Diversification works great...until it doesn't
Many financial advisers tout the benefits of diversification. They reason that spreading your eggs among many baskets can protect your aggregate egg count in case one basket drops.
But, what if there is some underlying reason that causes all baskets to drop all at once? Then, of course, all your eggs drop.
Most people didn't think this was possible, and yet it happened in 2008. Almost every asset class dropped as the market panicked. The one major exception was U.S. Treasury Bonds.
As John Authers put it in his "The Short View" column in the Financial Times, "...last year's sell-off was so extreme that diversification would not have helped one whit."
But, isn't it at times like this, when everyone is panicking, that diversification is supposed to provide benefits? Yes, it is supposed to. But, that doesn't mean it does.
The reason why is that all financial markets are linked. Just because everyone is running from one investment does not mean another "historically uncorrelated" asset is necessarily doing well. This was very clear in 2008.
Diversification seems to work best when you don't need it. People don't get excited about diversification during normal times. It just gives you average instead of slightly better or slightly worse returns.
If you have half your money in U.S. stocks that provide a 5% return and half your money in foreign stocks that provide a 15% return, you get 10% returns. All you manage to do is lock in mediocre returns all the time. Getting 5% returns versus 10% or 15% returns in a single year won't ruin someones retirement. Losing 40% the year after retiring almost certainly will.
When markets really panic, everything goes down together. Even a brief glance at economic history confirms this. Diversification fails when people want it most. Like...well, like in 2008.
There is a very real benefit to be gained from this situation, though. Not all investments have bad underlying characteristics. The very fact that a panic has occurred means both good and bad investments were sold off. So, you can currently buy excellent investments for the same price as the poor ones.
But, if you diversify you'll get both the bad and the good returns going forward. Someone down 40% will see a world of difference between getting a 67% return (being in the good investments and returning to starting principal value) and getting a 33% return (being diversified in half the good investments that go up 67% and half the bad investments that go nowhere, thus still being down 20% from starting principal value).
Or, as John Authers put it, "If there is any consolation, it is that the sell-off was so indiscriminate. The odds are overwhelming that some stocks and asset classes will now begin to outperform."
I don't know when, exactly, those good stocks and asset classes will take off, but I'm quite comfortable I have identified them and believe very strongly my clients and I will benefit going forward.
This may very well be a case where not being too diversified will reap great benefits.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, January 30, 2009
Friday, January 23, 2009
Economists are like diapers
Economists love to make forecasts. The problem is: most economists are like diapers, they require frequent changing and for the same reason (i.e. they are full of crap). Don't spend too much time thinking or worrying about economic forecasts, they are seldom if ever right.
This may seem like an overly harsh judgment, but I cannot think of any profession that has a worse track record (even politicians seem to do better, and from me that's quite a concession).
Most economists are either from or in academia. Their focus is on an other-worldly fantasy that has few similarities to the world we live in. Not surprisingly, this ivory tower approach leads to terrible forecasts.
You would think this would bug economists, but it doesn't. Most seem quite happy to profess theories based on assumptions they will gladly admit are false. They are more concerned with theoretical elegance and mathematical precision than with accurately predicting reality.
One school of thought is that markets are always efficient--they are always rational in the sense of an unemotional investor with all the facts at their disposal. I don't know any unemotional investors, and any experience with markets would quickly convince any honest person that markets are not rational in the short term (though they definitely are over the long term).
Another school of thought is that markets are irrational and thus require government intervention. But, if the human beings in the market are irrational, what prevents government employees--also human beings as far as I know--from not also make irrational decisions in their intervention? No answer is given.
Another school of thought is that the government printing money can solve bad lending. But, if printing money fixes problems, then why not just print it all the time and make everyone happy always. Sounds like a perpetual motion machine to me (more accurately: hyper-inflation).
Another school of thought is that the government can cut taxes while continuing to spend recklessly. But, if it's dumb for an individual to spend beyond his means forever, why would it be smart for a government to do so? Because the government exists on another plane of reality?
Another school of thought refuses to make precise predictions because it acknowledges the impossibility in the realm of human endeavors. Paradoxically, this seems to be the only school that correctly foresaw the Great Depression, the inflation of the 1970's, the Internet Bubble, and the Housing/Credit Bubble. No one listens to this school, it's considered fringe by many, and is taught in only a handful of colleges (Auburn is one).
Next time you hear or see an economist make a prediction--on the radio, in print, on TV--keep in mind the field's lousy record. Remember they are mostly academics with little success in predicting real world events.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Economists love to make forecasts. The problem is: most economists are like diapers, they require frequent changing and for the same reason (i.e. they are full of crap). Don't spend too much time thinking or worrying about economic forecasts, they are seldom if ever right.
This may seem like an overly harsh judgment, but I cannot think of any profession that has a worse track record (even politicians seem to do better, and from me that's quite a concession).
Most economists are either from or in academia. Their focus is on an other-worldly fantasy that has few similarities to the world we live in. Not surprisingly, this ivory tower approach leads to terrible forecasts.
You would think this would bug economists, but it doesn't. Most seem quite happy to profess theories based on assumptions they will gladly admit are false. They are more concerned with theoretical elegance and mathematical precision than with accurately predicting reality.
One school of thought is that markets are always efficient--they are always rational in the sense of an unemotional investor with all the facts at their disposal. I don't know any unemotional investors, and any experience with markets would quickly convince any honest person that markets are not rational in the short term (though they definitely are over the long term).
Another school of thought is that markets are irrational and thus require government intervention. But, if the human beings in the market are irrational, what prevents government employees--also human beings as far as I know--from not also make irrational decisions in their intervention? No answer is given.
Another school of thought is that the government printing money can solve bad lending. But, if printing money fixes problems, then why not just print it all the time and make everyone happy always. Sounds like a perpetual motion machine to me (more accurately: hyper-inflation).
Another school of thought is that the government can cut taxes while continuing to spend recklessly. But, if it's dumb for an individual to spend beyond his means forever, why would it be smart for a government to do so? Because the government exists on another plane of reality?
Another school of thought refuses to make precise predictions because it acknowledges the impossibility in the realm of human endeavors. Paradoxically, this seems to be the only school that correctly foresaw the Great Depression, the inflation of the 1970's, the Internet Bubble, and the Housing/Credit Bubble. No one listens to this school, it's considered fringe by many, and is taught in only a handful of colleges (Auburn is one).
Next time you hear or see an economist make a prediction--on the radio, in print, on TV--keep in mind the field's lousy record. Remember they are mostly academics with little success in predicting real world events.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, January 16, 2009
The perils of leverage
One of the biggest lessons of the current financial crisis is: don't take on too much debt.
This may sound like common sense advice, but it's amazing how often people forget it.
If you buy a house with cash and its value increases 20%, you've gotten a 20% return. If, however, you borrow 80%, put 20% down, and its value increases by 20%, you've just doubled your money. There's a big upside to using leverage.
But, debt is a double-edged sword. It doesn't just give you bigger returns if things go well, it also gives you bigger losses if they don't go well.
Using the same example above, someone who pays cash for a house that decreases 20% in value losses 20%. Someone who only puts down 20%, though, has lost everything.
Archimedes said he could move the world with a large enough lever. The lever multiplies the impact of your input. But, such leverage works both positively and negatively.
When banks were as free as they've been, in the late 19th century (1800's), they carried 40% equity and borrowed 60% (levered 2.5 to 1). Banks operated that way could generally survive the inevitable economic storms that come along with economic cycles.
But, banks nowadays are regulated to be levered 10 to 1: they borrow 10 dollars and only contribute 1 of their own (or shareholders'). Such leverage is a double-edged sword, too. If a bank levered 10 to 1 makes loans and 9.1% of them go bad, the bank is basically insolvent. That's what's been happening recently.
Investment banks were levered 30 to 1. The top 5 investment banks are all gone or have been forced to become levered 10 to 1. Mortgage insurers and bond insurers were levered as highly as 140 to 1, they are now almost all insolvent. Many other insurers were levered up too much, such as AIG, and they didn't understand the leverage they had taken on. That lack of understanding didn't save them (or taxpayers).
Our current crisis is a perfect illustration of the perils of leverage. Companies like GM and GE are in trouble because they financed their companies with too much debt. It is difficult for almost any but the least levered companies to borrow money, now. As a result, almost any company with too much leverage has had their stock price massacred.
Everyone seems to understand that too much leverage is bad. But many businesses and individuals took on too much leverage and they blew up. Those are the folks getting bailed out now, and they are being bailed out by those who didn't take on too much leverage. That just doesn't seem right.
It seems like taking on too much leverage is a lesson that must be learned periodically. Those who survived the Great Depression were terrified of borrowing money.
Unfortunately, our country is currently trying to fix our leverage problems by levering up our government. It's hard to understand how you can solve the problem of leverage with more leverage.
When a government gets too levered, the resulting problem is almost always inflation. Inflation solves the government's problem with leverage, but not its citizens'.
Beware leverage. Beware inflation.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
One of the biggest lessons of the current financial crisis is: don't take on too much debt.
This may sound like common sense advice, but it's amazing how often people forget it.
If you buy a house with cash and its value increases 20%, you've gotten a 20% return. If, however, you borrow 80%, put 20% down, and its value increases by 20%, you've just doubled your money. There's a big upside to using leverage.
But, debt is a double-edged sword. It doesn't just give you bigger returns if things go well, it also gives you bigger losses if they don't go well.
Using the same example above, someone who pays cash for a house that decreases 20% in value losses 20%. Someone who only puts down 20%, though, has lost everything.
Archimedes said he could move the world with a large enough lever. The lever multiplies the impact of your input. But, such leverage works both positively and negatively.
When banks were as free as they've been, in the late 19th century (1800's), they carried 40% equity and borrowed 60% (levered 2.5 to 1). Banks operated that way could generally survive the inevitable economic storms that come along with economic cycles.
But, banks nowadays are regulated to be levered 10 to 1: they borrow 10 dollars and only contribute 1 of their own (or shareholders'). Such leverage is a double-edged sword, too. If a bank levered 10 to 1 makes loans and 9.1% of them go bad, the bank is basically insolvent. That's what's been happening recently.
Investment banks were levered 30 to 1. The top 5 investment banks are all gone or have been forced to become levered 10 to 1. Mortgage insurers and bond insurers were levered as highly as 140 to 1, they are now almost all insolvent. Many other insurers were levered up too much, such as AIG, and they didn't understand the leverage they had taken on. That lack of understanding didn't save them (or taxpayers).
Our current crisis is a perfect illustration of the perils of leverage. Companies like GM and GE are in trouble because they financed their companies with too much debt. It is difficult for almost any but the least levered companies to borrow money, now. As a result, almost any company with too much leverage has had their stock price massacred.
Everyone seems to understand that too much leverage is bad. But many businesses and individuals took on too much leverage and they blew up. Those are the folks getting bailed out now, and they are being bailed out by those who didn't take on too much leverage. That just doesn't seem right.
It seems like taking on too much leverage is a lesson that must be learned periodically. Those who survived the Great Depression were terrified of borrowing money.
Unfortunately, our country is currently trying to fix our leverage problems by levering up our government. It's hard to understand how you can solve the problem of leverage with more leverage.
When a government gets too levered, the resulting problem is almost always inflation. Inflation solves the government's problem with leverage, but not its citizens'.
Beware leverage. Beware inflation.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, January 09, 2009
After a financial crisis, recessions are worse than average
Not all recessions are the same. Most recessions are a manifestation of the business cycle. But, when a recession is the result of a crisis in the financial sector, things get much worse.
What does that mean for investors? It means this is a once or twice in a lifetime opportunity to buy equities at very low prices. This opportunity may exist for some time, but trying to predict when markets will recover is a losing proposition. Get invested now and keep some cash on hand in case things get significantly worse.
A recent paper by Carmen Reinhart and Kenneth Rogoff, called "The Aftermath of Financial Crises," provides support for the view that recessions following a financial crisis are worse than average.
In their paper, they show that asset markets collapse more deeply and for a longer time period. Real (after inflation) housing prices collapse an average of 35% over 6 years. Equity prices collapse by 55% over 3 1/2 years. Unemployment rises an average of 7% over 4 years. Output falls 9% over 2 years. The real value of government debt explodes.
The average recession lasts 10 months. Using that average, we would have come out of this recession last October because we entered it in December of 2007. As I'm sure you know by now, that didn't happen. In fact, the recession hit high gear around that time.
Averages are not a proper expectation for what will happen. If you stuck your head in an oven and your feet in a freezer, your average temperature would be comfortable, but I guarantee you'd be miserable. Averages can be deceiving and misused.
But, averages can be useful for gauging what could happen. My intention here is to prepare you for the downside and how rough this ride will be, not to predict what will happen or when.
Asset markets have been down around 40%, so getting to down 55% would require another 25% decline from the down 40% level. I wouldn't be surprised to see markets go significantly lower, but that's impossible to predict. A decline to the 55% level, or even the 90% level like the Great Depression, is likely to be very short lived. The best thing to do is be prepared for the downside while acknowledging that the upside for equities from here is extraordinarily good. Try to pick the bottom is a fool's errand.
We're only a year and a half into the housing price decline, but this market was unusually over-valued at the top, so I expect it to end up more than 35% down. I also wouldn't be surprised to see this last shorter than it has historically because of how rapidly it declined and how actively the government is intervening.
Unemployment bottomed around 4.4%, so it would have to get over 11% to reach historical average. The rate is around 7.2% currently, so we are well on our way there. Remember, unemployment is a lagging indicator. It will almost certainly hit its peak long after the markets and economy are recovering.
Output has only started to fall, and getting to the down 9% level will be painful. Like with employment, this will be a lagging indicator. By the time we see it recovering, markets will almost certainly be up significantly.
Government debt is already ballooning and will continue to do so. Government officials are already calling for a $1.2 trillion deficit this year, and that is only the tip of the iceberg. When an institution issues a lot of debt, even the U.S. government, their cost of debt will go up. Be prepared for higher interest rates and inflation. This may take years to develop, but when it does it will be truly life-changing.
Recessions following financial crises are deeper and longer lasting than average. It looks like we're in such a situation. Be prepared for the downside. Be prepared for a lot of negative news going forward. But, most importantly, get invested to take advantage of the recovery and be prepared for even lower prices--in case they happen--in the future.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Not all recessions are the same. Most recessions are a manifestation of the business cycle. But, when a recession is the result of a crisis in the financial sector, things get much worse.
What does that mean for investors? It means this is a once or twice in a lifetime opportunity to buy equities at very low prices. This opportunity may exist for some time, but trying to predict when markets will recover is a losing proposition. Get invested now and keep some cash on hand in case things get significantly worse.
A recent paper by Carmen Reinhart and Kenneth Rogoff, called "The Aftermath of Financial Crises," provides support for the view that recessions following a financial crisis are worse than average.
In their paper, they show that asset markets collapse more deeply and for a longer time period. Real (after inflation) housing prices collapse an average of 35% over 6 years. Equity prices collapse by 55% over 3 1/2 years. Unemployment rises an average of 7% over 4 years. Output falls 9% over 2 years. The real value of government debt explodes.
The average recession lasts 10 months. Using that average, we would have come out of this recession last October because we entered it in December of 2007. As I'm sure you know by now, that didn't happen. In fact, the recession hit high gear around that time.
Averages are not a proper expectation for what will happen. If you stuck your head in an oven and your feet in a freezer, your average temperature would be comfortable, but I guarantee you'd be miserable. Averages can be deceiving and misused.
But, averages can be useful for gauging what could happen. My intention here is to prepare you for the downside and how rough this ride will be, not to predict what will happen or when.
Asset markets have been down around 40%, so getting to down 55% would require another 25% decline from the down 40% level. I wouldn't be surprised to see markets go significantly lower, but that's impossible to predict. A decline to the 55% level, or even the 90% level like the Great Depression, is likely to be very short lived. The best thing to do is be prepared for the downside while acknowledging that the upside for equities from here is extraordinarily good. Try to pick the bottom is a fool's errand.
We're only a year and a half into the housing price decline, but this market was unusually over-valued at the top, so I expect it to end up more than 35% down. I also wouldn't be surprised to see this last shorter than it has historically because of how rapidly it declined and how actively the government is intervening.
Unemployment bottomed around 4.4%, so it would have to get over 11% to reach historical average. The rate is around 7.2% currently, so we are well on our way there. Remember, unemployment is a lagging indicator. It will almost certainly hit its peak long after the markets and economy are recovering.
Output has only started to fall, and getting to the down 9% level will be painful. Like with employment, this will be a lagging indicator. By the time we see it recovering, markets will almost certainly be up significantly.
Government debt is already ballooning and will continue to do so. Government officials are already calling for a $1.2 trillion deficit this year, and that is only the tip of the iceberg. When an institution issues a lot of debt, even the U.S. government, their cost of debt will go up. Be prepared for higher interest rates and inflation. This may take years to develop, but when it does it will be truly life-changing.
Recessions following financial crises are deeper and longer lasting than average. It looks like we're in such a situation. Be prepared for the downside. Be prepared for a lot of negative news going forward. But, most importantly, get invested to take advantage of the recovery and be prepared for even lower prices--in case they happen--in the future.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, January 02, 2009
Happy New Year!
I enter 2009 as enthusiastic as I've ever been about future returns.
That's not a forecast for returns this year. I don't know what returns the market will generate over the next week, month or year, and anyone who tells you they do know is lying.
What I do know is that stock prices are as low as they've been relative to fundamental business values since the early to mid 1980's.
Does that mean the stock market won't go lower? No.
If the stock market bottoms where it did in the 1970's, it would be 33% lower than it was at year end.
If the market bottoms where it did in the early 1950's, it would be 40% lower than it was at year end.
If the market bottoms where it did during the early 1930's--at its worst during the Great Depression--it would have to go down another 60% or more.
Those aren't forecasts, that's just a report of how bad things could get based on historical information.
But, as Mark Twain said, history doesn't repeat, but it sure does rhyme. No one knows what precisely will happen, even if they get lucky and their prediction turns out to be right.
All a prudent investor can do is invest based on the facts, and the facts say that stocks are cheap. If they get cheaper, then even better bargains will be had. If they get dearer, investors will see their portfolio values climb.
Based on fundamentals, it's reasonable to expect the S&P 500 to be up 10% - 15%, annualized, over the next 5 years. That's unlikely to be a smooth path upward, but it's a very likely outcome.
Even better, carefully selected stocks are likely to do much better than that.
And, that's why I'm as optimistic as I've ever been in my 13 years of investing.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
I enter 2009 as enthusiastic as I've ever been about future returns.
That's not a forecast for returns this year. I don't know what returns the market will generate over the next week, month or year, and anyone who tells you they do know is lying.
What I do know is that stock prices are as low as they've been relative to fundamental business values since the early to mid 1980's.
Does that mean the stock market won't go lower? No.
If the stock market bottoms where it did in the 1970's, it would be 33% lower than it was at year end.
If the market bottoms where it did in the early 1950's, it would be 40% lower than it was at year end.
If the market bottoms where it did during the early 1930's--at its worst during the Great Depression--it would have to go down another 60% or more.
Those aren't forecasts, that's just a report of how bad things could get based on historical information.
But, as Mark Twain said, history doesn't repeat, but it sure does rhyme. No one knows what precisely will happen, even if they get lucky and their prediction turns out to be right.
All a prudent investor can do is invest based on the facts, and the facts say that stocks are cheap. If they get cheaper, then even better bargains will be had. If they get dearer, investors will see their portfolio values climb.
Based on fundamentals, it's reasonable to expect the S&P 500 to be up 10% - 15%, annualized, over the next 5 years. That's unlikely to be a smooth path upward, but it's a very likely outcome.
Even better, carefully selected stocks are likely to do much better than that.
And, that's why I'm as optimistic as I've ever been in my 13 years of investing.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, December 19, 2008
At some point, inflation
Sometimes it's useful to look beyond the current headlines to what may be coming over the next 3 to 5 years.
From my vantage point, what I see coming is inflation.
Currently, the news is filled with signs of deflation. Asset prices are collapsing. Housing prices are down significantly. Almost anything, other than U.S. Treasury securities, seems to be down over the last year.
Commodities have been particularly hard hit. It wasn't that long ago that oil was at $147 per barrel and people were talking about it going over $200. Now, it's below $40.
But, what has changed? Mostly, demand has dropped dramatically. As Economics 101 will tell you, when the demand curve shifts down and the supply curve stays the same, you get lower prices. I think I can safely say that has happened.
So, why had demand been crushed. In a word, deleveraging. The economy as a whole--businesses and consumers, at least--have been paying back debts to keep from going bankrupt. Not everyone is succeeding.
This reduction in debt has led to a tremendous fall-off in demand for goods and services of all sorts. You can see that clearly in the GDP and employment numbers. For those those who thought only Wall Street was in trouble, take another look.
But, the biggest debtor out there--the U.S. government--has been borrowing and printing money like it's going out of style.
Eventually, such borrowing and printing will get credit markets going. And, when they do, we'll all owe a lot more debt and have a lot more dollars chasing the same number of goods. In other words, inflation.
I don't think it will happen soon. Although the Fed is printing money and Congress is finding all kinds of ways to spend it, economic activity has slowed down so much that all it's doing is making deflation happen less quickly. Eventually, and over the next several years, economic activity will pick back up again and this will be visible in the so-called velocity of money.
When that happens, the demand curve will shift back up and prices will recover. But--and there's always a but--the government will be in a lot more debt and there will be a lot more dollars chasing the same amount of demand.
In 3 to 5 years, and perhaps sooner, the news won't be about deflation, but inflation. And, that inflation will be a lot higher than in the 80's, 90's or 00's. In fact, it wouldn't surprise me to see $300 a barrel oil and double digit inflation rates (not the core rate, but including food and energy).
With that in mind, you may want to consider inflation-proofing your portfolio over the coming years. Think about companies that can jack up their prices and customers will still pay. Think about commodity producing companies. Be wary of bonds with low payouts or higher risk of default.
It may not happen right away, but over the next several years, get prepared for inflation.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Sometimes it's useful to look beyond the current headlines to what may be coming over the next 3 to 5 years.
From my vantage point, what I see coming is inflation.
Currently, the news is filled with signs of deflation. Asset prices are collapsing. Housing prices are down significantly. Almost anything, other than U.S. Treasury securities, seems to be down over the last year.
Commodities have been particularly hard hit. It wasn't that long ago that oil was at $147 per barrel and people were talking about it going over $200. Now, it's below $40.
But, what has changed? Mostly, demand has dropped dramatically. As Economics 101 will tell you, when the demand curve shifts down and the supply curve stays the same, you get lower prices. I think I can safely say that has happened.
So, why had demand been crushed. In a word, deleveraging. The economy as a whole--businesses and consumers, at least--have been paying back debts to keep from going bankrupt. Not everyone is succeeding.
This reduction in debt has led to a tremendous fall-off in demand for goods and services of all sorts. You can see that clearly in the GDP and employment numbers. For those those who thought only Wall Street was in trouble, take another look.
But, the biggest debtor out there--the U.S. government--has been borrowing and printing money like it's going out of style.
Eventually, such borrowing and printing will get credit markets going. And, when they do, we'll all owe a lot more debt and have a lot more dollars chasing the same number of goods. In other words, inflation.
I don't think it will happen soon. Although the Fed is printing money and Congress is finding all kinds of ways to spend it, economic activity has slowed down so much that all it's doing is making deflation happen less quickly. Eventually, and over the next several years, economic activity will pick back up again and this will be visible in the so-called velocity of money.
When that happens, the demand curve will shift back up and prices will recover. But--and there's always a but--the government will be in a lot more debt and there will be a lot more dollars chasing the same amount of demand.
In 3 to 5 years, and perhaps sooner, the news won't be about deflation, but inflation. And, that inflation will be a lot higher than in the 80's, 90's or 00's. In fact, it wouldn't surprise me to see $300 a barrel oil and double digit inflation rates (not the core rate, but including food and energy).
With that in mind, you may want to consider inflation-proofing your portfolio over the coming years. Think about companies that can jack up their prices and customers will still pay. Think about commodity producing companies. Be wary of bonds with low payouts or higher risk of default.
It may not happen right away, but over the next several years, get prepared for inflation.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, December 12, 2008
Keeping your head in trying times
The hardest part of watching the stock market recently has been keeping things in the right context.
The stock market is not a crystal ball that reveals a company's true worth. It merely shows what people are willing to buy and sell partial ownership of companies at any point in time.
But who is buying and who is selling?
Are sellers under pressure because they bought with borrowed money? Are they professional investors who are selling because their customers are cashing out in a panic?
Are buyers carefully considering the value of companies? Are they waiting to see what the government or other buyers and sellers will do next?
Markets do not reveal underlying worth, they simply reveal what people are willing to pay at a point in time. But, those assessments change over time--sometimes dramatically.
The way I'm keeping my head in these difficult times is to look past stock prices at the underlying businesses I own. Such businesses are in good shape and have bright futures.
Focusing on the underlying business is key to keeping your head. It allows the market to be your servant instead of your master.
Right now, and for some time to come I think, that servant will provide wonderful bargains on great companies.
As long as you look past the price at the underlying business, you too can keep your head and benefit from trying times.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
The hardest part of watching the stock market recently has been keeping things in the right context.
The stock market is not a crystal ball that reveals a company's true worth. It merely shows what people are willing to buy and sell partial ownership of companies at any point in time.
But who is buying and who is selling?
Are sellers under pressure because they bought with borrowed money? Are they professional investors who are selling because their customers are cashing out in a panic?
Are buyers carefully considering the value of companies? Are they waiting to see what the government or other buyers and sellers will do next?
Markets do not reveal underlying worth, they simply reveal what people are willing to pay at a point in time. But, those assessments change over time--sometimes dramatically.
The way I'm keeping my head in these difficult times is to look past stock prices at the underlying businesses I own. Such businesses are in good shape and have bright futures.
Focusing on the underlying business is key to keeping your head. It allows the market to be your servant instead of your master.
Right now, and for some time to come I think, that servant will provide wonderful bargains on great companies.
As long as you look past the price at the underlying business, you too can keep your head and benefit from trying times.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, December 05, 2008
Things are looking up
I'm not a market timer, but when market sentiment is as negative as it is now, it's not a bad idea to look for the silver lining which may mean things are improving.
Today, new unemployment claims came in at over 500,000, the worst report since the brutal 1974 recession. After these figures are fully adjusted over the next several years, it would not surprise me to see this number close to 1,000,000.
How is that good news? Because the market is up today!
When extremely negative numbers come out about the economy and the stock market doesn't go down by much or even goes up, it means people have fully grasped how negative things are and are starting to look for a future recovery.
That doesn't mean the market has bottomed or that all the bad news has been announced. But, it does mean that market participants are recognizing how bad things are and are perhaps seeing that things won't be so bad in the future.
Added to this, employment figures are a lagging indicator. That means that employment figures tend to look worst near stock market bottoms. Employment is a reaction to economic conditions, not a forecaster of them. Employment figures look bad when employers are throwing in the towel and laying people off. This is usually when the stock market begins to recover.
Why? Because the stock market is a forecasting mechanism. The price of a stock should be equal to all future cash flows. Prices shouldn't reflect current conditions, or even conditions over the near term, but should reflect all future possibilities of a company.
That's why the stock market tends to recover long before the economy, and why waiting for economic figures to improve is a sure fire way to miss out on huge market rallies.
I don't know if the stock market will go up next week, month or year, but I do know that many companies are trading at depression levels even though they have bright futures.
In other words, the best bargains in 25 years can be found right now, if you can see the silver lining.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
I'm not a market timer, but when market sentiment is as negative as it is now, it's not a bad idea to look for the silver lining which may mean things are improving.
Today, new unemployment claims came in at over 500,000, the worst report since the brutal 1974 recession. After these figures are fully adjusted over the next several years, it would not surprise me to see this number close to 1,000,000.
How is that good news? Because the market is up today!
When extremely negative numbers come out about the economy and the stock market doesn't go down by much or even goes up, it means people have fully grasped how negative things are and are starting to look for a future recovery.
That doesn't mean the market has bottomed or that all the bad news has been announced. But, it does mean that market participants are recognizing how bad things are and are perhaps seeing that things won't be so bad in the future.
Added to this, employment figures are a lagging indicator. That means that employment figures tend to look worst near stock market bottoms. Employment is a reaction to economic conditions, not a forecaster of them. Employment figures look bad when employers are throwing in the towel and laying people off. This is usually when the stock market begins to recover.
Why? Because the stock market is a forecasting mechanism. The price of a stock should be equal to all future cash flows. Prices shouldn't reflect current conditions, or even conditions over the near term, but should reflect all future possibilities of a company.
That's why the stock market tends to recover long before the economy, and why waiting for economic figures to improve is a sure fire way to miss out on huge market rallies.
I don't know if the stock market will go up next week, month or year, but I do know that many companies are trading at depression levels even though they have bright futures.
In other words, the best bargains in 25 years can be found right now, if you can see the silver lining.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, November 21, 2008
Market prices are only relevant if you have to sell
Andy Kessler wrote an excellent opinion piece that appeared in the Wall Street Journal yesterday. His article was titled "Ignore the Stock Market Until February."
His basic point is that a lot of selling in the stock market over the last 2 months has been due to reasons other than a rational assessment of investment merit.
He goes on to list the reasons why many people have been selling:
- tax loss selling - selling to book losses, thus reducing taxes
- mutual fund redemptions - people selling mutual funds cause the effected money manager to have to sell something, and such managers tend to chose things that have gone down the least
- mutual fund cap-gain distributions - investors are selling to pay their capital gains taxes
- hedge fund redemptions - just like mutual fund managers, hedge funds facing redemptions have to sell something, and they are choosing to sell things that have gone down the least
- margin calls - people, both individual and institutional investors, who bought stocks on margin are selling to cover margin calls as stocks go down--the so-called process of de-leveraging
I'll add another thing to that list--stop loss orders. People who think that putting in stop loss orders will save them from losses are having their stop loss orders triggered over and over again as the market goes down. This tends to be sell-reinforcing on the way down.
The result is a bunch of forced selling that is causing the stock market to go down more than it otherwise would. This may seem bad, but it's actually a good thing. (If there were a self-reinforcing cycle that made flat screen TVs go down in price, we'd be tickled pink because the value of the TV to us doesn't go down as the price does--how are stocks different?)
Why are declining stock prices good? Because that means the stocks being sold are getting pushed down to lows they would not otherwise hit. The underlying value of the business isn't changing, just the quoted price other people want to buy/sell it. If you hold a company whose price has gone down, you are free to disagree with the market by not selling, or even buying.
As long as you don't have to sell, the current market quote isn't relevant.
Only when you have to sell are market prices relevant. If you don't have to sell, you don't have to book losses. And, if you don't have to book losses, then you haven't really lost anything, yet.
Benjamin Graham once said the market should serve you, not be your master. Right now, the market is serving up unbelievable discounts on some of the best companies around. This is a great time to buy, or a great chance to sell things that haven't gone down and buy great companies that have gone down significantly.
Kessler makes the point that the market will continue to go down in December as tax loss harvesting continues and leverage is unwound. In January, a bunch of money managers will get fired for lousy performance, and the new managers will be selling in January to get rid of the previous manager's mistakes. That means market prices are likely to be far off underlying values until at least February.
That means you have 2 months--2 glorious, happy months--to buy into the best bargains seen in almost 25 years. I've never been so excited about future returns.
When February comes, I'll be well positioned to benefit, and so will my clients.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Andy Kessler wrote an excellent opinion piece that appeared in the Wall Street Journal yesterday. His article was titled "Ignore the Stock Market Until February."
His basic point is that a lot of selling in the stock market over the last 2 months has been due to reasons other than a rational assessment of investment merit.
He goes on to list the reasons why many people have been selling:
- tax loss selling - selling to book losses, thus reducing taxes
- mutual fund redemptions - people selling mutual funds cause the effected money manager to have to sell something, and such managers tend to chose things that have gone down the least
- mutual fund cap-gain distributions - investors are selling to pay their capital gains taxes
- hedge fund redemptions - just like mutual fund managers, hedge funds facing redemptions have to sell something, and they are choosing to sell things that have gone down the least
- margin calls - people, both individual and institutional investors, who bought stocks on margin are selling to cover margin calls as stocks go down--the so-called process of de-leveraging
I'll add another thing to that list--stop loss orders. People who think that putting in stop loss orders will save them from losses are having their stop loss orders triggered over and over again as the market goes down. This tends to be sell-reinforcing on the way down.
The result is a bunch of forced selling that is causing the stock market to go down more than it otherwise would. This may seem bad, but it's actually a good thing. (If there were a self-reinforcing cycle that made flat screen TVs go down in price, we'd be tickled pink because the value of the TV to us doesn't go down as the price does--how are stocks different?)
Why are declining stock prices good? Because that means the stocks being sold are getting pushed down to lows they would not otherwise hit. The underlying value of the business isn't changing, just the quoted price other people want to buy/sell it. If you hold a company whose price has gone down, you are free to disagree with the market by not selling, or even buying.
As long as you don't have to sell, the current market quote isn't relevant.
Only when you have to sell are market prices relevant. If you don't have to sell, you don't have to book losses. And, if you don't have to book losses, then you haven't really lost anything, yet.
Benjamin Graham once said the market should serve you, not be your master. Right now, the market is serving up unbelievable discounts on some of the best companies around. This is a great time to buy, or a great chance to sell things that haven't gone down and buy great companies that have gone down significantly.
Kessler makes the point that the market will continue to go down in December as tax loss harvesting continues and leverage is unwound. In January, a bunch of money managers will get fired for lousy performance, and the new managers will be selling in January to get rid of the previous manager's mistakes. That means market prices are likely to be far off underlying values until at least February.
That means you have 2 months--2 glorious, happy months--to buy into the best bargains seen in almost 25 years. I've never been so excited about future returns.
When February comes, I'll be well positioned to benefit, and so will my clients.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, November 14, 2008
"buy some good stock and hold it till it goes up"
I recently got back from a trip to Rome. Wow, what an amazing place. I've spent the last several years learning all about ancient Rome, and making a trip there really capped it off nicely.
On part of the plane ride back, for there were many legs, I sat next to a nice man who is an architect.
In conversation, it came up that I was a professional investor. He commented that this must be a terrible time to be in this field, and I retorted that it's a wonderful time because I'm good at what I do and the opportunities are legendary.
His response was that someone who sold several months ago would have proven brilliant.
I didn't respond because I was dumb-founded that someone who seemed so intelligent was suffering from such powerful case of hindsight bias.
It reminded me of the Will Rogers quote, "take all your saving and buy some good stock and hold it till it goes up, then sell it. If it doesn't go up, don't buy it."
Of course, Rogers was making fun of the concept of hindsight bias. He was poking fun at the people who think you can successfully invest by only buying things that went up in hindsight.
But, most investors seem to think that's the way to make money. Just sell at the top and buy at the bottom. The problem is that no one can do this consistently. Some people have done it because they were lucky once or twice, but no one does it consistently. Even worse, the people who try are almost always doing worse than someone who just buys and holds.
People who try to sell at the top and buy at the bottom end up guessing on the roll of a die and either getting lucky or unlucky. That's not investing wisdom.
A smart weather predictor doesn't try to boldly guess the weather. They look at the facts, consult a lot of data, read a lot of history, and make judgments based on hours of analysis. And, even then, they use percentages to forecast how likely certain weather phenomenon are to occur.
The stock market is even more difficult to predict than the weather. There aren't any successful investors who time the market, just like there aren't any successful weather predictors who guess about the weather.
The secret isn't to look into the past and wish you had timed things perfectly. The secret is to do analysis, consult history, and make bets where the odds are heavily in your favor--even though you don't know exactly what will happen.
The people who try to sell high and buy low almost always end up doing the opposite, and their investing results and overall wealth reflect that strategy.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
I recently got back from a trip to Rome. Wow, what an amazing place. I've spent the last several years learning all about ancient Rome, and making a trip there really capped it off nicely.
On part of the plane ride back, for there were many legs, I sat next to a nice man who is an architect.
In conversation, it came up that I was a professional investor. He commented that this must be a terrible time to be in this field, and I retorted that it's a wonderful time because I'm good at what I do and the opportunities are legendary.
His response was that someone who sold several months ago would have proven brilliant.
I didn't respond because I was dumb-founded that someone who seemed so intelligent was suffering from such powerful case of hindsight bias.
It reminded me of the Will Rogers quote, "take all your saving and buy some good stock and hold it till it goes up, then sell it. If it doesn't go up, don't buy it."
Of course, Rogers was making fun of the concept of hindsight bias. He was poking fun at the people who think you can successfully invest by only buying things that went up in hindsight.
But, most investors seem to think that's the way to make money. Just sell at the top and buy at the bottom. The problem is that no one can do this consistently. Some people have done it because they were lucky once or twice, but no one does it consistently. Even worse, the people who try are almost always doing worse than someone who just buys and holds.
People who try to sell at the top and buy at the bottom end up guessing on the roll of a die and either getting lucky or unlucky. That's not investing wisdom.
A smart weather predictor doesn't try to boldly guess the weather. They look at the facts, consult a lot of data, read a lot of history, and make judgments based on hours of analysis. And, even then, they use percentages to forecast how likely certain weather phenomenon are to occur.
The stock market is even more difficult to predict than the weather. There aren't any successful investors who time the market, just like there aren't any successful weather predictors who guess about the weather.
The secret isn't to look into the past and wish you had timed things perfectly. The secret is to do analysis, consult history, and make bets where the odds are heavily in your favor--even though you don't know exactly what will happen.
The people who try to sell high and buy low almost always end up doing the opposite, and their investing results and overall wealth reflect that strategy.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, October 31, 2008
How low can you go?
A lot people are wondering how bad the stock market can get.
I don't know how low it will go, but I have a pretty good idea of how low it can go.
Before I outline my reasoning, let me forewarn you: the answer is ugly.
I'm not trying to predict what the market will do or when--no one really can. I'm just trying to prepare you for the worst case scenario just in case it happens.
You don't want to sell at the bottom. Nothing will hose up your long term goals as much as going to cash in hopes you can sell at the top and buy at the bottom. The odds are highly in favor of you doing just the opposite--most people do. Knowing how bad things can get may help you avoid selling at the bottom, and that's what I'm trying to do in this blog.
The reality is I've never been as bullish as I am now. I'm projecting the highest returns going forward I've seen in 13 years! I'm terribly excited about the returns I believe I'll get over the next 5 years. But, and there's always a but, the stock market could go a lot lower before it goes back up again.
How low? History indicates the market can get as low as 7 times normalized earnings. I've talked about normalized earnings in the past, but let me explain it again briefly.
The stock market's per share earnings have grown quite steadily at around 6% a year over the last 50+ years. In boom times earnings are above this trend, and in bust times earnings are below. But, over time, the earnings always return to trend.
Such earnings are like true north to a navigator. They point the way in all circumstances and provide a ready reference for where you are and where you're going.
That's why I use normalized earnings--it's a steady guide. In boom times, the stock market sells at over 20 times earnings. In bust times, it tends to go down below 10 times earnings. In the worst times, it gets down to around 7 times normalized earnings.
What would 7 times normalized earnings mean for the S&P 500? Normalized earnings in the next year for the S&P 500 will be around $67 a share. 7 times that gives you a value of $469 for the S&P 500, roughly 52% below today's closing price of around $970 on the S&P 500. That would correlate to a Dow Jones Industrial Average of $4,500.
I'm not saying we'll get that low. In fact, I consider that quite unlikely. I'm not saying I want to see it go that low--I'd feel terrible if it did. But, I am saying be prepared for it to go that low just in case it does.
Benjamin Graham, the father of value investing, once said you shouldn't invest in the stock market unless you're ready to see your investment cut in half and double in value. I agree with that sentiment. Be prepared for the worst, hope for the best.
On a brighter note, the stock market usually trades at an average of 15 times normalized earnings. That would mean an S&P 500 of around $1,000 and a Dow of $9,600. In other words, the market is already below fair value.
The problem is the stock market almost always goes below fair value after boom times. It already has, but could go lower still. Be prepared for how low it can go and don't sell at the bottom.
Like I said above, I'm finding the best values I've found in years. Great companies are selling at prices that are likely to generate very high returns over the long run. Even if things go significantly lower, this is an absolutely great time to invest!
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
A lot people are wondering how bad the stock market can get.
I don't know how low it will go, but I have a pretty good idea of how low it can go.
Before I outline my reasoning, let me forewarn you: the answer is ugly.
I'm not trying to predict what the market will do or when--no one really can. I'm just trying to prepare you for the worst case scenario just in case it happens.
You don't want to sell at the bottom. Nothing will hose up your long term goals as much as going to cash in hopes you can sell at the top and buy at the bottom. The odds are highly in favor of you doing just the opposite--most people do. Knowing how bad things can get may help you avoid selling at the bottom, and that's what I'm trying to do in this blog.
The reality is I've never been as bullish as I am now. I'm projecting the highest returns going forward I've seen in 13 years! I'm terribly excited about the returns I believe I'll get over the next 5 years. But, and there's always a but, the stock market could go a lot lower before it goes back up again.
How low? History indicates the market can get as low as 7 times normalized earnings. I've talked about normalized earnings in the past, but let me explain it again briefly.
The stock market's per share earnings have grown quite steadily at around 6% a year over the last 50+ years. In boom times earnings are above this trend, and in bust times earnings are below. But, over time, the earnings always return to trend.
Such earnings are like true north to a navigator. They point the way in all circumstances and provide a ready reference for where you are and where you're going.
That's why I use normalized earnings--it's a steady guide. In boom times, the stock market sells at over 20 times earnings. In bust times, it tends to go down below 10 times earnings. In the worst times, it gets down to around 7 times normalized earnings.
What would 7 times normalized earnings mean for the S&P 500? Normalized earnings in the next year for the S&P 500 will be around $67 a share. 7 times that gives you a value of $469 for the S&P 500, roughly 52% below today's closing price of around $970 on the S&P 500. That would correlate to a Dow Jones Industrial Average of $4,500.
I'm not saying we'll get that low. In fact, I consider that quite unlikely. I'm not saying I want to see it go that low--I'd feel terrible if it did. But, I am saying be prepared for it to go that low just in case it does.
Benjamin Graham, the father of value investing, once said you shouldn't invest in the stock market unless you're ready to see your investment cut in half and double in value. I agree with that sentiment. Be prepared for the worst, hope for the best.
On a brighter note, the stock market usually trades at an average of 15 times normalized earnings. That would mean an S&P 500 of around $1,000 and a Dow of $9,600. In other words, the market is already below fair value.
The problem is the stock market almost always goes below fair value after boom times. It already has, but could go lower still. Be prepared for how low it can go and don't sell at the bottom.
Like I said above, I'm finding the best values I've found in years. Great companies are selling at prices that are likely to generate very high returns over the long run. Even if things go significantly lower, this is an absolutely great time to invest!
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, October 24, 2008
Hanging in there is tough, no doubt about it
October has been a brutal month.
I saw this crisis coming years ago, and my returns have benefited from that foresight, but this hasn't kept me from feeling the pain.
I was feeling pretty good about myself at the end of September. Having beat the market by more 8% over the last two years and by more than 4% over the last three years (annualized, after fees), I was feeling pretty cocky.
But, that was before October. In October, my returns have paralleled the market's path down. I haven't enjoyed the ride, even if I started from a higher place.
This has been particularly frustrating because I've invested in some of the strongest companies around. You'd think the strongest businesses would be untouched, or much less touched, by recent turmoil.
That hasn't been the case. When people are under a lot of pain, they do crazy things, like selling great companies at huge discounts to underlying value. Many of those investors were probably buying on margin. Some were hedge funds that were forced to sell long positions and cover short sales after the SEC banned shorting certain companies.
What's been happening is the usual capitulation you tend to see when markets are bottoming. People are under so much pain that they're selling everything, regardless of the price they're getting.
This isn't fun for a value investor like me because I hate to see my clients' money or my own money decline in value. I work hard to be sheltered by the storm, even though I know some markets are so brutal that everything goes down.
What's a person to do? I'm on a buying spree.
I'm taking the opportunity to sell strong performers and buy poorly performing great companies. I'm finding some absolutely astounding bargains and, most likely, boosting future returns. And, although it's no fun to see the market and portfolios go down dramatically, I'm having a lot of fun putting things in place to benefit when the market does recover.
When will the market recover? No one knows. The market could go down by another 33% to hit historical lows reached in the past, or it could rally by 67% (a 40% decline requires a 67% increase to get back to break even) as it's also done in the past.
You don't need to be a fortune teller or have a crystal ball to make money from here, you just need the gut wrenching fortitude to buy great companies at great prices--now. As long as you believe our economy won't permanently collapse, this is a great time to invest.
Although it's no fun to live through, I'm quite confident that buying at times like this make for very high long term returns in the future.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
October has been a brutal month.
I saw this crisis coming years ago, and my returns have benefited from that foresight, but this hasn't kept me from feeling the pain.
I was feeling pretty good about myself at the end of September. Having beat the market by more 8% over the last two years and by more than 4% over the last three years (annualized, after fees), I was feeling pretty cocky.
But, that was before October. In October, my returns have paralleled the market's path down. I haven't enjoyed the ride, even if I started from a higher place.
This has been particularly frustrating because I've invested in some of the strongest companies around. You'd think the strongest businesses would be untouched, or much less touched, by recent turmoil.
That hasn't been the case. When people are under a lot of pain, they do crazy things, like selling great companies at huge discounts to underlying value. Many of those investors were probably buying on margin. Some were hedge funds that were forced to sell long positions and cover short sales after the SEC banned shorting certain companies.
What's been happening is the usual capitulation you tend to see when markets are bottoming. People are under so much pain that they're selling everything, regardless of the price they're getting.
This isn't fun for a value investor like me because I hate to see my clients' money or my own money decline in value. I work hard to be sheltered by the storm, even though I know some markets are so brutal that everything goes down.
What's a person to do? I'm on a buying spree.
I'm taking the opportunity to sell strong performers and buy poorly performing great companies. I'm finding some absolutely astounding bargains and, most likely, boosting future returns. And, although it's no fun to see the market and portfolios go down dramatically, I'm having a lot of fun putting things in place to benefit when the market does recover.
When will the market recover? No one knows. The market could go down by another 33% to hit historical lows reached in the past, or it could rally by 67% (a 40% decline requires a 67% increase to get back to break even) as it's also done in the past.
You don't need to be a fortune teller or have a crystal ball to make money from here, you just need the gut wrenching fortitude to buy great companies at great prices--now. As long as you believe our economy won't permanently collapse, this is a great time to invest.
Although it's no fun to live through, I'm quite confident that buying at times like this make for very high long term returns in the future.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, October 17, 2008
Warren Buffett is buying American stocks
I'm not the only one feeling more bullish lately--so is Warren Buffett (yeh, I'm flattering myself).
Warren Buffett is the richest man in the world and probably the best investor alive today. To top it off, he seems like a grounded, happy guy. He still lives in the house he bought in his 30's, still drives himself around town, and has good relationships with his kids. Pretty amazing for a multi-billionaire.
Buffett wrote a letter to the editor of the New York Times that was published today titled "Buy American. I Am." You can access it here to read the whole thing.
Buffett's basic argument is that because the financial world is a mess, this is a historic time to buy American stocks.
He cautions that unemployment will rise, business activity will slow and headlines will be scary. Despite these issues, he's buying stocks in his personal account (not just for Berkshire Hathaway, the holding company he runs). Up until recently, his personal money was all is U.S. government bonds. But soon, he will be 100% invested in U.S. equities.
As Buffett has said many times before, "Be fearful when others are greedy, and be greedy when others are fearful." In other words, buy when everyone is scared and sell when everyone is euphoric. This is very difficult to do, but it is also very profitable.
He cautions against investing in highly leveraged companies and businesses with weak competitive advantages. He also cautions that he can't predict short term movements in the stock market. Let me let you in on a secret--no one can!!! It may keep going down over the next year or two, but in 5 years, it's the best place to invest (especially at today's low prices).
Buffett is seldom if ever outright bullish. But, when he says, "What is likely...is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up," I stand up and listen. What he's saying is you can't wait until things look good to invest, because by then you'll have missed significant gains. I've rarely, if ever, heard Buffett say something so bullish. The last time he seemed to be this optimistic was 1982, and that was an outstanding time to invest.
He goes on to give examples of why waiting doesn't work. During the Great Depression, the stock market bottomed in the summer of 1932, long before the economic picture improved. During World War II, the market bottomed in the spring of 1942, long before it was clear the Allies would defeat Axis powers. In the early 1980's, when inflation was double-digit and the economy was in a deep, double-dip recession, the time to buy was in 1982, long before the economy's recovery was clear in 1983 and 1984.
The lesson from a guy who has generated 20%+ returns for over 50 years is: you buy when everyone is pessimistic, and that time is NOW!
He warns that buying stocks only when you feel comfortable leads to poor results, so does selling because you feel scared.
He also warns against sitting in cash. Holding cash now feels comfortable, but it's an unwise investment decision. Cash doesn't pay much of a return, especially now, and it will depreciate in value. As he warns, government policies directed at alleviating the current crisis will probably prove inflationary and make cash an even worse investment.
He believes that "[e]quities will almost certainly outperform cash over the next decade, probably by a substantial degree." You should invest for where things are going, not for where they are today.
At a time when people are looking for something to hang their hopes on, Warren Buffett is a voice of clarity in the maelstrom. I'm listening, and so should you.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
I'm not the only one feeling more bullish lately--so is Warren Buffett (yeh, I'm flattering myself).
Warren Buffett is the richest man in the world and probably the best investor alive today. To top it off, he seems like a grounded, happy guy. He still lives in the house he bought in his 30's, still drives himself around town, and has good relationships with his kids. Pretty amazing for a multi-billionaire.
Buffett wrote a letter to the editor of the New York Times that was published today titled "Buy American. I Am." You can access it here to read the whole thing.
Buffett's basic argument is that because the financial world is a mess, this is a historic time to buy American stocks.
He cautions that unemployment will rise, business activity will slow and headlines will be scary. Despite these issues, he's buying stocks in his personal account (not just for Berkshire Hathaway, the holding company he runs). Up until recently, his personal money was all is U.S. government bonds. But soon, he will be 100% invested in U.S. equities.
As Buffett has said many times before, "Be fearful when others are greedy, and be greedy when others are fearful." In other words, buy when everyone is scared and sell when everyone is euphoric. This is very difficult to do, but it is also very profitable.
He cautions against investing in highly leveraged companies and businesses with weak competitive advantages. He also cautions that he can't predict short term movements in the stock market. Let me let you in on a secret--no one can!!! It may keep going down over the next year or two, but in 5 years, it's the best place to invest (especially at today's low prices).
Buffett is seldom if ever outright bullish. But, when he says, "What is likely...is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up," I stand up and listen. What he's saying is you can't wait until things look good to invest, because by then you'll have missed significant gains. I've rarely, if ever, heard Buffett say something so bullish. The last time he seemed to be this optimistic was 1982, and that was an outstanding time to invest.
He goes on to give examples of why waiting doesn't work. During the Great Depression, the stock market bottomed in the summer of 1932, long before the economic picture improved. During World War II, the market bottomed in the spring of 1942, long before it was clear the Allies would defeat Axis powers. In the early 1980's, when inflation was double-digit and the economy was in a deep, double-dip recession, the time to buy was in 1982, long before the economy's recovery was clear in 1983 and 1984.
The lesson from a guy who has generated 20%+ returns for over 50 years is: you buy when everyone is pessimistic, and that time is NOW!
He warns that buying stocks only when you feel comfortable leads to poor results, so does selling because you feel scared.
He also warns against sitting in cash. Holding cash now feels comfortable, but it's an unwise investment decision. Cash doesn't pay much of a return, especially now, and it will depreciate in value. As he warns, government policies directed at alleviating the current crisis will probably prove inflationary and make cash an even worse investment.
He believes that "[e]quities will almost certainly outperform cash over the next decade, probably by a substantial degree." You should invest for where things are going, not for where they are today.
At a time when people are looking for something to hang their hopes on, Warren Buffett is a voice of clarity in the maelstrom. I'm listening, and so should you.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, October 10, 2008
It's normal to worry, but this is not the time to panic
Below is a slightly altered version of an email I recently sent to clients:
Dear Clients,
As you'll see next week, my client letter was written at quarter end and doesn't address recent market volatility. With that in mind and considering the recent market drop, I decided to throw together a quick email to all clients giving my opinion of what is happening and what my response is.
I've summarized my thinking in quick bullet points for those short on time or not as interested. Then below, I go into more detail on each point for those who want more info. Finally, my intent is to try to answer your questions as well as I can and to get a dialogue going if you are concerned. Please feel free to contact me at any time if you want to talk to me about what is going on. I will be available or quickly return your calls. This is a stressful time, and I'm here to answer your questions.
1. It's natural to be worried, but panic selling now will lead to regret in the long run.
2. Historically, this decline is not out of the ordinary.
3. I believe recent government action will work, although it will take some time and it will lead to higher inflation in the long run.
4. It's not possible to time the market, so trying to sell now and buy at the "bottom" almost always leads to worse results than holding on.
5. The market is throwing the baby out with the bathwater.
6. Our underlying businesses are strong even though their prices are going down.
7. This is a historic time to invest!
8. One of the reasons you hired me is to let me worry about the market for you. That's what I'm trying to do for you now.
Now, the details.
1. It's natural to be worried, but panic selling now will lead to regret in the long run.
Being worried is normal--I'm having no fun watching your and my portfolios decline. It's easy to anchor on recent market tops and expect the highs to continue--there was a lot of media coverage about the Dow hitting 14,000 this time last year. People are panicking because they are scared, but reacting by selling is the worst investment plan and will lead to tremendous regret when the market does rebound. Temporary highs and lows can make you feel better and worse than you want to. The market swings up and down dramatically, so it's best to focus on longer term averages. A wise person once said that courage is not the lack of fear, it's the ability to act in the face of fear. Right now, not selling is taking a lot of courage.
2. Historically, this decline is not out of the ordinary.
The stock market tends to decline an average of 40% when recessions hit, which is about every 5-10 years. We're down around 40%, so this decline is in line with history. As Mark Twain said, history doesn't repeat, but it sure does rhyme. Sometimes the market goes down by 20%, sometimes it goes down by more. No one knows where this one will bottom, and trying to pick the bottom is a fool's errand. Our economy and financial sector are facing the worst period since the Great Depression, but that doesn't mean it will look just like the Great Depression. Comparisons to history are useful, but expecting the same outcomes in the same way is a mistake.
3. I believe recent government action will work, although it will take some time and it will lead to higher inflation in the long run.
Current government plans have flaws, but I believe they will get credit markets and the economy going, eventually. The cost will be higher long term inflation and more regulation, but I do think it will work. The market tends to bottom 6-9 months before the economy does. Economic data comes out months and years after the economic bottom is clearly reached. Waiting for the economy to improve will lead you to miss the huge stock market rebound that will occur. It's hard to see past our current turmoil, but a long term focus helps.
4. It's not possible to time the market, so trying to sell now and buy at the "bottom" almost always leads to worse results than holding on.
Like the search for the Holy Grail and a perpetual motion machine, people are always trying to time the market by buying at the bottom and selling at the top. Unfortunately, this isn't possible, and every attempt to do so ends in tears. I remember buying a company called JLG in 2000 at $8.88 per share, watching it decline to $3.95, and then selling it when it climbed above $17. I had doubled my money when the market was doing terribly, so I felt good about myself. But then JLG climbed to $60. It's easy, in hindsight, to think I should have known that JLG was worth a lot more than $3.95 at the bottom and buy more. It's easy to think I should have waited for $60 to sell at the top. Having been through that ride, though, I know very well that it's not possible to pick the tops and bottoms. Instead, I focus on the underlying value of the business and buy when it goes down and sell when it goes up. I never pick the exact bottom or top, but over the long run, I've had very good results.
5. The market is throwing the baby out with the bathwater.
When the market panics, everyone feels so much pain they sell no matter what price they get. This leads people to throw the baby out with the bathwater, and that is what I've been seeing since Oct 1st. People are selling good companies and bad ones, small and big, everything. When that happens, it's very unprofitable to join the crowd and sell, too. This is a sign of how much pain people are in, not the underlying value of businesses. In the long run, the market will recognize underlying business value, even if it takes a while and some pain to get there.
6. Our underlying businesses are strong even though their prices are going down.
When I look at our underlying businesses, I feel very confident. Software companies will continue to sell software and make money, even in a down market. People will still subscribe to cable, even if they don't pay for HBO anymore. Smart insurance companies will continue to write insurance. Discount retailers are doing better than ever as people look for bargains. Europe's lowest cost airline is still lowest cost and, and with little debt, can continue doing business and make more money than competitors, smart holding companies have investment money on the sidelines and the inside scoop on the best deals in the market when everyone else has no cash to invest, well capitalized insurers are writing more insurance now that AIG and other insurance companies are in severe trouble, big pharmaceutical companies will continue to sell drugs to people who need the medicine to live longer, happier lives, great banks are expanding by buying competitors at a fire-sale price because most other banks are on the ropes, auto insurers will continue selling car insurance because people have to buy it to drive, smart chemical companies will continue to make vital chemicals and pay lower prices for gas and oil inputs, large integrated oil companies will continue producing and refining fuel for people who will continue to heat their homes and drive their cars, large international banks will continue to grow their international banking franchises and will be able to buy up competitors because they are more conservatively financed than competitors. Many companies are strong and exploiting the downturn--but their prices are going down! Why? Because people are panicking, not because the businesses are going bankrupt.
7. This is a historic time to invest!
If you look back at market history and see 2002, 1998, 1991, 1987, 1982, 1974, 1962, 1953, 1942, 1938, 1932, etc., you will see market bottoms where things were awful. 2002 was the bottom of the tech blowout. 1998 was the bottom of the Asian Contagion. 1991 was the Saving and Loan bailout and recession. In 1987, the market dropped over 20% in one day! 1982 was a sharp recession and the Time magazine article of the "End of Equities." 1974 was a terrible recession, extremely high inflation, the pullout of Vietnam, etc. And so on and so forth. They were each excellent times to invest and extremely tough moments to do so. What made them great times to invest? Because some people panicked and others didn't. The people who didn't panic made out like bandits. If you have extra cash to invest, put it to work now. If you don't, hold on for now. The roller coaster is on the way down, our stomach is in our throat, we know it will go back up again but can't think about that because we feel awful. But, holding on is the most profitable route.
8. One of the reasons you hired me is to let me worry about the market for
you. That's what I'm trying to do for you now.
An important part of my job, in addition to researching and picking investments, is to take the pain for you of watching the market go down. If you can, turn off the TV, get off the Internet, put down the business section of the newspaper. Go out and do something fun. Spend time with loved ones. I remember watching TV for 48 hours after 9/11 and after Hurricane Katrina, and I managed to convince myself that more doom was right around the corner. It wasn't, and it probably isn't now. Let me focus on this stuff for you, let me take the pain for you. That's what you pay me for.
I don't want to short change current events. These are tough times.
I don't want to undercut how miserable it is to watch our portfolios decline in value--I'm agonizing because I feel responsible for your money.
If you still have concerns, please call or write me. I'm standing by and waiting to talk to anyone who calls.
Take care and have a great weekend,
Mike
Michael Rivers, CFA
Athena Capital Management Corp.
719-761-3148
www.athenacapital.biz
Visit my blog: www.mikerivers.blogspot.com.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Below is a slightly altered version of an email I recently sent to clients:
Dear Clients,
As you'll see next week, my client letter was written at quarter end and doesn't address recent market volatility. With that in mind and considering the recent market drop, I decided to throw together a quick email to all clients giving my opinion of what is happening and what my response is.
I've summarized my thinking in quick bullet points for those short on time or not as interested. Then below, I go into more detail on each point for those who want more info. Finally, my intent is to try to answer your questions as well as I can and to get a dialogue going if you are concerned. Please feel free to contact me at any time if you want to talk to me about what is going on. I will be available or quickly return your calls. This is a stressful time, and I'm here to answer your questions.
1. It's natural to be worried, but panic selling now will lead to regret in the long run.
2. Historically, this decline is not out of the ordinary.
3. I believe recent government action will work, although it will take some time and it will lead to higher inflation in the long run.
4. It's not possible to time the market, so trying to sell now and buy at the "bottom" almost always leads to worse results than holding on.
5. The market is throwing the baby out with the bathwater.
6. Our underlying businesses are strong even though their prices are going down.
7. This is a historic time to invest!
8. One of the reasons you hired me is to let me worry about the market for you. That's what I'm trying to do for you now.
Now, the details.
1. It's natural to be worried, but panic selling now will lead to regret in the long run.
Being worried is normal--I'm having no fun watching your and my portfolios decline. It's easy to anchor on recent market tops and expect the highs to continue--there was a lot of media coverage about the Dow hitting 14,000 this time last year. People are panicking because they are scared, but reacting by selling is the worst investment plan and will lead to tremendous regret when the market does rebound. Temporary highs and lows can make you feel better and worse than you want to. The market swings up and down dramatically, so it's best to focus on longer term averages. A wise person once said that courage is not the lack of fear, it's the ability to act in the face of fear. Right now, not selling is taking a lot of courage.
2. Historically, this decline is not out of the ordinary.
The stock market tends to decline an average of 40% when recessions hit, which is about every 5-10 years. We're down around 40%, so this decline is in line with history. As Mark Twain said, history doesn't repeat, but it sure does rhyme. Sometimes the market goes down by 20%, sometimes it goes down by more. No one knows where this one will bottom, and trying to pick the bottom is a fool's errand. Our economy and financial sector are facing the worst period since the Great Depression, but that doesn't mean it will look just like the Great Depression. Comparisons to history are useful, but expecting the same outcomes in the same way is a mistake.
3. I believe recent government action will work, although it will take some time and it will lead to higher inflation in the long run.
Current government plans have flaws, but I believe they will get credit markets and the economy going, eventually. The cost will be higher long term inflation and more regulation, but I do think it will work. The market tends to bottom 6-9 months before the economy does. Economic data comes out months and years after the economic bottom is clearly reached. Waiting for the economy to improve will lead you to miss the huge stock market rebound that will occur. It's hard to see past our current turmoil, but a long term focus helps.
4. It's not possible to time the market, so trying to sell now and buy at the "bottom" almost always leads to worse results than holding on.
Like the search for the Holy Grail and a perpetual motion machine, people are always trying to time the market by buying at the bottom and selling at the top. Unfortunately, this isn't possible, and every attempt to do so ends in tears. I remember buying a company called JLG in 2000 at $8.88 per share, watching it decline to $3.95, and then selling it when it climbed above $17. I had doubled my money when the market was doing terribly, so I felt good about myself. But then JLG climbed to $60. It's easy, in hindsight, to think I should have known that JLG was worth a lot more than $3.95 at the bottom and buy more. It's easy to think I should have waited for $60 to sell at the top. Having been through that ride, though, I know very well that it's not possible to pick the tops and bottoms. Instead, I focus on the underlying value of the business and buy when it goes down and sell when it goes up. I never pick the exact bottom or top, but over the long run, I've had very good results.
5. The market is throwing the baby out with the bathwater.
When the market panics, everyone feels so much pain they sell no matter what price they get. This leads people to throw the baby out with the bathwater, and that is what I've been seeing since Oct 1st. People are selling good companies and bad ones, small and big, everything. When that happens, it's very unprofitable to join the crowd and sell, too. This is a sign of how much pain people are in, not the underlying value of businesses. In the long run, the market will recognize underlying business value, even if it takes a while and some pain to get there.
6. Our underlying businesses are strong even though their prices are going down.
When I look at our underlying businesses, I feel very confident. Software companies will continue to sell software and make money, even in a down market. People will still subscribe to cable, even if they don't pay for HBO anymore. Smart insurance companies will continue to write insurance. Discount retailers are doing better than ever as people look for bargains. Europe's lowest cost airline is still lowest cost and, and with little debt, can continue doing business and make more money than competitors, smart holding companies have investment money on the sidelines and the inside scoop on the best deals in the market when everyone else has no cash to invest, well capitalized insurers are writing more insurance now that AIG and other insurance companies are in severe trouble, big pharmaceutical companies will continue to sell drugs to people who need the medicine to live longer, happier lives, great banks are expanding by buying competitors at a fire-sale price because most other banks are on the ropes, auto insurers will continue selling car insurance because people have to buy it to drive, smart chemical companies will continue to make vital chemicals and pay lower prices for gas and oil inputs, large integrated oil companies will continue producing and refining fuel for people who will continue to heat their homes and drive their cars, large international banks will continue to grow their international banking franchises and will be able to buy up competitors because they are more conservatively financed than competitors. Many companies are strong and exploiting the downturn--but their prices are going down! Why? Because people are panicking, not because the businesses are going bankrupt.
7. This is a historic time to invest!
If you look back at market history and see 2002, 1998, 1991, 1987, 1982, 1974, 1962, 1953, 1942, 1938, 1932, etc., you will see market bottoms where things were awful. 2002 was the bottom of the tech blowout. 1998 was the bottom of the Asian Contagion. 1991 was the Saving and Loan bailout and recession. In 1987, the market dropped over 20% in one day! 1982 was a sharp recession and the Time magazine article of the "End of Equities." 1974 was a terrible recession, extremely high inflation, the pullout of Vietnam, etc. And so on and so forth. They were each excellent times to invest and extremely tough moments to do so. What made them great times to invest? Because some people panicked and others didn't. The people who didn't panic made out like bandits. If you have extra cash to invest, put it to work now. If you don't, hold on for now. The roller coaster is on the way down, our stomach is in our throat, we know it will go back up again but can't think about that because we feel awful. But, holding on is the most profitable route.
8. One of the reasons you hired me is to let me worry about the market for
you. That's what I'm trying to do for you now.
An important part of my job, in addition to researching and picking investments, is to take the pain for you of watching the market go down. If you can, turn off the TV, get off the Internet, put down the business section of the newspaper. Go out and do something fun. Spend time with loved ones. I remember watching TV for 48 hours after 9/11 and after Hurricane Katrina, and I managed to convince myself that more doom was right around the corner. It wasn't, and it probably isn't now. Let me focus on this stuff for you, let me take the pain for you. That's what you pay me for.
I don't want to short change current events. These are tough times.
I don't want to undercut how miserable it is to watch our portfolios decline in value--I'm agonizing because I feel responsible for your money.
If you still have concerns, please call or write me. I'm standing by and waiting to talk to anyone who calls.
Take care and have a great weekend,
Mike
Michael Rivers, CFA
Athena Capital Management Corp.
719-761-3148
www.athenacapital.biz
Visit my blog: www.mikerivers.blogspot.com.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, October 03, 2008
It's ugly out there
The economy is getting to look downright ugly.
The reason why the U.S. government was working so hard on the bailout is because credit markets are frozen. For those who don't know, our economy operates mostly on credit. When most companies buy inventory, purchase property, plant and equipment, or pay wages and salaries, it's frequently done with credit.
So, when credit markets are frozen, businesses (and municipalities) can't keep operations going, they can't expand, and they can't pay their employees.
It's unclear that the government bailout will unfreeze credit markets. Banks aren't lending because their balance sheets are either close to or insolvent. They can't lend. Having the government purchase illiquid securities may facilitate the rebuilding of bank balance sheets, but it won't rebuild bank balance sheets directly.
The credit freeze has been slowing the economy remarkably over the last two months, and precipitously over the last two weeks. That is why Secretary of Treasury Paulson and Federal Reserve Chairman Bernanke have been running around like chickens with their heads cut off trying to get the bailout going.
Warren Buffett says this is the worst he's seen in his 50+ years of investing. The situation is being touted as the worse financial crisis since the Great Depression.
It's going to get worse before it gets better, but, if free markets are left alone to work, it will get better. The U.S. economy is the most dynamic and resilient in the world.
We may be over-leveraged with debt, we may have too much debt, we may not save enough, but we have the best protection of property rights and a relatively sound rule of law. That's all it takes, and individuals will do the rest.
It's always darkest before dawn. Things look pretty dark out there now. Believe it or not, that can be a great time to invest. By the time things look better, you will have missed the upswing.
I'm not saying investing at a time like this is easy, but it is smart. In the long run, investments made today will do very well, even if it's looking ugly out there right now.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
The economy is getting to look downright ugly.
The reason why the U.S. government was working so hard on the bailout is because credit markets are frozen. For those who don't know, our economy operates mostly on credit. When most companies buy inventory, purchase property, plant and equipment, or pay wages and salaries, it's frequently done with credit.
So, when credit markets are frozen, businesses (and municipalities) can't keep operations going, they can't expand, and they can't pay their employees.
It's unclear that the government bailout will unfreeze credit markets. Banks aren't lending because their balance sheets are either close to or insolvent. They can't lend. Having the government purchase illiquid securities may facilitate the rebuilding of bank balance sheets, but it won't rebuild bank balance sheets directly.
The credit freeze has been slowing the economy remarkably over the last two months, and precipitously over the last two weeks. That is why Secretary of Treasury Paulson and Federal Reserve Chairman Bernanke have been running around like chickens with their heads cut off trying to get the bailout going.
Warren Buffett says this is the worst he's seen in his 50+ years of investing. The situation is being touted as the worse financial crisis since the Great Depression.
It's going to get worse before it gets better, but, if free markets are left alone to work, it will get better. The U.S. economy is the most dynamic and resilient in the world.
We may be over-leveraged with debt, we may have too much debt, we may not save enough, but we have the best protection of property rights and a relatively sound rule of law. That's all it takes, and individuals will do the rest.
It's always darkest before dawn. Things look pretty dark out there now. Believe it or not, that can be a great time to invest. By the time things look better, you will have missed the upswing.
I'm not saying investing at a time like this is easy, but it is smart. In the long run, investments made today will do very well, even if it's looking ugly out there right now.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, September 26, 2008
With trouble comes opportunity
Things look pretty grim out there right now.
Credit markets are freezing up. Unemployment is climbing. Housing sales, both existing and new, are hitting new lows. Orders for durable goods are down signficantly.
Our government has helped bail out 3 of the 5 largest investment banks. Fannie Mae and Freddie Mac, upon which the housing market depends so much, are in our government's conservatorship. The largest insurance company in the world, AIG, has sold itself to our government's majority ownership. Washington Mutual, the largest thrift bank in our nation, was siezed last night and parts were sold off to JPMorgan.
The U.S. executive and legislative branches are struggling to put together a multi-billion dollar plan (the bill will probably come to over a trillion, in my opinion) that will allow the government to purchase and liquidate currently illiquid securities. The Securities and Exchange Commission is preventing a growing number of companies from being sold short.
Baby, it's cold outside.
So, where are the opportunities? Let me tell you!
The only thing building up faster than the credit market "snow" outside: bargains! I've never seen so many great quality companies selling at cheap prices. And, best of all, the strongest companies are able to grow while weak companies are wallowing in too much debt.
It's always hard to buy when things look bleak, because they almost always seem to get bleaker. But, that shouldn't prevent a long term investor from taking advantage of the great opportunities available right now.
It's hard to remember how things looked in the fall of 2002 and spring of 2003. It's hard to remember how bad the market and economy looked in the fall of 1990 and spring of 1991. It's hard to remember the brutal recession of 1982 that followed a recession in late 1979 and early 1980. Same for 1974 and 1970, and on back in history.
The best time to invest is when things look terrible! That doesn't mean we are at a bottom in the stock market--no one can predict that with any degree of accuracy. But buying when things look terrible has been a pretty good method to use over time, and now looks pretty dreadful.
With touble comes opportunity. This is an outstanding time to invest, and I will be glad to point back to this point in time several years from now and say, "wasn't that a GREAT time to invest!"
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Things look pretty grim out there right now.
Credit markets are freezing up. Unemployment is climbing. Housing sales, both existing and new, are hitting new lows. Orders for durable goods are down signficantly.
Our government has helped bail out 3 of the 5 largest investment banks. Fannie Mae and Freddie Mac, upon which the housing market depends so much, are in our government's conservatorship. The largest insurance company in the world, AIG, has sold itself to our government's majority ownership. Washington Mutual, the largest thrift bank in our nation, was siezed last night and parts were sold off to JPMorgan.
The U.S. executive and legislative branches are struggling to put together a multi-billion dollar plan (the bill will probably come to over a trillion, in my opinion) that will allow the government to purchase and liquidate currently illiquid securities. The Securities and Exchange Commission is preventing a growing number of companies from being sold short.
Baby, it's cold outside.
So, where are the opportunities? Let me tell you!
The only thing building up faster than the credit market "snow" outside: bargains! I've never seen so many great quality companies selling at cheap prices. And, best of all, the strongest companies are able to grow while weak companies are wallowing in too much debt.
It's always hard to buy when things look bleak, because they almost always seem to get bleaker. But, that shouldn't prevent a long term investor from taking advantage of the great opportunities available right now.
It's hard to remember how things looked in the fall of 2002 and spring of 2003. It's hard to remember how bad the market and economy looked in the fall of 1990 and spring of 1991. It's hard to remember the brutal recession of 1982 that followed a recession in late 1979 and early 1980. Same for 1974 and 1970, and on back in history.
The best time to invest is when things look terrible! That doesn't mean we are at a bottom in the stock market--no one can predict that with any degree of accuracy. But buying when things look terrible has been a pretty good method to use over time, and now looks pretty dreadful.
With touble comes opportunity. This is an outstanding time to invest, and I will be glad to point back to this point in time several years from now and say, "wasn't that a GREAT time to invest!"
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, September 19, 2008
Dumbfounded
It first started to occur to me around 5 years ago that the housing market would probably crash and that it would almost certainly drag credit markets down with it along with home builders, mortgage insurers, bond insurers and several financial institutions.
But, if you had asked me 5 years ago what the Dow Jones Industrial Average (DJIA) would trade at given that:
1) 3 of the top 5 investment banks in the US would no longer be independent and the final 2 would be tottering
2) the US government would take over Fannie Mae and Freddie Mac because they were insolvent
3) the US government would own 80% of AIG's equity because it was also insolvent
I would have said the DJIA would be at $5,000, not $11,388.
What color is the sky in most investors' world? Does anyone really believe all these bailouts will be cost free?
I'm dumbfounded.
Don't get me wrong, my investors and I are doing very well both absolutely and relatively to the market.
But, isn't the US economy entering what could be the worst recession since the early 1980's? Isn't government intervention on a scale not seen since the Great Depression an indication of how bad things are? Isn't the world economy entering the first widespread slowdown in a generation?
Then, why is the market down so little?
I have no idea. In fact, I'm dumbfounded.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
It first started to occur to me around 5 years ago that the housing market would probably crash and that it would almost certainly drag credit markets down with it along with home builders, mortgage insurers, bond insurers and several financial institutions.
But, if you had asked me 5 years ago what the Dow Jones Industrial Average (DJIA) would trade at given that:
1) 3 of the top 5 investment banks in the US would no longer be independent and the final 2 would be tottering
2) the US government would take over Fannie Mae and Freddie Mac because they were insolvent
3) the US government would own 80% of AIG's equity because it was also insolvent
I would have said the DJIA would be at $5,000, not $11,388.
What color is the sky in most investors' world? Does anyone really believe all these bailouts will be cost free?
I'm dumbfounded.
Don't get me wrong, my investors and I are doing very well both absolutely and relatively to the market.
But, isn't the US economy entering what could be the worst recession since the early 1980's? Isn't government intervention on a scale not seen since the Great Depression an indication of how bad things are? Isn't the world economy entering the first widespread slowdown in a generation?
Then, why is the market down so little?
I have no idea. In fact, I'm dumbfounded.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, September 12, 2008
The (temporary) triumph of momentum over value
As I've mentioned before, momentum investments have been out-performing value investments over the last couple of years.
If you had just picked what had gone up in the past, it continued to go up.
Value investing, instead, focuses on understanding the value of a business and trying to buy below that value, thus providing a margin of safety (like building a bridge to handle more than you think it will bear over time).
Value has been, over the long run, one of the (if not the) smartest ways to invest.
Just because it hasn't done well lately doesn't mean it won't do well in the future. In fact, quite the opposite is true--value investing is VERY likely to out-perform momentum investing in the near future.
As additional support for this contention, take a look at a recent Motley Fool article by Andrew Sullivan, CFA. In it, he gives you a flavor of the returns that are possible for value after it has under-performed.
Trying to time when momentum will out-perform value and vice versa is a fools errand, but, at times like this, it's very easy to be patient and wait for value to begin out-performing again.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
As I've mentioned before, momentum investments have been out-performing value investments over the last couple of years.
If you had just picked what had gone up in the past, it continued to go up.
Value investing, instead, focuses on understanding the value of a business and trying to buy below that value, thus providing a margin of safety (like building a bridge to handle more than you think it will bear over time).
Value has been, over the long run, one of the (if not the) smartest ways to invest.
Just because it hasn't done well lately doesn't mean it won't do well in the future. In fact, quite the opposite is true--value investing is VERY likely to out-perform momentum investing in the near future.
As additional support for this contention, take a look at a recent Motley Fool article by Andrew Sullivan, CFA. In it, he gives you a flavor of the returns that are possible for value after it has under-performed.
Trying to time when momentum will out-perform value and vice versa is a fools errand, but, at times like this, it's very easy to be patient and wait for value to begin out-performing again.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, September 05, 2008
The Wall Street Journal gives short sellers a hand
In October 2007, I took the Wall Street Journal to task for a weak article hammering Wal-Mart. Their timing turned out to be impeccable, as I wrote about in July of this year. Wal-Mart's stock has handily beat the market since the October 2007 article.
Last week, I think the Journal may have done it again, this time with Sears (full disclosure: my clients and I own shares of Sears Holdings).
The Wall Street Journal's article, titled "Mr. Lampert, Fire Thyself," again seems thin on facts and long on generalized evaluations.
The gist of the article is that Eddie Lampert, Chairman and majority owner of Sears Holdings, should fire himself because his strategy with Sears has failed.
To support this claim, the article says another dismal quarter at Sears proves its strategy is failing. The article states that rivals are eating its lunch, too. Missing from the article is any support for these contentions. Which rivals? What made Sears' quarter so dismal? How has Sears done versus rivals both in terms of stock performance and fundamental economics? None of this information is provided.
The article goes on to mischaracterize Lampert's strategy with Sears. It claims that Eddie simply decided not to invest in Sears in hopes that would jack up return on investment. If you read any of what Lampert has to say, you'll see that he would love to invest more in Sears as long as it provides an adequate return on investment. That's what companies are supposed to do. The author either deliberately or ignorantly misses this distinction.
The article highlights same store sales are down 6% at Sears, but no mention is made of how Kohls, JC Penney, Nordstrom, Target, or any other competitors are doing. The author seems to believe these facts are not important, only the negative evaluation of Sears.
The article does point out that Sears has had a revolving door of executive managers. That's fair. And, the author points out that Lampert will have a hard time using financial engineering with crunched credit markets and a difficult real estate market. That's true, too.
But, a couple of facts and a lot of evaluative statements not supported by facts isn't good reporting. Sears is generating a ton of cash, and its balance sheet is more solid than many rivals. This can be seen in share buybacks if nothing else. Why isn't that mentioned, I wonder?
Sears isn't investing much in stores, but perhaps that's a smarter strategy than throwing good money after bad. Why isn't that highlighted? And why didn't the author differentiate between not investing in stores as a strategy versus not investing in inadequate return on capital projects?
I have a guess. I think short sellers are eager to see Lampert and Sears fail. At the same time, Wall Street Journal journalists are hungry for a sensational story. Combine these two ingredients and mix liberally with lack of scruples, and you get a Wall Street Journal article thin on substance and high on sensation.
Perhaps the Journal has called the bottom on Sears like they did on Wal-Mart. I'll be eagerly watching to see what happens.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
In October 2007, I took the Wall Street Journal to task for a weak article hammering Wal-Mart. Their timing turned out to be impeccable, as I wrote about in July of this year. Wal-Mart's stock has handily beat the market since the October 2007 article.
Last week, I think the Journal may have done it again, this time with Sears (full disclosure: my clients and I own shares of Sears Holdings).
The Wall Street Journal's article, titled "Mr. Lampert, Fire Thyself," again seems thin on facts and long on generalized evaluations.
The gist of the article is that Eddie Lampert, Chairman and majority owner of Sears Holdings, should fire himself because his strategy with Sears has failed.
To support this claim, the article says another dismal quarter at Sears proves its strategy is failing. The article states that rivals are eating its lunch, too. Missing from the article is any support for these contentions. Which rivals? What made Sears' quarter so dismal? How has Sears done versus rivals both in terms of stock performance and fundamental economics? None of this information is provided.
The article goes on to mischaracterize Lampert's strategy with Sears. It claims that Eddie simply decided not to invest in Sears in hopes that would jack up return on investment. If you read any of what Lampert has to say, you'll see that he would love to invest more in Sears as long as it provides an adequate return on investment. That's what companies are supposed to do. The author either deliberately or ignorantly misses this distinction.
The article highlights same store sales are down 6% at Sears, but no mention is made of how Kohls, JC Penney, Nordstrom, Target, or any other competitors are doing. The author seems to believe these facts are not important, only the negative evaluation of Sears.
The article does point out that Sears has had a revolving door of executive managers. That's fair. And, the author points out that Lampert will have a hard time using financial engineering with crunched credit markets and a difficult real estate market. That's true, too.
But, a couple of facts and a lot of evaluative statements not supported by facts isn't good reporting. Sears is generating a ton of cash, and its balance sheet is more solid than many rivals. This can be seen in share buybacks if nothing else. Why isn't that mentioned, I wonder?
Sears isn't investing much in stores, but perhaps that's a smarter strategy than throwing good money after bad. Why isn't that highlighted? And why didn't the author differentiate between not investing in stores as a strategy versus not investing in inadequate return on capital projects?
I have a guess. I think short sellers are eager to see Lampert and Sears fail. At the same time, Wall Street Journal journalists are hungry for a sensational story. Combine these two ingredients and mix liberally with lack of scruples, and you get a Wall Street Journal article thin on substance and high on sensation.
Perhaps the Journal has called the bottom on Sears like they did on Wal-Mart. I'll be eagerly watching to see what happens.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, August 22, 2008
Credit markets still crashing
Although I'd love to see the US economy recovering, I believe that the credit meltdown is still on-going.
After listening to several conference calls, including American Express, Target, CarMax and Lab Corp, it sounds like the US consumer is still struggling in a major way.
Another sign of credit market malaise can be seen in yield spreads. The spread between low and high quality credits keeps getting wider, and this is a sign of continued credit market weakness.
How big of an impact do credit markets have on the US economy and US businesses? Very big.
It's easy to see why businesses must borrow frequently--they must produce before they can sell, and many businesses borrow to do that. But, many don't seem to grasp to what degree US consumers have been living beyond their means for the last decade.
US consumer debt is at record highs when compared to income and assets. Consumers are having a harder time paying their bills and their debt levels aren't helping.
US consumers borrowed against their homes to buy stuff over the last decade.
American Express highlighted this in their recent conference call. Their customers in markets with declining housing prices are spending much less than they were a year ago--across all income levels!
Target is also experiencing difficulties with their credit racked customers. CarMax is struggling to sell cars because customers can't get loans. Why? Because the credit markets aren't buying car loans.
Even Lab Corp, a company that specializes in running tests for hospitals and physicians, is feeling the credit pinch. On their conference call, analysts hammered company management about their receivables and why customers weren't paying. The answer--US consumers are strapped.
Credit markets will not recover until banks rebuild their balance sheets. Banks won't rebuild their balance sheets until the US consumer recovers. And, the US consumer will not recover until housing bottoms.
I don't know when that will happen, but I know it hasn't happened, yet.
Stock markets may do well as election year uncertainty clears up this fall. But, when that is past, investors will refocus on corporate earnings, credit markets, the financial services industry, and the housing market. Until those things improve, I wouldn't expect too much from stock markets.
(Full disclosure: I don't own any shares of American Express, CarMax, Target or Lab Corp).
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Although I'd love to see the US economy recovering, I believe that the credit meltdown is still on-going.
After listening to several conference calls, including American Express, Target, CarMax and Lab Corp, it sounds like the US consumer is still struggling in a major way.
Another sign of credit market malaise can be seen in yield spreads. The spread between low and high quality credits keeps getting wider, and this is a sign of continued credit market weakness.
How big of an impact do credit markets have on the US economy and US businesses? Very big.
It's easy to see why businesses must borrow frequently--they must produce before they can sell, and many businesses borrow to do that. But, many don't seem to grasp to what degree US consumers have been living beyond their means for the last decade.
US consumer debt is at record highs when compared to income and assets. Consumers are having a harder time paying their bills and their debt levels aren't helping.
US consumers borrowed against their homes to buy stuff over the last decade.
American Express highlighted this in their recent conference call. Their customers in markets with declining housing prices are spending much less than they were a year ago--across all income levels!
Target is also experiencing difficulties with their credit racked customers. CarMax is struggling to sell cars because customers can't get loans. Why? Because the credit markets aren't buying car loans.
Even Lab Corp, a company that specializes in running tests for hospitals and physicians, is feeling the credit pinch. On their conference call, analysts hammered company management about their receivables and why customers weren't paying. The answer--US consumers are strapped.
Credit markets will not recover until banks rebuild their balance sheets. Banks won't rebuild their balance sheets until the US consumer recovers. And, the US consumer will not recover until housing bottoms.
I don't know when that will happen, but I know it hasn't happened, yet.
Stock markets may do well as election year uncertainty clears up this fall. But, when that is past, investors will refocus on corporate earnings, credit markets, the financial services industry, and the housing market. Until those things improve, I wouldn't expect too much from stock markets.
(Full disclosure: I don't own any shares of American Express, CarMax, Target or Lab Corp).
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
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