August 2002

In recent weeks, stock-market investors have witnessed markets worldwide gyrating wildly, sometimes with record one-day falls or one-day rebounds. By the middle of last week, the Dow Jones industrial average had fallen a massive 25 percent in the previous nine weeks, before rallying 6.4 percent in a single day (the biggest one-day rally in 15 years and the second biggest since the Second World War).

For some stock-market investors, these gyrations are a delight, because they are the source of much wealth. These people are mostly options traders who are smart enough to buy put and call options to ride both the ups and the downs--and lucky enough to read the market correctly. But for most stock market investors who buy stocks and sit on them, hoping that they will go up in value, the last two years have been a disaster.

In the last few weeks I've been traveling extensively, looking at real-estate deals in Southern Europe. For me, one of the pleasures of traveling is being able to devour local newspapers and magazines to get a feeling for what's going on in various parts of the world. Recently, one theme has repeatedly come through in Europe, the Mediterranean basin and North America: Investment portfolios--and indeed people's life savings--have been decimated because of the disastrous performance of stock markets around the world.

It is being widely reported that many stock market investors have finally given up on the market and are quitting for fear that the recent rally is no guarantee the 28-month-old bear market is over. After all, potent but short-lived rallies are common during continuing market declines.

Now, I know that the greatest test of willpower is to refrain from saying, "I told you so," but I along with many others have been predicting a major correction in the market for some time.

In their defense, hardcore stock-market investors are saying things like, "Who could have predicted we would have had such huge problems with the likes of Enron, WorldCom, and Adelphia?"

In saying these things, they're confirming the very point I've been making publicly for years--namely that when you invest in the stock market, you lose almost entire control over your investment. Sure, you can attend shareholder meetings and even vote at them, but you exert little influence. History has repeatedly shown that even though the vast majority of shareholders may be disgusted and upset with the absurdly high payments executives receive--often despite tough times for their companies--shareholders have little power to change the magnitude of those payments.

Simply put, about the only thing you can control when you buy stocks is when to sell them. In other words, there you are, serenely floating down a river, hoping to reach greener (and richer) pastures, unaware that Niagara Falls may be just a half-mile down the river.

Right about here, real estate detractors will jump up and loudly proclaim, "Hang on a minute, real-estate markets suffer major downturns as well!" And they're right. However, "major" when applied to real estate does not encompass a 25 percent decline in a mere nine weeks.

If there is a 5 percent decline in a real-estate market in a year, the write-ups talk of a major slide in real-estate values, with predictions that it may take years for a recovery to begin. I'm not sure a statistically significant measurement could even be made to reflect a mere nine weeks in the real-estate market.

One aspect of market-performance measurement is certain, however. Most stock-market indexes measure the top companies in that market. For instance, the Standard & Poor's 500 Index looks at the top 500 companies. By definition it does not take into account thousands of lesser-performing companies. And if one of the fold goes under - bankrupt - then that company is simply removed from the index. That seems to me a bit like looking at the market through rose-colored glasses. Imagine if we only looked at the top 500 pieces of real estate to determine how the real-estate market is doing!

An interesting point to note about how the real-estate market is measured is that returns are measured relative to acquisition price. If most real-estate investors put up the entire purchase price in cash (the way most stock-market investors do), then such a measurement method would be fine. However, most property buyers--and certainly nearly all property investors--arrange a mortgage for most of the purchase price. Through this leverage, their returns (be they positive or negative) are greatly magnified. Consequently, when a stock-market index is compared with a real-estate index, I believe there is a bias in favor of one against the other that belies the true relative performance of real estate.

Sure, there will always be examples of spectacular gains made by numerous stock-market investors who give all other investors hope. It's a bit like stories highlighting the one-in-three-million lottery winner, there so the countless masses of lottery-ticket buyers will continue to purchase their tickets week in, week out, even though the returns on lottery tickets are, on average and by definition, negative.

I maintain this: If you take 1,000 stock-market investors at random, 1,000 real-estate investors at random and, for that matter, 1,000 lottery-ticket "investors" at random, and track their performance over five, 10 or 20 years, one group will consistently stand out as having done far better than the other two, with less nail-biting, anguish and lost hope.

And I put my money where my mouth is.

Successful investing!

Dolf de Roos