Investing is supposed to be risky. It’s the risk that enables the returns.
If you wait until an investment has no perceived risk, then you’re buying the investment at a premium…the investment is ‘priced for perfection’.
Trouble is (and this is the paradox of investing) when an investment reaches this point, where it appears nothing can possibly go wrong, that’s when things can go wrong. And when that happens, because it’s so unexpected, it can result in big price moves…
Why CBA Shareholders Should Heed This Lesson
That’s why we offer caution to investors in Commonwealth Bank [ASX: CBA]. Two weeks ago the newspapers went bonkers at the news CBA was now valued at $100 billion.
As the Sydney Morning Herald reported:
‘The bank’s shares rose to its highest-ever value — $63.24 — at the close of trading on Thursday, as the ASX200 reached a 19-month high and the market continued to rally following the US Congress’ temporary aversion of the “fiscal cliff” crisis.’
That’s got to be good news. As the report continued:
‘“People are comfortable with the fact that these are safe haven banks,” Bell Potter Securities banking analyst TS Lim said.
‘You get consistent cash flows coming out and very good risk-adjusted returns. You’ve seen a lot of banks blow up overseas but over here, it’s been well run and well-regulated…
‘“CBA has always had a positive trajectory. If you look at CBA’s earnings in the last 10 years, it’s been going up, compared to the other local and international banks that have dips here and there,” he said.’
What phrase springs to mind? That’s right, ‘priced for perfection’.
When an asset is priced for perfection, you know what happens. Just look back at the stock market in 1999 and 2000. Back then, financial analyst Martin Sass told the Independent, ‘There won’t be a cataclysmic decline but the market is priced for perfection.’
Sass said that in May 1999. At that point the Dow Jones Industrial Average was at 11,000. That was close to the top. Four years later the market had fallen below 8,000 points.
Even Gold Can’t Avoid This Phenomenon
When something is priced for perfection, it comes as a big shock after it’s shown things weren’t perfect. Two recent examples of pricing for perfection and the fascination with the market reaching specific are the US Gold ETF [NYSE: GLD] and Apple [NASDAQ: AAPL].
In August 2011, the Wall Street Journal reported:
‘GLD, the SPDR Gold Trust ETF, is now bigger in terms of assets than SPY, the SPDR S&P 500 ETF. GLD has $77 billion in assets, compared with $75 billion for SPDR…’
The GLD ETF hit USD$183 in September 2011. By the end of the year it was down to USD$151. In September 2011, gold was priced for perfection. Investors were betting on the collapse of the fiat monetary system and the prospect of a US debt default. So far, that hasn’t happened.
Apple Shares Were Priced for Perfection
Another example. In August last year, the Sydney Morning Herald reported:
‘Apple became the most valuable public company of all time after its market value climbed beyond $US620 billion to surpass a milestone set by Microsoft more than a decade ago.
‘Its shares were up 2.3 per cent at $US662.73 in overnight trade, after having gained more than 8 per cent this month as Wall Street bets on the September 12 rollout of the latest version of the iPhone, the device that revolutionised the mobile industry.’
Apple was priced for perfection. Its shares hit USD$705 in September. Today the shares are USD$506.09, and the market cap has slipped to USD$476 billion.
What happened to the market in 2000 and 2007, and what happened to the Gold ETF and Apple is what eventually happens to all stocks. They go up and up and up, until they’re priced for perfection and no-one can see how the stock price can possibly fall…but then the stock price falls.
Traders like Murray Dawes thrive from finding stocks that are priced for perfection. Those are stocks that are usually trading at the top of what Murray calls the ‘distribution’.
Right now, today…17 January 2013, it looks to us that Commonwealth Bank [ASX: CBA] is priced for perfection. So if there’s a stock on the Aussie market ripe for traders to short-sell, CBA seems to fit the bill.
That’s got to be a real risk for CBA shareholders.
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