 harvest months.

Remember, almost everything in the grocery store you eat likely involved corn in its production. Cosmetics, yogurt, toothpaste, Windex, Goodyear rubber tires, hand sanitizer (ethanol-based), plastics, crayons, and even hand soap use corn.

And corn is used as feed for chickens, pigs, cows, and other farm animals.

So, gasoline, crude oil, and even that ham sandwich are now more expensive.

What’s happening with commodity prices today has no precedent. There’s never been a global, interconnected economy of this size reemerging from a crisis.

Not even 2008-09 compares to our current predicament.

So, how do we choose which stocks to ride if we want to protect ourselves against rising costs? That’s where TradeSmith works its magic.

Understanding the Economic Story

I don’t know if you took Economics 101. But somewhere in the back of my mind sits that one lesson about consumer prices.

Right after the professors teach the basics of supply and demand, the next lesson is vital.

The difference between “elastic” demand and “inelastic” demand.

Elastic demand is the change in consumer demand based on rising or falling prices. If prices are higher, people buy less.

If the price of an elastic product drops, consumers buy more.

Inelastic demand is different. Consumers will largely buy those products regardless of price. Buying habits do not change.

Think gasoline, salt, cigarettes, prescription drugs, and a lot of raw materials. At the manufacturing level, a company will look to pass on the rising cost of raw materials to consumers.

That’s especially true in the housing sector right now.

In February, the National Association of Home Builders (NAHB) released a pricing report that said higher lumber costs would increase the average new home price by $24,000.

Three months later, that NAHB figure is now almost $36,000.

That’s what happens when lumber prices increase by 340%.

Yet, housing companies like Lennar Corp. (LEN), Meritage Homes (MTH), and PulteGroup (PHM) continue to build. Their share prices continue to rise. And all three remain in the Green Zone within TradeSmith Finance.

Meanwhile, Louisiana-Pacific (LPX), a manufacturer of building products, just crushed earnings today. It produces weather-tested siding, fences, sheds, and frames. Their customers are the housing companies listed above.

It too sits in the Green Zone on TradeSmith Finance.

Despite rising prices, homebuilders are gobbling up LPX products.

Of course, it’s not just housing products and lumber that are facing strong price increases.

If we’re looking at inelastic demand, one has to think about food. With rising prices, food manufacturers will pass on these rising commodity costs to protect their margins.

With the price of food materials rising, we want to find companies that can avoid brand substitution by customers or sell products that serve as low-cost alternatives.

Let’s check TradeSmith Finance for an idea that just emerged as a buy on Monday.

This Looks Like a Buy

Hormel Foods (HRL) is a global food company with several big brand names. It has more than 35 brand categories that hold the No. 1 or No. 2 position in market share.

The company operates in four segments.

·      Refrigerated foods (54.9% of revenue)

·      Grocery products (24.8% of revenue)

·      Jennie-O Turkey Store (13.9% of revenue)

·      International & other (6.4% of revenue)

Last year, it generated 67% of its revenue from retail stores.

Another 26% came from foodservice. One can expect this to increase with restaurants reopening.

Finally, it generated 7% of revenue from international operations that include joint ventures, licensees, and subsidiaries.

This company is very U.S.-centric. Brands include Hormel bacon, Chi-Chi’s, Don Miguel, Justin’s, Jennie-O, Skippy, and Spam.

You might laugh at the idea of Spam.

But love it or hate it… Spam is inexpensive. The pork meat in a can is a very popular item when food prices increase. Back in 2008, when food inflation was running hot, Spam sales surged.

In the second quarter of 2008, Spam was one of the primary reasons why profits increased by 14%.

We can expect a similar boom if food prices continue to rise.

The company is also a trendy dividend stock. It has increased its dividend for 55 straight years. Today, it pays a dividend of 2.09%. We expect the company to hike that dividend again in 2021.

Hormel’s stock has been treading water this year. It has underperformed the S&P 500 and lagged against the Consumer Staples Select Sector ETF (XLP).

But the stock looks to be emerging from its slumber.

It just entered the Green Zone within TradeSmith Finance on Monday.

Given that we’re looking for conviction on HRL, we also see it qualifies for three Ideas Lab strategies: Low Risk Runners, Best of the Billionaires, and Sector Selects. Also, we see that Ray Dalio, the head of the world’s largest hedge fund, is an owner.

If you’d like to learn more about the Low Risk Runners, Best of the Billionaires, and Sector Selects, you can go here.

Remember, TradeSmith can help you remove the emotion from buying and holding stocks. We can identify major trends like rising food prices. Then, with our screeners, we can identify new companies that just entered the Green Zone.

We use trend analysis to qualify the opportunity and TradeSmith to quantify it. Tomorrow, I’ll be back with more ways to curb your emotions and ride the opportunities this market provides.

Over the weekend, Berkshire Hathaway reported earnings.

I’m sure you’ve read Vice Chairman Charlie Munger’s rants about Bitcoin.

It’s incredible to see Munger and Warren Buffett still at it.

They’re both in their 90s now.

And they’re still incredibly passionate about making their investors money.

Today, I thought I’d start with a classic Buffett story.

Then, I’ll show you the lesson of the story… and the exact stocks that you should consider owning.

The Oil Prospector Goes to Heaven

It’s always important to think for yourself as an investor.

Warren Buffett has always told a classic story about following the herd. It goes like this…

An oil prospector passes away and makes his way to heaven. Upon arrival, he ends up in line with hundreds of other oil prospectors at the Pearly Gates.

St. Peter is checking names at the gate, and this prospector is growing impatient. The line is not moving…

Suddenly, the crowd of prospectors disperses. People start running in the opposite direction of the gates.

The oil prospector gets to the front of the line and meets St. Peter.

St. Peter asks, “Why did everyone run off?”

The oil prospector smiles: “Well, I yelled that oil was discovered in hell.”

St. Peter then asks the oil prospector why he would like to be let into heaven.

After a minute of reflection, the oil prospector says, “You know. I’m going to join my colleagues to see if there is any truth to that ‘oil in hell’ rumor after all.”

How Should You Build Your Portfolio?

It’s very common for investors to buy stocks that they see in the headlines.

To join the herd. To get a sense of “missing out” and chasing the crowd.

If you turn on CNBC, you’ll hear pundits rambling on and on about Facebook, Netflix, Alphabet, and McDonald’s.

There’s nothing wrong with these companies. They’re great American companies.

But when they’re all you hear about, the prospect of “familiarity bias” creeps into your mind.

This means that you’ll only invest in “familiar” companies, the ones that so many other people own.

I’ve written extensively in my Money Talks with Keith column over the last few weeks on how to build a portfolio to weather any market. [You can read the first four parts of the series here: Part 1, Part 2, Part 3, Part 4].

If you only build a portfolio based on names you know, it can create all sorts of problems. These include overallocation to a specific sector and underperformance compared to benchmarks.

Of course, it’s not just what you see on television.

Where you live has a lot to do with how you invest.

A professor named Gur Huberman at Columbia Business School did a fascinating study about familiarity bias.

He found that in 49 of 50 states, investors were more likely to own shares of their local telephone company than any other phone company. Why? Because that was the company that they knew best in the sector.

It’s not just familiarity bias that investors need to avoid.

It’s following the herd as well, which Buffett addresses in his prospector parable.

Buffett has long invested in Apple and innovative tech companies. But he has also invested in some VERY boring companies. He has created a very unique portfolio across Berkshire Hathaway.

This portfolio can provide an optimal return. It can mitigate risk…

And… it can be very BORING, which is a good thing.

Berkshire owns a lot of shares of Restoration Hardware, which sells furniture.

BORING!

Berkshire’s subsidiary BNSF is a freight operator that moves oil and corn across the continent.

BORING!

Berkshire owns some of the most recognizable and mundane companies – all of which you’ll instantly recognize – including Duracell, Fruit of the Loom, and  GEICO Insurance…

GEICO Insurance… is there anything more boring?

It also owns Business Wire for press releases, Acme Brick Company, a specialty insurance firm, and a candy company.

Berkshire’s portfolio isn’t contrarian.

But it’s structured to do one thing.

This portfolio offers incredible amounts of cash flow from many diverse industries and generates profits for its investors, which is exactly what I’ve been talking about via the portfolio thinking articles I’ve written (and referenced above).

EVERYONE these days wants to invest in the latest tech companies. People are pouring money into non-fungible tokens (NFTs), the FAANG stocks, and “space.”

But, you’ll never see Buffett or value-focused investors speculating much in these areas.

Buffett doesn’t lose money very often.

Boring Versus Speculative

At TradeSmith Daily, I’ve been giving our readers actionable recommendations when they emerge, as highlighted by the TradeSmith tools.

So, let’s briefly look at an example of buying boring versus buying into the hype.

How often do you hear about Virgin Galactic? People talk up the trend of space tourism constantly…

But how’s the stock doing? It’s extremely volatile. In fact, shares plunged more than 8.5% this morning.

Within TradeSmith, it has been  in the Red Zone since early March, is in a side-trend and has a sky-high risk of 64.77%.

When TradeStops signals that a stock is in this situation, we don’t touch it. As I like to say, “the trend is your friend.”

So, while everyone else might be barking about what a bargain SPCE stock is…

We’ll sit back and avoid it. We’ll wait to see when and IF it returns to the Green Zone.

Meanwhile, how excited are you to own a company like… H&R Block? This is a company that sells tax software.

Can it be any more boring?

But guess what? It’s tax season. Its retail locations are opening up after COVID, and its software throws off gobs of cash flow thanks to monthly subscriptions.

In addition, it has been in the Green Zone for more than three weeks, is in an uptrend, and has a medium risk of 28.55%. Our Platinum users can see that the latest addition to our program, Ratings by TradeSmith, has it at a Strong Bullish level. (And while I’m talking about TradeSmith signals, our Timing product is showing HRB in a valley area, signaling an ideal time to buy, until May 14.)

Since TradeStops flashed a buy signal on April 6, shares have traded in the $22 to $22.50 range. But it pays a solid 4.6% dividend.

I’m happy to buy into those boring companies. They reduce likelihood of a concentrated exposure within a single sector.

It also allows us to build a more balanced portfolio that includes different consumers, cash flow, and commerce.

Best of all, I sleep better at night. I’ll be back tomorrow to discuss more on the topic of cognitive bias.

Here we go…

After a wave of earnings reports from America’s top tech companies, a small selloff ensued. The Nasdaq, S&P 500, and the Dow… they all fell Friday morning.

A selloff right before the weekend.

The average investor sees this downturn and has their finger on the sell button.

But not me.

This week, we’ve talked about ways to manage loss aversion and the temptation to jump in and out of stocks. Cognitive bias leads to underwhelming returns. It also leads to missed opportunities.

Even if we do see a selloff next week – and there’s always SOMEONE predicting a selloff “next week” – I’m not worried.

In fact, I’m using TradeSmith to identify buying opportunities…

Let’s talk about the right way to trade and invest moving forward.

Don’t Make This Mistake

The markets are back at all-time highs.

But here come the “fearful headlines” once again.

Europe is back in a double-dip recession.

Analysts are raising alarms about semiconductors, chicken, corn, meat, MacBook, and other shortages.

Blah. Blah. Blah.

The last time I remember this much noise it was about a week from the November 2020 election.

Concerns about COVID, the election, economic growth, and more weighed on the market. A selloff started the week of Oct. 12.

Market momentum went NEGATIVE the week of Oct. 26.

Panic selling ensued. You can see it in the chart. The S&P 500 tanked in the weeks ahead of the election.

 [alt: TradeSmith charts showing October 2020 performance of S&P 500]

If you sold out at that point – you likely didn’t get back in.

And then the market absolutely ripped through March.

 [alt: TradeSmith charts showing early 2021 performance of S&P 500]

This recent rally is evidence of why you HAVE to ignore the noise.

If you’re a “buy and hold” investor, you need to set aside your emotions.

TradeSmith helps you do this. We give you custom trailing stops upon entry of any position. And we tell you exactly when to buy, hold, and sell based on our Green Zone, Yellow Zone, and Red Zone system.

If you don’t yet follow the signals of TradeSmith and would like to learn more, click here.

In the meantime…

Are you looking for a long-term trade after this week’s earnings report, in spite of Friday’s downturn?

I have one for you.

This Tech Giant Has Entered the Green Zone

The attention this week centered on Apple, Amazon, Facebook, Microsoft, and Tesla.

All five of these companies have sat in the Green Zone on TradeSmith for months. And all five generated massive profits and revenues during their earnings reports.

But we are always looking for fresh ideas.

Four days ago, TradeSmith signaled a buy on one of the world’s most iconic semiconductor firms.

That company is Qualcomm (QCOM).

According to the Ideas by TradeSmith screener, Qualcomm reentered the Green Zone before earnings.

And on Thursday, the firm shattered earnings expectations. Shares of QCOM popped as high as $145 after a mind-blowing report.

The firm reported a 52% increase in quarterly revenue. The reason? Qualcomm is a major provider of chips and technology linked to the ongoing 5G boom.

Qualcomm beat Wall Street reports by a mile. Their earnings of $1.90 per share topped forecasts of $1.67. The firm cited strong sales of chips for smartphones across China and the United States.

In China alone, revenue increased by 63%.

Qualcomm is benefiting from the big 5G trend. It said that the ongoing deployment of these advanced networks will be a boon for semiconductor demand in the year ahead, especially as people start to travel more and the economy reopens.

Now, keep in mind, Qualcomm was a beaten-down stock. Before the firm reported earnings, shares were off by double digits, while the S&P 500 was up 12%.

And for weeks it wasn’t considered a buy.

But TradeSmith recognized it as a great idea heading into earnings.

And after earnings, it remains in the Green Zone.

In fact, TradeSmith recognized the upside potential before Wall Street analysts. The stock entered the Green Zone on Monday.

Wall Street analysts issued gushing praise and increased price targets on Thursday. One analyst at Raymond James projected an upside of $190 per share. Another at Canaccord Genuity said $188.

Twelve analysts issued price targets. Only one (a Goldman Sachs perma-bear who got Apple’s performance wrong) cut his target. Everyone else expects the stock to move higher, a signal of positive conviction for the stock.

Now, Qualcomm might be a little volatile; TradeSmith rates it at a medium risk with a VQ score of 29.04%. That’s the nature of the technology sector, which attracts massive sums of capital.

And because it can be volatile, our algorithms account for historical price movements. This enables a custom trailing stop that can help you better manage the stock if it sits in your portfolio.

Remember, there is a lot of noise in the market. But TradeSmith continues to generate great ideas and great trades BEFORE Wall Street.

Qualcomm is the latest proof.

Charles Wilson was a CEO of General Motors (GM).

At a congressional hearing in 1953, he said, “As goes GM, so goes the nation.”

Sixty-eight years later, America has changed.

One should now say, “As goes Apple, so goes the nation’s stock market.”

I said on Tuesday that this was a critical week for the markets.

Forget about the Federal Reserve meeting. And forget President Biden’s speech.

This week, six mega-cap companies – representing north of $9 trillion in combined market cap – reported earnings.

The biggest titan of this fraternity reported quarterly earnings yesterday.

Apple’s (AAPL) earnings report is very important. I can’t stress this enough.

The company represents nearly 6% of the weight of the S&P 500 and almost 11.3% of the NASDAQ 100.

So, pay attention if you invest in stocks, index ETFs, or even U.S. bond markets.

Here’s what you MUST know about the world’s largest tech company (by revenue and brand value), its earnings results, and what to do about its stock.

These Numbers Are Just Absurd

In 2006, Apple’s market capitalization finished the year just under $73 billion.

Fifteen years later, its market cap sits at roughly $2.24 trillion.

That figure is larger than the gross domestic product of all but seven economies worldwide.

Here’s another figure to show how fast Apple has grown.

Yesterday, it announced plans to add $90 billion in cash to its existing stock buyback program. That’s right. Its new cash injection to buy back its own stock is larger than its market cap from 15 years ago.

Now, you likely know Apple’s story.

Tech visionaries Steve Jobs, Steve Wozniak, and Ronald Wayne founded Apple in 1976. The company found acclaim for its innovative design and exciting marketing strategies.

But it struggled in the 1980s due to high costs and limited software applications. It also saw infighting among executives. Wozniak and Jobs left the firm in the mid-1980s.

Jobs returned and became CEO in 1997 after Apple purchased his company NeXT. He inherited a struggling company that lost significant market share and faced financial challenges.

Jobs soon launched a strategy to revitalize its market position. In 2001, the company shifted part of its focus to music and music players with the onset of the iTunes store and the iPod.

It also opened its chain of popular retail locations called Apple stores.

(If you own any Apple products like I do, you may have spent time at one of these locations learning how to use them.)

Apple’s shift at the start of the 21st century focused on a mix of hardware and services. A few years after the success of its growing digital-music footprint and the iPod, it would soon revolutionize communications.

In 2007, Jobs’ team released a new product: the iPhone.

That set off one of the greatest runs for a consumer product in the history of capitalism. The iPhone is in rarified air with other hot consumer products like Sony’s PlayStation consoles, the Star Wars franchise, the popular Toyota Corolla, and Apple’s own iPad tablet devices.

There have been 12 iterations of the iPhone, each delivering greater sales each time.

Statista notes Apple had the largest global market share of smartphone sales in the final three months of 2020. The iPhone generated more than $40 billion in net sales in fiscal Q2 2021 all by itself. That monster figure is only one highlight of Apple’s blowout fiscal Q2 earnings report.

The Fiscal Q2 Blowout

The few skeptics left around Apple hurried out the door Wednesday. In fact, Goldman Sachs analyst Rod Hall finally threw in the towel and admitted defeat after nearly a year of rating the stock a Sell. Since Hall put Apple on the bank’s Americas Sell List last April, shares have rallied 70%.

He upgraded the stock from Sell to Hold on Wednesday.

It’s an understatement to say things are well at Apple Park, the firm’s headquarters in Cupertino, California.

Apple experienced revenue records across each of its international business segments. Sales in China increased by 88% year-over-year, while North American sales popped by 35%.

Apple reported a 54% increase in total revenue, raking in $89.6 billion for the fiscal Q1 of 2021. That figure crushed Wall Street analysts’ consensus expectations by $12.3 billion. iPhone and Mac product sales drove a significant chunk of that success.

At this point, I have to ask, “What would Apple need to do in the future to disappoint people?”

Its gross margins increased by 42.5%, rising from $22.4 billion in fiscal Q1 2020 to $38.1 billion in fiscal Q1 2021. That big boost created gobs of cash flow that fortified Apple’s balance sheet.

The firm’s balance sheet increased its cash on hand to – get this – $195.57 billion.

That figure nearly rivals the State of California’s proposed annual budget ($227.2 billion) for 2021-22.

With that much cash, Apple can do anything it wants.

It could buy one of hundreds of firms on the S&P 500 (barring antitrust opposition, of course).

It could afford Morgan Stanley’s market capitalization of $154.6 billion. It could afford Volkswagen ($153.7 billion), or even Snap and General Motors in a double deal (a combined $178.9 billion).

None of those deals will happen (again, antitrust issues or lack of strategic fit).

But it gives you a sense of how much cold, hard cash this company has to put to work in the future.

And, it turns out, executives did so on Wednesday for their shareholders.

Apple announced it would increase its dividend by 7% to $0.22 per share. It also announced expanding its existing stock buyback program by another $90 billion.

This is very good news for investors.

But after all this positive news, is the future still bright at Apple?

Should You Sell Apple Right Now?

Apple shares continued to trade higher today.

They’re back within striking distance of an all-time high of $145.09.

The question on every investor’s mind is what comes next.

Should investors sell Apple shares after this strong earnings report?

That seems like a no-brainer. But let’s go a step further.

If you’re an Apple shareholder, what tools would you use to decide what to do next?

And if you are thinking about buying Apple, what resources can help you make the best decision?

The newspapers? CNBC? Barron’s?

Don’t make me laugh.

Remember, I told you a crazy number about the “smart money” on Monday. It turns out that 74% of money managers think they are above average at their jobs. (That’s a statistical improbability that shows many people are overestimating their performance.)

We’ve talked this week about overconfidence and loss aversion.

These are cognitive biases that can impact your decision-making.

Do you trust those media sources?

I don’t. And you shouldn’t either.

If you look at the headlines, the talking heads will tell you that the broader markets are very top-heavy.

The data will show we haven’t seen P/E ratios like those we face today since the dot-com bubble.

There are so many threats, like inflation. There’s no shortage of chatter about the Federal Reserve, China, COVID, or a semiconductor shortage…

And what is Wall Street saying?

You don’t have to read Barron’s to get some analyst with a 50-50 track record to tell you his latest price target. There are several analysts who rate Apple a sell right now.

This is all hogwash, in my view. It’s all noise meant to distract you.

You ONLY need actionable signals that tell you exactly when to buy and hold and when to sell.

If you’re worried about the stock falling, you can use a standard trailing stop, or – even better – TradeSmith’s custom trailing stops, which give you the optimal exit point to protect your principal and gains.

A day after earnings, Apple sits in the Green Zone, signaling that it is an excellent time to buy and hold the stock.

Now, Apple has been in our Green Zone just over a year and is nearly double its price in that timeframe.

You’re probably saying to yourself, “this stock can’t go higher,” but it can and it will.

These tools remove the emotion of buying and owning a stock. And they provide a precise exit point based on price history and risk tolerance.

Apple’s risk, or VQ, within TradeStops is a little more than 25%. That means it poses a medium risk as compared with a stock like Tesla that’s more than double that.

Apple will move around over time, but it’s in our Green Zone and it carries moderate risk.

And there are more signals that improve our conviction around Apple. The stock is a common component in various strategies on the TradeSmith platform.

Each strategy reflects different investment styles, risk tolerances, and expected outcomes.

These strategies include Low Risk Runners, Best of the Billionaires, and Sector Selects.

Apple is also a popular position in the Billionaire’s Club and is owned by prominent investors like Warren Buffett, Bill Gates, and Charles Schwab.

So, if you don’t own Apple now, it’s still a great time to get in on the stock!  And for me, the perma-Apple fan, I will always love their stock!

Tomorrow, we’ll discuss how TradeSmith generates its signals on another Green Zone stock.

Let’s make a bet.

We’ll flip a coin.

If it comes up “heads,” I’ll pay you $20.

If it comes up “tails,” you’ll owe me $10.

The odds of the coin toss are 50-50.

But the payoff potential is 2-to-1 in your favor.

Would you take that deal?

Most people would not, according to a library of academic research.

This unwillingness to play this game is linked to a very simple cognitive bias.

You see, behavioral economics and psychology research show that human beings are TWICE as fearful about losing money as they are about winning money.

This bias is known as loss aversion.

This bias won’t just make people avoid games, even if they offer favorable odds…

It can and will stifle your ability to maximize returns in the stock market.

Let’s dive in.

Making a Bet

Let’s revisit our game for a second.

Nobel Prize-winning economist Daniel Kahneman first proposed this heads-tails game to measure human risk.

He started his research by asking students how much money he would have to risk to get them to bet $10 on a coin flip.

The answer was typically higher than $20.

Here’s the thing: Even at $20, you should make this bet.

You should want to make it over and over again.

It might take a second to understand the math. But each flip provides a mathematical net benefit to you of $5 per flip.

That $5 is the “expected economic outcome” of each coin flip.

We obtain that number by calculating the 50% odds of the $20 wager minus the 50% odds of the $10 outcome, or ($20 * .5) – ($10 *.5) = $10 – $5 = $5.

The odds are in your favor the more times you play.

Now, you might ask: “What if I lose four out of five times? Or worse, five times in a row?”

That type of conflicted thought process drives individuals to avoid risk-taking, even if the odds favor them.

Human beings are very happy when they win.

But they’re very upset when they lose. And that fear makes them take fewer risks.

Does that sound familiar?

Think about your mood on days when your portfolio increases by 2%.

You’re pretty content, right? You think about how much you’ve made on paper.

Now think about those days where a selloff occurs. Even if you’re a long-term investor, the idea of being off 2% on paper elicits stronger emotions…

How Loss Aversion Impacts Your Investing

Consequently, loss aversion drives investors to make bad decisions around their investments and their strategies. This can include:

• An urge to invest in low-paying bonds, gold, or other “safe products” like cash. These assets offer little real return and can reduce your long-term purchasing power due to inflation.
• The unwillingness to sell a stock – ditching your losers – simply because you don’t want to take a loss. As a result, the stock might fall further and further, creating bigger losses and more regret. This ties into another example that people don’t believe they have lost until they sell.
• Selling stocks to avoid losses when signals suggest that you should either hold the stock or even build a position with strategies like dollar-cost averaging.
• Buying a stock and quickly selling it for a small gain simply to feel the satisfaction of having a winner.
• Calling a brokerage to talk about building a 401(k) retirement plan, and ending up purchasing a high-fee, ultra-conservative annuity plan.

It’s not just the stock market where we see loss aversion take hold.

• Due to a fear of “losing” money, many people won’t sell their homes at a loss, even if they need to leave town for another work opportunity. This can result in higher costs over the long run, especially if they cannot retain a tenant.
• An unwillingness to change the status quo in an expiring contract. As a business owner, I’ve known plenty of people who want or expect the same types of contracts when terms end and won’t make concessions or alter terms even if it benefits both parties in the deal.
• The sunk-cost fallacy might lead someone to purchase a beat-up car and pump lots of cash into it to keep it running. While it might make more sense to sell the vehicle, the inability to concede a financial loss will make people continue to engage in upgrades instead of buying a new car.

Why This Matters and How to Fix It

Loss aversion can lead you to avoid risk and build overly conservative portfolios.

TradeSmith provides the tools necessary to “set your portfolio and forget it.”

Instead of spending countless hours jumping in and out of stocks, our risk-based volatility  scores (VQ) help you understand the risks associated with each equity or fund you own.

Your fear of loss aversion combined with the overconfidence we discussed on Monday can lead you to jump in and out of stocks.

TradeSmith helps you eliminate these biases and know the right time to buy, sell, and hold a stock.

Tomorrow, we’ll talk more about earnings reports in several major companies that issued updates. I’ll show you what TradeSmith thinks of each company and how easy it is to avoid the temptation to fall into the traps of cognitive bias. 

Buckle up.

Because this earnings week is unlike any that we’ve seen in a long time.

We’re awaiting reports from Apple, Alphabet, Microsoft, Amazon, and Facebook.

And yesterday, we received a surprising recap from Tesla (TSLA).

What do the companies listed above have in common?

They’ve all been driving the momentum of the S&P 500 for months.

These six companies have a combined market capitalization of more than $9 trillion.

That figure is one-tenth of the entire universe of 4,840 publicly traded stocks on U.S. exchanges, according to CompaniesMarketCap.com.

We’ll see what happens over the next 72 hours.

We could see a lot of panic in the market.

Or we might see a frenzy of buying activity.

The question is what you should be doing… right now.

And I want to share some insight that I assure you doesn’t exist anywhere else.

Mind Your Behavior

Yesterday, we discussed the cognitive bias known as overconfidence.

It’s rooted in the belief that we’re better at picking stocks than the universe of money managers, machines, algorithms, and the rest of our competition.

As I noted, even money managers are overconfident.

Roughly 74% of money managers believe they are “above average” at their job compared to the average analyst.

One of the key points that I made in yesterday’s TradeSmith Daily is that overconfidence fuels additional errors in bias.

Specifically, it can lead to people trying to time the market, over-trading, and blaming outside influence when they are wrong.

According to the historical data, this is important because all three of these factors lead to underperformance.

Today offered a valuable lesson in handling earnings and controlling emotions at this critical time of the year.

Talking Tesla

This week’s earning calendar is essential.

Price momentum in the S&P 500 has broadly been defined in recent weeks by the mega-cap stocks that report this week.

There are concerns that underperformance or profit-taking could fuel a sell-off this week.

Given that these companies compose such a large part of the S&P 500 and the Nasdaq, the indexes could fall quickly. For example, Apple and Microsoft represent 11% of the S&P 500, while they compose 21% of the weight on the Nasdaq 100.

That’s just a reflection of how big these companies are and their impact on the headline numbers that you might see scrolling on the bottom of the CNBC screen.

Many investors will see a 3% or 4% drop in a stock or an index, and they’ll rush to sell immediately.

That appeared to be happening today with TSLA.

On Monday, Tesla easily beat its profit and revenue expectations for the first quarter. In addition to selling a lot of Bitcoin at a profit, the firm reported record vehicle deliveries. The report wasn’t earth-shattering, but there wasn’t any bad news, either.

However, it set off a battle among Wall Street analysts who push to get their names in the newspaper with bold price predictions.

Some analysts believe that Tesla is overvalued at today’s price of about $708.

Analysts at GLJ Research and J.P. Morgan set price targets of $67.00 and $155.00, respectively, after Tesla’s earnings report. Those expectations represent respective declines of about 91% and 79% from Tuesday’s prices, to put those figures into perspective. 

Meanwhile, others believe Tesla is a global energy and automotive powerhouse that will redefine the entire world one day.

Bullish analysts offered much higher price targets. An analyst at Piper Sandler projected a 62% jump to $1,200 per share, while two additional analysts set targets north of $1,000.

What should long-term investors believe?

Well, they should listen to what TradeSmith’s tools say.

Tesla Shares Fell, Now What?

Tesla shares fell by 4% in early trading on Tuesday.

It appeared that retail investors saw Monday’s post-market drop and followed many investors out of the market.

We’ve talked about overconfidence, and tomorrow we’re talking about loss aversion, a bias that can make people sell out of stocks because they are more afraid to lose than they are excited to win.

It’s possible that a few investors are selling their shares in reaction to several of the bearish price targets offered by Wall Street analysts.

A projected 90% drop – as GLJ Research predicts – is scary.

Most people would rather avoid losing that 90% than stay in the market to obtain that 62% price target offered by another research house.

This is why trailing stops and the algorithms at TradeSmith are so critical.

All of these price targets and headlines are just noise.

TradeSmith shows that Tesla is still squarely in the Green Zone despite this small drop on Tuesday.

The stock has also been in an uptrend for the better part of the year. If you’re a TSLA investor who has experienced a significant gain over the last 12 months, I recommend using trailing stops to protect your principal and gains.

These tools are designed to help you better navigate volatile, noisy times like this week.

We’ll talk more about ways to tame loss aversion bias on Wednesday.