By Michael Cintolo
From Cabot Market Letter 12/1/10

If you think about it, you find most things in life oscillate within ranges and are bound by limitations. The temperature here in the Northeast, for instance, averages as high as 82 degrees (in July) and as low as 22 (in January). More than 90% of all men in the U.S. are between 5’ 5” and 6’ 2” tall. And more than 85% of all passenger cars in the U.S. are at least three years old.

Note that none of these measures are naturally “bound”—there’s nothing that says we can’t have a day when the temperature hits 115, or that your son won’t grow to be 6’ 7”, or that you can’t drive through a town and notice all brand new cars!  But we know from experience (and statistics) that such events are relatively rare.

Because of this, most investors approach the stock market with the same mindset … that most events fall near the “average” and that big moves (in the overall market, a sector or an individual stock) are rare. But that’s a big mistake!  Case in point: According to Ibbotson (a historical market research firm), the average annual total return for the S&P 500 since 1926 is right around 10%; thus, if the market followed the pattern of most things in life, we’d expect the majority of years to return between, say, 0% to 20%. As it turns out, however, the opposite is true.

Out of a total of 84 years in Ibbotson’s sample, the S&P 500 has finished 24 with negative returns, while a whopping 32 years have finished with gains of more than 20%. In other words, two-thirds of all years have produced returns at least 10% higher or lower than the “average.” To take it a step further, in fully 30 years (more than one-third of the time) the S&P return was at least 20% higher or lower than the average (either below -10% or above +30%). This is a much higher degree of variability than standard models predict.

Plus, while we don’t have exact data to back it up, we know that the same pattern exists among individual stocks—that is, a higher percentage of stocks than most people believe put on amazing advances … or fall to devastating depths. How do we know? Because we’ve made a living out of it for the past 40 years—both by finding exceptional growth stocks that make outsized moves … and by avoiding bear markets like 2008 that crash in a matter of weeks.

The point of this discussion is to reinforce the fact that, in the stock market, trends often last longer and go farther than most investors expect—what is thought as “unusual” action actually occurs far more regularly than many realize. At the current time, keeping this in mind means you shouldn’t write off some stocks that have made super-powerful moves in recent weeks just because they seem “too high.”

A perfect example is Las Vegas Sands (LVS), which four weeks ago was gapping higher and greatly extended above any support. Given that evidence, it was prudent to take some partial profits, which we did by selling one-third of our position. After a quick 20% haircut, however, the stock is now beginning to quiet down and, believe it or not, could be shaping up for another run. It’s worth keeping an eye on, as are other, less liquid stocks with similar patterns which we write about in this issue.

A corollary to this applies to the price of a stock. Many investors shun higher-priced stocks because they think they can’t afford many shares (which is meaningless) and because they think, “Hey, how much higher can a stock go if it’s already at 300 or 400?” But it’s that type of thinking that caused many investors to miss stocks like Baidu (BIDU), Apple (AAPL) or Priceline.com (PCLN) during this bull market—some of the best leaders of all.

We’re not saying you should focus solely on high-priced stocks, nor that you should only look at stocks that have moved up 75% or 100% in the past couple of months, like Las Vegas Sands. But you should keep an open mind about such things—doing so will allow you to uncover some profitable opportunities that most investors overlook.

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