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spacer October 2000

When Benj worked in Nepal last year, one of the most common expressions was, "Ke garne? Ke garne?" Literally translated, it means, "What to do? What to do?"

This is a question we've been faced with lately as our financial returns have dwindled over the past couple of years from the stratospheric heights of the previous eight. Should our contrarian spirit be shed and another philosophy adopted? Is it time to become momentum players and hop on the Nortel bandwagon? Run to the Internet and high-tech stocks? What's the best solution when it appears the crowd is starting to run ahead and your feet are mushing around in quicksand?

One of the initial steps is to reevaluate your system. Has it been working well for one year? Five? Twenty? The longer one is successful with any given methodology, the more likely it is that failures are simply a temporary aberration. Everyone knows of moments in their lives when the fat ball of bad luck rolls off the hill and won't be swayed. Even Wayne Gretzky had periods where plays backfired and goals and assists dried up. In investing, difficult times occasionally rear their head and one has to be patient and roll through them.

What is bad luck in a Contra sense? Let's take a straightforward example: Suppose you're a bottom fisher and you choose five stocks where there is a 10 percent chance of bankruptcy, but a 50 percent chance of tripling your money. This will work out well in the long run, but in the short run, three or four busts in a row are possible. To be sure, it is difficult to perfectly define the odds. We are not actuaries. Sometimes even insurance companies end up making huge payments for multiple hurricanes, even though their weather actuaries have accurately assessed the odds.

Of course, sheer bad luck is often a simplistic excuse. That may wash with the denizens of Vegas who take deep bows for their crafty strategy when they win and blame bad luck when they lose. Citing bad luck in this case is a pathetic rationalization to soothe wounded pride. Certainly, this same rhetoric undermines many who gamble on the stock market.

But stupidity is just another in a list of reasons for failure. Sometimes cycles are the beguiling devils that impact returns negatively. An investment methodology that works during one period may be suspect at best in another.

When analyzing the Contra technique, it was obvious that, over the past couple of years, money has not been thrown in our value direction. Warren Buffet and David Dremen, two leaders in this field, have suffered along with us. In fact, for a few months there was a deluge of articles about Warren losing his touch. Well, if anyone in the world can afford to have a dry spell, Warren is the man, but his humbling streak was plainly a product of the times. Investors were lapping up technology stocks and IPO's, hoping to ride a meteoric wave  o areas in which Mr. Buffet chooses not to dabble.

The nature of money is that, at any given point in time, it is finite. Therefore, it can only move in so many directions. If major funds are being invested in the technology sector, then less money is left for the value arena. This was a key factor why investors like us were recently left out in the cold, dreaming of warmer climes.

Waiting can be confused with indecision, but patience is often the best solution when stock market returns are substandard. But even when plain ol' bad luck might be the reason for it, this should not be an excuse for laziness. The Contra system was carefully reevaluated and perused for holes. Per usual, a few minor flaws were found, leading to tinkering to augment the investment results.

One other key thing was also done. We didn't panic, going off half-cocked, making all kinds of trades that would have meant forking over commissions and enriching brokers at our expense. In fact, practising patience, we slowed down. Since May, we have only made tax loss sales, exiting positions that should leave more money in our pockets when the reckoning is done.

In their fascinating book, Why Smart People Make Big Money Mistakes, Gary Belsky and Thomas Gilovich present a number of startling facts regarding investor behaviour. One is that from 1984 through 1995, the average stock mutual fund posted a yearly return of 12.3 percent, yet the average investor in these funds earned 8 percent. The authors suggest that this makes about as much sense as being told that the average commercial jetliner flies at an altitude of 35,000 feet, while the average passenger in a commercial jetliner flies at 15,000 feet.

Why the shortfall? Many investors frequently switch from fund to fund, chasing higher returns. As part of their yearly review process, they'll often chuck the underachievers and switch to whomever holds the hot hand of the day. But, the authors say, the data shows that "By investing with the herd, many investors take their money out of poor performing funds just before they begin to rebound and put their dough into zooming funds just before they stall. Then they repeat the cycle over again."

Sticking to your guns and waiting for the trend to turn in your favour should not be confused with another failing strategy, in which investor overconfidence is combined with paralysis. It is a psychological fact that people tend to overvalue investments in which they have taken a position. As a result, they tend to hold on to losing investments, believing themselves to be correct, even when the overwhelming weight of information indicates otherwise.

This overconfidence is difficult to overcome, but the best bet is to confront this belief by reevaluating the losing stock as if you did not own it, as if it were sitting out there on your watch list. Would you buy it? If the answer is "Interesting, but no," then you should seriously consider replacing it with something else that appears to be a better purchase. The conclusion is that while being patient can be a blessing, paralysis is a curse.

We are great believers that one makes their own luck. The more one studies, the harder one works at something, the better their luck seems to be. But a person should recognize when the investing winds are blowing badly, calling for a retreat. Taking a vacation from the market can be the pause that refreshes, helping to restore clarity and insight to the investment vision.

Ke garne? Ke garne? At Contra, we've been lying lower. Don't forget to put this very viable, but low-key, option in your strategic repertoire.

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