All That Glitters / Don't Wait for the Bubble to Return

Investors must be sure to get into the market at a realistic level somewhere around the average.

I made 20% in the last month, he boasts. Then he adds, "Now I just have to make up for my losses in the preceding half year, and I'm getting out of the market. I decided to put all my money into linked assets, because I don't trust the economy or the stock market."

Yossi said it, Yael said it, you name it, if he or she is in the game they said something along those lines. Even seasoned market animals are talking about recouping their losses and bowing out of the game. It's natural enough: Nobody likes to lose money. Most people will go out of their way to avoid acknowledging their losses, or dealing with them. They'll stay in the game just long enough to leave it without admitting to a loss.

It's the same thing that happens at casinos all over the world. A guy's on a losing streak but he plays another round and another round. He's desperately hoping to recoup his losses and avoid the protracted agony that will ensue if he gets up from the table and leaves. He'd rather stay in the game and risk more loss, than skulk off while in the red.

Your "luck" is the same every round in games of chance, which include poker, by the way. The outcome of a game doesn't depend on the outcome of the previous game. That isn't the case in the financial markets, where each round is based on the preceding one. Past experience shows that financial markets have a habit of mushrooming to unsustainable, "bubble" proportions. Then the bubble bursts. Then the market overshoots on the downside. Asset prices fall below their true economic value.

The fact is that after equities fell about 50% from their peak, to prices that many felt were "too low," they've rebounded strongly. The TA-100 index has gained 27% this year. American stocks gained 20% in less than six weeks. Markets have a strong pull to return to the average after a strong surge or fall, it seems.

Ostensibly, relying on these findings would argue for staying in the market while waiting for the rebound that must follow the bust. But that's only half the big picture. For a strategy of "I'll wait inside until I recoup my losses" to work, the investor must be sure that he or she got into the market when it was at a realistic level somewhere around that average. If an investor gets in at the top, the strategy will fail.

Why? Because when markets converge on the average, bubbles don't just form again, at least not for a few decades. Generally they don't form again in the same area ever again. Tulip prices never regained the heights reached in the 17th century. Railroad stocks in the U.S. never regained their level from the late 19th century. Even at the height of the 2007 stock market bubble Internet and technology stocks never even neared their heights of 2000.

Take Cisco, the technology giant that survived the tech bubble and continued to grow. In March 2000, its share price was $70. In 2002, at the lowest point, Cisco was trading at $10 per share. From there it rebounded to $30, in October 2007, the eve of the current crash. It sank to $15 and last month rallied to $18. Cisco will continue to climb, but nobody thinks it could reach $70 again.

The question in America is when housing prices will stop dropping and start recovering. That is a critical question for millions of homeowners as well as the banks and the entire financial system.

The conventional assumption is that a rally will come at some point, but some voices say nay. They argue that housing prices in America were a bubble. The drop will stop and prices will steady, but they will never regain their height of late 2006, they say.

These voices aren't saying there won't be any bubbles ever again. more. They just claim that the next one isn't going to be in housing prices, but will target some other area.

So before you "stay in the market" to regain lost money, ask yourself when you got in. Did you buy stocks at bubble prices?

Israeli real estate companies, mainly the ones operating abroad but the local ones too, as well as banks, finance companies, holding companies and certain industrial concerns rose on the global real estate and credit bubbles of 2006-2008. They were part of the story.

If your investment portfolio consists of these stocks, and you bought it during that period, or if you bought an expensive apartment in Tel Aviv or in one of the big cities of the West, say in the U.S. or in Europe, then you may find yourself in for a very long wait to recoup your losses. If ever.