On and off the bandwagon

By DAVID MOON, Moon Capital Management, LLC
November 18, 2008

When a Citigroup analyst assigned a 15 percent probability of bankruptcy to E*Trade Financial, shares of the discount broker and fledgling bank fell by more than half in a single day. Investors couldn't sell the stock fast enough. At one point during the day, the stock had declined 84% since the beginning of this year.

Only two days later, investors realized that a 15 percent probability of bankruptcy equated to an 85% probability of not-bankruptcy. The stock rebounded 50 percent.

A skittish bunch, those Wall Street types ' don't you think?

Bring in some two-by-fours. We're going to need to shore up the floor of the bandwagon. It's a phenomenon that doesn't just exist in athletics. Stocks, like football teams, can swing wildly in their popularity based on short-term factors.

And one of the most influential short-term factors is the opinion of others.

A client recently told me that he thought he should sell most, if not all, of his stock positions and hold the proceeds in cash until after the presidential election next year or until stock prices began to increase again. A friend of his who had recently done this explained that very little was likely to happen in the economy until the political questions were answered, so why leave your money at risk between now and then?

Off the bandwagon.

How did you select the investments in your 401(k) plan? If you're like many people, you asked your friends at work what funds they chose. You picked the one(s) that seemed to be the most popular among your coworkers.

On the bandwagon.

One of the disturbing influences among investors is the parade phenomenon. That is, you wait for a parade to start, and then rush out to get in front of it.

This is characterized by the 'let's wait until prices begin to go up before we buy anything' mentality.

It's also the failed logic of the overvalued-stock seller. 'Yes, I know the stock isn't worth $80 a share, but it's going up. I'll wait until it starts to go down to sell it.'

How do you know when a stock 'starts to go down'? When it declines ten percent? If so, you would have sold Google at $455, following its ten percent decline from $506.

Off the bandwagon. But then you would have missed the run-up to $637. Whoops. The parade's gone. I suppose you could buy it now, but it seems a bit counterintuitive to sell low and buy high ' but that's what parade-jumpers do.

The alternative is to ignore the recent price movement in a stock. Remember, a stock is simply an inanimate representation of ownership in a company. It has no idea if it's fallen from $50 to $30, or increased from $15 to $30. By itself, the price of a stock means nothing. You have to compare it to the value of the asset it represents.

In one area of Florida, condominium prices have fallen by 50 percent. Using the bandwagon philosophy, this would be a great time to sell Florida condos. After all, the prices are declining; isn't that when you want to be selling? Don't laugh; people do it with their stocks all the time.

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

Add me to your commentary distribution list.

MCM website