TMFDeej (99.47)

Here Be Dragons

January 13, 2009 – Comments (3)

A little while ago I was speaking with a very intelligent investor about an asset management holding company that has a wide variety of assets on its books, including a bunch of commercial real estate.  The company has a ton of cash on its books as well and this person suggested that the company may be a buy because it can use this cash to go "bargain hunting."  I thought that my friends here at CAPS might be interested in my thoughts on the subject:

"About bargain hunting though...I have to wonder whether today's commercial real estate prices are really the bargains that they appear to be at first glance or whether they are just the new norm. The astronomical rise in both residential and commercial real estate prices over the past two decades were fueled by the increasing availability of cheap credit.

Suppose that we never return to that sort of environment and credit loosens up some, but never returns to the "normal" that apparently may not have been that normal after all. The ability for companies to lever up like they have in the past will almost certainly be restricted in the future. So may be banks' ability to securitize loans.

It is entirely possible that anyone who purchased commercial re over the past decade significantly over paid for it, even if they got what was considered to be a good deal at the time. If this is the case, then anyone who has cash to buy today is merely getting a normal deal...or worse than that if the market continues to slide as many believe it will.

I'm not bashing this company, I'm just stating that investors definitely need to reevaluate what normal markets are. We (myself definitely included) have been spoiled by decades where everything, including stocks, went up in price nearly every single year. We may be in for an extended period where asset prices are stagnant or even fall further and growth rates aren't even close to what they were in the past.

The cartographers of years ago wrote on the unexplored portions of their maps, "Here Be Dragons." The dragons are here today, in the form of an economic environment that the world has not experienced in 30 years or more...if ever. It is difficult to say whether, the Federal Reserve, which is furiously pumping liquidity into the system by printing money and slashing interest rates, will be successful in reflating asset prices this time. I wouldn't bet against the Fed's ability to do so, but then again I wouldn't be shocked if it wasn't able to either.  We definitely are in uncharted territory."

Anyone who claims to know where the economy is headed is merely making an educated guess (some less educated than others).  I truly believe that it virtually impossible to know for certain whether the United States, and the rest of the world for that matter, is headed for a period of massive inflation or a period of prolonged deflation.  There are so many variables out there, such as what Obama's stimulus package will look like, whether foreign countries' appetite for U.S. debt continues, whether emerging markets like China are successful at nurturing enough domestic demand to keep their economies afloat, etc...  that the answer to this question may not have even been determined yet.

This is why I strongly believe in diversifying one's portfolio.  I have some stocks, such as a couple in energy and infrastructure, that will benefit tremendously if massive inflation rears its ugly head.  On the other side, I have a number of stocks in the safer havens like healthcare and consumer staples.  I have some money sitting in cash.  Heck, I've even dabbled in financials a little bit. 

One thing that almost all of my holdings have in common, both in real life and in CAPS, is that they pay dividends.  A third potential outcome, after massive inflation and deflation, is...nothing.  It is entirely possible that the markets could do absolutely nothing, neither go up nor go down significantly, and form an "L shape" over the next several years.  If this does happen, I will end up being paid 5%, 6%, all the way up to 10%+ to hold on to this basket of stocks that I have put together (yes I know that dividends can be cut, that's why one always has to pay close attention to companies' dividend coverage, cash flow, and balance sheets)

The key in uncertain times like this is to diversify, including having money in cold hard cash, and keep squirreling money away on a consistent basis.  I am under no illusion that the government is going to be able to take care of me if I am some day able to retire.  I'm going to have to take care of myself and my family.  The only way to do this is to save and invest.

Deej

Note I originally came across the awesome phrase "Here Be Dragons" in a Barron's article a couple of weeks ago.  I believe that it was used in an article by Michael Santoli.