An Investment Opportunity of Historic Proportions

It's difficult to have any confidence in today's market. In the past 365 days, we've seen a housing bubble pop, a credit crunch ensue, a gigantic investment bank nearly go under, and extreme -- even "bailout" -- measures from our federal government. To top it off, yesterday the Dow hit a yearly low.

Save for a few specific industries (notably agriculture, thanks to PotashCorp (NYSE: POT  ) , Monsanto (NYSE: MON  ) ), stocks have been hit hard. The S&P 500 is off its autumn highs by a little more than 15%.

You've done even worse over the same period time if you're a value investor (the Russell 1000 value index is down 20%). Small-cap value investors have fared slightly, but not markedly, better (the S&P SmallCap 600 value index is down about 14%). So it goes for a strategy that embraces "losers" such as Morgan Stanley (NYSE: MS  ) , US Bancorp (NYSE: USB  ) , and Citigroup (NYSE: C  ) on the large-cap side, and Southern Union (NYSE: SUG  ) and Micros (Nasdaq: MCRS  ) on the small.

Where is the market headed?
It's no surprise that as stocks have fallen, investors have become more and more anxious and have further sold off stocks. Life savings -- for down payments on houses, retirement nest eggs, a child's education -- are on the line.

But perhaps now's the time to buck up. We don't know what direction the market will take from here, but there are highly accredited professional money managers of the value persuasion who like what they're seeing in today's stock prices.

In his most recent quarterly letter to shareholders, money manager Richard Pzena said he believes "the opportunity has grown." He continues, "What the current crisis has done is to propel what was a very attractive valuation opportunity in the financial sector to one of historic proportions."

Pzena already has been invested in some financial-sector-related companies, and while those bets haven't worked out so far, he's thinking long-term.

He's not alone
Legendary but recently maligned Legg Mason Value Trust manager Bill Miller had a similar take in his quarterly letter to fundholders:

That sets the stage for what should be an improving environment for investors in stocks. ... With most investors being fearful, I think it makes sense to allocate some capital to the greedy side of that pendulum, and that means putting cash to work in equities.

Then there's the team that runs Dodge & Cox Stock -- which has outperformed the S&P 500 by five percentage points per year over the past decade! You'll see a variation on this same theme in recent remarks:

As investors continue to grapple with disappointing news about credit market dislocations and the near-term U.S. economic outlook, we believe that significant investment opportunities are being created for the patient, long-term investor.

Four out of four smart investors agree
Finally, there are these cautious, but upbeat, words from Ian Cumming, the chairman and president of Leucadia National:

It may take quite a while for the scrubbing of balance sheets and the unwinding of leverage to come to an end, and we suspect that not all will survive. ... We are confident that the financial system will repair itself and to learn to better distinguish who is a worthy borrower and what is a worthy loan. On the bright side, opportunities for courageous investors should abound.

So, to recap:

  • The market downdraft has created more opportunities in today's market.
  • Most investors are fearful, but noted money managers are putting cash to work in equities.
  • To take advantage of those bargains, investors need to be patient and courageous.

Rock, meet hard place
That last point makes it so tricky for individual investors to make big money in the stock market. We're hardwired to be neither patient ... nor courageous.

But if you count yourself among those who feel more comfortable sitting on the sidelines today, consider reassessing your decision sooner rather than later. There will come a time when you and people like you decide that it's safe to get back into stocks. When that happens, the market will jump, and valuations will skyrocket.

You want to be fully invested before that happens. Trust us. After all, it was a lot better to buy Google the day before its recent fantastic earnings report caused the stock to jump more than 20%. Sure, you could have been early to the story, but if you can tolerate any volatility, know that great companies like Google -- and like the market at large -- prevail in the long term.

Change your POV
As you can probably guess, we've struggled with volatility at our Motley Fool Hidden Gems small-cap value investing service. As advisor Bill Mann wrote in our recent review issue, "Investors have come to some sobering realizations: Casinos can't print money in good times and bad, and housing prices don't only go up, for example."

But like so many great investors, we're banking on the long term, and taking advantage of current pessimism to build out positions in the companies we admire most. In fact, we recently completed a six-month review issue, re-recommending a financial company that's woefully undervalued.

Will it rise tomorrow? Of course not. But its prospects are bright.

If you'd like to learn more about that financial company as well as all of our top picks for new money, click here to join Hidden Gems free for 30 days. There is no obligation to subscribe. This article was first published April 29, 2008. It has been updated.

Neither Tim Hanson nor Brian Richards owns shares of any company mentioned. Google is a Rule Breakers recommendation. US Bancorp is an Income Investor pick. The Fool has a disclosure policy.

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  • Report this Comment On June 28, 2008, at 1:43 PM, FOOLBEFREE wrote:

    "We are not hardwired to be patient and courageous.". "Your emotions are your worst enemy". "Buy when everyone is fearful"

    These have been mentioned by many of the best investors.

    To become better investors, if we want to retire some day, we have to learn to be patient and courageous.

    Patient to wait before buying a great stock (wait for the good price). Patient to wait after if it drops (do not sell because it dropped if the company's prospect are still great).

    Courageous is to buy when everyone is fearful. It is to buy the great companies that the market is selling at a discount when everybody is selling and panicking. It is also not to sell a great stock because it dropped. Most hedge funds and mutual funds over sell. They have to show good returns every 3 months. Individual investors do not.

    To be patient and courageous, learn to control your emotions. The great investor control their emotions.

    So how to know when to buy the great stocks ? How to find the great stocks ? How do you spot the long term trends and sector bull markets?

    Do you buy what other great investors have been buying ?. Do you buy index ETFs, great mutual funds and individual stocks ? Do you subscribe to news letters ?. Perhaps all of the above.

    I think buying the great companies in the coming weeks is an opportunity of historic proportions if you are a long term investor.

    Possible reasons to buy now, from books written by the best investors:

    1. Stock returns are much higher than 10 year bond returns (10 year treasury note).

    Historically, when this happens, stocks do very well. I am personally watching labor inflation (still contained in the US), the PCE (May 08 core PCE deflator is 2.1%, still contained).

    If these two spike, the 10 year bond rate should spike. If the 10 year bond rate gets to 5.5% (currently 4%), stocks will get slammed hard. Also EPS are trending lower, but they have to be a lot lower.

    Long-term interest rates remain benign, signaling inflation is not a near-term concern.

    2. Global yield curve is normal, steep, not inverted, which coincides with periods when stocks do very well because recessions do not normally happen when yield curves are normal.

    However, US banks with no capital cannot lend, which may be the same as an inverted yield curve. This may mean that we have to consider buying global and international stocks.

    3. The 4th year of a US presidential cycle is normally good for stocks. The President and Congress do not introduce many changes.

    4. Fear is high and rising (VIX is 23.44 and trending higher--> Time to buy the great stocks on sale for the long term, and uptrending stocks/ETFs, when they pull back. Do not sell the good stocks when the market panics. Keep on investing new money in the good stocks on sale.

    In summary, all the above could change if unit labor cost go out of control and spike. You have to assume unit labor cost will not go out of control because labor productivity is high and will remain high in the US.

    Therefore, buy the good stocks that the best investors have been buying or buy index ETFs (QQQQ, DIA, SPY, MDY, IWM) and sell covered calls to get some return.

    The market may not do anything for the next few months and years. This is why it is a good idea to sell covered calls now to get 12%-15% a year. If the market buys your stock/ETF, buy it again if you still like the stock/ETF and redo the covered call.

    Assuming the worst, if inflation goes out of control, buy stocks with durable competitive advantages (moat) with low debt. Companies with moats can raise prices when inflation goes up.

    "Where is the market headed?"

    Historically, periods when commodity prices rise are not good for stocks (input cost are higher, EPS go down).

    The stock market indexes may be flat or up a little, down a little for the next months, or few years. Commodity stocks should go up in the next months and few years. China, India, Brazil should continue growing and demanding more commodities in the next few years.

    Therefore, it is also a good idea to buy commodity related ETFs (MXI, OIH) to diversify and get better average returns in the coming years.

    Current trends are high global demand of commodities and more energy exploration. The US will have to allow more offshore drilling. Time to buy OIH on pullbacks, perhaps. If couragous enough, buy RIG, ATW, SLB.

    Yes, I have been buying stocks, ETFs and a few of the great mutual funds (CGMFX). Our retirement portfolio is showing gains right now because we mostly buy when the market is down like right now. We buy what other great investors have when these stocks are down.

    Also, diversification has proven to work, we bought commodity related stocks over a year ago (oil, natural gas, alternative energy ETFs, copper, gold, iron ore--> PBR, RIO, CHK, XTO, FCX, PBW). Because of the commodity related returns, the portfolios are doing well during this difficult times.

    My two cents from someone who wants to retire some day. Comments are welcome.

  • Report this Comment On July 17, 2008, at 6:22 AM, jay1214u wrote:

    What is your % accuracy every quarter/year and have you beaten the Stock Advisory pick fo TMF

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