Contrary to consumer behavior in retail, investors tend to shy away from the stock market when shares are cheap, but seem to be drawn to it like moths to a flame during market bubbles, when prices are highly inflated. In its June 2008 issue, The Wall Street Journal’s magazine “Smart Money” published a chart showing how investors are pulling money out of mutual funds during down markets. In other words, they are selling low.
Another example: Between 1973 and 2002, NASDAQ stocks gained an annual average of 9.6%. Yet, on average, investors only earned about 4.3% annually. One reason: $1.1 trillion were invested late in the game, between 1998 and 2000, when stock prices were highly inflated and the internet bubble burst soon after. And it is not just individual investors who fall victim to this behavior; Merrill Lynch’s professionals, for example, have been accused of getting into the dot.com bubble late as well.
Some advisors now suggest to hedge against the weak dollar by buying mutual funds that invest in stocks traded in foreign currency overseas, even though the outstanding performance of such funds over the last few years does not suggest that one should engage in foreign investment now—quite the opposite.
Taking Europe as an example, when the Euro hit lows close to U.S. $0.80 in 2000 and 2001, and the U.S. federal funds interest rate reached 6.5%, investing in funds that held European stock may have been a splendid idea. But now that the Euro hovers between U.S. $1.50 and 1.60, and the U.S. federal funds rate is likely near its low point at 2% while the European Central Bank’s key interest rates appear to be near the peak of this cycle (the marginal lending rate has reached 5.0%), and with European leaders being openly hostile to the high exchange rate of their currency, investing in the Euro, including a fund whose value depends on it, seems a questionable strategy. European tourists have been swarming U.S. shopping malls like locusts lately to take advantage of their currency’s exchange rate, which, in turn, says a lot about the disparity between the buying power of €1.00 in Europe versus U.S. $1.60 over here. In the long run, it will not be sustained.
Indeed, a fund’s long-lasting excellent performance may be interpreted in two ways: While the performance speaks for the fund manager’s ability to pick the right investments, it also speaks to how much these investments (or the types of investments the fund targets) have risen, and unless the high performers have all been turned over, chances are that there is some pretty expensive stock in that fund. In short, while its performance proves that it was a good investment for those who invested in the fund years ago, it does not necessarily imply that buying in after the fund has already had substantial gains for years is always a good idea.
Instead, it seems prudent to invest long-term in the bargains currently offered by the domestic market, particularly stock of companies that got truly hammered since the subprime mortgage crisis hit last year, but which are either a victim of market circumstances rather than a bad business model, or, in the alternative, which are at least going to survive their mistakes and recover eventually. One example of each is discussed below. In the spirit of “practice what you preach,” I invested in both.
A company whose shares lost substantial value while its business hasn’t been going badly—most certainly not to the extent that the decrease in its share price suggested—is Alvarion Ltd. (ALVR), an Israel-based wireless broadband systems provider (including for “Worldwide Interoperability for Microwave Access” technology, or WiMAX), which is the result of a merger of BreezeCOM Ltd. (formerly BRZE) and Floware Wireless Systems Ltd. (formerly FLRE) back in 2001. For example, in April, Alvarion gained authorization by the FCC for its equipment operating in the 3.65 GHz frequency band, a band for which federal approval is required and which the FCC specifically allocated for wireless broadband to help overcome service gaps (including wireless “last-mile” technology, one of Alvarion’s specialties).
Yet, Alvarion lost 66% of its value between its peak of $15.21/share in October last year and its low point of $5.20 in March this year. Why? One explanation is that Israel’s currency, the shekel, has been very strong lately, while the U.S. dollar has of course been rather weak. As a result, Israel-based companies’ operating costs appear higher, and profits lower. However, as argued above, the U.S. dollar may be nearing its low point, and any gain against the shekel should mean higher share value for Alvarion stock.
Another phenomenon is the amount of short positions currently held by traders betting on further market decline, which included two million shares, or about 3%, of Alvarion’s stock held in short interest before Alvarion issued its first quarter results on Monday, May 5. But short traders were proven wrong, and Alvarion’s stock rose 11% on that day, when it reported record revenues. Alvarion has since traded as high as 75% above its low point in March.
An example of a big loser over the last year by its own fault is E*Trade Financial Corp. (ETFC), whose investment in mortgage-backed securities famously almost caused its bankruptcy. In January, E*Trade shares traded as low as $2.08/share, down 90% from its 52-week high at $25.79 last year in June. However, E*Trade has likely avoided its ultimate demise, in part with a cash infusion from hedge fund Citadel Investment Group. And with a stock value of $2/share, there were not many directions to go. Indeed, E*Trade’s stock was up over 150% within one month of its low in January, and it continues to stay up between 50% and 120%.
Disclosure: The author owns ALVR and ETFC.
Russell Pearlman, “Tied-Up Funds,” Smart Money, June 2008, at 80-85.
Jason Zweig, “How to Lose $9 Trillion in a Bull Market,” Money, Dec. 2007, at 76.
Daniel Fisher, “No Thain, No Gain,” Forbes, Apr. 7, 2008, at 76-82.
Zack O’Malley Greenberg & James M. Clash, “Riding the Dollar,” Forbes, Feb. 11, 2008, at 52-54.
Nicole Bullock, “Strong Plays for a Weak Dollar,” Smart Money, Mar. 2008, at 72-75.
George Mannes, “The Best Ways to Protect Your Money Today,” Money, May 2008, at 95-97.
Avi Tiomkin, “The Demise of the Euro,” Forbes, Apr. 21, 2008, at 34.
Penelope Wang, “Fund Watch: Four Funds Join Our Preferred List—These new MONEY 70 picks share good performance and a record of looking out for their investors,” Money, Dec. 2007, at 78-80.
“BreezeCOM Ltd. and Floware Wireless Systems, Ltd. Complete Merger, Company Changes Name to Alvarion,” Alvarion Press Release, Aug. 1, 2001, http://www.alvarion.com/presscenter/pressreleases/3315/.
“Alvarion® Earns FCC’s First Authorization for 802.16e BreezeMAX® Equipment for 3.65 GHz,” BusinessWire, Apr. 22, 2008, link.
“Movers & Shakers (Monday's biggest gaining and declining stocks): Berkshire Hathaway, Hovnanian, Microsoft, Yahoo, more,” Marketwatch, May 5, 2008, link.
“Alvarion® Reports Record Revenues for First Quarter 2008,” BusinessWire, May 5, 2008, link.
Zack Miller, “Special Report: Strong Shekel’s Impact on Earnings,” Israel Opportunity Investor, Mar. 10, 2008, link.
Shlomi Cohen, “IPTV Industry Is Up and Coming,” SeekingAlpha.com, Apr. 30, 2008, http://seekingalpha.com/article/74823-iptv-industry-is-up-and-coming.
Katrina Brooker, “The Day $2 Billion Walked Out The Door—Inside a bank panic, customers deserting, investors fleeing, billions in losses. Survivors of a run at E*Trade tell how they fought to hang on.,” Fortune, Apr. 14, 2008, at 99-106.
Evelyn M. Rusli, “Citadel Storms E*Trade,” Forbes.com, Nov. 29, 2007, link.
For a history of federal funds rates going back to 1990, see http://www.federalreserve.gov/fomc/fundsrate.htm.
For a history of European Central Bank key interest rates since 1999, see http://www.ecb.int/stats/monetary/rates/html/index.en.html.