The Market Is ‘Due’? That’s Doodoo.

by Kyle Woodley | May 29, 2013 11:34 am

There’s nothing like Memorial Day weekend to give my baseball-watching habits a good kick in the pants … and also to remind me just how much I hate the sport’s clichés.

In particular, I’m miffed about the thought that something “is due” — you know, “He’s due for a hit.” And I’m doubly peeved because this bleeds over into my professional life in financial media.

The latter is especially worrisome, because reading this phrase over and over again (and believing it) could lead investors like you and me to make some stupid, unwarranted moves.

Let me explain.

The Washington Nationals Aren’t Due

At its purest, most logical level, saying something is due simply refers to the belief that its performance will revert to the mean.

The ultimate example of someone being due: John Olerud during the middle of his 1998 season with the New York Mets.

Olerud was a career .295 hitter who was batting .305 before the start of 1998. He then hit .354 to log the Mets’ all-time best single-season average. But he didn’t exactly get there in a straight line. The notable splits (courtesy of Baseball-Reference.com[1]):

March 31 – June 5: .372
June 6 – June 30: .195*
July 1 – Sept. 27: .383

If someone in late June had said Olerud was due, they’d have been right on the nose. A solid career hitter who had a brilliant first month, then proceeded to bat not only far worse than said first month, but more than 100 points below his career average for about 20 games despite being uninjured, was absolutely due to revert to the mean. (Of course, by hitting .380-plus for the rest of the season, he actually reverted past the mean and into excellence.)

However, when I recently heard a local sports radio host say the Washington Nationals were due to start winning, I fumed.

It’s difficult to say an entire team is due to do anything, let alone win, because the factors behind an entire team performing are more numerous and complex than those behind a single player hitting a ball at a certain frequency. You can say a team is due if it’s playing well and losing a lot of close games on fluke plays … but that’s a much rarer occurrence than most beleaguered fans would have you believe.

In the Nationals’ case, many people (and the radio host) are mistaking “reversion to the mean” with “doing what we hoped they would/expected them to do.”

2012 was Washington’s best season in franchise history, an incredible 18-win improvement on the previous season, thanks to many players who performed well above their historic averages, and despite numerous injuries. So while it’s reasonable to expect some of that outperformance was players maturing and improving, it’s hard to call 2012 the “mean.”

And expecting that another injury-plagued team off to a lousy start will revert up to that mean without some change to the status quo … well, that’s just sheer lunacy.

So, how does this thinking apply to Wall Street?

The Market Isn’t Due, Either

Individual stocks and the major indices not only have a similar relationship as players and teams (the former comprises the latter), but they also share the same relative complexities. For that reason alone, it’s easier to say (and likelier) that a stock is due.

In the case of stocks, being due refers to a company’s valuation reverting to a stock market or industry norm, or “better reflecting” the business’ fundamentals, and the stock price acting accordingly.

An example that comes to mind is Steiner Leisure (STNR[2]), which Will Ashworth recently posited is undervalued and has significantly underperformed[3] considering its balance sheet and financial situation … and thus, assuming Steiner’ strong business continues, investors eventually will “get wise” and bid up the stock.

But the same issue pops up when it comes to making the same call about the market being due — say, for a correction.

It’s not to say that large groups of stocks don’t move in concert; they can and do, usually pushed by large, macro forces such as central bank initiatives. But by saying something like “the S&P 500 is due for a correction,” you’re saying you expect the majority of its components to revert to some sort of lower mean — and given the variable nature of the S&P 500’s diverse set of holdings, that’s a hell of a reach.

But you know what? That’s fine. If you find a valid argument you buy into — a large number of stocks being historically overvalued is, to those in the value camp, a damn good reason to think an index could mean-revert (and thus decline) — you should act on it.

The problem is the still-too-pervasive surface statements — not fear bred from actual data, but simply the notion that the market has moved too high too fast or for too long.

We buy into this lazy thinking for the same reason I used to jump off my sled near the bottom of big hills: “This is going too fast, and it’s out of my control. Better to take the bumps on the hill than kiss a tree.”

However, unlike my death sled, the fact that you have no control over the market isn’t a guarantee that it’s going to plunge into an icy creek.

Bottom Line

The past 28 days alone should be all the proof you need that “too much” isn’t a good enough reason to say something is due. Heading into May, the S&P 500 was breaking records daily amid an 11% year-to-date surge — one of the best four-month starts in the index’s history, and nearly equal to all its 2012 gains. If that wasn’t enough reason for countless calls to jump ship, you also had another meaningless “it’s suppos’ta!” argument in the form of “Sell in May and go away.”

The S&P 500 has tacked on another 4% this month, proving yet again that too much ain’t too much, and that an old adage is a saying, not an oracle[4].

The lesson here (and always) is to get past the screaming headlines and seek out the facts and figures. Your money deserves better than some yahoo’s gut feeling.

*Non-baseball fans are urged to read about the Mendoza Line[5].

Kyle Woodley[6] is the Deputy Managing Editor of InvestorPlace.com[7]. As of this writing, he did not hold a position in any of the aforementioned securities. Follow him on Twitter at @IPKyleWoodley[8].

Endnotes:
  1. courtesy of Baseball-Reference.com: http://www.baseball-reference.com/players/o/olerujo01-bat.shtml
  2. STNR: http://studio-5.financialcontent.com/investplace/quote?Symbol=STNR
  3. is undervalued and has significantly underperformed: http://investorplace.com/2013/04/3-leisurely-ways-to-capture-profits-pej-deo-stnr/view-all/
  4. an old adage is a saying, not an oracle: http://investorplace.com/2013/05/will-sell-in-may-and-go-away-take-hold-in-2013-after-all/
  5. Mendoza Line: http://en.wikipedia.org/wiki/Mendoza_Line
  6. Kyle Woodley: http://www.investorplace.com/author/kyle-woodley/
  7. InvestorPlace.com: http://investorplace.com
  8. @IPKyleWoodley: https://twitter.com/#%21/ipkylewoodley

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