Perception vs. Reality

by Jeffrey Saut of Raymond James, 12/3/18

Living with a loss is folly, taking a loss is wisdom.”
. . . Lewis Owen

For years we have quoted Benjamin Graham’s book The Intelligent Investor, which Warren Buffet has said is the best book ever written on investing. The operative quote from said book is “The essence of portfolio management is the management of risks, not the management of returns.” He closes that thought by saying, “All good portfolio management begins, and ends, with this premise.” My father put it much more succinctly when he said, “If you manage the downside in a portfolio, and avoid the big loss, the upside takes care of itself!” This is why investors need a good financial advisor, or portfolio manager, to manage the risk, re-balance portfolios, trim investment positions from time to time, hedge the downside at times, raise cash when appropriate, and hold investors’ hands through a bottoming process like we identified between October 2008 and March 2, 2009. At the time investors had not headed our “sell signals,” or managed the risk, given the Dow Theory “sell signal” of 11/21/07, or for that matter the Dow Theory sell signal of 9/23/1999 (we wrote about both of those). In fact, they were liquidating their equity holdings when they should have been buying. If they had managed the risks in either September 1999, or November 2007, their investment results would have been much better. We wrote about both of those “sell signals,” as well as the “buy signals” in June 2003 and March 2009. Now Wall Street’s “pretzel logic” has it that NOBODY can consistently time the stock market; and, we agree. However, if one listens to the message of the market, one can certainly determine if one should be playing hard, or not playing so hard. Verily, we think that cash is actually an asset class, which is why we are never fully invested. My father used to tell me, “To assume that the investment opportunity sets that are available you today, are as good as those that will present themselves next week, next month, or next quarter, is naive; and, you have to have cash to take advantage of those opportunities." Accordingly, we always have a cash reserve.

We revisit these aforementioned thoughts as we enter tax loss selling season and reflect on the old stock market axiom from Lewis Owen, “Living with a loss is folly, taking a loss is wisdom.” Over the years, we have learned the hard way that when, and what, to sell tends to separate successful investors from the amateurs and drives much of a successful investment model. This is particularly true for 2018’s tax-loss selling season given the recent volatility and resulting mispriced “prices of paper” (read: certain stocks).

The causa proxima for the volatility, since our short-term sell signal of October 2, 2018, has been evolutionary. It began with the Muellerinvestigation’s revelations, the Chinese trade tiff, softening economic numbers, FED fright, heightened investors’ fears (near record bearishness), worries about peak earnings (we have heard this for the past six quarters), and the list goes on. Consistent with this, we advise participants to carefully review their portfolios, with an eye for selling companies’ shares whose fundamentals have deteriorated with little chance of improving in the intermediate to longer-term. We also like the strategy of “pruning” some shares from portfolios where “the news cannot get any better.”Remember, gains can be offset with losses for tax purposes, and that the rebalancing of asset classes may be in order. In this investment review process, some participants will not do their homework as well as others and therefore sell for tax reasons perfectly good companies where the bad news is already priced in and the fundamentals are bottoming. This spells opportunities for astute investors and is exactly the kind of environment where one is able to find mispriced securities providing an excellent, low risk, buy point; and, the difference between perception and reality is where our opportunities lie!