Tuesday, February 20, 2007

A Time for Especial Caution

Frequent readers of this site will know how averse the MOS folks are to capital loss. We see our first and foremost mission as capital preservation, not capital appreciation. A Mandarin proverb, loosely translated underscores our objective - "with the lush mountain intact, one should not be afraid that there will be insufficient wood for a fire".

Over the long weekend, the talk dominating cocktail parties here is "Singapore 4000". It is not a catchy phrase of a new government campaign. But it refers to the optimism that the benchmark Straits Times Index will hit a high of 4000 points and luxury apartment prices will reach S$4000 per square foot soon. And there would bound to be someone sharing how fast bucks were made flipping the numerous initial public offerings which trebled within days of their listing.

In fact, as this stellar run in the equity market and property prices continue, more and more cautious investors are throwing in the towel - "to heck with valuations" and succumbing to the temptation of hitching a ride on this "relentless" bull. For the last few holding out, let us suggest that it may be more worthwhile to pack up for a getaway to Phuket to enjoy the Andaman Sea breeze and sun instead. There, you are assured not be to bombarded with news of market highs if your Blackberry is left behind.

With prices escalating more than before, we argue that the danger now of sustaining a capital loss with an indiscriminate purchase is higher than ever. Indiscriminate to the extent that the business quality is actually poor, or possess cyclical earnings but is masked by the current buoyant economic conditions. The foregoing caution is not novel; but one that has been expounded by Mr Benjamin Graham. We end this post by quoting several paragraphs written by the superinvestor.

In the 1951 edition of "Security Analysis", Mr. Graham offered the following - "When the general market is high there are always a number of individual issues that appear definitely undervalued by objective standards, and consequently even more attractive in contrast to the inflated level of other stocks... But that is a time that calls for especial caution. Not only may the 'neglected security' continue neglected for the remainder of the bull market, but when the downturn comes it is likely to decline in price along with the general market and to fully as great an extent. In a word, beware of 'bargains' when most stocks seem very high."

Mr. Graham went on to elaborate on the above in "The Intelligent Investor" - "The risk of paying too high a price for good quality stocks - while a real one - is not the chief hazard confronting the average buyer of securities. Observation over many years has taught us that the chief losses to investors come from the purchase of low quality securities at times of favorable business conditions. The purchasers view the current good earnings as equivalent to "earning power" and assume prosperity is synonymous with safety... It is then, also, that common stocks of obscure companies can be floated far above tangible investment, on the strength of two or three years of excellent growth." Mr. Graham continued, "These securities do not offer an adequate margin of safety in any admissible sense of the term... Thus it follows that most of the fair weather investments, acquired at fair weather prices, are destined to suffer disturbing price declines when the horizon clouds over - and often sooner than that".



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