Goodbye, ugly Ursa!
If 2008–09 was your first bear market, congratulations – you got through it.
Or did you? Did you stay the course, perhaps even adding issues to your portfolio during the sell-off, or did you toss in the towel in the first quarter of 2009? Hopefully it was the former, not the latter.
It is interesting how one’s perspective and claims change in tumultuous markets. Three investors with whom I spoke in early ’09 bragged about their prescience in selling out in late 2008 along the lines of, “I saw the sell-off coming.”
My conversations with them took place shortly after they received our investment alert in which we stated that our list of undervalued stocks was the longest it had ever been in my 40 years in the business.
One said he was thinking about getting back into the markets, and two were of the “I’ll wait until everything looks better” camp. When I spoke with those two last week they were still waiting – and now are concerned that the current market is “too high.”
That’s one example of what I wrote about last month: Waiting for the “all clear” can severely impact one’s profit opportunities.
But waiting for the signal – for the bell to ring – is a common characteristic of investors who believe, in spite of all the evidence history has provided, that one can time the markets. If one could actually do that, it is likely he would be getting out in an ebullient period and back in during times of despair. But that is too often not the case, as cashing out at or near market bottoms is reflective of fear. Buying in momentum-driven markets – think the tech bubble – is an example of unbridled and irrational greed.
In spite of our best intentions and professed commitment to a disciplined investing method, it is very easy to get caught up in the emotions of the crowd during market extremes. As markets approach a peak and CNBC gives us “the news alert” in breathtakingly urgent tones, it is easy to join the enthusiasm and chase stocks that have little or no measurable value, while ignoring the fact that we are participating in the Greater Fool Theory that says an irrational buyer acquires an asset because he expects to sell it to an even greater fool. This behavior is not new: Do an Internet search for “Extraordinary Popular Delusions and the Madness of Crowds,” and read about the Great Tulip Mania.
The other extreme – investor despair in a bear market, especially in the capitulation phase – gives credence to the expression that, “In a bear market, money returns to its rightful owners.” At this point, frustration and fear take over and it’s, “Get out before it’s too late.” That may appear to provide some peace of mind, but in reality only assures that the investor has locked in his losses and precluded those sold issues from the possibility of appreciation.
Telling how fortunate one was in getting out before the big decline took place is common during the sell-off period; we seldom, if ever, hear that individual tell of his getting back in near the bottom.
Consistent with what we wrote last month, all this general market timing talk is looking at the forest, while ignoring the trees – the individual companies on which serious investors focus. With the knowledge that any asset – a stock, real estate, mineral properties or your own business – that increases your income regularly will over time appreciate in value. (Note that gold does not meet this requirement.)
Real bond risksA few cautionary words about bonds, starting with the fact that you can lose money in them. There is credit risk, the possibility in difficult economic times that a corporate or even sovereign debt, Greece, for example, can be downgraded by the rating agencies. There is the principal eroding risk of rising interest rates for as rates increase bond values decline. Investment grade bonds, ideally those rated “A” or higher, offer a significant degree of protection against credit risk. And if held to maturity, they’ll return the investor’s principal, but during the holding period, will not be immune to falling in value as interest rates rise.
Municipal bonds carry their own risks, as many municipalities and states have large budget shortfalls and unfunded long-term liabilities, jeopardizing principal and interest payments. An additional risk in this area exists because many smaller issues are rated only at the time of their initial offerings and are not reviewed regularly to determine if their rating remains valid. Municipals also generally have a wide spread between their bid and asked price, a fact that makes trading them in small sizes difficult for individual investors.
We use very few municipals and those corporate and U.S. Treasury bonds that our client portfolios hold are structured along a relatively short ladder of maturities along the yield curve – with no maturities longer than seven years.
Clark Davis is a 37-year investment veteran and CEO of St. Louis Investment Advisors, a specialized money-management company. He can be reached at cdavis@slia.com.
