Tagging along as a spousal unit today at an investment forum by the Davis Advisors group, I listened to a fascinating presentation by portfolio manager Chris Davis on "What Happened and What Do We Do Now?" Basically, Davis argued that this is a normal financial cycle that got magnified by a financial "doomsday machine." Generally, a financial cycle has four stages, (1) an asset class produces good returns, (2) money pours into the class fueled by envy and commissions, (3) leverage is added reducing asset quality, and (4) the mix proves toxic and a collapse occurs. Davis pointed out that the tech bubble asset class was only $3 to $4 trillion whereas the financial asset class totaled about $20 trillion.
The "doomsday machine" that has magnified and accelerated the current collapse works the following way: (1) an asset price goes down, (2) it must be marked to market (thanks Sarbanes-Oxley), (3) which then lowers a company's stock price, (4) then rating agencies lowers the company's credit rating, (5) which results in forced selling, which (6) lowers asset prices and so the positive feedback loop continues ad nauseam.
I don't pretend to know if this analysis is right, I'm just reporting here. Davis and other participants were quite fond of quoting the legendary investor Warren Buffett's aphorism: Be fearful when others are greedy, and be greedy when others are fearful.
And today, the Oracle of Omaha has an op/ed in the New York Times reprising his advice and looking past the gloom of a looming recession to a more profitable future:
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.
So … I've been buying American stocks. This is my personal account I'm talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.
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. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation's many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now….
A little history here: During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor's best friend. It lets you buy a slice of America's future at a marked-down price.
Whole Buffett op/ed is well worth reading here.