By Martin Hutchinson
Investors who trade actively and are closely in touch with the ebb and flow of opinion on Wall Street have one enormous barrier to good investment performance: They will often be seduced by what’s fashionable – whether it be in terms of sectors, countries or individual stocks.
But in this market, as in all markets, it’s best to look at the unfashionable – sectors that are scorned or ignored by the market and countries whose stock markets have been beaten down by adversity. Of course, it’s difficult to do this if you constantly have an ear to Wall Street. Perhaps that’s why Warren Buffett’s bases his investment business in Omaha, Neb., not New York.
Fashionable investments can do very well in the short term. In 1998-99, you could have made a lot of money in tech stocks. In 2006-07, you could have made lots of money investing in China. If you were given perfect foresight, you could construct a successful investment philosophy around “momentum” sectors, buying whatever is currently “hot” and dumping it before the market turned. For most of us, there’s nothing more boring than an investment that just sits there.
The problem is that none of us have perfect foresight, and what’s worse is that we all have a tendency to believe what limited foresight we do have is better than it really is.
But if investing in fashionable sectors is pretty well guaranteed to give you worse returns than the market, then there must be some other strategy that will give you better returns, on average. After all, for every loser there must be a winner.
And while some of those winners are Wall Street insiders trading on privileged information – the Securities and Exchange Commission can’t catch them all – there is also reason to suppose that a winning investment strategy is to invest in sectors and countries that are actively unfashionable, in which the conventional Wall Street wisdom is to shun them, even on a “bottom-fishing” basis.
One example of this appeared in the banking sector a few weeks ago when Citigroup Inc. (C) shares sold for less than a dollar.
During 2008, there had been innumerable attempts to rally the banking sector’s stock prices, mostly led by the same types of Wall Street operators who had caused the banks’ initial problem. But by February/March 2009, the hot money had stopped trying – either through bankruptcy or exhaustion – and Citigroup’s decline to $1, after several months languishing around the $4 to $5 level, was a pretty good sign that the pros had given up.
At that point, there were two possible routes for the unfashionable investor to take: Invest directly in the stocks that had been beaten down by buying Citigroup or Bank of America Corp. (BAC); or go in the opposite direction, staying with the unfashionable banking sector but looking for the banks that were best run and had the fewest operating or asset problems.
The first strategy, if blessed with pinpoint timing, would have made the most money in the short run, no question. A buyer of Citigroup at $1 would today be sitting on a 300% profit in about six weeks.
However, that was a risky strategy. Citigroup could have been subjected to a government intervention that wiped out its shareholders. Further it was in no sense “value investing.” Even the bankrupt American International Group Inc. (AIG) has risen five-fold from its nadir to $1.70, in spite of the fact that the government owns 80%, and would be due to receive no less than $150 billion before AIG shareholders got a penny in the case of a liquidation.
Indeed, investing in either would have been like gambling at a Las Vegas casino – fun when it works, but not if you might need the money.
But at the other end of the spectrum investment in banks such as U.S. Bancorp (USB) or BB&T Corp. (BBT) made a lot of sense. I said as much in my late February review of the top 12 U.S. banks.
Those banks had made money even in the dire fourth quarter of 2008, and looked likely to continue making money going forward. They have powerful franchises in attractive regions of the country, and with short-term rates now much lower than medium term rates their new businesses should be exceptionally profitable. USB has risen 110% from its early March nadir and BBT is up 80%. And both were, and are, investments into which you could reasonably put a decent chunk of money.
Going forward, the banking sector is no longer unfashionable; analysts are waiting eagerly for first quarter figures and the results of the government “stress test” so they can pick winners. It is, however, more than possible that at some point in the future the current recession will once again cast a cloud over the banking sector, making it possible to invest while it is again unfashionable. If not, some other sector will be in the doghouse, and we at Money Morning will try and alert you to that event.
Another example, this time an international one.
In 1999, I was working as a banker in Croatia. The North Atlantic Treaty Organization (NATO) was engaged in its Kosovo campaign, dropping bombs on neighboring Serbia and Montenegro (with the occasional stray hitting Croatia, Bulgaria and Macedonia). Needless to say, the tiny Croatian stock market was itself “bombed out” and people were saying that the country was economically doomed.
That was obvious nonsense. Croatia has an exquisite coast and 5,000 islands, and when the neighborhood is free from explosions they attract tourists from all over Europe and beyond. So, I put my modest savings into Croatian shares – the least risky I could find; a medium-sized bank and a food company. Within a year, I had tripled my money.
Opportunities for unfashionable investment occur fairly rarely, but are more common in bleak economic environments like the present. When they occur, they can prove exceptionally rewarding.
[Editor's Note: When it comes to banking or global economics, there's literally no one better than Money Morning Contributing Editor Martin Hutchinson – a former investment banker with more than a 25 years experience. Hutchinson has proven himself to be a market maven and he is currently offering investors an opportunity to make $4,201 in cash in just 12 days. You can also subscribe to Martin's new investment service, The Permanent Wealth Investor, by clicking here.]
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