Sir John Templeton was a twentieth-century American-born British investor, banker and fund manager. He entered the mutual fund market and founded the Templeton Growth Fund, which grew an average of more than 15 percent per year for 38 years. He once said, “To buy when others sell despondently, and to sell when others buy eagerly, requires the greatest fortitude.” Warren Buffett also once said that it is wise for investors to “fearful when others are greedy, and greedy when others are afraid.”
Easier said than done I hear you say. How do you keep your head around when everyone loses theirs? Thinking contrary has always been a great strategy and one that I have applied extensively over the years. Of course, to be honest. Thinking differently from the crowd requires patience, discipline and very little emotion. These are traits that sometimes need to be embedded (or even forced) into your brain. Especially if you lose money. As every asset class is on the decline, it pays to be less emotional, have endless patience and be more disciplined than ever. Test times with investing. For all of us. Including myself. But I’ve been here before.
Way back in early 2009, and the last truly terrible market in my 35 years of financial memory, the world imploded. In 2007-2009, what was known as the “financial crisis” actually started years earlier with cheap credit fueling a housing bubble, which then collapsed — costing people jobs, savings and their homes. Major institutions such as Bear Stearns and Lehman Brothers, known for their risk appetite, also collapsed when they held large positions in subprime and other lower-rated mortgages while securitizing the underlying mortgages that people simply couldn’t afford and defaulted. On. Stock markets were hit.
The two-month period from January 1 through February 27, 2009 was the worst start to a year in the history of the S&P 500, dropping nearly 19 percent. By March 2, the Dow was down more than 50 percent from its October 2007 high. The drop has been compared to that of the Great Depression of 1929, which was 53 percent between September 1929 and March 1931. It was a mess.
I’ve always had a contrarian head about me. I’ve never been mainstream and that’s why I never participate in fads or trends (sometimes to my detriment), but in March 2009 I had seen the markets collapse and felt this had to end at some point. I needed a trigger and it was something out of the blue that turned out to be one. Stocks went cheap and I had the advantage of a few smart analysts around me to help with valuations. It seemed that some of the big companies were selling far less than they were actually worth. The economy was in a deep recession. Bankers and banks were blamed for taking huge bonuses and draining consumers. The world was in turmoil. Markets hadn’t seen anything like this since the September 11 attacks. Unemployment reached 10 percent. About 4 million Americans lost their homes through foreclosure, an increase of 81 percent in 2008 and 225 percent compared to 2006. The news couldn’t have been worse. The question for me was: where does this end?
I read Barron’s newspaper on a Saturday morning in March 2009 and opened the front page. I don’t specifically remember the title of the article, but it was a piece that talked about the turmoil in the markets. The whole newspaper was actually full of bad news. I remember a clear line that said: “…the small investor sells.A light went on. I knew from experience (and especially the experience of the dotcom bubble in 2000) that the retail investor always enters last and exits last. This was the opportunity I had been waiting for. I identified what I wanted to buy on my watchlist and ranked them from 1-10, with 1 being my highest conviction. On a separate note that we won’t dwell on the details, I went to the woman and asked if I could re-sell the house to invest in stocks, as this was a once-in-a-lifetime opportunity. I got a quick “no” so that was the end. Anyway, the following Monday I filled my boots with stocks I thought were worth at least 100 percent more than what I paid. Many of them traded at their cash level. The thing was, it just didn’t feel comfortable at all, in fact, it was pretty scary. The market gave me companies that I thought were free money, but if you ignore the emotion for you now as it was for me then, it could be the bulk of your investment arsenal. The approval of the government’s bailout packages shortly after the collapse stabilized stock markets, which bottomed out in March 2009 and then embarked on the longest bull market in its history.
So what lessons can you draw from history and apply to today’s markets? It’s a cliché, but history really does repeat itself and especially with the general market cycles. I’ve been around long enough to spot a big one and a bigger one is definitely happening now. Consider the following broad framework for investing in the current environment.
The world is cyclical
The world is made up of cycles. Lots of small, medium and large. They exist all around us. Planetary, organic, physics, but also business and economic. Even the math of the waves of those cycles. The stock market is also made up of cycles. One of the differences with stock cycles compared to the others I’ve noticed over the years is that there is a tremendous amount of emotion in them. Look at the examples I gave earlier. How did you feel in the depths of the recession in 1992? How did you feel when the real estate market collapsed in 2007 and how did you feel when you were on dotcom losses in 2002? So, how did you feel on the peaks of those cycles before it cratered? Amazing, right? One thing to remember is that it always feels worse on the way down. As humans, we have a pessimistic bias that refers to a tendency to overestimate the probability of negative events and underestimate the probability of positive events. This can lead to a very depressed world view. The tendency to overemphasize the negative can impact the choices we make and the risks they are willing to take. It’s the same principle as why “bad news sells.” In addition, if you constantly surround yourself with the doomsayers, you can become very despondent about the future and it has been shown to cause deep depression. The problem is that most investors and traders either fail to recognize that markets are cyclical or forget to expect the end of the current market phase.
Below is a great reminder of stock market cycles along with the accompanying emotion. Personally, I think we’re somewhere between denial and panic, but that’s a subjective opinion. I’ve made some of my best investments in other people’s panics. This includes stocks, not just markets, so this can be applied to anything financially related. A cycle can last from a few weeks to several years, depending on the underlying cause in question.
Patience is your friend
Use the cyclical patterns of markets and stocks to facilitate entry timing. Being patient and waiting for that right moment can save you a lot of stress and of course a lot of money. Financial crises throughout history often end in major failure. LTCM (1998) Worldcom (2002) and Lehman (2008). Watch out for these kinds of events, as they can indicate a rock bottom. So recognize where we are now, and as much as I love to see failure, some institutions are going to go down in spectacular fashion, and it’s here that it can herald some kind of bottom. The stock market cycles have typically expected economic cycles averaging 6-12 months† The cycles are well known: the economy is expanding and contracting and the markets are rising and falling. Our emotions are often swept up in the recurring ebb and flow.
To be ready
So you’ve established where we are in the cycle. The next step is to choose your stocks. Keep a watch list. You can do this through Google, Yahoo or paid services that notify you. Make sure you find out what you want to buy, at what level and at what valuation, and how much your risk determines that you should fill your boots. Being prepared is half the battle. In retrospect, we are the largest investors in the world. Unfortunately, this is where emotion will beat you. Historically, major purchases of mine have been made when the world was theoretically on the brink of collapse. Of course it never was, but your emotion will make you believe it and so you miss that opportunity. As the big investor Peter Lynch once said: “The single most important lesson I have learned about being a successful investor is the need to maintain emotional detachment”.
Finally, many of these points may be simple and you could even say that you are already doing them. The main question is what makes a share go from price to value? Everything is cheap and getting cheaper all the time. Some of the tech names I’m looking at right now I expect to go to zero. So where do you check if everything is on offer?
Look for hidden names thrown out by the market. These can be IPOs made at the top of the market, new secondary listings, spin-offs, carveouts, spin-offs and orphans. Stocks ignored by research analysts and as a result may trade at low P/E ratios. Also look for companies that have announced strategic change. You are essentially buying more of a margin of safety and the market, in its slump, will sell indiscriminately. You can also search for beloved stocks that the small investor and the media at the top loved. All these names are the first to be sold when there is panic and blood in the streets as the majority want to leave the last thing they bought and also companies with limited trading history. We at The Edge monitor these types of potential investments and they have proven to outperform all economic cycles.
- The world is cyclical. Recognize the part of the cycle you are in. The bottom is usually indicated by an event, e.g. bankruptcy, etc.
- Make sure you have a watchlist. Great opportunities rarely stay in markets for long. You should be ready.
- Make sure there is a catalyst to move price to value. Try to buy something not just because it is cheap, but because there is an additional catalyst to move price to value. For example, emerging business transactions such as a spin-off. You get much more for your money.
- Be contrary. Go against the crowd. You win more often than not.
- Protect your capital. Finally, if you can’t make head or tail of what’s going on, stay out of the market and remember that no one has ever been fired to make a profit.
Contact The Edge here to discuss the forward calendar of interesting names with a catalyst and how you can benefit from our research. follow me on Twitter or LinkedIn† look at my website†