An Investor's Finest Hour

Warren Buffett has referred to the current financial crisis as a potential "economic Pearl Harbor." And it does seem likely that this manic market will prove disastrous for Wall Street speculators and short-term traders.

This market presents some wonderful opportunities, however, for patient investors who have an investing timeframe that's measured in years, not days. Perhaps it's wise to remember that America rose to great heights as a world power after Pearl Harbor.

Things change
I wasn't always so enthusiastic. Here's what I said back in October 2005, in an article titled, "Real Estate Bubble? You Bet!"

I expect financial institutions to take a hit, consumer spending to dry up, default rates to rise significantly, and a long-overdue crackdown to come on loose underwriting standards. According to The Economist, over the past four years, consumer spending and residential construction have accounted for 90% of the total GDP growth. Additionally, more than 40% of all private-sector jobs created since 2001 have been real-estate-related sectors. In short, it's going to have a serious impact on our entire economy.

Unfortunately, I take absolutely no joy in being right. More importantly, I'm feeling much more optimistic than I was back then. Why, you ask? It's simple: There are some wonderful companies trading at very reasonable prices. Before we talk stocks, let's take a quick look at what's causing all of the concern these days.

What's dragging us down?
Housing is truly the 800-pound gorilla in the room, and in my opinion, it's not reached a bottom. Though housing prices are down about 20% in aggregate, they will likely continue to fall. With 11 months of supply, scared buyers, and a much tighter supply of loans, this situation is unlikely to improve in the next year or so.  

The other drag on the economy has been oil. We have been helped by the easing of oil prices, and that trend is likely to continue. It's unlikely that you can see a quick tripling in the price of any commodity without eventually affecting demand. That seems to have happened to oil. Just drive by any car lot and count the number of SUVs and V-8s that are drastically marked down to fire-sale prices.  

The third leg of this stool is consumer debt, which now sits above 100% of our GDP. Note that it's only consumer debt, and it doesn't include Uncle Sam's deficit. These are the highest levels since the 1940s. This isn't a problem that will go away quickly. With so much debt and people's homes worth less than they owe, it's going be tough on our economy. Unfortunately, this is not a situation we can spend our way out of.

What should you do?
Get some helpful perspective. There have been 11 bear markets since World War II (not including the current bear market), with an average decline of 31% and a duration of 393 days. So we're down about 40% from the October 2007 peak. Does anyone really believe that the value of all those businesses has decreased by 40%? I know I don't. No one knows just how long or how deep this downturn will be, but it's already greater than average.

Stay focused on the long term. It's important that you don't let short-term movements or macro events rule your decisions. Remain focused on the things that are within your control, such as analyzing and assessing great businesses. If one of those great businesses suddenly gets 30% cheaper, go ahead and purchase some.

Be patient. Don't chase falling companies or overweight positions because they got 5% cheaper than they were last week. Buying in thirds is a good practice. You can also consider adding to a position when it drops 20% from where you last purchased it.

Avoid leveraged entities and financials that you can't easily assess. As mentioned above, real estate does not appear poised for a near-term turnaround, so stay away from homebuilders such as Pulte and Toll Brothers (NYSE: TOL  ) . I would also be wary of companies that have large exposures to the states of California, Florida, Arizona, Nevada, and New York. Big discretionary purchases from the likes of distressed auto companies such as Ford (NYSE: F  ) and General Motors (NYSE: GM  ) are likely to be delayed.

Resist the temptation to be more active. Your reason, not your emotions, should rule your decisions. If you find yourself feeling compelled to buy or sell based mostly on stock or market movements, take a break, wait a day, and try to look at the long-term value of the business.

Remember that market timing is an awful idea. Since the 1960s, we've become more speculators than long-term investors, and taking this approach really hurts performance. According to John Bogle, total market turnover of stocks has risen from 20% per year in the 1950s to about 215% in 2007 (if you included ETFs, it's up around 280%). That means the investor holding period has moved from five years to less than six months.

Remember, too, that investors perceive risks to be much higher when stock prices are lowest. A kite and a portfolio often rise against the winds of consensus.

Some who will benefit
OK, I promised you a few ideas, and here they are.

You can't buy preferred stock in Goldman Sachs (NYSE: GS  ) or General Electric (NYSE: GE  ) with a guaranteed 10% yield. Fortunately, Warren Buffett can. By investing in Berkshire Hathaway (NYSE: BRK-B  ) , you get the world's greatest investor working for you. He's the world's best capital allocator, who can also demand better terms than just about anyone else.

You see, an investment by Buffett inspires an instant boost of investor confidence -- and he demands a premium for that. You can bet that his $3 billion investment in GE made it much easier for GE to raise the next $9 billion. Despite the high sticker price, the shares are worth 15%-20% more than the market is currently pricing them at.

Here's another idea. People want to live long, healthy lives, and Pfizer (NYSE: PFE  ) is there to help. This health-care behemoth is out of favor, but it's also yielding nearly 8%. Don't fret over the election/health-care jitters. This is an outstanding company trading at a discount.

If you want a few more bailout-resistant stock ideas, check out this excellent Fool article.

What now? The Motley Fool is here to answer your questions about this financial crisis. Send us an email at AsktheFool@fool.com, and check back at Fool.com as we answer your questions and cover the latest on the Panic of 2008.

Buck Hartzell owns shares of Berkshire Hathaway. Berkshire is an Inside Value and Stock Advisor recommendation. Pfizer is a recommendation in both Income Investor and Inside Value. The Motley Fool owns shares of Berkshire and Pfizer and has a disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 17, 2008, at 11:40 PM, markwg1 wrote:

    In my opinion, companies' revenues and profits cannot go up indefinitely... so it's a waste of time to use the strategies "buy and hold," "P/E," "Book value" in stock markets to buy stocks.

    Best examples: if you invest in stocks like GM, F, GE, YHOO, C, BAC, WB, WM, LEH... 10 years ago... today's returns are less than 5% even some stocks like LEH went bankrupt and GM falling to its 1960s level.

  • Report this Comment On October 18, 2008, at 7:33 AM, EaglesonUK wrote:

    I would agree that "buy and hold" is a waste of time if you're not going to follow through with it when things get tough. Of course today's returns are low - we're in one of the biggest market corrections in history. But the market is cyclical, and today, when stocks are bouncing off the bottom, we are presented with one of the best buying opportunities that we'll ever experience in our lifetimes. Obviously, a buy and hold strategy won't work for mismanaged companies, which is why you should do your homework, evaluate your holdings, and periodically adjust your portfolio.

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