If, after 2008, you're still looking at the stock market as a way to fund your retirement, most people probably consider you a few congressmen short of a bailout. (Zing!) It's probably progressed far beyond the point of people refusing to make eye contact with you. In all likelihood, your dog is, too.
Yes, it's tough proclaiming yourself a bull after a year in which every bull became a steer.
But there are a few perks. Like getting the profits that come from buying stocks at what could be some of the best prices you'll ever see.
A brief history of 2008
Last year was a fantastic demonstration of what happens when, in a highly leveraged world, everyone needs liquidity at the same time.
Anyone who borrowed to buy mortgage-backed securities needed cash when mortgage values plummeted. Investment banks like Morgan Stanley needed cash as the mortgage-backed securities on the companies' books began to fall. Retail banks like Citigroup needed cash to maintain capital ratios as defaults escalated. AIG needed cash to balance its losses in credit default swaps. Hedge funds needed cash to fund redemptions and reduce leverage when assets declined.
The liquidity crunch spilled over into other industries; dry bulk shipper DryShips (NYSE:DRYS) recently broke debt covenants. And, just this week, Moody's downgraded Capital One (NYSE:COF) on the expectation of rising credit costs.
The problem is, when everyone needs cash, the only way to get it is to sell off assets. And that's what investors did, dumping almost every asset class, with the exception of ultra-safe Treasuries. The stock market took it on the chin.
An overreaction
That's not to say that the market collapsed simply because everyone cashed out. The problems in our economy are real. We've seen huge bankruptcies, the unemployment rate has spiked to higher than 8%, and consumer confidence is low. Companies that need cash are finding it tough to raise money at reasonable costs.
But the carnage in the market isn't limited to the shaky companies that are likely to suffer the most. The S&P 500 contains the biggest, most successful, and most stable businesses in America. Yet more than 94% of the companies in the S&P 500 fell during 2008. Over 30% lost more than half their value! Certainly, deteriorating business prospects are responsible for some of that drop. But based on valuations, it seems likely that stock investors are selling because they must. Like everyone else, they need the cash.
And that's a really great thing if you're not one of Wall Street's forced sellers.
The sweet spot
Large-cap value stocks could be the best way to exploit this opportunity. I'm not just talking about slow-growing companies trading at low, single-digit earnings multiples; I'm talking about compellingly cheap growth stocks.
For instance, these days, the universe of large-cap value stocks includes eBay (NASDAQ:EBAY). eBay has a strong competitive advantage, $2 billion of net cash on its balance sheet, an 18% estimated annual growth rate going forward, and is trading for a below-market earnings multiple. At these prices, eBay is a large-cap value stock.
So why are large-cap value stocks a great investment these days? Not because these stocks are certain to outperform the other categories under all circumstances, but because they present the ideal trade-off between risk and reward in these troubling times.
While there's a good chance that the economy will start showing signs of life sometime in 2009, there's a possibility that things will get even worse. When you're betting your retirement, you should own businesses that can survive the worst-case scenario.
Low risk, high reward
Generally, large-cap stocks fit that criterion. They have the most stable cash flows, the most well-known brands, the greatest economies of scale, and the best chance of recovering from mistakes.
Would you put your money on Best Buy (NYSE:BBY) to withstand a depression, or Radio Shack (NYSE:RSH)? Would you bet on Amgen (NASDAQ:AMGN) or Discovery Laboratories? These two examples may be somewhat hyperbolic, but it's absolutely true that powerhouses like Best Buy and Amgen are far more likely to survive than companies with smaller moats -- because they have the financial clout, the economies of scale, and the proven, winning business models.
In normal times, you'd really have to pay up for these sorts of dominant companies. But thanks to forced selling from investors struggling to raise cash, right now you can buy some excellent businesses for a song. The S&P 500 is trading at around 14 times estimated 2009 earnings, its lowest earnings multiple in 20 years.
What's more, due to the poor economy, the earnings of these powerhouse companies will be depressed in 2009, which means that the normalized earnings multiple is even more compelling. Large-cap stocks are extremely cheap, and I believe they will offer superior returns over the next few years.
The Foolish bottom line
Of course, you still have to be careful -- as 2008 has shown us, you can't just throw a dart at the S&P 500 and expect to avoid a blow-up. You still need to pay attention to balance sheets and how much cash companies are bringing in during these troubling times.
But if you're alert, you can find the stocks right now that will pay for your retirement. So, now is a good time to start buying large-cap value stocks. If you're interested in ideas, our Motley Fool Inside Value team has identified the dirt-cheap stocks that we think offer the most enticing combination of safety and upside potential. You can read our complete analysis with a 30-day free trial.
This article was originally published on Jan. 8, 2009. It has been updated.
Fool contributor Richard Gibbons owns shares and is long calls on eBay. eBay and Best Buy are both Stock Advisor and Inside Value recommendations. Moody's is also a Stock Advisor pick. The Fool owns shares of Best Buy. The Fool's disclosure policy wears a large cap to avoid sunburn.
