“. . . A man has rigged up a turkey trap with a trail of corn leading into a big box with a hinged door. The man holds a long piece of twine connected to the door that he can use to pull the door shut once enough turkeys have wandered into the box. However, once he shuts the door, he can’t open it again without going back into the box, which would scare away any turkeys lurking on the outside. One day he had a dozen turkeys in his box. Then one walked out, leaving eleven. ‘I should have pulled the string when there were twelve inside,’ he thought, ‘but maybe if I wait, he will walk back in.’ While he was waiting for his twelfth turkey to return, two more turkeys walked out. ‘I should have been satisfied with the eleven,’ he thought. ‘If just one of them walks back, I will pull the string.’ While he was waiting, three more turkeys walked out. Eventually, he was left empty-handed. His problem was that he couldn’t give up the idea that some of the original turkeys would return . . .”

. . . Why You Win or Lose: The Psychology of Speculation, by Fred C. Kelly

We have used this quip from the book Why You Win or Lose: The Psychology of Speculation by Fred C. Kelly many times in our missives over the past nearly five decades because the wisdom of its message is timeless. We recalled it last week in many of our meetings in New York City when we heard certain individual investors, as well as portfolio managers (PMs), say “I should have!” Some of the quotes included: “I should have raised some cash in January;” “I should have bought the undercut low on February 9;” “I should have bought Facebook when the Cambridge Analytical scandal took the shares down to $150;” and the list goes on. The “I should have market” goes all the way back to when the bottoming process began on October 10, 2008, when 92.6% of all stocks traded had made new annual lows. As often stated, “That is a seven or eight standard deviation event, which means it is unlikely to happen in your lifetime.” In October 2008 is when the majority of stocks bottomed. However, the indices went lower into the March 2009 bottom because the financial sector was so heavily weighted in the S&P 500, and the financials kept going lower.

Speaking to the financial sector, we fielded many questions about the financials last week because the group is down some 12% from its January high. Meanwhile the S&P 500 (SPX/2779.66) is down a mere 3.4% from its January high. So why the disparity? It likely has to do with the “yield curve” and worries the yield curve will invert (short-term yields above long-term yields), which has tended to be a precursor to a recession. As Investopedia writes:

“The flat yield curve is a yield curve in which there is little difference between short-term and long-term rates for bonds of the same credit quality. This type of yield curve is often seen during transitions between normal and inverted curves. The difference between a flat yield curve and a normal yield curve is a normal yield curve slopes upward.”

Yet an inverted yield curve does not always imply there will be a recession (chart 1 on page 3), but we digress. We continue to like the banks, believing they are cheap relative to the overall equity markets and as my father used to say, “Good things tend to happen to cheap stocks!” My two favorite portfolio managers playing to the financial stocks are David Ellison, portfolio manager for the Hennessy Large Cap Fund and the Hennessy Small Cap Fund; and Anton Shultz, portfolio manager of the RMB Mendon Financial Services Fund.