March 14, 2022.
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In our most pressing news from the past week, Alhamdulillah, I was blessed with my first child. He hasn’t made up his mind yet on whether he is going to subscribe to my channel but he’s seriously considering it. If this video gets 1000 likes I will have a second child Insha Allah.
On a serious note, thank you sincerely for all the well wishes and duas which I’ve received from our community, it warmed my heart and my family and I really do appreciate it.
All right, let’s get down to business…
As of the date of recording this, the Dow Recently notched its fifth straight week of losses as the Russia-Ukraine conflict drags on.
The question investors often grapple with during times like these is: Given the market turmoil, where should we invest our money? What are the best things to buy? Oil? Gold? Growth? Value?
I’ll give you my answer to this question. That is, I’ll tell you where I like to put my money in times like these.
If you’re new here, my name is Rakaan Kayali, founder of Practical Islamic Finance where we help people globally build wealth in a halal way. You can follow the crypto and stock portfolios that I manage by becoming a member. Be sure to follow us on social media, including joining our discord group and signing up for our newsletter. You can also see the list of stocks and cryptos we’ve reviewed and assigned a comfort level to, for free, on practicalislamicfinance.com. Links to everything I’ve just mentioned are in the description.
To answer the question of How to Trade the news, I’m going to share a few observations that have informed my judgment…
John Maynard Keynes was an influential English economist whose ideas fundamentally changed the economic policies of governments, especially in the first half of the 20th century.
He observed that shares of ice companies (not talking about internal combustion engines but literal ice (frozen water) were higher in the summer months when sales were higher.
This fact is surprising because, in an efficient market, stock prices should reflect the long-term value of a company, a value that should not reflect the fact that it is warm in the summer and cold in the winter.
Why did the predictably higher sales of ice in the summer, cause the stocks of ice companies to trade for more in the summer?
Don’t people know summer is followed by winter and ICE sales are bound to drop again?
Shouldn’t Ice company stock prices reflect the average sales these companies are expected to experience and not the sales they’ve experienced recently which are clearly influenced by what season we are in? Does it make any sense for farmland to be cheaper when bought in the winter than it is in the summer?
However, it seems this is exactly what happens in the public markets.
Indeed it has been found that companies with seasonal businesses have higher prices in seasons when their earnings are higher.
Why is this?
It’s likely because investors suffer from something called Availability Bias which, according to psychologists, says we subconsciously base our decision-making on what is easily available to recall in our minds, which are often not the most probable events but the most recent ones.
This means that what we’ve recently seen and heard in the news and social media tends to have an unjustifiably large influence on our outlooks for the future.
Because of availability bias, we think that what we are hearing and seeing now is a permanent trend that is not likely to go away anytime soon.
Recall in 2020 at the outset of the pandemic when the price of oil went negative and now, only 2 short years later, it is nearing all-time highs.
During this period, the price action of oil corresponded rather well with the price action of Oil companies. If you look at the S&P Global Oil Index, this index measures the performance of 120 of the largest, publicly-traded companies engaged in oil & gas exploration and extraction & production from around the world. The price of this index crashed after the pandemic, but now it’s back to pre-pandemic levels.
In retrospect, this seems like quite an easy trade that one could have made but few actually took advantage of this opportunity. Why?
Because people have availability bias.
Allah swt says in the Holy Quran…
خُلِقَ الْإِنسَانُ مِنْ عَجَلٍ
Humankind is made of haste
We have a tendency to put more value on what we think is going to happen soon or what has happened recently and often unfairly discount that which is probable in the long run and requires us to wait.
The truth of the matter is, over time, the most probable prediction for prices after a dramatic change is that these prices will revert to their average. Not always, but probably.
The book Misbehaving by Richard Thaler refers to a study done where the best-performing stocks on the New York Stock Exchange were labeled “winners” and the worst-performing stocks were labeled “Losers”. Then they took a group of the biggest winners and losers (say the most extreme 35 stocks) and compared their performance going forward.
Over the next 5 years, the stocks labeled losers outperformed the market by 30% whereas the stocks labeled winners underperformed the market by 10%.
So a difference in performance of 40% between the stocks labeled as winners and losers based on past performance in favor of the stocks labeled as losers.
As long as the period looked back on to label stocks as winners and losers was long enough, say three years, the “losers” portfolio did better than the “winners” portfolio.
Now I’m not saying go out and buy shares of “Blockbuster” the video rental company. Some companies are in industries that are basically dead or are dying.
What I am saying is that often in the stock market it pays to be a contrarian. It pays to not follow the crowd.
When companies that are in growing industries, have low levels of debt and are clearly not going to go bankrupt, experience dramatic drops in price because of some news event or they’re simply not in style right now and have fallen out of favor with investors, going against the crowd can be very profitable.
When people are bullish on energy and bearish on tech, it’s often much more profitable in the long run to be bullish on tech and bearish on energy. This is why most of my portfolio right is growth tech stocks.
In order for this trade to work, you need to not invest with money you are going to need anytime soon, definitely don’t invest with borrowed money that’s always a horrible idea, and you have to have a stomach for volatility. If you’re investing in a stock that is down a lot, chances are you haven’t timed the bottom perfectly and it will likely go down even more. So just be prepared to stomach that.
So in summary, the way to trade the news profitably is often to do the exact opposite of what the crowd is doing. This is what I do at least.
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Until next time, make sure to take care of yourself. Assalamu ‘alaikum and peace be upon you all.