The Mosquito Effect

Jack is getting a little frustrated.

He came on board as a new client just before Christmas. At the time, I recommended he invest half of his funds now and leave the balance in cash, just to take advantage of a correction in the market.

We’re now six months down the track and he’s sick of waiting. The market is going nowhere so he just wants to invest the rest and get a better return than the 2.5% in a term deposit.

Again, I’ve encouraged him to sit tight because stock prices, especially in the US, are trading at a 30-40% premium, some much higher. Not only that, the market is entering the tenth year of a bull run (upward market). Bull markets usually last for nine years.

Jack then asks what will cause the market to enter cheaper territory again. i.e correct

I explain it could be a few things but quite honestly, it will be the thing we least expect. It always happens in an expensive market.

It’s what I call…

The Mosquito Effect.
Mosquitoes strike without warning. They’re indifferent to size as well. They don’t go for the biggest juiciest looking man, they generally go for certain blood types instead.

Market mosquitoes are the same. Market mosy’s are the cause of a correction you never saw coming. The cause you least expect.

Sometimes it’s impossible to know what the mosquito will be. You just need to know it’s out there lurking, but it’s only lurking for two particular blood types – the greedy and the impatient. Everyone else is immune.

To better explain my point to Jack, I share one of the best examples I have ever seen.

Pubs Drunk With Debt
Just over 10 years ago, the hotel industry was seen as the darling of the property sector. The thought was you could never go broke in a pub. Three reasons underpinned this theory:
• Pubs are brick and mortar assets
• Pokies were a license to print money
• The hotel sector was one of the most powerful lobbies in state government. i.e. untouchable

Consequently, every Johnny-come-lately started getting into the hotel game, including institutions such as the banks and retailers like Woolies. Such was their confidence, buyers paid 3-4 times what hotels were actually worth, mostly on borrowed money.

I remember one occasion when the ING bank rode into Newcastle strutting their stuff and shelled out $50,000,000 for 4 hotels. Everyone knew the hotels were only worth a third of what ING paid for them, but hubris got the better of them because they wanted to be big swingers in the hotel industry.

And then the unthinkable happened.

In July 2007, the no-smoking laws were introduced, and hotel gaming revenues literally dropped like a stone overnight. It wiped out a heap of hoteliers, especially the late comers into the market because they had taken out the biggest loans but now had less revenue to service their debts…on overpriced assets.

Not surprisingly, the likes of ING did their dough.

The mosquito was the NSW Govt. No one ever thought state parliament would touch the hotel lobby. But they more than touched it, they stung it like no one ever imagined.

The Upside
Whilst the hotel sector took one hell of a beating a lot of good came out of it as well. The whole sector became much more innovative resulting in some wonderful changes, especially around alfresco eating. As with every sector, the quality assets recovered and are now selling at all-time highs again.

The mosquito only stung those who paid overs for hotels and used cart loads of debt to fund them.

The Best Repellent
The best repellent for Jack right now is to sit tight. Have some money invested and the rest sitting in cash.

The easiest way to avoid being stung is not to let emotion overcome you. Every market has a mosquito just waiting to bite if you pay overs for an asset or borrow too much. And I guarantee you won’t see it coming.

Have a great weekend!

Adam

P.s thank you for all the replies to the last Moowsletter – ‘Would You Pay Your Kids $1 a Day To Brush Their Teeth?’. It really struck a chord, especially with single parents.

Footnote – Jack is not his real name.