Saturday, November 15, 2008

Buy Baby, Buy

What happened? Were we bushwhacked, or should we have seen it coming? How did we end up in the middle of a perfect storm at a most imperfect and inconvenient time? Here we are, supposedly the most sophisticated and certainly the most technology adept and computerized country in the world, suddenly confronted with doubts as to whether a capitalistic based society is, as almost universally accepted by our citizens, the best system within to live and prosper.

Popular Delusions

It is only eight years ago that the bubble burst, and investors thought. “Never again, we learned our lesson.” But it seems that mankind has a deficient “bubble” gene that malfunctions when least expected. That malady might be best expressed as follows: “Popular delusions began so early, spread so widely, and have lasted so long, that instead of two or three volumes, fifty would scarcely [be] sufficient to detail their history. We find that whole communities suddenly fix their minds upon one object, and go mad in its pursuit; that millions of people become simultaneously impressed with one delusion, and run after it, till their attention is caught by some new folly more captivating than the first…Men it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.”

Those thoughts were written in 1841 by Charles Mackay as part of the preface to the seminal book titled, Extraordinary Popular Delusions, and the Madness of Crowds. The book was influential enough for Bernard Baruch to credit it for his withdrawal from the stock market ahead of the Crash of 1929. The book described the Dutch Tulip mania in the 17 th century, the South Sea Bubble in England in 1711-1720, and the Mississippi Scheme in France in 1720. More recently we can chart the Nifty Fifty stocks in the early 1970’s, Japanese stocks in the late 1980’s, and the Bubble in the late 1990’s. The worst of the lot of course was the Crash of 1929, when according to a recent article in the Wall Street Journal, “The Dow Jones Industrial Average closed at 41.63, down 91 percent from its level exactly three years earlier.”

Bubbles Do Burst

The problem is that the vast majority of professionals, much less individual investors, do not recognize––or at least suggest––that a bubble is in the making until it has burst. James Grant, editor of Grant’s Interest Rate Observer was quoted in The New York Times as providing the following humorous explanation: “People keep stepping on the same rake because money, like romance, is only partly an intellectual experience.” Mr. Grant continued, “Money, like sex, brings out some thought––but also much heavy breathing and little stored knowledge. In finance the process is cyclical. Some people learn from their ancestors, but mostly they repeat the same mistakes. Thus it has always been, and thus it will always be.”

Past failures to recognize a bubble in some tangible manner have led to a number of dire consequences. For example, the last bear market––March 2000 to October 2003––resulted in the S&P 500 Index dropping over 49 percent. About 75 years ago, in 1932, the Index fell some 60 percent over the following five-year period. There are some who predict that the current disaster could end up even worse than the 1929 debacle. Others believe that unlike the inaction of the Hoover administration then, the aggressive intervention currently, will produce much better results.

Is Now the Time to Buy?

So, what should the average investor do now? There are very few people smart enough and reliable enough to answer that question. (I certainly am not one of them.) However I can cite the opinions of a few that I believe might fit the bill. One happens to be the financial genius I admire most.

In an op-ed piece in the Wall Street Journal, the following headline appeared:Buy American, I Am.” The opening paragraph read, “The financial world is a mess, both in the United States and abroad. Its problems moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter, and headlines will continue to be scary.” The author continued, “So…I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but U.S. government bonds.” Who do you think would have been smart enough to plan a stock-free personal portfolio, and thus avoided the recent stock market meltdown? If you haven’t guessed the author of that op-ed piece by now, it’s Warren Buffett.

It’s his recommendation that prompted the Buy Baby, Buy headline at the top of this article. He explains his philosophy quite succinctly writing, “A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly fear is now widespread, gripping even seasoned investors.”

A brand new 950 page authorized biography titled The Snowball: Warren Buffett and the Business of Life was just released and is already number one on The New York Times bestseller list. Some might remember my six part series of articles published here in Viewpointe a few years ago. I described the enormous influence of Benjamin Graham, Buffett’s teacher at Columbia University, who also became his mentor and idol. In the 1929 Crash, just eight days before stocks hit rock bottom, Graham summarized, “…stocks always sell at unduly low prices after a boom collapses.” He went on, “Or stated differently, it happens because those with enterprise haven’t the money, and those with money haven’t the enterprise.”

Buffett learned well at his master’s feet and wrote accordingly in his op-ed piece, “Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month – or a year – from now. What is likely however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.” He ends his piece this way: “I don’t like to opine on the stock market and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I’ll follow the lead of a restaurant that opened in an empty bank building and then advertised: ‘Put your mouth where your money was.’ Today my money and my mouth both say equities.”

Sage Advice?

But Buffett is not the only sage recommending equities. Two well known and highly respected finance professors echo Buffett’s philosophy. Burton G. Malkiel, economic professor at Princeton says, “But just because stock markets have panicked, investors should not. The best position for investors today is not ‘fetal and 100% in cash.’ We are not going to have a depression, and we have survived financial crises before. A century of investing experience, as well as insights from the field of behavioral finance, suggest that investors who bail out of equities during times like these are almost always making the wrong decision.”

Professor Jeremy Siegel at the University of Pennsylvania Wharton School wrote in U.S. News & World Report, “I think these [low] prices will be viewed as extremely cheap even a year from now and people will wish they had the guts to go in. We’ve come back from every bear market and moved on to new highs. Those people with long horizons should look at this as an excellent opportunity to accumulate stocks.”

But note the phrase “long horizon.” Therein lies the rub. According to S&P Index Services, since the 1930’s there were 11 bear markets. The average incurred a loss of 34.1% over a 20-month period. However the worst one in the 1930’s lost 60% of its value and lasted for 62 moths. There was also about a 16-year period when the Dow started at 825 and ended in 1982 at only 826, no gain whatsoever. However, offsetting that, over the same 78 odd year period from the 1930’s, there were 12 occurrences of bull markets that averaged a 164% gain over an average of 57 months each. In other words, the average bull market not only outperforms the bears by five times, it also lasts almost three times as long.

The point here is that while historically speaking, Warren Buffett, the professors, and the above headline are probably correct, it depends on your time horizon. If you are at a point in life when you repeat the old saying, “I don’t buy green bananas,” more caution might be desirable. However, when my son, who is also a Buffett aficionado, asked my opinion of Buffett’s advice, I suggested, “Buy Baby, Buy!”


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