Investment Losses Can Be Profits – Weekly Blog # 616

Originally published February 16, 2020

Losses from investments can, and often should be, counted as profits. This is not from my normal contrarian side, but from my lifelong attempt to learn something from most occasions, every day. Losses materialize when our portfolios are out of sync with the markets. In terms of results, there is no difference in being premature or being wrong.

Why Now?

One should rarely delay in acting on a mistake. This may be a particularly appropriate time to accept the “wisdom” of the market. This week we witnessed the S&P 500 and the NASDAQ Composite going to new highs, with the Dow Jones Industrial Average close behind. The American Association of Individual Investors sample survey rose to an often unsustainable level of 41% bullish. Depending on one’s historical measure, the US stock market has been rising for over one or ten years. In this latest week WSJ chart 85% of the weekly prices rose, of 72 stock price indices, currencies, commodities, and ETFs. This is the highest percentage gain I have seen for the 72 elements and I therefore don’t expect it to continue.

During this period of generally higher stock and high-quality bond prices, it is a good time to review one’s portfolio. Any stocks that are currently being held at double-digit, absolute percentage losses or are selling at significant losses relative to their benchmarks should be considered candidates for “capital liberation” or complete/partial disposal.

One should be aware of the following statement by the market analysis group of Bank of America’s (NYSE:BAC) brokerage affiliate, Merrill Lynch “We stay irrationally bullish….We expect peak positioning along with peak liquidity(need) in the second quarter, triggering a “Big Top” in risk assets.” Why accept market prices that could be wrong?

Considering general stock market prices have risen beyond being fairly-priced (having as much upside as downside) to being fully-priced (having more risk of a decline than upside). If a position’s price has not risen with the market or its appropriate benchmark, it is a serious candidate for sale.

What is the Benefit of Selling Now?

All of life should be treated as a learning experience. Outside of purchases used as part of a hedge strategy, investment losses are not additive to accomplishing one’s investment goals. (Often in a hedging strategy, one leg will produce an actual or relative loss while the other produces gains. In assessing whether the strategy is succeeding, the entire hedged investment must be reviewed to see if they are doing their job.) Almost everything in life follows some cyclical pattern, such as investment opportunities in the present often being similar to those in the past. This is because people usually follow similar patterns when exposed to similar situations. Hopefully, after recognizing a losing situation, we can identify some of its characteristics. Remember the old market saying, fool me once and it is your gain, fool me twice and it is my loss. Winning the investment game calls for escaping avoidable losses.

One of the benefits of selling a loser is to redeploy the money into other investments or leave it in cash for future deployment, either at lower prices or when better opportunities arise. For the taxable investor, the loss can be used to shield gains. It is not unusual to have long-term gains as well as losses. Some of the gains are quite large and are in securities that are not performing to expectations. Some investors make the mistake of letting “the taxman” be their portfolio manager and avoid taking profits. Losses can be used to offset some of these gains. Thus, the size of the capital available for redeployment doubles when an equal amount of the loss is used to free up some mothballed gains.

For Americans, this is a Good Weekend to Think About Losses

On Monday, the nation celebrates Presidents’ Day, a combined vacation and shopping day replacing the birthday celebration of our two greatest presidents, George Washington and Abraham Lincoln. You could spend a lifetime studying these two great men. Of interest to me is that both Presidents started their position of power with significant military losses, based on poor strategy and key leadership gaps. In each case, they learned from their mistakes and found the better leaders that were needed. Washington stopped attacking the British in New England and the Mid-Atlantic States, as did Lincoln in Virginia.

Washington opted for better training in his winter camps in New Jersey and Pennsylvania. He also had good leadership in the South with the local militia. Lincoln finally found the right generals and shifted the campaign to the Midwest, recognizing the strategic value of the east-west railroads after Lee had almost accomplished his mission of disrupting the east-west railroad through Pennsylvania. Grant and Sherman captured the east-west railroad through Atlanta, logistically crippling the South. While there are many reasons to celebrate these two Presidents, their ability to learn from mistakes were traits few others demonstrated. For us as investors, I hope we all learn from our mistakes.

Applying the Lessons

I am undecided when to recognize the only loss vs. purchase in one account. It is a fund management company that used to have some noteworthy performance and an unusual distribution pattern. While it could recover its former glory, that would take both time and talent. Based on history, the obvious solution is for it to merge into a larger and hopefully stronger investment group. This has been true for a couple of years, but it hasn’t happened yet. This may be because management wants to stay in control and has convinced the funds’ boards of directors and the key distribution people that they can rebuild the company. Possibly, the existing management wants too high a price. This stalemate has gone on for too long and I should probably recognize my relatively small loss. On occasion, something new happens. This week my old firm, now a part of Refinitiv, calculated that the mutual funds and ETFs included in the Lipper Financial Services Funds segment are attracting sizable net inflows. These positive net flows followed substantial net redemptions in the last two years, which about equaled the net inflows in the 2013-2017 period.

My quandary is, should I show a little more patience and see whether the new flows result in a terminal price high enough to get management to sell out? Any thoughts?

Original post

Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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