TCS Daily

Loving Corrections

By Steven Selengut - November 13, 2007 12:00 AM

During every correction, I encourage investors to avoid the destructive inertia that results from trying to determine: how low can we go; how long will this last? Investors who add to their portfolios during downturns invariably experience higher Market Values during the next advance. For just as surely as there is a Santa Claus for every five year old, there is another "value stock" rally for every fingernail biting fifty-five year old. Value Stocks have entered the sixth month of a broad downturn, and nearly 50% of all Investment Grade companies are now down more than 15% from their highs. Seventy percent of those are down more than 20%. Working Capital Model users should be running out of cash about now, while they add more issues to their portfolios, and more shares to existing holdings. Investors know that good companies rarely close their doors, or even cut their dividends.

Corrections are as much a part of the normal Market Cycle as rallies, and they can be brought about by either bad news or good news. (Yes, that's what I meant to say.) Investors always over-analyze when prices become weak and lose their common sense when prices are high, thus perpetuating the "buy high, sell low" Wall Street lunacy. Waiting for the perfect moment to jump into a falling market is as foolish a strategy as taking losses on investment grade companies and holding cash. Corrections in both Equity and Income securities produce the same kind of hysteria as a spring sale at Macy's... but in reverse. The fundamental quality of value securities does not change simply because their prices fall in response to market conditions. When all value stocks are moving lower, it's an opportunity, not a problem. When all [insert: bank, insurance, agriculture, oil, entertainment, travel, transportation, advertising] are lower, it's an opportunity, not a problem.

During every correction, I'm amazed at the shocked reaction of the Media, the confused explanations emanating from the Market Gurus, and the incredibly poor advice streaming forth from the Oracles of Wall Street... every last one of them. It's no wonder that the average investor is in a state of panic! If they could buy a new car, a new business suit, or a new house for half price, they would be ecstatic! Why does a lower price for a share of a high quality stock make them go bonkers? The Conventional Wisdom from Wall Street makes it so; the Conventional Wisdom from CPA land reinforces it; the Conventional Wisdom from financial advisors preys upon it. Experienced Investor Wisdom is boldly different. For example: (1) Corrections are always buying opportunities, the broader the correction, the better. Wall Street thrives on the fear and suffering. (2) Rallies are always selling opportunities. Wall Street would rather stroke your greed button with visions of upward only prices. Your accountant doesn't want you to take profits, and has you convinced that losses are really better than gains. (3) Higher Interest rates are good for investors... so are lower interest rates. Wall Street doesn't really care. They push short-term vehicles to address investors' fear of price fluctuation, and shun simplex income producing strategies while they promote complex derivatives that always unwind badly. (4) The calendar year is of no particular investment relevance. (5) Investment performance analysis should be an objective based program monitor instead of 365-day horse race with irrelevant Market indicators. Wall Street used to agree with (4) and (5). Since then they have learned that they make more money from unhappy investors.

Repetition is good for your CPU, so forgive me for reinforcing what I've said in the face of every correction since 1979... if you don't love corrections, you really don't understand the financial markets. Don't be insulted, very few financial professionals want you to see it this way and, in fact, Institutional Wall Street loves it when individual investors panic in the face of uncertainty. But uncertainty is the regulation playing field for investors, and hindsight isn't welcome in the stadium. Rarely do corrections kill good companies, no matter how bad the news, how big the scandal, or how troubled the economic outlook. If you've been investing in quality companies and have a secure cash flow within your portfolios, you will weather any storm. Loss taking is never smart, savvy, or necessary... even if it cuts the tax bill. Buy more of lower priced good companies while maintaining smart diversification according to the Working Capital Model. Add to lower priced income securities to reduce the cost per share. Make your retirement plan contributions yesterday!

There is an Investment Mindset Solution for the problems that most people have dealing with corrections, recessions, inflation and the Red Sox. Bad news creates opportunities; so does good news. I've never understood why yard-sale prices in the stock market are so scary. And recession? Most people don't realize that a recession is just two consecutive quarters of lower GDP. Not a big deal until it happens, and then, really good things get done to fix it! In recent years, Wall Street and the media have turned the process of investing into a competitive event. What was once a long-term, goal-directed activity has become a series of monthly and quarterly sprints. The direction of the market isn't nearly as important as the actions we take in anticipation of the next change in direction. Performance evaluation needs to be "rethunk" in terms of cycles!

The problems, and the solutions, boil down to focus, understanding, and retraining. You need to focus on the purposes of the securities in the portfolio. You need to understand and accept the normal behavior of your securities in the face of different environmental conditions. You need to overcome your obsession with calendar period Market Value analysis, and embrace a more manageable asset allocation approach that centers on your portfolio's Working Capital. You need to stop looking at your account on line so frequently and go to the movies. You need to elect new people who know how to connect the economic dots and who will restructure the tax code to eliminate all taxation of investment earnings. Corrections fuel rallies, it's just a matter of time. But for now, relax and enjoy this correction. It's your invitation to the fun and games of the next rally, when you will see that correction is spelled o-p-p-o-r-t-u-n-i-t-y after all.

Steve Selengut has ben in professional portfolio management since 1979.


perfect names
I don't normally comment on real names, but the author's last name is perfect for a stock analyst.

perfect name?
Why perfect, because it sounds Jewish? Or what do you mean?

loving it
Great article and I love it too. If people see the housing market down, some will think it's a good time to buy, or if a store has a sale they're happy to buy at a discount. But in a stockmarket correction they do the opposite and follow the herd to sell low, and buy again when it's higher. I like the old saying from, I think it was, the Baron de Rothschild who said, "Buy when the blood is flowing in the streets". I guess he bought up a bunch of downtown Paris after the revolution there.

no, sound it out

Buy buy buy buy Roy, wake up, this is your chance to get even.
Time to buy everyone or getting close.

...except if you are foreigner
because then the ongoing depreciation of the dollar will kill your investment.

But, for Americans it sure is a nice time to buy...and then sell high to the foreigners later on.

"the dollar may be our currency but it is Europe's problem" John Connolly, Treasury Secretary, 1972 [paraphrased]

splendid article
Thats good stuff.

Except one lonely little sentence. I didn't copy it but its in the last paragraph or two of the article. The sentence that says we should push for zero tax on investment returns. I understand you probably can't get an article published on TCS without some expression of moronic ideology, so theres the expression. But come on! WHY do people insist on making life as easy as possible for rich people? And I'm conflicted on the idea, I don't want to pay tax on my investment returns, I wish my returns would be enough to be my income, I support removing the tax for middle earners. But why should Warren Buffet, who already only pays 17% income tax because all his income is from investment returns, get an even bigger break and pay zero tax?

Thats not the answer. Maybe a tiered system...

Really bad argument
Have a 401K, retirement fund? Mutual Fund?

In Democratic/Political/Leftist circles only the rich realize investment income. It is hyperbole. In reality, any diligent person who saves has some. To argue that only the rich would benefit is group-speak.

Also, consider that investment income is the formation of capital and capital drives the economy. However, to the left anythings that does not derive from government is evil?

Well if the dollar sinks low enough even we will suffer.
However, if the Democrats are elected we can count on the economy tanking totally as well, about 2010 when the tax cuts are revoked.

In my humble opinion...
Not many things in life are clear... but one thing is. This is not yet the time to be buying anything.

At the center of the panic is the fact that the system doesn't have as much money in it today as everyone thought it did. And that things are going to be getting worse for the next year, as fresh defaults predictably occur. We know there's still plenty of air left in this balloon.

Call me next year... or sooner, if effective federal action is taken to stanch the cash hemorrhage. But I'm not betting MY bankroll that the bunch currently in power is going to be doing anything intelligent about keeping families in place and paying down their mortgages.

You know things are getting bad when it's the big institutional investors who are glancing warily at the exits. I'm talking holders of dollars worldwide. Gas could well be five bucks by the time this mess has wound down.

Why won't Buffet donate his money to the Treasury?
In any case he plans on giving all his money away to charity just as many wealthy do every day.

THAT money is put to much better use than the US government could do.

In any case, I bet Buffet pay more taxes than you do.

Ever hear of Chuck Feeney?
"Chuck Feeney has given most of his vast fortune to charities while steering clear of the limelight. Irish people should follow his lead, writes Colin McCrea, who is a vice-president of his organisation."

Yes, let's tax the rich so they won't be able to create charities which will put socialist governments out of business.

If people like Feeney and Gates and Ford and Carnegie had all their wealth confiscated by the government, the government would just waste it, like they do now, and kill entrepreneurs. But that's what socialists want, no?

Now would be a great time to buy USD assests.
Assets priced in dollars like stocks or businesses and even real estate should be a great bargain for those with Euros or pounds or even the Canadian dollar.

re splendid
Do you know of any instances and countries where they have tried confiscatory (means really high) taxes in the world? Do you know what happened? And what do you mean by 'moronic ideology', the advocating of more freedom? Are you one of the statist authoritarians around here?

your humble opinion
It sure is humble because here you go again with your: "if effective federal aaction is taken" . So in spite of it being the federal government that caused the problem in the first place with their crappy 'fiat' money policy. Here goes Roy, statist par excellence, proposing that the very same irresponsible dysfunction government can solve the problelm with even MORE federal action. Jeez.

Hungarian pengos are VERY cheap now
The state of your mental faculties disturbs me. In a climate where the dollar can be reliably forecast as sinking against the Euro, you would advocate that anyone might convert his savings-- er, capital-- from Euros into dollars?

Tell you what. You perform the experiment. Then a year from today, tell us how much money you've made.

I'm certainly not asking for a bailout
Let's examine the consequence of NO federal tinkering... because that's what we've had. A laissez faire approach has brought this crisis upon us. It's exactly the same thing that happened when the S&Ls were deregulated. Immediately, they began getting themselves into trouble.

I would agree-- in fact, I've stated as much-- that the best solution would be if all the lenders decided to preserve their assets and told their debtors they were voluntarily renegotiating these poisoned loans, allowing the cash to continue flowing. And maybe to some extent that will happen.

My guess would be, though, that these brilliant minds grow wise too slowly, and too late, to prevent a snowballing disaster hitting the rest of us as our major financial institutions all suffer crises of liquidity while trying to shore them up.

Such crises would require major bailouts from the federal governmentm using MY money. And that's the one kind of federal intervention I would avoid at any xost.

I humbly disagree
In a true lending market the banks would have been more cautious. Federal policy encouraged all this largess.

Also, if you pick equities very carefully it is a good time to buy. However, since I know your on SSI your not in a risk position but rather income mode. I thus empathize.

The entire thing was predicated upon infinite price growth, something even the dumbest investor should recognize is a myth. I knew we were in trouble when I saw the dude on TV who bought a 600K condo in SF on a ZERO principle ARM, all predicated on inflation creating his equity so he could transition to a normal loan.

Since he risked nothing only the bank loses if he defaults, a really bad risk in my opinion.

There is a reason people need equity, it is called risk mitigation.

S&L's were not de-regulated
They still had government backed insurance so there was no risk to the owners.

If banks had no FDIC, do you think they might be more cautious?

When you start with false assumptions, like assuming de-regulation, your solutions are skewed and bound to fail.

What did I say?
Why not take those Euros and buy some forclosed real estate?

A double bonus, low dollar and cheap property.

I said buy USD ASSETS, like stocks or real estate.
I didn't say buy dollars.

There you go again, having a FED, then they print fiat money, is not what you had, 'a laissez faire approach which brought this crisis upon us". The feds CAUSED it in the first place. They would never have to use YOUR money if they did't do such irresponsible things. You want the fox that was guarding the chicken box, to go and restock it.

In a semi-defense of Roy...(dodging the rotten fruit right now)...
...I interpreted his meaning to be the same as my own post's:

Yes, a foreigner can buy assets in the US on the cheap. But so did the Japanese in the late 80s and early 90s. They even bought some landmark properties. And, they ended up taking baths. When you have assets whose sale value is limited to dollar denominated transactions...and the dollar keeps falling, the math.

Note: Some assets are more liquid than others. Stocks and bonds are more liquid than real estate assets. But even if they sold their bonds real fast, they still will take a hit.

paying down their mortgages is govt responsibility?
"But I'm not betting MY bankroll that the bunch currently in power is going to be doing anything intelligent about keeping families in place and paying down their mortgages."

A) That's government responsibility?
B) Do you expect the 'next' bunch in power will help people pay down their mortgages? Because if you do, you are sorely disillusioned. The only thing people in power in DC (and too many state capitals) do with regards to the citizenry and debt the Banker's tune and get people into even more debt.

because profits are already excessively taxed
Before they issue dividends, corporations have to pay up to 35% on that to the feds. Then, the individual has to pay 15% (used to be as high as 39%) on that AGAIN.

But the real reason is incentives. Back in the old Soviet Union, agriculture was all collectivized. Guess what? Food shortages happened. Tractors would rot in the fields and the workers would spend all day drinking vodka in the barn. Then the Politburo allowed workers on the collective farms to grow and sell their own crops grown on 1 acre per worker.

Besides all those single acre farms under cultivation, the collective farms still remained fallow. But, those farmers ended up supplying the bulk of the Soviet Union's grown food (there were still shortages, but mostly due to poor distribution of the food grown...again due to poor to nonexistent incentives to the workers building roads and trucking the produce in).

And, since decisions are mostly marginal...and rational investment decisions are all marginally determined, you will always have people who will decide that they will not bother putting up Y risk/work for X amount of return-on-investment than others will. That means what YOU think is a fair and tolerable tax burden doesn't mean others do and they will behave accordingly, no matter how 'greedy' or 'uncooperative' you judge judge them being. In short, Envy Politics does nothing to ensure that the trains run on time. In fact, it does ensure that the train schedules will get worse.

Note: There is one way to do gun point. Perfected in Stalinist Russia and Maoist China, it does work...for a while. It is never sustainable, though.

But we as a FREE society want as many people participating in the economy to the best of their ability, no? So, the ones who won't work/invest until after-tax rewards for doing so increase even further get to set the minimum policy bar. Like many other important aspects of life, it ain't 'fair' but it is reality.
Either that, or we accept slower economic growth and lower economic standards of living, like the Europeans claim they do as the price for their socialist 'nirvana'.

It's telling that folks living in formerly communist economies have figured this out. Despite dire warnings from the IMF and other Western economic 'experts, flat taxes and other 'supply-side' economic policies have been enacted in most of the former Warsaw Pact nations now and their GDP growth rates are skyrocketing. If they keep it up, after twenty years even poor Slovakia will have a higher per capita income than Germany does. The math doesn't lie.

got that right dbt. Whose argument is it?
"To argue that only the rich would benefit is group-speak."

You're the only person to say only the rich would benefit. I didn't say it.

Investment income is just one form of capital formation. I dare say its a small piece of the pie. Thats just my common sense though, I don't know exactly how big a slice it is.

"However, to the left anythings that does not derive from government is evil?"

Absolutely not. The left wants to derive more from middle class, the common person, rather than rely on the wealthy to derive the bulk of economic activity.

Why won't you lick a donkey's nuts clean?
Because thats stupid! Thats the answer to your question and mine.

"THAT money is put to much better use than the US government could do."

Amen to that.

"In any case, I bet Buffet pay more taxes than you do."

No duh. He makes THAT MUCH more income than I do that he can pay a lower tax rate and still pay A LOT more in taxes than I do. Don't you get it? Thats exactly why the rich pay so much of the total tax burden in this country, BECAUSE they make THAT MUCH more than everyone else.

Why do you say this?
"But why should Warren Buffet, who already only pays 17% income tax because all his income is from investment returns, get an even bigger break and pay zero tax?"

re re splendid
"Do you know of any instances and countries where they have tried confiscatory (means really high) taxes in the world? Do you know what happened?"

No and no. I don't want higher taxes. But I do want a balanced federal budget, and if it means higher taxes then so be it, thats what we deserve for who we elect.

Moronic ideology is the kind that argues for zero tax while completely ignoring the bigger picture. Eliminating tax on investment income is a neat idea, but is it really a good idea that billionaires like Warren Buffet would pay zero tax if it happened? Thats why I thought out loud about a tiered system. For example, for incomes under a certain level - no tax on investment income. So middle earners would get the benefit. For incomes over a certain level - x% tax on investment income. Or maybe 3 tiers, so the "rich, but not super-rich" pay tax but not a lot, and then a higher rate for guys like Buffet.

I want lower taxes, but we have to be realistic. Eliminating tax on investment income would help virtually everyone, thats good. It also would benefit the wealthy to a much larger degree, which, they're wealthy, they don't need it. And it would cause a loss of revenue to the government that would have to come from somewhere else - higher taxes or higher debt. Or, unbelievably, the federal government could actually spend less money, but like I said, we have to be realistic.

Because Buffet already pays a fantastic rate, a lower rate than people making far less than he does. Why should the super-rich be allowed to pay zero income tax and not anyone else? I'd advocate benefits to middle earners, people who could use it, versus additional benefits to rich people, who really don't need it.

Selengut said we should eliminate the tax on investment income. I disagree because of the point above and because its not realistic in our current circumstances.

the more money in Buffet's account, the more he can give to charity, to philanthropy, and put back into circulation for the benefit of others.

He's giving all his money away at his death because he has three voluntarily loser sons whom he thinks don't deserve to inherit it.

And Marjon is correct: Buffet's actual dollar amount of tax is probably equal to about 2 - 3% of the total U.S. income tax bill every year. The richest 10% of Americans pay about %70 of that bill all by themselves every year.

It is buffoonish to want to punish people for having a lot of money. That is nothing but pure, immature jealousy and envy talking. Instead, you should be inspired to aspire to make more money yourself.

You should read
the article here at TCS by Kling that makes the case for the elimination of all federal taxes and replacing them with a flat 23% consumption tax.

If that's too much for you, try researching the organization FAIR and their FAIR tax plan.

A "balanced budget" ain't gonna happen without a total revolution in the tax system.

Besides, it's not that big a deal. The government engages in deficit financing. The Congress buffoons scream about balancing the budget to give themselves something to do--like make excuses on why you need to pay more taxes and why lobbyists and constituents deserve special programs from the feds.

How about tax free bonds?
Most of the rich park their cash in tax free bonds.

Should the rich who own stock pay taxes only when they sell or when the value of their stock increases?

Why punish investment by paying taxes on investment income?

For every Buffet there are thousands of little guys who invest, too.

If you want a balanced budget, CUT SPENDING!
And follow the Constitution.

Why don't you support that?

to Bob re moronic
OK, I got it, moronic ideology is actually expecting the federal government to spend LESS. Maybe you're right, I'm not realistic, but instead too idealistic.

still don't get it.
It doesn't sound like anything to me, but I'm not a native speaker. To me it sounds like, 'good soul' in german or yiddish, a jewish name probably.

That may be your intent
However, the politicians are not on that page. Want reliance from the wealthy? Become wealthy...

Nothing in this country says you have to be stuck in a situation. Start a business.

TCS Daily Archives