A Conversation I'll Never Forget

A conversation I'll never forget... Let this man's story serve as a lesson... A warning sign from FedEx... The pendulum of investor psychology continues to swing...

Years ago, Bill – an affable gentleman in his 60s – shared a personal story with me that I'll never forget...

As you can probably guess, it ends tragically. What made the story unforgettable is that it didn't have to end that way.

Today, I (Mike Barrett) would like to share with you Bill's heartbreaking tale of stock fortunes won, then suddenly lost.

Like many people in their 60s, Bill moved to Florida after living most of his life somewhere else – in this case, Corning, New York.

"Crystal City" is also the world headquarters for glassmaker Corning (GLW), a Fortune 500 company with dozens of manufacturing facilities around the world. Corning's roots in this small town started in 1851, dating back to the early days of America's glassmaking industry.

Bill became nostalgic as he recalled his many years living in Corning. He fondly remembered executives and plant workers routinely "rubbing shoulders" at their kids' school events and in the town's shops and restaurants.

Everybody, it seems, was also a Corning shareholder. Bill told me he had owned shares most of his adult life, added to them over the years when he could, and reinvested the dividends.

In 1999, Corning's stock (and Bill's net worth) suddenly began to soar...

Shares doubled between June 1999 and December 1999... then doubled again as the dot-com mania hit full stride, peaking in August 2000 near $325 (on a pre-split basis).

Corning's meteoric 1,200% rise in just 24 months meant Bill was suddenly worth millions. With retirement just a decade away, he was set. It was too good to be true... And then, without warning, it wasn't.

We all know what happened next...

The dot-com bubble suddenly burst... tech stocks crashed... and $5 trillion in paper wealth disappeared.

Two months after hitting an all-time high near $325, Corning shares were down 50%. They wouldn't stop falling until they hit $3 in October 2002... a stunning 99% implosion.

Tragically, Bill never sold.

My colleague Dan Ferris says investors tend to make their biggest mistakes at market extremes. Sadly, this is a perfect example of what he's referring to.

Achieving financial independence and letting it slip through your fingers takes an enormous mental toll. I'm sure not a day goes by that Bill doesn't wonder how his life might be far better had he handled things differently – probably when his alarm clock goes off, reminding him to get up and get ready for work every day.

Of course, with the benefit of hindsight, it's easy to ask the most obvious question...

Why didn't Bill sell some of his shares before it was too late?

The answer is less obvious: Bill was too emotionally attached to Corning and its stock. He wasn't prepared to part ways with it, because he never imagined such a day would come.

In his latest book, titled Mastering the Market Cycle, investing guru Howard Marks identifies one of the greatest and most underappreciated attributes of superior investors – an unemotional nature. Here's how he explains it...

One of my most persistent observations and – in a related way – one of the questions I'm most often asked is whether people can learn to be unemotional. My answer is "yes and no."

I think it's possible for people to be on the lookout for potential emotional influences and to try to restrain their effect. But I also think people who are inherently unemotional will have it much easier.

A lack of emotionality is a gift (in investing, that is, but perhaps not in other areas, like marriage). It's not my point that emotional people can't be good investors, but it will require a great deal of self-awareness and self-restraint.

Let Bill's heartbreak serve as an important lesson: It's easy to get complacent about a stock that has treated you well... But never allow yourself to get so emotionally attached that it clouds your judgment.

The Corning story offers two lessons that are becoming important for investors these days...

Marks eloquently sets the stage for them both, with the following excerpt from his book. (As an aside, the seventh chapter, titled "The Pendulum of Investor Psychology," is a must-read for serious investors.) As he wrote...

In the real world, things generally fluctuate between "pretty good" and "not so hot."

But in the world of investing, perception often swings from "flawless" to "hopeless."

The pendulum careens from one extreme to the other, spending almost no time at "the happy medium" and rather little in the range of reasonableness.

First there's denial, and then there's capitulation.

During the late '90s, Corning's business was "pretty good." It started doing what many companies do when times are good – acquiring smaller competitors and consolidating the industry.

The acquired companies brought lots of new revenue streams and caused earnings to soar. Investors, in turn, saw the exceptional numbers and assumed Corning's earnings would be flawless for years to come.

I wrote about this phenomenon in the November 2 Digest. Investors generally figure the near future will look a lot like the recent past. Most of the time, they're pretty much right. But eventually, the future doesn't look as good as the recent past, which triggers an abrupt shift in investor expectations... and causes stock prices to plummet.

In the fall of 2000, it became increasingly clear that Corning's stock was priced to perfection, and that its future would likely be far less than that. The pendulum of investor psychology suddenly swung toward hopeless.

Investors anticipated that Corning's acquisition binge would be disastrous once demand slowed. Sure enough, the company wrote down the value of its newly acquired businesses an enormous $5 billion the next year. It also acknowledged the following...

Most of the impaired facilities are currently available for sale [and] others will be demolished. The impaired equipment will be auctioned, sold, or disposed during 2002.

Four years later, in its 2004 annual report, Corning noted the market was still out of balance, saying...

We see few signs of a broader recovery in overall demand, mix of premium products, and pricing for our products [in the telecom division].

I want you to keep the following in mind...

Strong capital markets and historically low, near-0% interest rates have once again encouraged U.S. corporations to go on a "buy growth" binge over the past several years. As a result, investors have priced stocks to perfection, assuming that this strong growth will continue for years to come.

But at some point, the flawless sentiment priced into stocks will start careening the other way...

The recent earnings report from shipping giant FedEx (FDX) could be an early warning sign...

The company operates in around 220 countries and handles more than 14 million packages each day, so it's considered a global bellwether. Last month, it noted "significant weakness in business conditions," particularly in Europe, and reduced guidance for the second half of fiscal 2019.

"When you have a change that comes on you as fast as this did," Chairman Fred Smith noted, "it's hard to react to it."

Of course, FedEx is taking the sudden change in business conditions seriously. It's cutting costs, including a voluntary employee-buyout program and reductions in both capacity and discretionary spending. The stock fell 12% on the news and was down 29% in December.

Here's the other important lesson we can draw from our earlier Corning story...

As the pendulum of investor psychology swings like a wrecking ball away from flawless and toward hopeless, investors are sure to overreact and create a huge number of attractive investment opportunities.

When Corning finally bottomed in 2002 around $3 a share, sentiment was as irrational as it had been at the peak in August 2000. Sure, a full recovery was still years away. But Corning had proven it could weather the worst of storms. It was a classic deep-value moment... where the upside potential far outweighed the downside risk.

An investor buying Corning stock near its lows in late 2002 made 10 times his money a year later.

Superior investors learn to exploit the pendulum of investor psychology as it swings between flawless and hopeless.

In the December issue of Extreme Value, we found a management team with exemplary 'pendulum riding' skills...

In my eight years as an Extreme Value analyst, I've studied dozens of elite management teams. None of them has demonstrated the courage or conviction our latest recommendation does.

Buying assets when sentiment is flawless tends to destroy capital. That's why this company has been selling assets for years and building a huge pile of cash with the proceeds.

Management believes the Federal Reserve's extreme loose-money policies of the past decade have produced over-capacity in this particular industry. When this becomes evident to investors, the inevitable swing in psychology toward hopeless will create buying opportunities that rarely come along.

The stock is still trading below our maximum recommended buy price, thanks to broad selling by investors of late. But we don't expect it to last long. You can gain instant access to this name and all of our premium research with a subscription to Extreme Value. And right now, you can get two years of Extreme Value for less than the price of a single year. Learn more here.

New highs (as of 1/3/19): Short position in iShares China Large-Cap Fund (FXI).

A quiet day in the mailbag. Did today's Digest strike a chord with you? Let us know at feedback@stansberryresearch.com.

Regards,

Mike Barrett
Orlando, Florida
January 4, 2019