If, after 2008, you still expect the stock market to fund your retirement, most people probably consider you a few congressmen short of a bailout. (Zing!) Yes, it was tough being openly optimistic after a year in which every bull became a steer.
But there are a few perks -- like profiting from buying stocks at what could be some of the best prices you'll ever see.
A brief history of 2008
2008 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 as mortgage values plummeted. Ambac (NYSE: ABK ) and the other bond insurers needed cash as the mortgage-backed securities they were guaranteeing fell. Banks needed cash to maintain their capital ratios as defaults escalated. AIG (NYSE: AIG ) needed cash to balance its losses in credit default swaps. Hedge funds needed cash to fund redemptions and reduce leverage as assets declined.
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.
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 risen to 10%, and consumer confidence remains low.
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 despite the recent market run-up, more than 78% of the companies in the S&P 500 are down from the start of 2008. Some 10% 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 sold because they had to. Like everyone else, they needed the cash.
And that's a really great thing if you're not one of Wall Street's forced sellers, because it means that despite the broader market run-up in 2009, at least some of those companies remain deeply undervalued -- for now.
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, but also compellingly cheap growth stocks.
For instance, these days, the universe of large-cap value stocks includes Google (Nasdaq: GOOG ) . Google has huge barriers to competition, $26 billion of cash on its balance sheet, an innovative culture, and a 21% estimated annual growth rate going forward, and it's trading for about 25 times trailing-12-month free cash flow. At these prices, Google 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 continue showing signs of life this year, 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 McDonald's (NYSE: MCD ) to withstand a depression, or Krispy Kreme (NYSE: KKD ) ? Would you bet on Wal-Mart (NYSE: WMT ) , or Dillard's (NYSE: DDS ) ? These two examples may be somewhat hyperbolic, but it's absolutely true that powerhouses like McDonald's and Wal-Mart are far more likely to survive than companies with smaller moats. The big guys simply 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 still find some excellent businesses extremely cheap.
What's more, thanks to the poor economy, the earnings of these powerhouse companies have been depressed this year, which means that their normalized earnings multiple is even more compelling. Large-cap stocks are still 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 strike it rich. You still need to pay attention to balance sheets, and monitor 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.
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This article was originally published Jan. 8, 2009. It has been updated.
Fool contributor Richard Gibbons knows all too well the pain of becoming a steer. He owns shares of Google, which is a Motley Fool Rule Breakers pick. Wal-Mart is an Inside Value selection. The Fool's disclosure policy wears a large cap to avoid sunburn.