Are YOU stuck in No Man's Land?
Food for thought: Does it ever make sense to sell at the low?

One of the old maxims of military history is that Generals always fight the last war. By that, we mean that they bring to the next battle the same experiences, tactics, and predispositions from the previous conflict. Unfortunately, when military tactics and strategies change, sticking to old methods can be deadly. History is replete with tales of glorious victories against overwhelming odds on the part of daring Commanders who brought new technology or techniques into battle against 'old-thinking' foes.

Historically, warfare emphasized massed infantry- foot soldiers attacking en masse, while hoping to avoid arrows, spears, and musket balls. In World War 1, trench warfare arrived, whereby grouped machine gun nests protected trenches that contained the soldiers. In WWI, you wouldn't want to be commanded by someone committed to the massed infantry approach, because countless soldiers perished in futile attempts to charge across the No Man's Land in front of these formidable defenses. Even if successful, the only 'prize' was a new mud trench a bit further down the road than the one you just left.

A few decades later in World War II, those poor souls who finally mastered the intricacies of trench warfare received a rude shock, when armored vehicles such as tanks, aerial bombardment, and the proximity fuse rendered trench warfare utterly obsolete. The point is, specific weapons and techniques that worked once seldom do well the next time, particularly if everyone else is doing the same thing.

So what does this have to do with investing? Quite a bit, actually.

Many investors today are in the financial equivalent of no-man's land.

Most investors are like Generals, clinging to yesterday's markets. The history of investing shows clearly that most money is lost by those grimly continuing to invest in areas which have done very well in the past, but are now, if not obsolete, at least severely overvalued - to the point that decades of miserable under-performance are required to wear off the accumulated excesses of previous years. It is well known, for instance, that what truly wiped out many investors in the Great Depression was not the crash of '29, but the downward market spiral for years after the crash. And there are other examples.

In 1980, gold reached an all time high of US $850/oz, up from $100/oz just 4 years earlier, and from $35/oz a dozen years earlier. You can be assured, for those of you who don't remember this personally, that there was plenty of speculation, wild forecasts, and general optimism about the price of gold at that time. There were also very good 'explanations' why gold was supposed to head much higher. Around that time, 'Gold Bugs' arrived on the scene (where were they 20 years earlier?). They had two characteristics - one intentional, the other not. Purposefully, they chose to put all their wealth into gold. The unintentional part was that they were forced to become very long-term investors - currently 24 years and counting! Of course, one-day gold will surpass $850/oz, and it may even be relatively soon - who knows? - but the point is that there was a huge lost opportunity cost for sticking in a horrible investment all those years.

More recently, the Japanese stock market reached a frenzied peak of almost 39,000 in 1989, and once again, there were new justifications to explain why Japanese stocks really weren't so expensive - different accounting rules, corporate structure, the Japanese long-term view, etc. Today, 14 years later, the Japanese index is around 11,000 - still down over 70%. Once again, hanging on to an over-valued investment was a terrible choice. Both times, the run-up created valuations so extreme that decades later, all-time highs are still nowhere in sight! Why is that? Because there still wasn't good value. If a stock is worth $20, but gets driven up in price to $100, a decline to $50 still doesn't make it a bargain. It's still overvalued by $30 - or 60%. It's an opportunity to sell, not buy. Recently, we experienced a similar mania, particularly in technology stocks, and in this case, valuations may have been even more extreme. At the peak 4 years ago, technology stocks were more overvalued that just about any asset class in history. Companies without earnings, and no expectation that they would have any in the foreseeable future, nevertheless rose to bizarre heights, netting their owners billions, and inflicting those same billions in losses on the hapless victims who fell for all the hype. Many people (myself included) think the valuations are still far from reasonable. This is what Warren Buffett, the world's richest investor, said in 2003 in an article in Forbes Magazine:

Buffett, as it happens, says stock prices are still too high. Though Buffett still professes his love for common stocks in principle, "We still find very few that even mildly interest us," he writes. "That dismal fact is testimony to the insanity of valuations reached during the great bubble. Unfortunately, the hangover may prove to be proportional to the binge."

Warren Buffett And Postcards From The Bubble Dan Ackman, Forbes Magazine, 03.10.03

Of course, the over-priced technology stocks or other poor investments that you currently own will go back to new highs (assuming no bankruptcies!). The only question is when: it may well take 25 or 50 years for that to happen. And in the meantime, there will almost certainly be another whole class of assets which perform far better. Eventually, a dollar invested at 1% will be worth $100 - but that doesn't make it a good investment option.

Let's go back to the gold example. Suppose you made a huge mistake, and bought gold at the peak in 1980 - $850/oz. Five years later, gold was at $300/oz. At that point, perhaps you had no idea whether gold was cheap or not, but you did feel that stocks in North America were reasonably cheap. The Gold Bugs would tell you to hang on - after all, why sell at the low? If you had hung on, you certainly would have made some money; 25% over the next decade, or a measly 2.9% per year. But if instead you sold, took the loss - even though it was a whopping 65% loss! - and bought North American stocks, you would have seen your money grow by 470% in total, or 19% per year. So the question should never be, "Am I selling at the low?", but rather, "is the valuation of this investment I'm holding such that I am going to get good returns from here on?". Contrary to popular belief, selling at the most recent low can make sense, if the fundamentals are still poor. Two years from now, the current low may in retrospect appear to have been a rather attractive selling point. Lows can always get a lot lower.

It's like burning your hand on a hot stove, and saying " What the heck, I'm burned already, so I might as well leave it there just in case it cools down." Well, it will eventually cool down - when the element burns out. Problem is, that won't do your hand much good in the meantime.

Many investors just can't get the recent high price of an asset out of their heads. They tend to measure the cheapness of a stock based on where they purchased it. Problem is, the market couldn't care less where you bought the stock or fund, and will go where it wants to go regardless of how much pain it may cause you along the way. The market never feels terribly obliged to return your money to you just because you want it to. In fact, a nasty psychological dynamic often develops - an investment falls, so it seems 'too cheap to sell'. If it falls further, it is even more 'too cheap to sell', leading many to ride bad investments all the way down into oblivion, waiting for an elusive recovery.

There's an old market saying that 'the market will always do what inflicts the most pain on the most people over the long haul'. Historically, markets in which huge swaths of the population have participated, where prices went beyond reasonable valuations, tend to be absolutely miserable investments for decades afterwards. It takes investors a long, long time to lose interest in their previous winners. Am I dead-set against all technology stocks? No, I'm not. But a lot of people feel trapped in bad investments. They're in a financial No Man's Land, and will continue to languish there, getting shot up as they buy the same type of investments repeatedly, until a different speculative mania catches their eye. Then, they'll start digging trenches just as the tanks are about to roll in.

Many investors who sit in front of me for the first time arrive with poor investments that are still down 30 or 40%, but they are reluctant to get out because it is below their cost. They hate to admit a mistake has been made, and fear 'selling at the low'. Or perhaps the advisor who got them into it in the first place tells them to hang on 'for the long run'. If the guy who tells you to hold it is the same guy who got you into it in the first place, then perhaps it's more than just the investment that needs changing.

If you'd appreciate an impartial, second opinion of your current financial situation, give me a call. I can promise you that I will give you an unbiased review, with a pre-disposition to preserving capital and seeking out under-valued assets which should appreciate over time. I have over 16 years experience in financial services, both in Canada, and in Singapore and London. Call me today for a free, no-obligation consultation. It will be well worth your time.

Sincerely,

Scott Swallow, HBA, MBA, CIM