By Bob Wood, MMNS
So there I was the other day, eating lunch alone, when a guy sitting nearby asked me if I knew how the stock market was doing. “Down again today,” I said, “just as it has been for the last few days. And this, in my opinion, will be followed by further movement to the downside.”
My comments didn’t seem to help his appetite. But after a while, he shrugged and said, ‘’Guess it’s too late to sell now.” So here was yet another investor resigned to be patient and wait for the market to resume an upward path.
This lunchtime encounter occurred as major U.S. stock market averages were sliding into what market promoters call “bear market territory.” That day, the major indices had fallen 20% from their prior peaks in October 2007.
The talkative diner said his holdings were invested in an S&P 500 index fund, which is normally a good option for individual investors. But, I explained, in a long-running bear market like the one now miring our investment environment, this fund becomes a very bad option. After mentioning what I do for a living, I said that our markets would surely continue to fall in coming months. Oddly enough, he scoffed at my position! Instead, he said he was sure I was wrong and would sit tight on his investment.
I wished him luck, though I could have spoken for an hour about the reasons I believe our markets will continue to head lower. (Frequent readers have seen those reasons presented in this space just about every week.) The nature of a secular bear market is to run as long as the preceding secular bull market has run. That’s one factor, but we must also consider the matter of valuations. The S&P 500 is now selling at more than 20 times earnings, a very lofty number! I wonder how long he could have spoken in defense of his view?
I have pointed out, too, the fact that earnings for some of our largest companies are dropping, and that sends P/E ratios higher still. Making matters worse is the fact that this financial sector, which last year comprised the largest sector of the S&P 500 by combined market capitalization, is experiencing not only diminished earnings but, in many cases, exploding losses.
Compounded by the effects of the nasty recession we now face — and which seems to be getting worse, the case for staying invested in U.S. markets makes no sense at all. While many financial media commentators still claim that the U.S. is not in a recession, look at the state of our housing, car and jobs markets — and make up your own mind.
I wonder if, at some point, my fellow diner might look back to this time and wonder why he didn’t do something to cut his losses — while he still could. I recall what has transpired in Japan over the past two decades and question when investors there began to wish they had decided to cut their losses — and live to invest another day.
The investor in Japan has seen his home stock market tumble almost 70% in the past 18 years, before factoring in the effects of inflation. He has seen the purchasing power of his invested assets shrink to a tiny fraction of their value at the market’s prior peak on day one of 1990.
Now, I look at the stock market in China, since that high flying market of 2007 has become one of the worst performers of 2008. That index has lost over half its value in a few short months! Checking stock market performance in India during 2008 reveals similar occurrences there — with the same potential investor regret for not selling out sooner.
Perhaps investors around the world have been convinced that stocks always head higher over time and, if they wait long enough, the markets will always rebound, and their profits will re-emerge. In some cases, this is a possibility, but underlying fundamentals would have to prove much stronger than they are here in the U.S.
I wouldn’t be at all surprised to see markets in China or India grow to much higher levels at some distant point in the future. For them, economic growth is strong, and demographic trends support a continuation of their growth.
That is not the case domestically. How long will U.S. investors ride lower with the markets, losing not only money but also valuable time for growing wealth before retirement and the hope of living well from their invested savings? At what point does it become obvious that getting out is what should have been done? How much pain must domestic investors endure before finally paying heed to the reality of the economy — and the damage done to their portfolios?
How long did investors hang on to their shares in Enron before admitting defeat? And, more recently, who continues to hold shares in General Motors, Fannie Me, Starbucks or the financial companies, while seeing their value plummeting?
Most amazing to me regarding many investors in our home markets is their lack of attention to the fact that the major averages are lower now than they were at the start of this decade! Wouldn’t you think they might have gotten a clear message by now? Maybe the short bull market cycle that ended last October gave them a false sense of hope. Maybe they have yet to discover the sheer folly of the ‘’stocks for the long run’’ argument!
I believe the time for selling comes when regret for having bought them in the first place takes hold of you. If others offer you a high price for the asset you hold, selling at a high price is certainly a valid move. Last year, when my shares in an Indian bank went so high that buyers were offering to buy them for more than 20 times earnings, I gladly sold them. Sometimes, that proves a case of selling too soon, which I have no fear of at all.
On the other hand, when shares in a domestic, high-end restaurant group slid well below what I paid for them a few months earlier I accepted defeat and acceded to the idea that I had made a bad investment. I sold those shares at a small loss. I find no shame in admitting a mistake and moving on, chastened by the thought that I must have missed important fundamental information. More hopefully, maybe something meaningful changed that helped send those shares lower — after I had invested.
Another example of bad investment management occurs when an investor pleads that he doesn’t want to sell top-performing holdings because of taxes that must be paid on gains. As I have said many times, do not make investing decisions based solely on tax considerations!
I think the worst part of failing to sell a losing position is that better performers are always available. I hope it’s not pride that causes too many investors to hold onto losers — while winners lurk a few mouse clicks away. Isn’t it obvious, when the overall market is selling and driving the price of your holdings lower, that the markets know something you don’t know?
Can all the signals be wrong while you are right and continue to hold on? Selling a loser is not a good feeling, but having the opportunity to re-allocate at least some of your original investment into a better position does help. Obviously, but sadly, too many miss that basic concept.
Don’t let my fellow diner’s big investment mistake happen to you. It’s never too late to sell a losing position!
Have a great week.
Bob Wood ChFC, CLU Yusuf Kadiwala. Registered Investment Advisors, KMA, Inc., email@example.com.