Excerpt: Buying at the Point of Maximum Pessimism
Click to Print This Page
In March 2009, the world stock markets unveiled a tremendous opportunity for bargain hunters. March 9, 2009 represented a new low in the 2007 through 2009 bear markets. To be more precise, the March 9 low represented a 57% decline in the S&P 500 from its previous high in October 2007. On a personal note, March 9, 2009 was a particularly exciting time for me. On that day, I sat in a hospital delivery room, simultaneously entering buy orders on my laptop and awaiting the birth of my daughter. To be sure, buying cheap stocks falls far short of becoming a father among life’s precious moments. There is no comparison. Still, the gravitational pull of a bargain hunter to inexpensive stocks can overcome many obstacles, including a less than enthused delivery nurse. The response to buy during periods of sharp market turmoil is not totally unique; there are other stories of investors doing the same. However, the total amount of buyers in the stock market during March 2009 were clearly a minority. Otherwise, the market could not have reached such a low.
Many investors view themselves as value investors or mention that they admire successful investors such as Sir John Templeton or Warren Buffett. Unfortunately, though, many investors find that they lack the conviction to buy when the market presents the greatest opportunities. Investors are commonly betrayed by their own shortsighted behavior when the greatest discounts appear in the market. The reason for this is clear; experiencing losses introduces uncertainty and a loss of confidence in one’s own investments. Until investors can counteract this routine behavioral reaction to market selling, they may be prone to selling at the wrong time. More specifically, I am referring to investors’ time-honored mistake of selling rather than buying at the bottom of a market. One significant step toward correcting this behavior is to prepare for these buying opportunities before they appear. Through this preparation, the investor learns not only to expect market sell-offs but also to look forward to these events. Ultimately, the goal of this preparation is to safeguard against the likely loss of confidence that every investor is susceptible to when the entire market falls in price. Once properly prepared for these events, an investor should be armed with the psychological fortitude to become a buyer during moments when most others in the market are sellers. The investor who wants to capitalize on points of maximum pessimism must be willing and prepared to replace the market’s perspective with his own. When the market is pessimistic, the challenge to the bargain hunter is to be optimistic, and vice versa. During his long and famous career on Wall Street, Sir John Templeton developed numerous methods and strategies that were designed to overcome the psychological inertia presented by the market. He often kept standing limit orders on stocks at prices well below the market that would force buying activity at the right time. Likewise, he also maintained a wish list of stocks that he had researched in advance in his desk drawer that he could use to make purchases as the market presented opportunities. This book follows a similar thread of investment strategy in that it provides a group of investment themes that could be used in a wish-list manner, or to make purchases during market corrections or future points of maximum pessimism. Naturally, all these investment themes represented bargain opportunities in late 2008 and early 2009 as the market descended toward its lows. Many of these stock ideas remain attractive bargains as 2009 comes to a close. Going forward, however, the attractiveness of the stock valuations tied to these themes may require some discretion. For this reason, the ideas may be most useful when applied during market corrections.
Buying at the Point of Maximum Pessimism introduces a half dozen investment themes that should maintain their fundamental appeal over the next five to ten years. The purpose of this book is to answer the question of what to buy during future bouts of market volatility. In sum, these themes could be thought of as CliffsNotes to be used in preparation for future tests in the stock market. These themes should help investors, at a minimum, inventory a list of investment ideas that may be applied over the years to come. The six investment themes described in this book are far from exhaustive. However, these themes have been targeted for their long-term nature. In addition to their longer time horizons, they also consider the growing risks created by policy makers around the globe, from their shortsighted responses to the financial crisis.
One substantial risk that is identified is the growing probability of a loss in the purchasing power of the U.S. dollar. We can all appreciate the large sums of money printed by governments in response to the financial crisis, but some investors may still be searching for ways to protect their hard-earned savings in the event that inflation rises. Inflation risk should be considered a staple risk to investment returns, irrespective of economic conditions. Inflation has been present for many decades in the markets, and the U.S. market has been no exception. For investors familiar with Sir John Templeton’s methods, it is no surprise that among his “16 rules” for successful investing, targeting a real return after inflation and taxes is the number one rule on the list. Most relevant in the current environment, though, is that recent policy responses by the U.S. government to the financial crisis have increased this risk for future inflation. Many investors have become attuned to this risk, but the advice seems to largely be the same in most corners: Buy gold. Rather than offering the recommendation to purchase gold as a response, Buying at the Point of Maximum Pessimism highlights other areas for investment, such as oil and energy, as well as agribusiness. These investments have historically offered protection against a loss of purchasing power in the U.S. dollar and also possess attractive long-term growth drivers. In this respect, the investment themes in this book illustrate the compelling fundamental growth drivers as a backdrop to investment in these spaces. The reason for this emphasis is that we cannot know with much certainty the future outcome of inflation, but we can become comfortable with the long-term dynamics of energy and agribusiness, including proteins. In the event that inflation appears, the investor still receives some protection, as indicated by historical relationships between commodities and the U.S. dollar. Conversely, the arguments for purchasing gold rest mostly on speculative outcomes as opposed to long-term growth drivers. In sum, the book presents investment themes that hold merit beyond attempting to protect against a loss of purchasing power.
Other risks that the book considers relate to the large amounts of both public and private indebtedness, as well as the increased scope for regulation that has resulted from policy makers’ responses to the financial crisis. The discussion of these risks, as well as the aforementioned specter of inflation, requires some context. For that reason, the book begins with the events leading into, culminating with, and lingering from, the financial crisis of 2008 and early 2009. These discussions are not meant to provide a thorough history of the events, but instead help explain how the investment themes have developed. The basic idea is that investors have been left with a new landscape that they must contend with and seek opportunity within over the coming years. These chapters help provide a picture of this landscape.
In the chapters that follow this discussion, I arrive at the previously mentioned investment themes. These chapters describe in detail six investment themes that investors may find an opportunity to deploy over the years to come. From a top-level view, some of these investment themes will sound familiar. For instance, many investors understand that China offers long-term opportunity for continued growth. In this case, however, the book fleshes out the most salient aspects of this growth. It also offers better insights into more specific fundamental drivers, as well as areas to target for investment in the country’s transition from a prototypical Asian exporter to a domestic economy. Still other investment themes, such as the state of the world’s fisheries, or the rare earths discussed in Chapter 11, “A Rare Opportunity,” may be less familiar to investors. They offer an opportunity to invest in areas with growth potential that have been neglected by investors.
In any event, the purpose of this book is to provide solutions to investors who are searching for long-term investments—in particular, what investments should be prioritized when the market presents future opportunities during a sell-off. Given the significant volatility in the stock market relative to these long-term investment themes, investors may find them most useful during future points of maximum pessimism, which is the best time to buy.
–Scott Phillips and Lauren Templeton. Excerpted with permission from Buying at the Point of Maximum Pessimism: Six Value Investing Trends from China to Oil to Agriculture (FT Press).
Comments