What's Wrong with It?

"What’s wrong with it?” is a question that first-time investors (and some seasoned ones) have a tendency to ask when a stock goes down.

The full question is, “I just bought the stock last week, and now it’s going down! What’s wrong with it?” The actual problem may be the company, it may be the market, or (most likely) may be the question itself.

When a stock drops, the first thing to consider is what the general market is doing. If the market is rising and your stock is dropping, it is likely that something is indeed wrong with the company, especially if the selling continues for more than a few days. On the other hand, if the whole market is dropping and yours is dropping along with it, there is nothing necessarily wrong with the stock you purchased. But, a decision is necessary. And you have to ask yourself a couple of questions before making that decision.

Question One: Has the company changed?

There should be some good reasons why you initially bought the stock. Hopefully, most of these reasons are related to the company behind it. If you bought a stock only because the chart looked good, you’ll likely lose money. If you bought the stock because the company has steady earnings, low debt, great return on equity, reasonable P/E ratio etc., and the chart looked good, you should be just fine. If the reasons you bought the company still apply, strongly consider keeping the stock.

Question Two: What is the state of the economy?

There’s an expression in investing: “Don’t try to catch a falling knife.” If the market begins falling from a peak, and you have reason to believe that the entire market will continue falling for an extended period of time, you should seriously consider selling the stock and buying it back later. No matter how good your stock is, if the entire market is falling, yours will likely fall with it. On the other hand, if you are not 100% sure (I repeat: 100% sure) that the market will be significantly lower a month from now than it is today, keep the stock.

Question Three: What is the state of the industry?

Have their been any rule changes or significant developments that have impaired the moneymaking potential of the business? Have their been any adverse political developments? If there have been changes, find out about them and assess their impact yourself – do not rely on others to do so for you. Emotions tend to run high in such situations, and emotions have no place in investing.

The fact is, stocks of good companies drop all the time. Just because a stock price drops does not necessarily mean that the stock is “bad.” In fact, if the price has dropped significantly, and the company still has all the great qualities that made you buy it in the first place, consider buying more. Many a fortune has been made by purchasing under-priced assets and having the patience to wait.

“What’s wrong with it?” is often just a way of saying; “I’m overwhelmed with the human fear of losing money, and have no confidence in my original decision.” If this applies to you, take a deep breath and re-read this article with your stock in mind. Then make a decision.

If you still feel overwhelmed, sell your stocks and get out of the market, forever. Not everyone was meant to own stocks. To make money in the market, you have to not care about money.
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“I think that if any reader of these chapters is convinced – really convinced – he cannot master the market, a great deal has been accomplished, because the great majority will fail in the market, & it’s worth dollars and cents to them to know it.”

Gerald Loeb, The Battle for Investment Survival

Abouuuuut….Face!

The CREA Gets Real




Just seven days ago, I wrote an article stating that the Canadian Real Estate Association should be ashamed of themselves for their cheery and completely unrealistic assessment of the Canadian housing market (see: CREA to the Rescue).

Today, in a stunning about-face, the CREA "updated" its forecast, admitting that by 2011 a "demand-driven downturn" will push Canadian home prices lower. They even added that the threat of rising interest rates and new taxes caused buyers to jump into the market sooner than they may have otherwise (something I wrote about in April, in Spending 'til it Hurts).

It’s unclear what prompted the CREA to come clean. I’d like to think it was my blog, but more likely they simply realized that a small dose of reality now prevents egg-on-your-face later.

Of course, the CREA is still being idealistic (read "deceptive"). Amongst other nonsense, they insist that Canada’s "conservative lending practices" and mythical "prudent borrowing" will prevent a large price correction; that the two most overpriced markets (Ontario and B.C.) will inexplicably plateau next year after a small drop; and, of course that the current market shows a good balance between supply and demand. But, at least they aren’t encouraging a new wave of oblivious buyers. The CREA has, with its latest press release, gained back a shred of dignity.

I have to give credit where credit is due: the CREA did the right thing. More of the same would be nice.

For the CREA's full press release, see Housing Forecast Revised.
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"Home sales are coming down from the mountain peak, but they will level out at a high plateau -- a plateau that is higher than previous peaks in the housing cycle.”

David Lereah, Chief Economist, National Association of Realtors, USA 2006

How to Speak Fed

The Federal Reserve: seen by some as an economic savior, and by others as an evil force.

Through its direct manipulation of interest rates and other mechanisms, the Federal Reserve determines the overall pace of U.S. economic growth (or decline).



Since investors trend toward euphoria when times are good & panic when times are bad, the Fed’s mandate is to control the economy; for example, to stimulate a weak economy by lowering interest rates, or to slow down an overheated one by raising interest rates. Yes, that's right – the Fed sometimes purposely initiates recessions. This is not conspiracy, but rather a method of controlling human stupidity (or at least cleaning up after it).

In good times wages tend to increase, which in turn increases spending, which increases prices of goods, which increases stock and real estate prices, which induces inflation, which causes wages to increase and so on. When times are good and voters are happy, the government wants it all to continue. If an independent Fed did not exist, human greed and optimism would allow bubbles to grow to stratospheric levels, then come crashing horribly down. The recent crash and burn of the U.S. housing bubble is an example of the Fed's failure to do its job – it let the bubble grow for too long.

Importantly, while the Fed always hints at what it wants to accomplish in the future, it does so in a cryptic manner. So, while the Fed’s intentions may be crystal clear to professionals, they pass by virtually unnoticed to non-professionals – exactly as intended.

Buying reasonably priced stocks of good companies is always a good idea, but it’s an even better idea to buy them when the tide of the economy is moving with you. The purpose of this article is therefore to teach the rules of “Fed speak,” the cryptic voice that shapes the nation’s economy.


Rule #1 - The Fed Understates Everything

The Fed is aware of its huge influence in the market, and takes care not to overstep its boundaries. If the Fed simply said, for example, “we intend to raise interest rates because we think there is a bubble in technology stocks,” the market would likely dive and the Fed would be blamed. For this reason, the Fed avoids stating anything of importance directly. Thus, “this market has a bit of froth,” really means, “this is a bubble of massive proportions.” Asking, “Is there a reason to think that homes are overvalued?” means that homes are terribly overvalued. Whenever the Fed states or suggests an opinion, you can safely magnify it tenfold.


Rule #2 –Recognize Moral Suasion

Moral suasion, also known as “jawboning,” is the name for scolding market participants in order to change behavior. By sending a warning to the market, the Fed hopes that it can delay or even avoid taking a negative course of action.

For example, in 2009 the Bank of Canada (Canada’s equivalent to the Fed) stated, “the recent sharp increase in the value of the Canadian dollar, if it proves persistent, could fully offset recent positive developments in financial conditions, commodity prices, and confidence.” This stern warning (see Rule #1) told market participants that if they keep buying the Canadian dollar, the Bank will take measures to devalue it (to improve exports).

In the long run moral suasion rarely works, but in the short run it can have the desired consequences. Moral suasion also indicates the course of action the Fed will take if moral suasion fails.


Rule #3 – Read the Speeches Verbatim

The introductions and conclusions of Fed speeches are made for public consumption (the media) and generally reflect useless broad opinions (such as, "the economy is improving.")

The subtle nuances with true predictive value are in the carefully chosen text. For this reason, any online news article about a Fed speech will include a link to the Fed’s word-for-word text. This verbatim text is meant for market professionals.

Examples of Fed Speak in Action:

“But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?"
Alan Greenspan, Chairman of the Federal Reserve Board, 1996 Speech

Translation: Stocks appear to be grossly overvalued (the Internet bubble).
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"It's pretty clear that it's an unsustainable underlying pattern. People are reaching to be able to pay the prices to be able to move into a home."
Alan Greenspan, Chairman of the Federal Reserve Board, 2005 Speech

Translation: There is a housing bubble in the U.S., and it will crash.
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“With recent improvements in the economic outlook, the need for such extraordinary policy is now passing, and it is appropriate to begin to lessen the degree of monetary stimulus.”
Bank of Canada, Press Release, Apr 2010

Translation: We will be raising interest rates soon.
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The importance of understanding the Federal Reserve cannot be underestimated. To a large extent, the Fed determines the near-term growth or contraction of business, and therefore the direction of the stock market. In addition, the Fed is a reliable asset bubble "early warning system." Learning to speak Fed can save you a lot of anguish.

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“Augmenting concerns about the Federal Reserve is the perception that we are a secretive organization, operating behind closed doors, not always in the interests of the nation as a whole. This is regrettable, and we continuously strive to alter this misperception.”

Alan Greenspan, Federal Reserve Board Chairman, 1996