The Case Against Stocks

A friend of mine -- an aerospace engineer -- refuses to own stocks. Lately, he also refuses to own actively managed funds. He's asked his 401(k) administrator to move his retirement savings into a "stable value" fund to preserve cash.

A stupid move, you say? A missed opportunity to buy quality businesses such as Coca-Cola (NYSE: KO  ) , Procter & Gamble (NYSE: PG  ) , and Nordstrom (NYSE: JWN  ) on the cheap? Perhaps.

But I think he's brilliant -- and not just because he's my friend.

Why stocks stink
His reasoning for not owning equities is simple and ironclad. He doesn't know how to value stocks in this market -- and he refuses to buy anything he can't price effectively.

He's nervous about the economy and about U.S. competitiveness compared to China, India, and the rest of the emerging world.

He doesn't see how trillions in stimulus will boost earnings for failing American stalwarts such as Ford (NYSE: F  ) and General Motors (NYSE: GM  ) . And without increased earnings, my friend argues, there's no reason for stocks to rise.

He's right. The stimulus, which I believe was necessary, could lead to higher inflation and obscure the real price of risk. That's a huge problem, since a fair assessment of risk is elemental to all stock valuation.

OK then, how about an alternative?
So there are excellent reasons to avoid stocks right now.

You may lack the time to study businesses. Or perhaps you're like my friend and lack the temperament to invest now, when artificial sweeteners such as the stimulus have turned the science of valuation into an art form. Or maybe you're like me and just plain tired of taking losses.

I didn't lose as much as the S&P 500 did last year -- our portfolio was down roughly 32% versus 40% for the broader index -- but that's little consolation. Losses are losses and, in 2009, I'm still taking them. I'm sick of it.

In every case, it's tempting to ask: Shouldn't I just flee to cash?

The answer is no.

Remember my friend's point about inflation? Cash is guaranteed to lose. You want some exposure to stocks so that you'll have a share of the gains when Mr. Market steps back from the ledge. Sooner or later, he will -- you want to be in the market when he does.

A market-matching index fund is the lowest-cost way to keep skin in the game without taking extra time to study and value businesses. Mix in a healthy cash position, and you've got a formula that should preserve wealth as you seek upside.

Um, is there a door number three?
But what if you want to do better than matching the market? Let's face it -- matching the market hasn't been so nice lately.

In that case, you'll have to take on the extra risk that comes with buying stocks. But even then, you can limit your downside by betting on managers who've steered their businesses through earlier recessions.

Buffett and Berkshire Hathaway (NYSE: BRK-A  ) come to mind. So does Costco Wholesale (Nasdaq: COST  ) chief executive Jim Sinegal, who co-founded the big-box retailer in 1976. Both stocks were market-beaters during 2008, despite being pummeled by the market. And both companies have emerged from earlier recessions stronger than ever.

Recession-tested managers are typically more conservative than their bull-market peers, and they excel at allocating capital. They've seen the destruction excess can wreak, so they avoid it, choosing instead to invest in sustaining competitive advantages built over decades.

Businesses like these are easier to value because they have a history. They're proven, and they've rewarded those who've bet on them for the very long term. They are, in short, the sorts of companies that David and Tom Gardner seek for Motley Fool Stock Advisor -- both Berkshire and Costco are active picks. Collectively, the portfolio is beating the market by nearly 30%. Care to learn more? Click here to get 30 days of free access to the service.

My friend is right; you needn't own individual stocks. But if you're like me -- if you must invest because you're passionate about business -- then seek first the recession-busters, businesses that already have a history of rewarding those who held during prior recessions.

Chances are, they'll do it again.

Fool contributor Tim Beyers, like The Motley Fool, owned shares of Berkshire at the time of publication. Berkshire, Costco, and Coca-Cola are Inside Value picks. Berkshire and Costco are Stock Advisor selections. Procter & Gamble is an Income Investor choice. The Motley Fool has an ironclad disclosure policy.

Read/Post Comments (24) | Recommend This Article (53)

Comments from our Foolish Readers

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  • Report this Comment On March 23, 2009, at 3:05 PM, Deepfryer wrote:

    Cash still looks good to me. What we're seeing right now is a "dead cat bounce". It's nice that people are becoming more optimistic about the economy, but that doesn't mean it's a good time to buy stocks.

    I expect the markets to be significantly lower in 6 months than where they are right now. Unemployment is still rising, and we could see a lot more bankruptcies this year from companies like retailers and industrials... and don't forget about GM. All it will take is a little more bad news, and the market will take another nosedive. There are too many unresolved issues right now for me to have any faith in the economy. If you really don't like cash as an investment, why not just make an extra payment on your car loan or your mortgage? It's a lot safer than buying stocks.

  • Report this Comment On March 23, 2009, at 5:24 PM, aangelis7 wrote:

    I don't know how you can properly value actively managed mutual funds. Stocks seem simple in comparison!

  • Report this Comment On March 23, 2009, at 5:29 PM, mikecart1 wrote:

    I agree with aangelis7. Mutual funds IMO are the worst investments. Either get an index fund, mma, or CD if you are going to be that conservative. If you do your research and don't take advice from every local naive investor, you can easily beat any other investment vehicle consistently for as long as you stay in the game.

  • Report this Comment On March 23, 2009, at 8:22 PM, GreenPhotog wrote:

    as far as research goes... it's hard to beat Investors' Business Daily and their CAN SLIM method. They boil things down to the simplest factors and tell you the best stocks out there. Try it out.

  • Report this Comment On March 23, 2009, at 9:05 PM, trenton1ryan wrote:

    Good post DeepFryer. In the weeks ahead, we'll see articles about getting out of stocks again (and getting into gold and silver) as optimism dims and flight to safety reemerges.

    Cash indeed.

  • Report this Comment On March 23, 2009, at 9:17 PM, Rick429CJ wrote:

    What other options are there? Treasuries are paying 0%, all this stimulus is going to seriously erode the value of cash. Gold maybe?

  • Report this Comment On March 23, 2009, at 10:40 PM, chantillydude wrote:

    Why not beat inflation with indexed treasuries? No stock risk and minimized inflation risk. As baby boomers retire demand for stocks will continue to decline. As baby boomers age demand for equities will decline as demand for bonds especially low risk bonds increase.

    Templeton and Bogle have both said presciently that the values of stocks are based on their supply and demand. If the demand declines, other things equal their value will decrease. If you can't assess the risk in stocks then you can't reasonably speak to their value without betraying that you have some motive other than honest valuation underlying your analysis.

    That's become my problem with the Motley Fool. The supposed analysis is more and more obscured by "Stock ownership Forever" mantra. For those of us expecting to need money for 4 or fewer years the analysis falls flat. Cash is King.

  • Report this Comment On March 23, 2009, at 10:46 PM, tomd728 wrote:

    I've been in GNMAs since November '08.

    All in,mind you.We'll find out real soon if this

    Bear Market move up is for real and fast.

    Last week I went into two great value funds

    for a 10 % taste.Sure,today 3/23, was a gift

    and an over-reaction but I'll take it.

    I will drop this foray into short-term optimism

    like a wet s--t when the shorts come to

    overpower and intimidate if the noveaux longs

    simply run for cover again.

    I sure as hell do not have the news I need

    to get in further, as I along with the others

    with their feet in, may trample each other

    at the exits.

    Indeed individual stock picking and ETFs

    are out.I'm simply looking for a broad average

    across the spectrum of Value to pay off.

    Let's hope we got legs Grable.


    looking for

  • Report this Comment On March 23, 2009, at 10:54 PM, colbob2 wrote:


  • Report this Comment On March 23, 2009, at 11:35 PM, ReillyDiefenbach wrote:

    "For those of us expecting to need money for 4 or fewer years the analysis falls flat. Cash is King."

    Indeed it is. The stock market is a passenger on the overall economy, not vice versa. I'll need to see a hell of a lot of improvement to justify risking my hard earned money in this volatile environment.

  • Report this Comment On March 23, 2009, at 11:59 PM, sgcole wrote:

    May I suggest an Indexed Annuity? It will track up markets (S&P, or Dow, etc.), but not down markets. There is always a floor interest rate of at least what a C.D is paying. Its tax deferred. Sure the minimum term is usually 5 years, but at the end you can take the money out (and pay some tax), or roll it over into another annuity, or, if you're at least 59 1/2, start an income stream for years or life.

  • Report this Comment On March 24, 2009, at 2:07 AM, slumbek wrote:

    Regarding sgcole's remark, where can I find out information about indexed annuity and from whom to buy?


  • Report this Comment On March 24, 2009, at 2:15 AM, AWF wrote:

    The case Against stocks failed to mention a few points.

    1) The Obama administration is in the process of "redistributing wealth " I ask whose Wealth?

    2) Increased government regulations.? Is the government going to pick winners and losers?

    3) Due you remember "enough is enough"

    Business is the most persecuted " minority " on the planet.! But to whom do we owe our standard of living --the business that create the wonderfull things we have and use. So lets tar and feather the bastards!

  • Report this Comment On March 24, 2009, at 4:37 AM, poored24 wrote:

    Hidden in cash.

  • Report this Comment On March 24, 2009, at 11:13 AM, lesolini wrote:

    Once again, a major FOOL contributor says some very un-foolish things such as:

    The stimulus was necessary?

    It MAY cause inflation?

    Contributors may not reflect the views of the FOOL brothers, but-- come on-- how Wall Street un-foolish can you get?

  • Report this Comment On March 24, 2009, at 12:50 PM, jesse2159 wrote:

    This is not the time to get into stocks. The market still has to digest over a trillion in bad assets and that will put a drag on the economy for many years to come. This isn't a run of the mill recession. This recession is still very dangerous and it's far from over. The stimulus programs simply switched the burden of risk to the public. Wall Street may do better for a time, but nothing feels right about the game between Washington and Wall Street and I doubt anyone other than the nitwits on CNBC have been fooled by the long term outcome of this nonsense.

  • Report this Comment On March 24, 2009, at 5:07 PM, onthewind wrote:

    There has been much written about the stimulus and its effect on inflation, fiat currency, etc mostly by the gold bugs, but no one mentions the effect of the overleveraged banks, the destruction of cash by credit default swaps, whatever they may be?, etc. I for one believe that fear of inflation is over stated until we see real signs of it.

    As for this market, I have been shorting a little, as the bottom is not yet here, in my humble estimation. And yes the last few days have been painful...But after the confidence of the description of how the feds are going to rid this toxic bank balance sheets, little has changed in the short run. More bad news is sure to follow, remember GM, GE, AIG ETC...but then I have been wrong before. Until then, keep your telltails flying, and stay on the wind!

  • Report this Comment On March 24, 2009, at 9:07 PM, sgcole wrote:

    Re annuities: The correct name is Fixed Indexed Annuities. American Equity, ING, Great American, Old Mutual are a few of the insurance companies that issue Fixed Indexed Annuities. Go to their websites and they will hook you up with an agent. Commissions do not come out of premiums paid.

  • Report this Comment On March 26, 2009, at 1:46 AM, Dollar450cents wrote:

    To say that it's time to buy stocks or not implies that one can predict where the market is going to be in 1 month or 1 year from now. The reality is that no one can do that unless they're lucky. Not even Warren Buffett or Peter Lynch can do that. However, if you focus on selecting 20 to 30 excellent businesses who have been around at least 12 years or more, are generally profitable and free cash flow positive, and you buy them at a very low relative PE (like 5 or less), and a low price to book value (say 0.7 or less for example), you can increase the probability of outperforming the broad market over the long term (10 years or more). The key is to know how to identify an excellent business, and how to value it. The value of any business is "the discounted value of the cash that can be taken out of the business over its remaining life, using a reasonable growth rate for the future free cash flow projections, and an appropriate discount rate. Compare this "intrinsic value" to the market cap (market price of the whole business), and buy only when the market cap is half or less than the intrinsic value (which is called buying with a margin of safety). Hold the stock until the market cap equals or exceeds the intrinsic value. Repeat this strategy while holding only 20 to 30 stocks in your entire portfolio at any given time. It's called focused value investing. Read, "The Intelligent Investor" by Benjamin Graham for more details on investing with a margin of safety. Also, think of risk not as volatility, but as the probability of a permanent loss of capital invested. Always assess the downside risk first, then the upside potential.

  • Report this Comment On March 26, 2009, at 5:06 AM, TMFMileHigh wrote:

    Hello lesolini,

    Thanks for writing. To your questions:

    >>The stimulus was necessary? Of course it was. Only now are we beginning to see the TED spread widen and credit unfreeze. Where would we be without this initial injection of capital?

    Certainly we can argue over whether all of the money being spent ought to be spent -- I think there's a *very* good argument that we're overspending now -- but the initial kick was unavoidable.

    >>It MAY cause inflation? Ah, you have a crystal ball -- excellent.

    Rampant inflation should be the result of the printing presses running as they have been. But if the last 15 months have taught us anything, it should be that we're living in unprecedented times.

    FWIW and Foolish best,

    Tim (TMFMileHigh and @milehighfool on Twitter)

  • Report this Comment On March 27, 2009, at 1:48 PM, freddyv3 wrote:

    Why would I take advice from someone who has lost over 30% in this market. I have made some 50% since late 2007 and it's all based on simply looking at the data by experts on the economy and Dow Theory.

    Your aerospace engineer friend is right. Let him stay in cash until things start to make sense again or when they get to a historic level (under 5,000) where even a poorly performing economy will eventually push the market up.

    If you know fair value for the market (somewhere around 6,500), can read a long-term chart (back to before The Great Depression) and pay attention to Leading Economic Indicators you can make much better decisions than most stock analysts.

    Buy low and sell high. We are now about neutral and trending lower as part of a major bear market so be patient.

  • Report this Comment On March 27, 2009, at 1:53 PM, freddyv3 wrote:


    What a FOOLISH comment.

    TODAY (March 27, 2009) is a GOOD day to be out of the market, or better yet, short of the market.

    And tomorrow? Who knows. We do know that Dow Theory has us in a confirmed bear market and until Dow Theory suggests a change it would be wise to follow perhaps the only succesful long term trading strategy ever developed.

  • Report this Comment On March 27, 2009, at 3:03 PM, surgcare2169 wrote:

    "Both stocks were market beaters (BRK, COST) ,despite being pummeled by the market " . What the hell does that mean . GM has been leading the marke higher as well as CITI . It may be a bear market rally but it is definitely "irrational" . Your friend who is gaurding his money is absolutey right . I wouldn't trust anybody to manage my money , These are the same guys buying at the top of this rally which is going to lose money for their clients . Shame Shame Shame

  • Report this Comment On March 29, 2009, at 11:55 PM, paducah5102 wrote:

    BRK/A a market beater??? Not the ones I own

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