I once had a young colleague with lots of potential, whom I liked very much and who was an excellent securities analyst …but who had only limited stock market success despite loads of potential.
Ass an apprentice portfolio manager, this person came to me with the idea of building a significant position in a company that made carpets. The firm was well run, apparently had sustainable earnings growth momentum and was trading at a low price earnings multiple. In this instance, I didn’t do my job as a supervisor well, more or less rubber-stamped the idea and okayed the purchase.
Soon after that (this was 1993), the Fed began to raise interest rates. This is something I had been anticipating but–maybe because this wasn’t crucial to the structure of my own portfolio–was information I failed to bring to bear on the carpet company idea. Higher interest rates slow down both residential and commercial construction, something which is bad for, among other things, sales of carpets. Replacement demand slows down, too.
I went to my colleague, explained the situation–including the source of my mistake, and urged selling the stock. We did, with a modest loss. The issue ended up losing almost two-thirds of its value in subsequent months.
Now the weird part.
Eight years or so later, my colleague came into my office to rehash this trade–which I had long since forgotten. The point was not to suggest that we buy the stock again–which would have been a fabulous idea, since business cycle conditions were finally very favorable. Instead, it was to say that my colleague had in fact been 100% correct in recommending the stock all those years ago (apparently the stock has finally reached the point where its cumulative performance matched that of the S&P 500.
I didn’t know what to say. This was somewhat akin to my aunt Agnes explaining that she was switching from natural gas to oil because the gas burner in the basement was really a malevolent space alien.
Why am I recalling this strange story–much less writing about it–now?
–we’re coming very close to another period of Fed-induced interest rate hikes. This is bad of early business cycle companies, including housing, commercial construction and related industries in the US, and
–it’s a life lesson about investing. My former colleague had extreme difficulty in recognizing an analysis was wrong or that a stock, for whatever reason, wasn’t working. But portfolio investors in the stock market are always acting on very imperfect information. And economic conditions, both overall and in inter-firm competition, are changing all the time. So having what one thinks is a better analysis than the other guy simply isn’t enough to ensure success. Recognizing when things aren’t going well, stepping back to regroup and seeking out possible sources of mistakes are all crucial, too. Denial may salve the ego, but it makes us poorer, not richer.