SweetSpot® Investments LLC

Advantages of SweetSpot Investing

Contrarian Is Best

Contrarian investing, or investing contrary to conventional wisdom, is known to be a superior investment strategy. Over time, betting against the crowd has been more rewarding than betting with it. But when should we place that bet? In the fall of 1928, a smart investor correctly saw that the stock market had become seriously overvalued as people chased ever-higher share prices. He was so sure of himself that he committed his capital to shorting the market, in effect betting that stock prices would fall. He was right that the market was overvalued, but he was early. When the crash arrived one year later, he was unable to capitalize on it — his short positions had left him penniless. SweetSpot investors take a contrarian position but not until after many of those who could move prices against us have already fled the scene.

High Reward, Low Risk

The market turmoil of recent years has reminded us that any stock-investment strategy entails substantial risk. In the short term, anything can happen, and the short term can be longer than we think. But over time, SweetSpot has achieved higher returns than the market while posing lower risk. This margin of safety comes from the simple fact that those who have sold out of the SweetSpot sectors we’re about to buy cannot then sell those sectors after we buy.

Investing is seen as a trade-off of risk for reward. The conventional wisdom is that we must assume greater risk to see bigger returns. Or, we must accept a lower rate of return in order to safeguard our capital. Is this universally accepted relationship between risk and reward unavoidable? Not necessarily. Maybe it’s the exception that proves the rule, but the sweet spot is a documented phenomenon. All that has been missing until now is a methodology for identifying the sectors that are most likely to be at or near their sweet spot 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 are often more volatile than the overall market, and volatility is a commonly accepted measure of risk. But what if we hold a diversified basket of sectors? Depending on how closely the price movements of our sectors correlate to each other, the resulting volatility may be lower than that of the market itself.

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 then root for our sectors to bounce hard off the floor.

Understandable

The best time to invest in stocks 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. Which sectors are more likely to be near a bottom than those that have seen the most selling?

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 – SweetSpot sectors benefit from a depleted supply of sellers who could create such pressure.

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 are on a par with the returns of Warren Buffett’s holding company, Berkshire Hathaway. But even better for investors with the right attitude, 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 has consistently outperformed 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, whether actively managed or indexed, almost guarantees mediocre results. Surely, some fund managers beat the market, but as a group they are less likely to continue doing so than poorly performing fund managers are to start doing well. Fund managers are people, subject to the laws of human nature just like the rest of us. History is replete with reports of wunderkind money managers whose performance suffered after their success became widely known and they found themselves on the spot.

Making matters worse, individual investors tend to fare much worse than their already sub-par mutual funds. How can that be?

Chalk it up to the tendency of most investors, when left to their own devices, to buy in at a high price and sell out at a low one. Yet SweetSpot has consistently beaten the market that has beaten the funds that have beaten most investors — and it’s beaten them all by a wide margin. It’s hard to beat that.

It Shouldn’t Matter What the Market Is Doing

As long as we are investing long-term capital and our assets are well deployed, it shouldn’t matter what the market is doing. Even the most recent market debacle gave us no reason to revise 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 say they would never consider a strategy that has them trading just once a year. To justify their fees, they need to be able to show that they’re working hard for you every day.

Individual investors also aren’t too interested in SweetSpot (yet) — they hear the word “sectors” and shy away because of what they think they know about the risks of sector investing. Yet those same investors won’t hesitate to buy an individual stock if they like its “story.” Apparently they don’t know that stocks are much riskier than sectors. All of this means that 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 at the conclusion of each trade). 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 and numbers, we’re not trying to sell ourselves anything and we have our own best interests at heart. (The financial adviser later invested in SweetSpot for his own account, but he has not shared the strategy with his clients. “They like to trade,” he said. Good luck with that…)

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 your SweetSpot returns.

By early 2009, stocks had taken such a beating 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 when to sell their other investments. For a month or so 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 when getting reinvested seemed to make sense. Only their SweetSpot holdings benefited from the entire move up from the bottom (and what a ride it’s been!). 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 act in impetuous, self-defeating ways. Once we recognize these forces for what they are, we are better able to 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 own 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….

See also: Annotated SweetSpot Bibliography.

 

Sketches from behaviorgap.com are reproduced here with the permission of the artist, Carl Richards.
The SweetSpot Portfolio’s past results are not a guarantee of similar future performance.