The stated reason? Or the real reason?

By DAVID MOON, Moon Capital Management
July 23, 2006

Has your spouse ever become intensely angry at you for some minor blunder you committed ' so much so that the response was totally out of proportion to your trifling dereliction?

If your wife calls the police to your house because you leave your socks on the floor or you put too much pepper in the chili, odds are that she's not really upset about your sloppy housekeeping or culinary skills. More likely, you did something to her parents or she's discovered the secret life you've been living as the leader of cannibal cult or as a plaintiffs' lawyer.

The stated reason is often not the real reason.

The same is true in the stock market. Remember that as stock prices react negatively to violence in the Middle East.

In early 2000 a judge ruled that Microsoft had used illegal, anti-competitive business practices to crush Netscape's Internet browser. This ruling gave credence to earlier lawsuits filed by the Justice Department and twenty states making similar allegations. Rumors swirled that Microsoft would be broken into little pieces.

The stock declined 50 percent in less than four months.

This helped trigger a three-year bear market in which tech stocks collapsed and many large, blue-chip companies (such as Coca-Cola and Wal-Mart) fell to prices from which they still haven't recovered.

What does the price of Coca-Cola or Wal-Mart have to do with six-year-old threatened lawsuits against Microsoft? Nothing. But their prices appeared to decline in reaction to the Microsoft decline, although that wasn't the real reason.

The real reason was that the prices of Coke and Wal-Mart were too high to begin with. Like your socks, Microsoft was a convenient excuse that came along at the right (wrong?) time.

Relative to the Microsoft news, Coke and Wal-Mart shares grossly overreacted ' again like your spouse and the socks. But relative to the real underlying issue (your secret life, the unreasonably high stock prices), those stocks reacted properly.

The right thing happened for the wrong reason.

After the Middle East fighting erupted on July 12, the Dow Jones Industrial Average declined more than 100 points on each of the next three days. Newt Gingrich called the violence 'the early stages of World War III.' My guess is that we have just witnessed the end of a rare period of relative peace in the midst of a multi-thousand-year war.

Either way, fighting in Israel and Lebanon has little impact on the underlying value of Kimberly-Clark, a company that makes, among many other things, toilet paper. Yet Kimberly-Clark's shares fell on those initial three days, right along with the rest of the market. My family's toilet paper usage suffered no similar decline.

The question investors have to answer is this: Is the right thing happening to stocks for the wrong reason? Or is the wrong thing happening for the wrong reason? The answer will tell you whether to buy or sell or hold.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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