WASHINGTON, October 11, 2012 – One of the errors that’s frequently made by individual investors is the habit of buying stocks and bonds at retail prices, particularly when “everybody” seems to be doing it. Take Apple (AAPL) for instance. Barely three weeks ago, some investment advisors were calling for this already pricey stock to soar from its $705 per share peak to $1000 per share and above. Why not buy it now? Buy indeed!
That kind of investment touting should have been your first clue that something was fishy. The frantic proclamations of Apple’s theoretically endless upside were sort of like the time not so long ago when the per-barrel price of oil, having already soared to around $150 bbl., was said to be heading for $200 and above within days, perhaps hours.
In both cases, almost from the moment these ridiculous overestimates were trumpeted by the foolish, headline-hunting financial media, both vehicles began to tank. Or, using the more antiseptic term, they began to “correct” for the excess optimism. Back in the day, that overpriced barrel of oil took a header into the $70 range. More recently, we’re watching Apple, which has receded to roughly $630 per share at the time we’re writing this, off over $10 a share just today.
The reasons why stocks, bonds, and commodities sometimes race ahead beyond all reason are many and varied, ranging from the habits of so-called momentum investors—who hop on every freight train they see leaving the station—to short-squeezes in which mass-quantities of short-sellers have to bail out of this or that due to unexpectedly good news, to funds and retail investors alike who are chasing the latest hot investment that “everybody’s buying.”
Professional investors can make a lot of money surfing these waves because they get info faster and earlier than you and I and already own the stocks. So the upshot of chasing hot stuff is usually a loss for you and me.
Retail investors don’t fully comprehend why a given stock, in particular, seems to be getting a considerable goosing. The reason why, though, is simple: if “everybody” is buying a given investment, then it’s already fully priced. It’s no longer a deal. And whether you’re investing in stocks, bonds, futures, or real estate, if you can’t get a good price, you can’t get a deal.
As you and I buy on the pumped up good news or the exciting momentum, those in the know, who had already bought the shares before the “news” hit the wires, are happily selling their merchandise to us at a nice profit. Our purchases at higher prices soon run out of momentum. The pros won’t buy the shares back. And so they tank.
All of which brings us to a point we’re not sure if we’ve raised forcefully enough in the past. Nice market moves like the one we were experiencing this morning (and which doesn’t look so hot at the moment) bring in buyers who will chase prices on this week’s hottest items. But, as when one shops in a department store, it’s always best to look for things you like that are getting marked down rather than the pricey designer stuff the store is pushing at full price.
In other words, rally days (like today) are not days to buy. You buy instead when “Sale” tags are attached to the merchandise, whether it’s the designer dress at Saks or, say, Apple, which is looking a lot more like a deal today than it was a couple of weeks ago. (And which, actually, might be a buy today since, contrary to the over all market, it’s down rather sharply.)
Our developing rule, the department store metaphor, often means that if you’re in the market, you should choose to buy merchandise on those nasty downside days, all things considered. The days when the merchandise is getting marked down. A good stock picker is like Sy and Marcy Syms’ best customer—an educated consumer.
Taking our bargain basement metaphor a bit further, Warren Buffett, whom we don’t much like as a political pundit, has often correctly observed that the best time to buy stocks, and even bonds, is when there’s “blood running in the streets.” This doesn’t happen terribly often, but it’s good advice. In other words, while buying marked down stocks is a swell idea, buying “fire-sale” stocks is even better. When “everybody” is hitting the panic button, you should already have your list of bargain stocks you’re ready to buy.
Example: The Prudent Man popped a few tranquilizers and went “all-in” in both the stock and bond markets at the beginning of March 2009 when all was said to be irretrievably lost. It seemed like our best bet ever, even though we white-knuckled it for a while. The market rarely looked back.
But for us at least, the best bet of all in those days actually turned out to be the deep-discount B-grade bonds we stocked up on with our idle cash, such as it was. Normally, bonds are excruciatingly boring and we avoid them like the plague, even though Mr. and Mrs. Prudence are flirting with retirement age. But stocking up on these puppies proved to be a phenomenally good bet.
Bonds at that time, both muni and corporate, were so eviscerated, price-wise, that we couldn’t believe it. We’d never seen prices so low for reasonably decent bonds.
Since the coupon a bond pays (with occasional exceptions) is always level no matter what the market price of a bond, your effective yield on a “crashed” bond can be amazingly high. We bought reasonably decent bonds that were yielding as high as 8-9% for tax-free munis, and as high as 11-13% on taxable corporates, an unheard-of return.
Most of these bonds have gone back to normal now, more or less, or even “premium”; that is, they are valued above par value (redemption value), which in the case of most bonds is $1000 per bond.
But here’s what’s interesting: over the past six months or so, a fair number of the bonds we bought in 2009 are getting “called” no matter what the maturity date of the issue. For example, we currently own a bond issued by a Virginia county to provide funds to underwrite major additions to that county’s only hospital. As with many munis, its maturity date was far in the future, in this case, they year 2031. (Maturity date is when the bond is redeemed at par, i.e., that $1000 face value times the number of bonds you own.)
But this bond, like many others, has a “call” feature, meaning that the issuer can terminate the issue early, paying you the interest owed to that point plus par for the bonds. Occasionally, in the early years of a call feature, you’ll even get those bonds redeemed for slightly above par—a bonus, if you will, so you won’t get too angry about losing your swell interest rate on the bond.
Our Virginia bond just got called, and will be redeemed above par per bond (102, or $20 per $1K in bond pricing parlance) on November 1. Our long-term capital gain on this bond will be a whopping 33%, given where we purchased it in 2009.
These kinds of capital gains are happening all over in the bond world, and they’re the kind of gains that you’d never expect in bonds. But most of them are due to the crash of 2008-2009 and the ensuing bond-selling panic that made them cheap. There was blood in the streets, and they were a smashing good, if scary buy. This sort of thing never happens, statistically, in the wonderful world of bonds. But it’s playing out now for the Prudent Man and other prescient (or just plain lucky) bond investors as bond after bond is getting called away in our portfolios.
This was probably a once-in-a-lifetime experience, at least in the stodgy world of bonds. But the outcome illustrates Buffett’s blood-in-the-streets strategy perfectly. The bonds we bought, generally thought to be stodgy investment vehicle, have over the last 3-4 years averaged long-term capital gains far in excess of most stock investments during the same period, even though stocks themselves have been recovering nicely more or less.
We hate to see our bonds and their swell effective yields gradually get purged from our portfolios. But the bond issuers are mostly calling them for the same reasons that would lead you to refinance your mortgage. Bond issuers still owe X amount of debt that was funded by the called bonds. And they still can’t liquidate the debt except on a 10-, 20-, or 30-year schedule. But they can sure as heck reduce the interest they’re paying on them, given today’s ridiculously low rates. So they call the current bonds and re-issue them, effectively, by selling new ones with a lower coupon.
Collectively speaking, all these recent bond refinancings are interesting to us. Clearly, states and corporations are calling older bonds and refinancing them as another way of getting their economic houses in order. If the Feds would get with the program (listening, Uncle Ben?) and start issuing a lot more 30-year debt now at current interest rates as they redeem older issues, this could help immensely in reducing this country’s job-killing debt load, at least as a first step. (It would be even nicer if Harry Reid would allow a budget to pass.)
Lessons here are two-fold:
First of all, the debt problem in this country still needs to be dealt with forcefully. As we’ve just indicated anecdotally, states, municipalities, and corporations are already doing so on an increasingly aggressive level. If it got at least a little adult action from Congress, Fed should be a little more forthcoming in this area. But alas, Congress continues to dither and the President continues to demagogue when it comes to actually putting our national economic house under adult supervision.
Second: keep looking for that “blood in the streets” moment when it comes to investing. The rewards can be substantial and can happen in unaccustomed places. All you need is cash on hand and at least some ability to stare raw fear directly in the face. Regular market downdrafts, unless the averages are in a clear and persistent downtrend, can also be useful for triggering new investments in bargain merchandise, as “blood in the streets” moments can be few and far between.
The market continues to gyrate here in confusion, excited about the inflationary effects of QE3 on stock prices, but wary of the ongoing nonsense in the Middle East, and the uncertainties of Obamacare and the upcoming fiscal cliff issue. It’s always best in uncertain times to keep at least some of your powder dry. But when you see blood, that’s often the time to act.
Disclaimer: The author of this column maintains several active trading and investment portfolios and owns residential and investment real estate. He currently owns, among other investments, positions in DGP, IAU, ACQ, SLV.
Positions mentioned above describe this author’s own investment decisions and should not be construed as either buy or sell recommendations. The current market is highly treacherous and all investors travel at their own risk, so caution should be exercised at all times.
Illustrations, charts, commentary, and analysis are only the author’s view of current or historical market activity and don’t constitute a recommendation to buy or sell any security or contract. Views, indications, and analysis aren’t necessarily predictive of any future market or government action. Rather they indicate the author’s opinion as to a range of possibilities that may occur going forward.
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Read more of Terry’s news and reviews at Curtain Up! in the Entertain Us neighborhood of the Washington Times Communities. For Terry’s investing and political insights, visit his Communities columns, The Prudent Man and Morning Market Maven, in Business.
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