A Sure Sign That Now's the Time to Buy

As I was flipping through the news earlier this week, I was stopped dead in my tracks by the hook at the beginning of a Bloomberg article. It was short, sweet, and pulled me in like a Death Star tractor beam. It read: "Wall Street's hottest new product is fear."

I had no choice but to read on.

The article discussed the new fund that bond giant Pimco is planning to offer. The fund will in essence be a giant hedge that theoretically will protect investors from a market plunge of 15% or more.

The idea of such a fund isn't all that new. Nassim Taleb, author of The Black Swan, started a fund to hedge so-called "tail risk" back in 1999 and Mark Spitznagel, a partner on that original fund, continues to carry that torch today. Nor is Pimco alone in chasing this strategy right now. Deutsche Bank (NYSE: DB  ) and Citigroup (NYSE: C  ) are among larger firms trying to get in the game, while smaller hedge funds pile in as well.

So what does it mean for all of us Fools when fear is the new hot item on Wall Street?

This is what happens without fear
Let's first examine the flip side of a fearful market. Let's rewind to February 2000. Here's a snippet from a New York Times article that paints a pretty good picture of where we were:

'I am having a hard time getting anyone to listen to anything but technology,' said Philip S. Dow, a managing director in equity research at Dain Rauscher Wessels in Minneapolis. 'Our clients want to be in the right stocks, and they want to be in the ones that are moving.'

That was just as the Nasdaq was breaking over 4,400, only to launch a month later into a long plunge. The Nasdaq wouldn't see that 4,400 level again until ... well, I don't really know because it hasn't seen that level again.

Or how about if we go to May 2005, when The New York Times reported:

Over all, home prices have never fallen by a significant amount, and Alan Greenspan, the chairman of the Federal Reserve Board, said last Friday that a national drop in price remained unlikely.

And backtracking just a bit, here's a little something from then Fed governor Ben Bernanke in February 2004:

One of the most striking features of the economic landscape over the past twenty years or so has been a substantial decline in macroeconomic volatility. ... Several writers on the topic have dubbed this remarkable decline in the variability of both output and inflation "the Great Moderation." ... Reduced macroeconomic volatility has numerous benefits. Lower volatility of inflation improves market functioning, makes economic planning easier, and reduces the resources devoted to hedging inflation risks. Lower volatility of output tends to imply more stable employment and a reduction in the extent of economic uncertainty confronting households and firms. The reduction in the volatility of output is also closely associated with the fact that recessions have become less frequent and less severe.

What's my point? That people can be spectacularly (and very publicly) wrong? That's part of it, but it's more so that when these excerpts were put in print the views were not fringe views espoused by a vocal minority. These were commonly held views that were propelling markets.

In other words, fear was a commodity in short supply.

This is your market on fear
Fear and skepticism aren't bad things. From an investor's point of view, they're actually really good things. In overdose levels -- as we saw early last year -- they can create tremendous values. Even in more moderate levels, they keep investors vigilant to risks and keep a lid on the so-called animal spirits that can cause markets to get carried away.

With new funds like Pimco's popping up to try and cash in on investors' discomfort, I can't help but think that there's still a more-than-healthy amount of fear permeating the markets. That's further underscored by very buyable valuations on many attractive stocks.

Company

Forward Price-to-Earnings Ratio

Expected Long-Term Growth

PEG Ratio

Ford (NYSE: F  )

8.9

14%

0.6

Visa (NYSE: V  )

17.4

20%

0.9

Teva Pharmaceutical (Nasdaq: TEVA  )

11.9

14%

0.8

Boeing (NYSE: BA  )

16.4

15%

1.1

Altria (NYSE: MO  )

11.5

8%

1.5

Source: Capital IQ, a Standard & Poor's company.

What's particularly interesting about the attractive stocks out there right now is that they're not concentrated in one particular corner of the market.

In this list we have a few stocks -- Teva, Visa, and Altria -- that don't need a searing economic rebound to keep up their growth pace. Teva sells generic pharmaceuticals, which will only become more popular as countries around the world look to contain medical spending. On a different side of the coin, Altria sells cigarettes -- one of the most addicting products out there and certainly a business that laughs in the face of recession.

Visa would certainly benefit from a robust economic recovery, but the company has been riding the global secular shift to electronic payments, a shift that's set to continue whether or not we have a strong economic bounce-back.

Ford and Boeing, on the other hand, are more hitched to the economic recovery. Ford will need to see a continued rebound in both consumer spending and confidence in order to move more of its cars, while Boeing needs a rebound in both commercial and military demand. But there should be more-than-ample returns for investors willing to bet on the outcome.

In short, a liberal sprinkling of fear over the stock market has created a pretty compelling environment for buyers.

Fear fades
But this environment won't last. Bloomberg quoted Taleb reacting skeptically to the me-too funds like Pimco's:

If you looked at numbers over a period of time -- six, seven, eight years -- there's much higher return ... But if you watch a trader in any given year, he looks like an idiot. No trader wants to feel like he's an idiot.

In other words, investors, traders, or both will get fed up with waiting for the next big disaster and these funds will most likely quietly shut down a few years from now.

Hypervigilance and skepticism about the market won't last either. It may help constrain the markets for a while, but investors will eventually get bored waiting for the next black swan and start to once again get comfortable with stocks and other investments.

But don't wait until then to start investing again, because it's then that you have to start getting concerned.

Berkshire Hathaway didn't make the list above, but my fellow Fool Alex Dumortier thinks it is extremely cheap.

Berkshire Hathaway is a Motley Fool Inside Value pick and a Motley Fool Stock Advisor recommendation. The Fool owns shares of Berkshire Hathaway. Ford Motor is a Motley Fool Stock Advisor pick. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy

Fool contributor Matt Koppenheffer owns shares of Berkshire Hathaway, but not of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy assures you no Wookiees were harmed in the making of this article.


Read/Post Comments (15) | Recommend This Article (51)

Comments from our Foolish Readers

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 July 21, 2010, at 5:42 PM, PositiveMojo wrote:

    The worst thing that you can do is trade on emotions. You need a method and process that works for you and eliminates emotional decision making.

    During the past three weeks, which have been highly volatile, I have seen a 4% increase in stocks. My formula is simple.

    1. Invest only in well managed companies.

    2. Only buy when 4-5 technical indicators are showing upward price momentum and demand for the stock (stochastic, moving avg, DMI, volume, RSI). Demand always pushes the price higher. (But I have spent years honing my chart reading and decision making).

    3. Have an exit strategy the minute you buy a stock. I use a trailing stop loss and set the stop amount based on the Average True Range (ATR) a measure of volatility. To determine the stop amount I go back about a month and tend to use the highest number - my decision is influenced by changes in volatility and whether volatility has been moving up or down over the past two weeks.

    Do those things and you'll dramatically reduce risk - and make some money.

  • Report this Comment On July 21, 2010, at 5:42 PM, PositiveMojo wrote:

    The worst thing that you can do is trade on emotions. You need a method and process that works for you and eliminates emotional decision making.

    During the past three weeks, which have been highly volatile, I have seen a 4% increase in stocks. My formula is simple.

    1. Invest only in well managed companies.

    2. Only buy when 4-5 technical indicators are showing upward price momentum and demand for the stock (stochastic, moving avg, DMI, volume, RSI). Demand always pushes the price higher. (But I have spent years honing my chart reading and decision making).

    3. Have an exit strategy the minute you buy a stock. I use a trailing stop loss and set the stop amount based on the Average True Range (ATR) a measure of volatility. To determine the stop amount I go back about a month and tend to use the highest number - my decision is influenced by changes in volatility and whether volatility has been moving up or down over the past two weeks.

    Do those things and you'll dramatically reduce risk - and make some money.

  • Report this Comment On July 21, 2010, at 7:57 PM, tomd728 wrote:

    I appreciate Graybear's approach as this ain't no old days "buy and hold" Market.

    When one thinks about the demographics in the

    U.S., who is really investing,how old the methods are.........it's a new ballgame.

    All of the principals cited in your piece are also doing a concerted and great job of scaring the dickens out of any one who is still interested in equities.

    I happened to catch Mohammed El-Arain of PIMCO on CNBC this week and this "new normal"

    razzle dazzle has many folks sleepless no doubt.

    Traders are going to win the prizes for the time being and we are in for that "hard rain" regardless of who says what.

    Thank you,

    Tom

  • Report this Comment On July 21, 2010, at 9:32 PM, wwt17 wrote:

    Graybear says: "The worst thing that you can do is trade on emotions."

    i look at it a little differently. i think it's great to trade on emotions; other people's emotions that is. i've gotten my sweetest deals when people were running scared and it's definately helped my bottom line.

    i'm not a stop loss guy either. if i had used a stop loss i'd be out of some really great gainers that have made up for any laggers in my portfolio.

    to each their own and good luck.

  • Report this Comment On July 21, 2010, at 10:44 PM, burrowsx wrote:

    Still too early. Wall Street needs to punish Obama for the reform package. That will require making the economy look bad by generating a correction in the August-October timeframe. I wish I were wrong.

  • Report this Comment On July 21, 2010, at 11:04 PM, EquityBull wrote:

    Good column. Just another way of saying Buffet's "Be greedy when others are fearful and fearful of when others are greedy"

  • Report this Comment On July 21, 2010, at 11:11 PM, WallstreetKnight wrote:

    Why would they want to punish Obama? With this thing in the state it is, they are in the clear.

    You make it sound like they regularly move the market up and down just to prove points.

    Remember, on the Street Profits > Politics.

  • Report this Comment On July 22, 2010, at 12:58 AM, TMFKopp wrote:

    @wwt17

    "i'm not a stop loss guy either. if i had used a stop loss i'd be out of some really great gainers that have made up for any laggers in my portfolio."

    I tend to agree. I'd be curious to see if anyone had anything empirical on the use of stop-losses... though mostly just for curiosity's sake.

    When I buy, I tend to buy as if I'm buying a piece of a company that I believe is worth a certain amount (hopefully a lot more than what it's selling for). If I'm going to sell, it's going to be because something changed or I realized something in my original calculations was wrong. Excepting that, a downward price movement is a reason to potentially buy more, if anything.

    And while there's more noise on the markets than there's ever been in the past, I also find myself disagreeing with CelticRiver's assessment that the game has change at its heart.

    Matt

  • Report this Comment On July 22, 2010, at 1:54 PM, LWILLS wrote:

    I agree with Matt & wwt17. While this may be a "traders market" and clearly there are short-term profits to be made in this manner, I would also argue that the bigger profits are to be made in finding the great or soon-to-be great companies at bargain prices and holding on to them long-term.

    And I also totally disagree on the comment that the game has changed. Everytime I hear this it always sets off alarm bells. It was the same thing that was said during the internet bubble, Enron's rise, housing bubble, I could go on and on. It should raise a red flag to everyone when we start hearing that phrase on a regular basis.

    But I also recognize that some people like technical trading and that a few have made good/great money. It's just not my cup of tea.

  • Report this Comment On July 22, 2010, at 2:53 PM, seagull2912 wrote:

    I glad to hear that I am not the only one who don't use a stop loss.

    Then the market goes down I always sell the naked putt gradually on all different strike prices (cash covered or/and equity line of credit) I do it for the position I would like to be long on and the price I would be comfortable with. I also use the naked putts for position I would like get read of in order to overage them down and for position I like to enhance the performance on the way up.

    I do sell cover call against the long positions I have. I sell for the price I would be happy with. And I always try to live certain amount of the long position uncovered to let them run up.

    Needless to say if I am able to pair my Puts with my Calls and use them on the dividend producing caws it brings the results Madoff would be envy.

    Surly I learn that hard way and on March 9 2009. My LEAPS Putts brought me to my knee but thanks to the low Interest rate ( I deepen to my Home Equity Line of Credit) I was able to weather it. This was my Black Swan.

    I am under impression the options are the Black Swan for the the Fools? may be because the are not as fool as they would like to be or may be it is so simple nobody understand it .....?

  • Report this Comment On July 22, 2010, at 5:39 PM, mtracy9 wrote:

    "The most common cause of low prices is pessimism -- sometimes pervasive, sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It's optimism that is the enemy of the rational buyer. I made by far the best buys I've ever made in my lifetime in 1974. And that was a time of great pessimism and the oil shock and stagflation and all those sorts of things. But stocks were cheap." --Warren Buffett

    http://shouldersofgiantsinvestor.com/

  • Report this Comment On July 22, 2010, at 6:44 PM, billypae wrote:

    How are the banks supposed to make any money to get themselves out of this mess? Interest rates are too low to make Citigroup any revenue, which the government overlooks as a source of tax revenue also. The government is being its own enemy. It's like the right hand doesn't let the left hand do anything. If banks really were allowed to make more money through banking, the government would get more taxes and everyone would be happier. We need to raise interest rates instead of worry about the stock market. We need to be more proactive instead of worried and passive aggressive. In Macroeconomics, raising the interest rates alone would increase the supply side of the supply-demand curves of GDP and prices, which would amount to more jobs alone. In other words, raising interest rates would stimulate lending by banks to corporations (supply side) and thereby create jobs. Jobs would then stimulate the equilibrium point to a point along the recovery or growth curve. Jobs help pay back debt or credit cards, and banks get more revenue. We need to help the banking sector. That much is obvious.

    I wish the government would not sell itself short and low for example in Citigroup and downturn share prices by threatening to sell its shares. If the government would realize that Citigroup could return to $50 dollars a share by three years or so in a recovery to NORMAL (as it was 3-10 years ago), individual investors could again buy at the low current prices and take advantage of the huge opportunity. JP Morgan Chase, Wells Fargo, US bank, and HSBC have all made quick strides to recover back to normal stock prices, so why can't we invest heavily in Citigroup collectively WITH the government to make about 10 fold ($4.09 to 50.00 dollars per share would be a huge profit that everyone would benefit from. Wouldn't we?) If the government is tepid, consumer and business confidence is affected too. Government, can we lend more confidence to Citigroup and help invest in a sure fire winner?

  • Report this Comment On July 23, 2010, at 10:45 AM, carjjc wrote:

    Well said!!!

    I think this is exactly correct. With fear high and unfounded negative opinion on the market and historic low valuations and a recovery already on the way. Now is the time to invest.

    jc

  • Report this Comment On July 24, 2010, at 1:42 PM, radicalaccountin wrote:

    Fear and debt.

  • Report this Comment On July 24, 2010, at 5:42 PM, tdiaczok wrote:

    This article has no economic basis. Demographics and debt will see this article proven wrong in the medium to longer term.

    The reasons for pessimism are structural this time and won't be fixed by a change of sentiment.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1241075, ~/Articles/ArticleHandler.aspx, 8/28/2014 11:29:33 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement