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Investors, including investment professionals, need to face their own psychology with decisions on when to exit.
With the Australian stock market on a tear, more investors will be wondering if it’s time to sell some stocks and get ahead of the market, particularly as the massive GDP and corporate profit bump is already priced into Aussie shares.
The problem is that while most of us think about it, we rarely get down to actually selling stocks. Nobody wants to be the one who sold too early against a universally positive stock market environment.
As with buying, there are no fixed formulas when it comes to selling a stock. But most people – including investment professionals – find it harder to sell than buy.
Three psychological factors hold investors back from selling stock in the current robust market environment.
The first is extrapolation. We tend to extrapolate the recent past into future expectations, assuming the most recent trends will persist into the foreseeable future – for example, being tempted to expect another great year for the stock market. Even the most decorated generals throughout history tended to prepare for the war they just fought rather than the war they were about to fight.
A classic case of extrapolation is seen via BHP. Investors who held on to BHP for too long, expecting the 2000s commodity super cycle to continue, saw BHP’s share price peak at just over $42 in 2011 before declining to just over $15 by 2016 as the commodity cycle bust.
More recent cases of extrapolation include online retailers Kogan and Temple & Webster, big winners during COVID-19 that have reversed as investors flocked to other beneficiaries of the recovery.
The second factor making selling difficult is anchoring. If we “anchor” on a share price, we may wait too long. For example, when Macquarie Group fell to $80 in March last year, at the peak of the pandemic, an investor with an anchoring bias who bought the stock at $140 would wait for the stock to get back to that purchase price before selling it.
This would be a lucky investor, as Macquarie’s share price did recover and exceed $140. But don’t be fooled. Anchoring is often a destructive investment behaviour. Other companies such as rail haulage company Aurizon and AGL Energy are trading at or below their pandemic-induced share price slump in March 2020.
The fundamentals of Aurizon and AGL Energy have changed in the past year – Aurizon because of deteriorating global coal demand and AGL Energy beause of lower wholesale electricity prices. The fundamentals, not the anchoring, should be the basis for selling.
Third, overconfidence can be a killer. Overconfidence is often fuelled by a strong market environment. But we need to remain humble and remember we all make mistakes.
I recall being overconfident in Mayne Pharma, a speciality and generic pharmaceutical manufacturer in Australia and the US. Mayne had a series of successful product launches in the US, leading to sequentially positive outlooks in 2015 and 2016. We didn’t anticipate the level of competition in the US generic pharmaceutical market that led to a significant margin crunch in 2017. We sold at a loss, at about 75¢. Mayne is now worth just over 34¢.
Overconfidence prevents us from seeing the constantly changing risk-reward trade-off. Markets and economies are in transition. If we’re to make good selling decisions, we need to understand what this transition could do to stocks.
The past 12 months have been driven by the combination of economies re-opening, interest rates at historical lows, pent up demand and significant fiscal stimulus. At some point the market will look through the upcoming economic strength and profit growth to focus on an environment without negative real interest rates, where governments rein in fiscal support.
The uniqueness of the past 12 months should be put in context and not as a tool to extrapolate what may happen. Particularly in cyclical sectors, this requires identifying the least commoditised, most differentiated and highest value-add companies in the industry, ones that have the ability to create long-term value independent of the economic environment.
ST Wong is chief investment officer at Prime Value Asset Management.
Source: Australian Financial Review
20 August 2021
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