Why most investors are mostly wrong, most of the time

Was there not far more 'uncertainty' in the market place during the high tech and telecommunication mania of the late 1990s!

After all, none of the then favorite companies from Cisco, Sun Microsystems and Amazon.com to PCCW delivered the, by investors, expected returns. Just about every company in the high tech and telecommunication sector has badly disappointed not only in terms of delivering earnings growth, but also in terms of its accounting practices and management integrity!

The problem is really that uncertainty is always with us, but near market tops, investors throw caution to the wind and become 'certain' that the up-trend will last forever. In other words, at market tops an overwhelming majority of market participants become convinced that there is no uncertainty and, therefore, pay totally ludicrous prices for investments whose future returns are in reality, and under the scrutiny of a critical analysis, 'highly uncertain'.

A 'certainty' in the minds of investors incidentally also occurs near market lows when economic, political and social fundamentals become horrible. Then, investors become also convinced that the market will never recover again and decline even more. At that point investors truly 'give up' and want to get out 'at any price'.

In my opinion, there always exists the same uncertainty about the future, but it is in our minds that the perception about uncertainty changes over time. Near market tops uncertainty becomes perceived certainty about future huge profit opportunities and leads to overconfidence, credulity, irrational behavior, and excessive optimism.

Similarly, near market lows uncertainty becomes certainty about an impending economic and financial meltdown and leads to desperation, gloom, and excessive pessimism within the investment community. The reason I am mentioning these facts is that it has been my experience that investors tend to buy homes, stocks, bonds, and commodities at the wrong time, namely then when their prices are already high, but fail to do so when prices are low, as they are now in the case of Asian stocks.

This observation applies incidentally even more so for international investors. Looking at international money flows over the last 20 years the following is striking. During the golden age for Asian stocks - that is between 1985 and 1990 - when markets like Taiwan, South Korea and Indonesia rose by between 10 and 20 times, foreigners were largely absent from Asia. Then after 1990 - encouraged by the Japanese success story - foreign money began to pile into Asia and European funds frequently had a larger exposure to Asia than to the US. In fact, record foreign purchases of Asian stocks were registered just prior to the Asian crisis in 1996!

However, after the 1997 crisis, foreigners remained largely net sellers of Asian equities right up to this very day. Instead they began to pile into US equities after 1997 and purchased a record amount in 1999, 2000 and 2001 right around the peak of the US market. 'Buy high, sell low' seems to be the mantra of international as well as most individual investors when it comes to investment decisions, a fact that has always fascinated me for the simple reason that in markets for physical goods, individuals behave far more rationally.

Housewives will usually defer their purchases until stores go on sales and then buy when prices have been marked down. Or when the price of beef goes up substantially, housewives will buy more chicken and lamb and curtail their families' consumption of beef. So, in these 'real' markets there is the tendency to purchase at low prices and avoid goods for which prices have risen sharply.

But, in investment markets, people's reactions are exactly the opposite. The longer the price of 'beef' stocks rises, the more investors will become convinced that 'beef' stocks always go up and therefore no price of 'beef' stocks will ever be too high, which in the end leads to a 'beef' stock investment mania!

The beauty of an investment mania is of course the fact that if the entire world's money flows into 'beef' stocks or for that matter into any other sector of the investment universe, it creates an under-valuation in other sectors, which are deprived of all the money flowing into the object of speculation.

In other words, when, in the late 1980s, all the international money flowed into Japan, it created a relative under-valuation in the US and Continental Europe, whereas when, in the late 1990s, all the money flowed into the US and Europe- specifically into the TMT sector, it created a relative under-valuation for so called 'value' stocks as well as for Asian equities and commodities.

The attraction of an investment mania is, therefore, usually not to be found in the investment object of the mania itself (properties, stocks, bonds, commodities, art, etc), but in assets, which are untouched by the investment mania. These assets are then totally neglected and overlooked, and the saying among investors will be that these investments 'only go down', 'never go up', 'are boring', etc.

But precisely for these reasons these assets, which are 'outside' the investment mania, become very under-valued compared to the assets which are the object of the investment mania and, therefore, they offer for the contrarian investor outstanding entry points. This was certainly the case for commodities including coffee, gold, oil, natural-gas 12 to 18 months ago and is still the case for Asian 'old economy' and small cap stocks, which became neglected and were out of favor during the TMT mania.

There is another point I find interesting about investors' behavior. When an individual purchases a car, refrigerator or TV, he will compare prices, go to different shops, read trade magazines, which evaluate carefully the different products - in short the individual will inform himself very well before making the purchase.

But, when it comes to stocks he will listen to some moron who is interviewed on CNBC or follow the tip of a friend at a cocktail party or take the advice of an obscure broker operating from some tax haven who he has never met in person and whose recommended penny stocks he has never heard of before. So, whereas people tend to inform themselves thoroughly about relatively minor purchases in money terms, they invest, frequently millions of dollars, on the spur of the moment in stocks about which they have not the foggiest idea.

Another thought I wish to share is the following: When investors complain about the fact that the market has been 'difficult', 'performing poorly' or outright 'horribly', such statements do not reflect that all asset markets have been declining, but that investors were collectively poorly positioned. In a world, in which central bankers keep on printing money and expanding the volume of credits, something will always go up in price.

How many investors complain about the lousy performance of Japanese stocks over the last 13 years (they just made a 20-year's low), but never mention how well they could have done in Japanese long term government bonds whose yields have declined since 1990 from almost 7% to less than 1%! Or take the last three years. With few exception stocks declined practically everywhere. But the CRB Index is up by almost 25% in the last 12 months, government bonds have performed superbly, energy and coffee prices are up by more than 100%, and gold is up by more than 40% since its low in April 2001.

Very clearly, there were plenty of terrific money making opportunities around - it is just that investors were not positioned in these well performing assets, but were stuck in money losing high tech and telecommunication shares. In this respect I remember well how, in early 2000 after a TV interview in Switzerland, a lady called me and asked what she should do with her money.

I told her to buy Swiss Franc government bonds upon which she told me 'that bonds were boring'. Since then Swiss government bonds have returned in US dollars about 50% whereas her portfolio will have declined by at least 50%. But it would almost seem that for the excitement, some investors are prepared to lose a lot of money!

A final consideration: It has been my observation that whenever a mania comes to an end (the bubble bursts), a new leadership will emerge. The gold and silver boom in the 1970s was not followed by a new bull market for precious metals but by a bull market in financial assets. Equally, when, in 1989, the bubble years came to an end in Japan, they were not followed by renewed strength in Japanese equities and real estate, but by a strong performance of US equities.

Therefore, I very much doubt that in the years to come the stock market leadership will be found in the US. Rather, it is my belief that Asian equities are inexpensive and that resource stocks will once again attract a lot of investors funds at the expense of America's financial stocks, which seem to be vulnerable because of rising bad loans and their derivative positions.

So what should an investor do now? I am sorry if my crystal bowl is muddy, but it would seem to me that the poor performance of the US stock market over the last three years should - sharp bear market rallies aside - continue for quite some time.

Continental European markets, which have declined in percentage terms more than the US seem to offer some strong near term rebound potential. Commodities may be near term overbought, and gold and gold shares are still correcting (I would not rule out a decline of gold to below $300), but this is where I see the 'new' leadership for the next five to ten years. Lastly, if commodity prices do strengthen, it will be very beneficial for resource rich countries around the world including Argentina, Brazil, Russia, Malaysia, Indonesia, and to some extent Thailand.