Investment Strategy--Darkest before Dawn

Investment strategy seems to be perpetually counter intuitive. In other words, despite our best intentions to "buy low and sell high", most of us seem to do exactly the opposite. Why is this? The reasons are too numerous to list here, but I can point to some reasons to believe that better days are ahead, for investments, for the economy, and for my personal sanity.

So back to the original point. I use the following as examples to illustrate the point at which you know the markets are in for a turn:

Example 1:
It was 1999, and I was working on a project in San Francisco. Each week or two, I'd fly into the airport there, and take a cab all the way into downtown. The cabbies out there are a talkative bunch, and an interesting array of personalities. Yet at that point in time, the cabbies were all taking turns asking me which tech stock I should buy, and telling me about funds, or positions that had made them money.

I should have known then that the tech boom had jumped the shark. But being young and naive, I thought, "hey, what's the worst that can happen? My Cisco Systems stake could drop 20% or so, and then I'll be back on my way to riches and early retirement".

Well, I was wrong, Cisco (along with many others) dropped from $80/share to about $15/share, and I eventually cashed out at $19/share, using the money to pay off my car loan a few years later.

As I studied what went wrong, I thought to myself that the signs of exuberance were all there--unsustainable P/E ratios, market euphoria, everyone in the world saying it was time to continue to pile on the investments in the market, tech was king, etc. Perhaps the next time I saw the world piling into an economic party, I should take it as a sign to get out while the gettin's good.

Example 2
Fast forward to 2006. I am at a party, and a friend starts asking me whether Interest only loans are a good idea for flipping houses. This time I was spending more time in New York and Boston, but again, some of the cabbies were asking about REITS, and other Real Estate mortgage deals. The cabbies again! I started thinking it was time to protect myself against real estate. I also pulled most of my personal investments from the market by early 2007, using the money to build a cash reserve. I was concerned. But I left the 401k in the markets, just in case I was wrong.

Well, I wasn't wrong, and as a result, I only suffered on retirement savings. Which is a hollow victory, when I consider what I could have done to avoid a mere 25% loss on my 401k holdings since 1/1/08.

So we have determined that conventional wisdom (in the form of cabbies and non-finance oriented friends) is the sign of when to EXIT the market place. Could this logic be equally applied to when to ENTER the market?

This morning, driving into work, I was flipping radio stations between the local d-jays and Bloomberg. All the news was bad. Everyone is getting out. The local d-jay was saying he was considering moving his retirement savings out of the market, despite having held on this long. It sounded like complete capitulation to me. Even my co-workers are asking about when to get out.

To my way of thinking, this is a sign that the bottom is soon. That's a little different from saying the bottom is a few points away. I think, from a timing perspective, the bottom is coming. It is getting to its darkest point. The dawn cometh though, and that right soon.

For the first time in months, I am optimistic about the market place, but there is one thing in particular I'd like to see first--Irrational Depression.

Not to be confused with Irrational Exuberance, The Irrational Depression I am looking for is starting to shape up. If companies like JP Morgan, and GE can hold onto profitability, and we can see P/E ratios continue to drop into the mid-single digits, these are signs that the market is getting ready to buy.

And we aren't far.

• GE with a P/E ratio under 5
• Cisco with a PE of 11.5 despite continuing its profitable ways, fabulously favorable current ratios, and little to no short term debt.
• Microsoft with a PE ratio under 10, with large cash and short term holdings, in excess of its debt loads. It still saw revenues and profits in the multiple billions of dollars.

At some point here, these positions become too good to pass up. I am not suggesting we are there yet, and that there isn't another leg down to come. Nor am I in a position to recommend even the stocks I have listed above. Don't buy them on my say-so. But as the market continues to get cheap simply due to people running for the exits, it may be time to stop, look around, and ask yourself one question,"why do I always seem to buy high and sell low?"

Personally, these moments of capitulation give me hope that better times are ahead, and if I can just get through these times, that perhaps we can build a better tomorrow on the lessons being learned today. At this point, I'd settle for a nice Spring day! Winter's lasted long enough, hasn't it?