Just thought that I would point to an article from MarketWatch.com author, Howard Gold. In it, he eloquently discusses a similar theme that I touched on in my August 24th post.
Remember “The Death of Equities,” BusinessWeek’s seminal Aug. 13, 1979 cover story? It claimed that investors, burned by years of poor returns in the 1970s, had abandoned stocks for good.
Well, last Sunday, The New York Times published what may as well have been entitled “The Death of Equities II.“
If you have been following the stock market for the last few months, you may as well have been watching daytime soap operas – you’d have found just as many twists and turns in either. Let me give you a very brief recap of the events of the summer season.
As the world has turned, young and restless traders and investors across the globe have helped to map out a market that is riddled with uncertainty and intrigue. The condition of the U.S. economy has seemingly been changing with the days of our lives – one minute it is upbeat and enthusiastic – the next moment, it is downtrodden and lethargic. Although corporate earnings have largely come in above consensus estimates, companies have seemingly chosen to use their copious amounts of cash to gobble each other up in bold, contentious displays of bargaining, rather than to expand their operations and hire more workers. Thus, the employment situation remains weak and consumer demand and sentiment have languished along with it. The capricious nature of the market has almost been enough to force even the hardiest of investors to check themselves into a general hospital. Now, many market participants seek a guiding light that will point the way to calmer waters. But from what source will this guiding light emerge?
Investors hoping for this light to come from near-term economic developments will likely be disappointed, as the most recent data suggests that the recovery is petering out. Whether or not this information reflects merely a minor bump on the path to economic growth or a major roadblock is up for debate.
Thus, if the news will not be forthcoming with positive developments, where else may an individual investor turn?
To a different strategy? Many commentators have boldly proclaimed that the age-old strategy of “buy-and-hold” is dead – that it isn’t enough to find good companies in which to invest for the long haul; rather, one must endeavor to profit from the volatility in the markets. What these commentators frequently fail to point out is the fact that research has consistently shown that over the long term, individual investors who pursue a marketing-timing trading strategy do not outperform the market.
To different asset classes? The recent stock-market malaise coupled with the strong performance in the bond markets have convinced some that the value of equities as an investment option has been permanently tarnished. This argument is nothing new, as previous decades of stagnant stock markets yielded such observations as well. In the face of poor performance it is certainly tempting to jump ship. Those who felt that market paradigms had shifted in the mid 1970s fell into that temptation, and, as a consequence, likely missed out on a substantial amount of the bull market in stocks that began in the early 1980s. Remember, historical after-inflation returns for stocks remain – by leaps and bounds – the highest amongst any asset class.
Now, I will be the first to admit that solely basing present strategies upon past returns is a recipe for failure. However, it would be folly to ignore nearly a hundred years of well-established historical paradigms.
My thoughts? Don’t let the soap-opera-esque twists and turns of the market lure you away from time-tested strategies. They have persevered for very good reasons.
I have a theory about horror films: What truly frightens the heck out of so many viewers isn’t so much the disturbing and grotesque imagery – rather, it’s the fact that what appears on screen does not rationally comply with the world that we know.
Consider the following: In the film, Saving Private Ryan, the viewer witnesses the often-grotesque deaths of many soldiers. While these visuals might certainly be disturbing to some, they do not deliver the type of intense fear that interrupts the blissful slumbers of quite a few horror-movie-goers. And why should they? Though the images from Saving Private Ryan may not make us feel warm inside, we expect to see them. In real life, soldiers do perish on far-off battlefields. What we see makes sense.
What doesn’t make sense are the following visuals: a horrifically mutilated girl crawls out of television screens and turns perfectly alive human beings into perfectly lifeless disfigured corpses (The Ring); a child crab-walks down a flight of stairs at a frightening pace and vomits when she reaches the landing (The Exorcist); a children’s doll comes to life and brutally murders people (Chucky).
Get the idea? When expected things happen (soldiers dying) – no big deal. When unexpected things happen (scary girl crawling out of TV) – panic. What really scares us – what really jars our minds – is when things happen that just don’t make sense.
Often, the stock market is a veritable factory for this type of fear. Consider the following example:
Xyratex Ltd., (XRTX) is a British data storage solutions provider whose six largest customers – NetApp, Dell, IBM, Seagate, Western Digital and Data Domain – are practically household names. By any rational analysis of its present financial condition, the company appears to be startlingly undervalued. The current consensus of six analysts expects Xyratex to earn $4.23 per share in FY 2010 on revenue of $1.6 billion. Given the company’s present share price ($11.49), this would equate to a P/E ratio of about 2.72 – or 2.26 if you back out the company’s $1.93 per share cash hoard. Granted, the analyst estimates for 2011 are not quite as rosy – $2.91 EPS on flat revenue – but even when one considers these less favorable forward projections, the company’s valuation remains shockingly low. Why then, does this company’s stock price languish at such low levels?
It just doesn’t make sense.
And that’s just it. When the recent stock market malaise began in late spring, this relatively unknown small-cap company seems to have been unfairly punished by the moody Mr. Market. What resulted was a dizzying 45% drop from the 52-week highs that Xyratex notched in April to the prices that investors see today. And when prices fall, investors tend to get scared.
“The stock price has gone down despite stellar earnings! Something must be wrong!” investors might reason. So they sell their stock, which, of course, lowers the price even more; this, in turn, creates more fear and induces even more people to sell their stock. What results is a self-reinforcing price depression that simply doesn’t make sense.
So how does it end? Well, if one trusts in the wisdom of noted investors Benjamin Graham and Warren Buffett, then the following conclusion to this stock market horror film seems realistic: At some point, the strong fundamentals of Xyratex will be made manifest in its stock price. Of course, there’s no telling when this may occur, but, for now, I am perfectly willing to wait until the end of this horror film.
Disclosure: The author holds a LONG position in XRTX.
Occasionally when I daydream, I like to imagine that I am an experienced and successful investor. The thought evokes warm thoughts: Me, staring at the desktop of my MacBook Pro – PDFs of press releases and SEC documents strewn carelessly about. Looking outside the window on my left to a radiant summer day. Looking towards the HDTV and Xbox 360 on my right that kept me from enjoying that radiant summer day. Logging into my investment account and being greeted with welcoming green numbers that intangibly massage all of my worries away.
Reality, however, usually has other plans. When it awakes me from my buoyant stupor I am greeted by several glaring facts:
These facts accost me whenever I conduct company research or log my performance at the close of the markets. They sully my confidence, trigger self-doubt, and lead to reticence when I am considering a possible trade. If only those cold facts did not exist. If only their influence upon my mind and emotions could be lessened.
While only time-tested performance can provide me the permanent pool of investing confidence that I so dearly desire, I have found one way to assuage the pangs of insecurity that abruptly awake me from my wishful day-dreams: By realizing that I am following in the investing footsteps of money managers with resources, levels of training, and experiences that far outweigh my own.
Thus, when I see that my carefully researched positions are supported with strong investments from well-regarded professional investors, I am able to rest a little easier.
Consider the following four small cap companies that I own that have attracted thorough due diligence and large investments from skilled money-managers.
I will be the first person to note that my untested background gives little reason for other investors to heed my opinions. So, if you decide to invest in any of the aforementioned companies, tell them that Fidelity Investments, Michael Dell or Hank Greenberg told you it was a good idea.
Disclosure: The author holds LONG positions in all of the discussed securities.