Staying the Course

By Bob Wood

If you have been reading this column regularly, you must be thinking that this bearish writer seems very wrong – as I continue to predict gloom in domestic equity markets. Maybe you are thinking: “Shorting the domestic markets while they hit new record highs must be evidence of being ‘out of touch’ and must weigh heavily on his mind. Surely he will realize that he is wrong — and must change course.”

Well, this writer is sticking with his long-term plan and resurrecting what has become an unpopular phrase, one long used by a man who also has become unpopular. I am “staying the course!”

Most investors have learned over the years that running with the crowd typically ends badly when involving stocks. We have all heard that being successful in the markets requires thinking differently. Being a contrarian means buying those unloved stocks now selling cheaply, since they’re ignored by the crowd. But being a contrarian isn’t easy, since it means looking wrong at times like this.

But I’m not totally alone. The greatest investor of our time, Warren Buffett, looked wrong in the late 1990s when all amateur investors and 27-year-old mutual fund managers were finding one big winner after another. Some thought that Buffett was getting old and didn’t understand the “New Economy” and what it involved. I remember reading in 1999 and 2000 about a half dozen highly regarded value investors managing hedge and mutual funds who lost their jobs at the height of the mania — because they didn’t “get it.’’

This was not the first time the legendary Buffett appeared to be sitting on the “wrong side” of the markets. He famously refunded cash to his limited partnership investors in 1969, thinking that stocks were too expensive and buying opportunities, too hard to justify. His own share of the partnership, his net worth, was about $25 million.

So there he sat in 1969 as the S&P 500 closed the year at 101. That index closed in 1970 at about the same level but then rallied for two years, ending 1972 at 132, a solid 30% gain from where the great investor decided to get out of stocks. I wonder how many then thought Buffett was not such a great investor?

Of course, we know now that Buffett is arguably the greatest investor of the modern era, following the earlier Wall Street legends J.P. Morgan, John D. Rockefeller and Joseph Kennedy. And Buffett’s net worth now makes him the second richest person in the world, attributable, in part, to his holding mounds of cash when the S&P ended 1974 at 76, down dramatically from the rallying period he missed after looking very wrong for about three years.

Can you imagine how long those three years must have seemed for the great investor, as he sat out a wonderful rally while investors who blindly threw money into stocks partied on their fast gains? I’m sure it seemed much longer than three years to him, but maybe the Buffett magic has more to do with knowing what and when not to buy, rather than what and when to buy. Avoiding pricey stocks in the early 1970s and the late 1990s may have had as much effect on his amazing track record as any active buying.

Another great family fortune was made partly by an investor’s avoiding expensive stock markets and his ability to be contrarian in a stock market powering higher. He sat on the sidelines, preferring cash to stocks. Joseph Kennedy famously cashed out of stocks in 1928, while most thought the stock market was hitting ‘’a permanently high plateau.’’ Supposedly, he saw as an unmistakable sign that the end was near when his shoe shine boy boasted about the easy money he was making in the stock market.

The ‘’permanently high plateau’’ comment came from Irving Fisher, a leading economist in the 1920s. He said on October 17, 1929 that he ‘’expected to see the stock market a good deal higher within a few months.’’ His enthusiasm for stocks was echoed by a market letter written by Goodbody and Company and quoted in the New York Times on October 25. ‘’We feel that fundamentally Wall Street is sound, and that for people who can afford to pay for them outright, good stocks are cheap at these prices.’’

Perhaps today these widely quoted market experts would be regular guests on CNBC’s Larry Kudlow show. And how hard was it in 1929 for investors to ignore noted economists and market newsletter writers who assured them that stocks would go ever higher and that the only risk in stocks was in not owning them? And we heard that again, many times, from market promoters in the late 1990s — about technology stocks.

Once again, the great investors simply sat out the end days of those long-running bull markets, perhaps looking stupid for missing rallies and getting beaten by people investing as a hobby. Yet again today, isn’t Buffett famous for holding over $40 billion in cash, saying that he can’t find much to buy in terms of domestic equities? How many of you are willing to bet that he’ll be wrong this time?

One thing that I quickly admit, when it comes to investing in stocks, is that Buffett knows a lot more than I do. He’s probably forgotten more about investing than I’ve ever learned. So if he’s sitting out this rally and holding cash, I have to think that is a signal of sorts.

Being a contrarian investor is awfully hard for most. Riding along the road less traveled is just too lonely for those who are led to believe that conditions are great and stocks selling for high valuations are simply signs of prosperity and future economic wonderment.

And that is one thing Wall Street does better than any other entity ever has. It can market and sell anything — and has done that very well for many years. Only in Las Vegas have more people been convinced to throw good money at losing propositions so consistently. But perhaps stock market promoters are aware of a basic human weakness: our inability to do nothing. And of course, the fear of missing out on the chance to get rich remains a powerful motivator.

If you are having some of these same behavioral problems, you’re lucky to live in these times where viable options exist. They were not available for investors in those pre-crash days of 1929 or 1969. Yes, holding cash is hard when the stock market is rallying, but we now can find other markets for seeking out value.

Lucky for me, those markets are now performing even better than the Dow or S&P 500. Markets in Latin America are hitting new highs, with, of all places, Venezuela enjoying a nearly 100% rise from its market lows earlier this year. India’s stock market has gone to a new, all-time high as it powers along with very favorable economic and demographic trends. The Thai market represents a speculative opportunity, now selling at about seven times earnings, albeit amid political uncertainty, but is still well positioned in the booming Asian continent.

I know full well that missing our stock market rally may look bad, but getting the full ride in other markets is helping to ease my pain. And I wait patiently for the resumption of secular bull markets in energy and gold to offer optimism for 2007.

And while some may feel mighty smart about staying in domestic stocks and enjoying the rally, a short history lesson on the economic and market environment of the late 1920s and 1960s might inspire caution at just the right time. Of course, timing the next leg down is too hard to predict. But when the greatest investor of our time sits on his cash for the second time in his investing career, I hope I am at least smart enough to read that signal.

And while I may look wrong now, I can see the potential for real values to emerge and the ability to get back into domestic markets when that option makes more sense. Until then, pockets of opportunity around the world will keep me busy.

I still adhere to the secular trends I write about so often: short here, long there, with healthy doses of the asset classes that do well in an inflationary environment. When it comes to the markets, nothing ever rises in a straight line. But as wrong as it may seem, staying the course still looks like the best option to me.

Have a great week,

Bob Wood ChFC, CLU Yusuf Kadiwala. Registered Investment Advisors, KMA, Inc.,


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