100,000 Lemmings Can't Be Wrong! Everyone knows they shouldn’t drive looking through the rear view mirror when investing. It was obvious that a lot of people were doing this during the bull market that began in 1982 and ended poorly in 2000. Many investors were chasing the latest investment fad, which was technology in the late 1990’s. Everyone could see where the market had been and it looked good—real good. Actually, it looked too good to be true and for many investors it was.
Unfortunately, many investors are a lot poorer for the experience. They all jumped off the cliff together. Regrettably, many financial service companies were kind enough to accommodate this bad investor behavior by bringing out more mutual funds and products to capitalize on these hot markets. I’m sorry, let me clarify…capitalize for their benefit, not the investors benefit. These investment firms were only too happy to roll out the latest Internet, IPO or Biotechnology investment.
Charles Duell, Commissioner of the U.S. Patent Office in 1899, said, “Everything that can be invented has been invented…” Wow! Did this guy get it wrong or what? What was he thinking? Was he trying to talk himself out of a job? At any rate, the financial services industry certainly has never heard of Mr. Duell. They’re never done inventing investment products.
“Following the herd” is as old as the hills. Don’t follow the herd. Find your own grass to graze on. When the herd is on the move, the group runs rampant. With this old herd, it was buying stocks, lots of stocks, as many as you can get. They just kept buying stocks, no matter what the valuation.
Hula Hoops and Pet Rocks
What’s the latest craze? There has been a big love affair with stocks that pay dividends after the tax changes of 2003. Previously, dividends were taxed as ordinary income, which could be as high as 35%. This legislation reduced the tax on qualifying dividends to only 15%. Wall Street has latched onto dividends and turned this into the new marketing machine.
Dividends are great now. Here we go again. Find what’s hot, or just create something new, and hype the heck out of it. Why not? People always go for it, don’t they? Remember, there will be times when growth investing easily beats value. There will be times when large cap shines. There will be other times when small cap rips the cover off the ball and large caps look like a bunch of slackers. There will be times when Real Estate Investment Trusts (“REITS”) are on a roll and other times when they rollover and play dead. There will be times when emerging markets are hot and at times they should be called submerging markets. So what is the point? Chase the current investment fad, ride it out, and then move onto the next one? No, not really. It’s the opposite of this. Have a plan and stick with your plan. Do you really know what the next hot investment will be? There are plenty of people who think they know where the next hot dog is and they’ve already bought into it. Leave investing in the next fad to the know-it-all-crowd.
The Three Big Bets
This isn’t like The Three Bears. There isn’t a happy ending here. The big, bad wolf knocked down a lot of investors’ houses. Most of these houses were built on the three big bets leading up to the stock market meltdown of 2000.
The operative word here is bet. The first bet was made on investment style. More and more money flowed into the large growth sector because that’s where all of the action and returns were. Value investing wasn’t meant to be considered. I should take that back—value was considered.
Investors that owned any value stocks considered selling them. Many investors didn’t think about this too long. They sold their value stocks and took the money to buy more growth stocks. Can’t own enough growth investment—they’re all going to the sky. Forget about a reasonable balance between growth and value, just go for growth. Slightly overweighting a portfolio to a style that has lagged makes sense. Piling into the hot sector is usually a recipe for disaster.
The next bet was a beta bet. Beta measures a stock’s movement relative to the broad market. The S&P 500 Index which represents the broad market has a beta of 1.0. A stock with a beta of 1.0 would move with the same volatility as the whole market. A stock with a beta of 1.2 would be 20% more volatile than the broad market. So, if the market went up 10%, a stock with a beta of 1.2 should go up 20% more or 12%. Conversely, a stock with a beta of 0.8 would be 20% less volatile than the market. The bet during the late 1990’s was for high beta stocks. This makes sense as growth stocks typically have higher betas than the broad market.
The last of the trifecta was a sector bet and the sector was “TMT.” This was the Technology, Media, and Telecommunications sectors and a ton of money flowed into them. Who needed energy, consumer staples, financials, hard assets, or any other sector? TMT was the only place to be. So many investors just piled in and bought as much as they could. Life was good; the market just kept going up. Well, at least for a while. Then the worm turned and life wasn’t so good.
These were three big bets, which were great on the way up. They were painful on the way down…very painful. Remember these times. There’s no need to make a big bet, never mind three big bets at the same time. The next time someone says, “It’s different this time,” run—don’t walk—run in the opposite direction as fast as you can.
Au Contraire
One way to invest is contrarily. This means doing the opposite of what everyone else is doing, which isn’t easy to do. Most people usually follow the crowd. When the market is going up, they just dive in and buy more stocks. The higher the market goes, the more they want to own. Conversely, when the market is declining, nobody wants to own stocks. The sell orders start coming in fast and furious. All of a sudden stocks are too risky.
It’s unclear if the market has hit bottom yet. Some investors wait to buy stocks until they come up again. They end up buying high and selling low, which guarantees a loss. This is the opposite of what should be done. Isn’t this the opposite of how you buy other things? When shopping, don’t you wait for things to go on sale? Of course you do. Why pay retail? You know when the sales are, so you wait. Sure, the selection isn’t as good, but that’s OK…you saved 30%! You’ll tell everyone about the great bargain you got.
Even if it’s not on sale, you haggle with the car salesman, look for “new” skis at the high school ski swap, and offer cash to your plumber if he will give you a discount. Why’s it so different when buying stocks? Perhaps it’s the two primary emotions, greed and fear. Many people get greedy during the bull market. They just can’t seem to buy enough stocks during this time period. Then when the bear market kicks in, everyone starts running for the hills. Fear takes over and everyone is dashing towards the exit signs. This encourages you to do the exact opposite of what you should be doing and what you do with most every other facet of your life.
Conclusion
Investors shouldn’t invest contrarily with their whole portfolio. Remember, everything in moderation. As Warren Buffet said, “We simply attempt to be fearful when others are greedy and to be greedy when others are fearful.”
If you would like help so that you don’t keep chasing performance, give us a call at (860) 645-1515 or e-mail Thomas.Scanlon@Raymondjames.com
Thomas F. Scanlon, CPA, CFP®
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