The happiness of "early" and the sadness of "too early": How to maximize your portfolio's happiness
02/22/2011 8:30 am EST
Early is buying Apple (AAPL) on October 6, 2008 at $98.14 and having to wait until March 2009—six months--before the stock moves up. And up. And up. On March 6, 2009 Apple closed at $85.30. A year later on March 5, 2010 the shares sold for $218.95.
Early is happy.
Too early is buying home builder DR Horton (DHI) in July 2009. You thought long and hard before you moved. You didn’t buy on the first bottom in the summer of 2008 or even in early July 2009. You wanted to see signs the sector had bottomed and started to recover. The end of July rally seemed to promise that and so you bought at $11.17 on July 29, 2009. Now it’s February 18, 2011 and the shares trade at $12.77. The 14% gain doesn’t seem paltry until you remember that it’s your gain over 18 months. And that DH Horton shares still haven’t actually taken off as you’d hoped.
Too early is disappointed.
And it can be even worse—if you decide you can’t wait any longer and just have to sell. Then there’s a good chance that you’ve spent months sitting on dead money before taking a loss.
It’s clear why we buy early—we want to get a bargain price before everyone else piles on. And it’s clear why we buy too early. We don’t want to pass up a bargain—and lose our chance—so we jump in too soon.
Are there any rules that might separate the “early” from the “too early” and let us maximize our investing happiness and minimize our investing disappointments? I think so—although the rules are more ad hoc than a complete system. And I think they tell us something about current early and too early opportunities.
For example, Spain has been too early until very recently, I’d argue, for reasons that are typical of why we buy too early. I’ll use the shares of the big Spanish and Latin American bank Banco Santander (STD) as a simple stand in for the Spanish market.
This stock traded at $21.84 in May 2008 and plunged to $5.19 by March 2009. Who wouldn’t at least consider snapping up some shares?
But you would have been early if you were looking for a return to the $21.84 of 2008. If you’d bought in March 2009, you would have enjoyed a great ride to $17.70 on December 4, 2009—and then given half of those gains back. The stock traded at $12.61 on February 18, 2011.
And I’ll just bet that if you’d ridden from $17.70 even part way back down, you’d in all probability be out of the stock now and not thinking about getting back in. Which is too bad since I think if you bought Banco Santander today, you would be early instead of too early and could look forward to a 25% gain in a year—and steady growth after that.
I think this example tells us a number of things about why we buy too early. I’d suggest that the bigger the fall the more likely we are to get over eager and buy too early--$21 to $5 is pretty tempting. The better a stock did before it tumbled, the more likely we are to get in too early—Banco Santander was up 19.5% in 2007 and 44.6% in 2006. The more we wished that we owned it before the fall, the more likely we are to get in too early—the stock’s price-to-book ratio, a measure of a value stock—had climbed to 1.9 in 2005 from 1.6 in 2004. Clearly too late to get in by 2005, many investors would have legitimately concluded.
Nothing terribly surprising about any of this—it’s only human nature to think that something, in this case a stock—will revert to its former price or trend. And it’s only human to hope that we might be able NOW to make up for the profits we missed THEN.
The stock illustrates another reason behind some of our too early decisions. We tend to think in straight line trends. Once Spain and Banco Santander had started to climb off the bottom in March 2009 just slightly above $5, many investors saw it as a sign that the trend was uninterruptedly uphill from there. They didn’t think about setbacks, relapses, or false dawns. That’s exactly what we got in Spain as the belief that the end of the global financial crisis meant the end of the Spanish banking crisis turned out to be very wrong and the country proceeded to plunge into its very own debt crisis.
The kind of interruption in a trend that seemed so promising, so certain to climb upward, happens to investors so often that we’ve developed names for it. One of my favorites is “head fake,” as if the market intended to take a stutter step to the right before shifting the ball to the off-hand and driving to the hoop. The real “head fake” though is inside our own heads where we’re convinced ourselves that a trend is in place before it really is.
I’m pretty sure there’s nothing we can do to totally eliminate this tendency to talk ourselves into seeing the trend we want to believe in. You can reduce that tendency, I think, by consulting trusted sources of strong opinions in order to test your own opinions, by examining as much data as you can as honestly as you can, by putting your opinions out there so friends and other investors fan challenge them—do all that and sometimes you’ll still convince yourself to believe where doubt would be the more accurate opinion.
One final thing you can do—and I think this is well illustrated by my Banco Santander example—is to find ways to avoid compounding any too early mistakes you make by selling in reaction to those mistakes. For example, I bought Banco Santander for my Dividend Income Portfolio http://jubakpicks.com/ way back on May 28, 2010. Since then there have been plenty of times when I’ve been willing to throw up my hands, yell “You were too early” and sell. But I haven’t (and the stock is up 24% through February 18) and not because of any superior discipline. I’ve held on because the stock pays a 6.3% trailing 12-month dividend yield. Amazing how a regular and juicy dividend can stiffen an investor’s willingness to hold on.
So where am I looking now for opportunities that are “early” but not too early—with the conviction that I’ll be wrong and be too early on some.
Spain I think is now early. There’s probably one more bump in the road—we haven’t seen the last of the euro crisis—but Spain has shown a surprising willingness to make some hard financial choices and has made more progress on fixing its broken savings banks—the cajas—than I’d expected. You can also hedge the danger of being too early in Spain by buying banks with hefty dividends such as Banco Santander and my recent Jubak’s Picks Banco Bilbao Vizcaya (BBVA) (see my February 15 buy http://jubakpicks.com/2011/02/15/buy-banco-bilbao-vizcaya-argentaria-bbva/ ) with its trailing 12-month yield of 7.2%.
I think it’s still too early for home builders and real estate developers—I don’t think we get a real turn in this sector until the foreclosure rate peaks later in 2011. The market has had a bit of a reprieve as the legal questions surrounding bank mortgage paperwork slowed foreclosures at the end of 2010. But banks have refiled much of that paperwork and the rate of foreclosures is picking up again. Still if I wanted to hedge my bets in this area, I might nibble at the timber companies with sizeable real estate operations that pay a decent dividend. That group includes Rayonier (RYN) with its 3.3% dividend and Plum Creek Timber (PCL) with its 3.95% yield.
I think it’s too early in the economic cycle to switch to lower risk stocks such as the big drug companies. When the current economic recovery gets long in the tooth, I think investors will want to own current laggards such as Abbott Laboratories (ABT). I’ve repeatedly made the case for that stock on its fundamentals but its performance—down 4.8% in 2011 as of February 18 and down 8.1% in 2010—suggests that investors just don’t care right now. The stock pays a yield of 3.8% but it’s not clear to me that’s enough given the market’s indifference to the shares.
Emerging markets are also too early, I think. The danger here isn’t sitting in these shares and having them go nowhere for years. I think you’ll want to own the shares in the second half of 2011.
The danger is that the first half of 2011 could still contain a further 10% or 15% drop in markets such as China, India, and Brazil on interest rate and inflation fears. China just raised interest rates and bank reserve requirements for the third and eighth time, respectively, since the start of 2010 and there’s no sign that the medicine is working yet. Brazil seems trapped between fears that the economy will slow—from 7% in 2010 to a projected 4.5% in 2011—and fears that the economy won’t slow and inflation will pick up speed. The Reserve Bank of India has been the most aggressive central bank in Asia at raising interest rate to fight inflation—which is one reason that Indian stocks are down 18% from November 2010.
The last thing you want to do with volatile emerging markets is be too early, get burned, and then be on the sidelines when they start to rally again.
But then I guess you’d say that about any promising opportunity that might still be a little too early.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Banco Santander as of the end of January. For a full list of the stocks in the fund as of the end of December see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/