In the midst of a pandemic, with all stocks getting bashed, betting on health care stocks coming back was an easy call. Figuring out where they go from here isn’t so easy.
During the good times, betting on stocks that are doing well and are in sectors that are doing well is actually a pretty easy task, and actually requires very little knowledge or skill to achieve an advantage over just going willy-nilly.
Willy-nilly approaches to investing may be king, but this king did not ascend to the throne by way of merit but by just having the torch passed down through the generations. The investment world for the most part is actually a dictatorship, not the meritocracy that we would think it would be if we knew nothing about it, or if we are under its command so much that we do not even notice that we are in a serfdom and we are the serfs.
You actually have to step out of the normal world of investing to even notice how much we have been programmed to approach our investments so indiscriminately, and see how much this contrasts with what at least should be the task of investing, to seek to pursue advantages.
King Willy-Nilly wants us to invest in everything, and we obey. We intuitively know that there are some investments that do better than others, but we’ve been commanded to ignore such things in favor of just deferring to a practice that abdicates our control over our own destinies and allow our king to decide these things for us, and King Willy-Nilly wants us to be as indiscriminate as possible.
Hardly anyone questions King Willy, because he is king, and we are only his lowly servants who aren’t allowed to think too much about whether he is a good king and whether following him is a good idea, not unlike slaves that are given tasks to do that they should never even dare to question. The Lords under his control exercise his will, the lords of the investment industry, and we willingly comply, not even realizing that we are the serfs in this play.
There is nothing at all intuitive about this, and all we really need to do is to ask ourselves why we would chain ourselves to such a strategy. We sure don’t approach real life that way. If we are looking to go into business, we’re not just going to pick some sort of business randomly, we’re going to want to differentiate between the possibilities and at least try to choose based upon potential.
When we are shopping for a certain fruit in a grocery store, we aren’t going to close our eyes and toss whatever our hands latch on to into our basket, or look to achieve some sort of balance between the good and bad looking fruit, we’re going to try to pick the best looking ones.
That’s actually a very good analogy of how King Willy wants us to select our stocks, where we are commanded to not only pick a random selection of fruit from the main grocery store in town, we also are sent elsewhere, to lower quality stores, where we then mindlessly take home whatever they offer, with no regard to whether any given purchase is a good or bad one, and aren’t at all turned off by a store that only sells junk.
When we ask our king why we are doing this, he tells us that diversity itself needs to be the goal, not performance, and we believe him. Never mind that this is a rationale that we should expect suffering a head injury to be a prerequisite, or at least one that we should be asking to see some sort of justification for, working out the numbers and showing how this could even possibly be a good idea, but when the King speaks, people just obey.
Even a ruler as powerful as King Willy gets questioned by at least some, as all kings do, and some have wondered why they should want to own all of the stocks in the S&P 500 for instance when they may instead select the better ones and toss the rest, where they actually are daring to question the idea of not wanting to seek performance.
In our heart of hearts, we all do want to do well with our investments, and inside us all is a rebel that looks at how certain investments do better than others and wants to be in these better investments, or at least to discriminate based upon quality. We may even cringe a little as we look at all the rotting fruit in our house that came in the grab bag we were told to buy with the big question mark logo on it, where the bag itself is our entire focus and we aren’t supposed to even care what is in it.
We could call this the blind approach to investing, just blindly buying and holding a basket of investments without ever looking in the bag, or even questioning whether owning the bag in itself is a good idea, we just buy it and put it away, where the only action we take is to put our hands together and hope that fate is kind enough.
If we are brave enough, we will look inside the bag and see that there are 10 boxes inside the one labelled the S&P 500, where the stocks that the bag contains are grouped into sectors. Our newfound courage has now allowed us to finally differentiate, where we can now examine these boxes to see how they measure up to each other in terms of quality, where we ready ourselves to discriminate.
Discriminate has become an ugly world in some circles, when discrimination is used to not serve its useful and even critical purpose of guiding us toward the better and away from the worse. Discrimination can also be used irrationally, taking our eye off of merit towards conclusions that are not logical. We might think that, for instance, many black people are less educated, see a black person, and assume that they are less educated even though they may hold several advanced degrees.
The problem with this isn’t that it is using discrimination, it is that we are using it stupidly. We cannot use generalizations to substitute for the facts, and it is the facts that we must discriminate with, where our beliefs must always be subject to verification by way of discrimination. If the beliefs supersede verification, that’s just dumb.
We do this with our stocks as well though, where in this case, the belief is that we cannot help ourselves by discriminating, a belief so powerful as it turns out that few question it, However, more and more people are at least starting to question this and look inside the bag to at least see what might be possible if we actually try to use our brains a little to help ourselves and not just turn over our financial future to a dumb King who doesn’t care about our fate and just wishes to order us around.
You Don’t Need to Think That Much to Help Yourself
Investors have a limited appetite for doing very much thinking about their fates, and there are certainly some big practical considerations involved. They aren’t going to want to spend hours a day doing this and seeing their skills honed over the years to being any sort of expert on the matter, as their interests in this is generally very limited and they would prefer to spend their spare time doing something else, fishing perhaps or toasting marshmallows around a campfire, or any of the other activities people enjoy more than poring over investment decisions.
This is why they allow King Willy to manage their portfolios, but the main impediment here isn’t time or interest, it is by way of mistakenly assuming that this fiduciary relationship is a good one, and don’t even question their assumption.
We’ve questioned it enough to look inside this S&P 500 bag and see these 10 boxes in it, these 10 sectors that have been sectioned off for us in case we wish to consider discriminating based upon sector performance. We may not wish to spend the time to examine this index stock by stock, although that’s a far simpler task than we believe it is, by disassembling each of the 10 boxes as well and discriminating what is inside those, but given that investors are so little disposed to do any discrimination, they need to start somewhere, at the broadest and simplest level.
Once we’ve made the decision to discriminate based upon sector performance, this will at least serve to wet our beaks and we may discover that we are thirstier than we thought we were, and may choose to discriminate at the level of individual stocks, but we need to get our first taste of this first, and sector ETFs are a great way to get introduced to the idea of actually choosing our investments based upon merit and not just willy-nilly as the King prefers.
Judging based upon merit is becoming even more important as the world of stock trading evolves, as more and more people join the revolution of sensibility which points them more towards the good and more away from the bad, making both good and bad choices count for more and more.
The health care sector hasn’t been anything really special over the years, although it has done decently well of late and has placed itself into the upper half of sectors. It never makes sense to go with anything that is in the lower half of performance, because being in these positions will reduce our returns relative to the median and therefore be statistically stupid, and we at least should want to be on the right side of that, where we leverage mathematical skills that we learned in grade school which many have long since forgotten.
When we looked at how these 10 sectors were running at the beginning of the year, the health care sector looked at least better than average, and using this very simple criterion of a sector’s relationship to the median had it included in a plan where investors were looking to go with the better 5 and avoid the poorer 5.
This turned out to be a decent enough call if you really wanted more variety than just going with the leading sector, or with a better basket such as the Nasdaq, both of which have outperformed health care stocks last year by a notable amount and continue doing so in 2020. Looking at these things is in a further lesson though, and we want to get the first one down first, the idea that better is better and not better is not better the crux of the strategy overall.
While no one has a validly working crystal ball and all of these decisions must be based instead on probabilities, probability is simply kinder to you when you are on the right side of it. While our understanding of these things can allow us to really tweak things in our favor, increasing the probability of our success, the principle behind this is a very simple one and even the simplest of distinctions can have us more on the right side of things on balance, as opposed to King Willy’s approach of seeking to normalize everything.
Normalizing the sectors in the S&P 500 is how King Willy would approach the problem, but all we have to do in order to look to step beyond this is to ask ourselves if there isn’t an easy way to take these 10 boxes out of our bag and do some discrimination.
There are a lot of ways that you can do this, but our ideas are only as good as the assumptions that we base our discriminations on. We do need to discriminate with stocks based upon assumptions that pan out in the real world, and just like the assumption that we cannot discriminate that King Willy wants us to believe, we can come up with all sorts of other invalid assumptions, ones that may involve delving very deeply into things like business fundamentals that are too loosely connected to results that they serve to confuse and misdirect instead of inform and help.
While looking to split up the S&P 500 into the upper and lower half of performance is way too coarse of a discrimination for our tastes, and achieving finer distinctions with probability will drive our success even further, people have to start somewhere, and this is at least a first step in investors getting their feet wet with taking this bag and at least looking to toss investments whose probabilities are on the wrong side of zero, investments where we may make money from but not in a way that is competitive with going with the better half of the things in our bag based upon recent performance.
There are two main ways to improve our results, starting with being even more fine with our discriminations, not just picking half of the sectors in the S&P 500 but focusing on the best of this bunch, either at the sector level or taking this to the level of stocks where we’re looking for the best of the best.
The other way is to manage our control of performance on a much finer level than just deciding once a year based upon past performance, and in particular, making adjustments through the year or even through the day if we are intraday traders, as the probabilities that we are looking to take advantage of unfold, both in terms of how the price of things are moving as well as how the external factors that shape our positions unfold, like when the coronavirus panic hit and probabilities decidedly shifted.
All this involves is taking the approach that top traders use to discriminate and then placing these strategies on the level of investing. The art of trading involves riding various waves of momentum in either direction, and when it comes to investing, we seek to be in investments that have a better probable outlook than others. Whether this involves very coarse discriminations such as going with the better half of the SPDR sector ETFs or using charts to manage trading positions in real time, this all involves the same principle, using investing physics to leverage the fact that the probability of further momentum is related to past momentum, as it clearly is if we bother to check.
We have spoken about looking to discriminate based upon these 10 sectors in past articles, which all involve culling the herd and leaving ourselves with sectors that are ahead of the pack and avoiding those who are not. We do need a dynamic element in this to manage it properly though, as we have to replace old data with newer data and not just compile it all because this will have recent data underrepresented.
Ideally, we would want to use weighted averages, like a weighted moving average does, which weighs data more in proximity more and weighs data less and less as we move away from it. We don’t want to make these things too complicated though and a simpler plan but one much easier to follow is definitely better for investors, something that can be easily applied such as using running intervals such as a year that can be easily dialed up on a chart and easily interpreted.
We do want to point out that there are better ways to do this than this, as this does commit the mistake of weighing the first month in the series as much as the 12th, but as long as our plan presents a statistical advantage, an advantage is always better than the no advantage that investing in the whole index involves.
We Need to Account for Both Where Something Has Been and Where it is Headed
We are using what is called technical analysis here, and technical analysis represents the potential for big advantages over other types of understanding stock prices because it actually studies stock prices and not something else that is far less correlated to it.
The health care sector has been running pretty well for a while, and has kept its position in the upper half of the index with a return thus far in 2020 of 3.4%. This isn’t blowing away the index return by any means, but it is at least ahead of the S&P 500’s 3% return by a smidgen, as opposed to several sectors who are well behind.
It’s more about what we don’t invest in rather than what we do invest in, and the health care sector hasn’t hurt us so far at least. 2020 has been a different year, where the sensible way to play stocks has been to just bail when the crash started and get back into various stocks or sectors that are more poised to rebound, and the health care sector was one of those.
It us up 43.2% from its March bottom, and our speaking well of this sector back then wasn’t anything that required a whole lot of thinking, being beat down this much in the midst of a pandemic and being particularly worthy of a good share of the rebound that we knew was coming.
This is a perfect example of why we don’t just want to rely on technical analysis and also want to account for these external influencers, especially when we are taking such broad swings such as running 12 month performance, and anything that has to do with the business outlook of stocks is actually an external and not the internal matter that those confused about this believe.
As we look upon the coming expectations for this sector, we not only have to pay attention to the strong enough technicals that this ETF currently enjoys, we also need to be aware of the risks that the sector faces.
No matter who wins the presidential election, both men have the pharmaceutical industry in their sights, a significant part of this sector. We grant monopolies to them and all monopolies must be constrained by regulation, especially those who have the lives of the people in their hands, where they can and will hold our lives hostage if allowed the opportunity. Other countries regulate drug prices, where in the United States, we have defunded the pharma police, and defunding the police is always a bad idea because this turns over power to the criminals.
While America has, thus far anyway, favored capitalism more than most countries, when you see the price that is being charged for pharmaceuticals being several times higher than what is charged in countries that restrain monopolistic practices more, this might be capitalism but it is far from the free-market capitalism that is at the heart of our economic philosophy. Monopolies are as far from the free market as we can get, and we need to restrain their absolute power enough to make them free enough.
We will likely see some real reforms with this no matter who wins, and as hard as the pharmaceutical industry has fought back, they can’t bribe everyone enough forever and are due to take a hit from all the pushback out there on this issue, and this certainly is a concern when it comes to wanting to ride the wave upward with this sector ETF.
The sad truth about this is that pharmaceutical companies prey several times more upon the American people because American politics is so corrupt, where the foxes buy and run the henhouses, but even corruption gets exposed over time to a certain degree anyway. No controls delight these companies, but at some point, the people themselves may end up caring about doing something about these predatory practices, and the tide here is turning.
There’s also the threat of health insurance reforms, and while this sector breathed a big sigh of relief when Sanders was eliminated from contention, make no mistake, he and others are sitting in the shadows and still wish to promote socialized medicine. Biden’s new wing woman is as much in favor of this sort of thing as anyone, and whether Biden will be deciding much on his own if he becomes President, or anything, his party has taken this from the periphery and has made it a more central issue now. If they were afraid of Sanders, they need to be similarly afraid of Biden and his socialist posse, which includes Sanders himself as one of the gunslingers.
Medicare for all isn’t a done deal by any means even if the Dems sweep. Even though they are crying out to end the filibuster rule in the Senate so that they can push through any sort of radical socialist agenda they please, with even Obama glibly calling for this, there’s one problem with this, and it’s that you need enough control of the Senate to pass a filibuster busting law without it being subject to a filibuster itself.
While we don’t want to be too worried about the full-blown version of Medicare for all, delivering a death blow to many of the companies in the health care sector, putting insurers out of business completely, any reform will be painful and the risk of this does weigh on the sector to some degree.
There’s also the general market upset that transitioning to a much more socialist government may cause, not unlike how the market got upset about the threat of the coronavirus, where the perception itself can wield a mighty club. The hope of a recovery did limit this crash, but ones based not upon temporary closures but policy changes of a more enduring nature can keep us down for a lot longer.
We do have evidence that the health care sector performs better when one party does not control all three branches of government, preventing them from being too targeted, and this trend especially will apply to an all Democratic government this time around, with so many pitchforks being raised against the industry.
We therefore need to be careful when holding this sector, even more so than other sectors. The energy sector for instance has been in intensive care for years now it it’s dropping over a third more this year is no surprise, and just not being exposed to this one is reason enough to want to be selective with sectors, if for no other reason than to exclude this one, as we’ve been telling you all along.
The financial sector is still in jail due to the state of the economy, and have already taken their bullets, but there are some guns aimed at the health care sector that may not wound them this badly, but since we want to be selective, there could easily come a time where the guns get locked and loaded and we may wish to flee.
We even want to be careful with the long-time leader of this pack, the technology sector, as even though this sector has outperformed the broader S&P 500 by 20% this year so far, and still outperforms it during the leaner times, there is something called zero that we don’t want to go below because no matter how well a sector stacks up comparatively, losing less is no consolation.
The next few months will be a very interesting time for stocks period, where it’s been a good year so far if you were in the right stocks, an very bland year if you just listen to King Willy, and a bad year if you listen to the fundamental analysts and have become overweighted in junk as a result. Willy actually beats these guys overall year after year as they dream of even keeping up, but mediocrity should never be our goal. We have the power to help ourselves by discriminating wisely though, if we can only take back our minds from this wishy-washy king that holds so many under his power.