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“Calling the bottom” is one of the hardest tasks most investors ever face. A wrong choice can devastate your portfolio.
We all fantasize about “bottom-fishing.” Usually it happens in hindsight. We hear on TV that “XYZ is up 91 percent in the last seven months.” Then we feel bad for missing an opportunity. XYZ was obviously “cheap” back then.
A better response: “Why didn’t you tell me about XYZ seven months ago?” Most of the time, the cheerleaders did not see the opportunity in real-time, either. They are Monday-morning quarterbacks.
Today I want to illustrate just how hard it can be to distinguish between an ETF that is “cheap” and one that is a “value.” Then I’ll tell you about a different approach I’ve used successfully for decades.
Cheap and Cheaper
For today’s example we’ll look at Guggenheim Solar Energy (TAN). This ETF was originally launched by Claymore back in April 2008. The name changed when Claymore was subsequently acquired by Guggenheim.
TAN holds a basket of 25 global stocks involved in the solar energy business. In May 2008, TAN shares traded as high as $30.79.
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| TAN holds 25 top solar energy stocks. |
Think about what was going on back then …
The financial crisis was still unfolding. Lehman Brothers was still in business. And most important for TAN, crude oil prices were north of $150. Capital was abundant and alternative energy was a growth sector.
If oil had kept marching higher, TAN may have been a good buy around $30. But that’s not what happened …
On July 31, 2008, TAN closed at $23.60 — down 23 percent from its peak. Was it a bargain? Some folks probably thought so. They were wrong.
By September 30, 2008, just two months later, TAN was down to $17.94 for a loss of almost 42 percent from the peak. Anyone who bought TAN at the end of July, when it was off 23 percent, ended September not with an open gain — but by losing another 23 percent.
Okay. “Surely the bottom is finally here,” the bottom-fishers said. “Let’s buy TAN at $17.94 and give it a couple more months.”
Big mistake. On November 28, 2008, TAN closed at $8.05. The same ETF that looked “cheap” at $17.94 had dropped an additional 55 percent!
But that’s not all. TAN got cheaper yet — as low as $4.65 on March 6, 2009, down another 42 percent from the unbelievable $8.05 bargain price.
At “the bottom” TAN had lost 85 percent in a little over seven months. That level, it turns out, really was a value for anyone brave enough to buy — and who knew when to get out.
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| Anything “on sale” today can always be “on clearance” tomorrow. |
By June 11, 2009, TAN had zoomed as high as $11.67. That, however, was it. TAN entered a sideways trading range … above the low but rarely in double-digits.
Nearly two years later, in February 2011, TAN was at $9. At that price, it was still more than 70 percent below its former peak and had not participated in the market rally of the prior 20 months. At this low price, many investors were convinced it was a valuable bargain.
However, as any shopper knows, what is “on sale” today can easily be “on clearance” tomorrow. And that’s what happened with TAN. Although it was selling at a cheap price, down 70 percent from its peak, it tumbled another 61 percent to as low as $3.50 earlier this week.
At $9, TAN was cheap, but it certainly wasn’t a value.
“Value” Is Tough to Define
TAN may well be near its long-term bottom now. I don’t know. Plenty of smart people thought it was a good buy at $30, $20, $10, and $5. At each level, they had very plausible arguments about valuation, fundamentals, and so on.
Here’s what I do know:
No matter how “cheap” a stock or ETF may look, it can always fall 100 percent from where you started. Many investors make the mistake of thinking that since it only cost $3.50, the most they can lose is $3.50. However, that is still a 100 percent loss — it’s not the price, it’s the percentage that matters.
This is why I have always preferred a “price momentum” approach to investing. The odds of further upward movement are better when upward movement is already happening.
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| As Isaac Newton discovered centuries ago, an object in motion tends to stay in motion … until something stops it. |
I like to buy ETFs that are already moving higher in price. I’ve found this approach works much better than looking for “value” in weak market segments. Decades of research support this conclusion. And it plays an important role in how I pick ETFs for my International ETF Trader members.
Following strength can be emotionally difficult. By definition, a momentum approach will never buy at the bottom. It also won’t sell at the top. But then again, as Bernard Baruch’s famous quote goes “Don’t try to buy at the bottom and sell at the top. This can’t be done, except by liars.”
Value investors can’t buy at the bottom or sell at the top, either. They succeed when they are patient. Warren Buffett is a great investor because he picks his stocks carefully and then gives them plenty of time.
Most people aren’t prepared to sit on a loss for years like Buffett. But whether you look for value, momentum, or something else, you should have a strategy and stick with it.
Best wishes,
Ron
