The Next Bull Market...
I am more excited about equities now than I have been in my entire life.
Everywhere I read headlines in the media, financial and otherwise, that life as we know it, the United States as we know it, is finished.
Houses are being left abandoned all over the suburbs, weeds are rapidly replacing the lawns, and a whole industry is springing up to tear down homes and recycle the lumber.
Everyone I know, thinks things are going to get worse; a lot worse.
In many cirlces, anyone who is still investing in the stock market is considered a fool.
Guns are flying off the shelves, and stores cannot keep ammo in stock.
Fear is so prevalent, that it has become the norm. The pessimism is so complete that the talking heads, who never saw the downturn coming, no longer talk of a severe recession, instead they confidently drop the word, "depression" as if it were an everyday occurrence.
An entire generation seems prepared to abandon stocks just as their grandparents did for two decades after the Great Depression.
I have read about times like these in books, but never thought I'd ever be lucky enough to be able to buy into such a market. It is hard to count he fortunes that were made by those men who began investing careers in or just after the Great Depression, but several prominent names come to mind: Benjamin Graham, John Templeton, Philip Fisher, Shelby Davis.
My friends are tired of hearing me talk about what Bank of America could be worth in 5 years; they are sick to death of hearing about how BAC's market cap is lower than it's estimate of this year's pre-tax, pre-provision income.
The legendary investor, Sir John Templeton, who passed away last year, once said that if you could find a company trading at 20% of it's true value, then you have found a great bargain. He shared his formula for evaluating a bargain, in a book penned by his great-niece, Investing the Templeton Way:
Calculate the earnings 5 years out. (Use the most conservative assumptions, and take into account the macro conditions)
Divide that number into the current stock price, and if the result is less than 5, you have a bargain.
I took Barron's estimate of Bank of America's earnings 5 years out (4.00 per share), and came up with an extreme bargain:
5.76 - 4.00 = 1.44
Last Sunday, when I originally did this calculation, the stock price was hovering just above 3.00 per share, and the result was .812, a screaming buy signal considering the stock price was lower than the projected earnings in 5 years.
If you had the fortitude to step up and buy on Monday, March 9th, in the 3.25-3.50 range, you made a nice return in just 4 days, or you are holding onto a stock with such a low cost basis, that if you can wait 5 years to cash out, you might be able to make up all the losses you had if you were as stubborn as me, and rode the bear all the way down. Or you might have a story to tell your grandkids as you help pay for their college.
No one knows what the future holds, but one thing is sure: if you can follow Warren Buffet's advise, and "be greedy when others are fearful, and fearful when others are greedy," it won't matter if you buy before, after, or just at the bottom as long as you have conviction to hold onto your bargain until it is no longer undervalued, and becomes popular again.
Financial stocks, especially banks like Bank of America and Wells Fargo, are out of favor. This is largely because they have serious problems, and everyone is worried that the problems will get worse, not better. No one completely understands the full extent of the problems, but one thing is clear: they are afraid, very afraid. No one, but "we few, we lucky few, we band of brothers" have been buying the stock at these levels. Yes, it's scary when what you buy keeps dropping, but that is the nature of trying to buy out-of-favor bargains. It is a lonely endeavor.
What is surprising to me, is that the mutual funds are hoarding cash even as the market has sold off to level not seen in years, and yet financial stocks in particular, seem poised to outperform for years to come.
From here on out, it seems unlikely that the new administration will repeat the blunders of the previous administration, so in essence, BAC, WFC, JPM, GS, GE and other major financial companies will not be allowed to fail, no matter how bad it gets. It is also unlikely that the government will deviate from whatever course spooks the markets the least. This means that it is unlikely we will have any late Friday afternoon or late Sunday night surprise takeovers, and when the investment community finally regains confidence in the system, these stocks will eventually be bid up to something approaching their true value.
Remember, the banks are getting money for next to nothing, and they have half the competitors and twice the market they once had. Expectations are so low, that it seems hard to see how their earnings can disappoint anyone. In every major downturn related to a banking crisis, the banks that survived made better investments than just about anything else, if bought when there seemed to be no hope, and sold when "irrational exuberance" returned.
I am guilty of having been optimistic for far too long, thinking that we were making a low on October 2nd of last year, only to find that 5 months later, we are trading close the October 2002 low of 7202. I could never get negative enough because I am a true believer. I could not see that the foundation of the global economy was rotten, having been destroyed by corruption and greed. And I got taken down hard, punished for not getting out of the market last year.
I never saw the downturn coming. Nor did any of the great investors, whose work and methods I've studied, except Jim Rogers. When Rogers made his call in the summer of 2007, I cut it out of the newspaper because it seemed so unlikely. He was calling for a blizzard in the middle of summer. And he was so right, but he was the only one who made that call when you could have sold near the market high.
I couldn't see the coming catastrophe. Neither could anyone else.
Warren Buffet came out on October 17th, 2008, over a year later, and said, "Buy American. I am."
If he foresaw how far the market could fall from that point of pessimism, I don't think he would written that compelling case for buying stocks. But one of the most admirable traits that my favorite investors--Warren Buffet, Peter Lynch and Sir John Templeton--share, is humility.
You can find no record of them calling tops or bottoms. Instead they focused on buying 20 and 50 cent dollars when they could, and not buying when a dollar was trading for more.
The average bear market lasts 14 months. Most "experts" say we are in the 14th month of this bear market. So, if history repeats, a bull market could potentially begin anytime, starting now.
Especially now, because according to Sir John Templeton, one of the greatest investors of all time (who passed away last year), "bull markets are born in pessimism, grow on skepticism, mature on optimism, and die of euphoria".
Every speech he gave, he would remind the audience that there would be another bear market if the bulls were riding high, and vice versa for a bull market.
In December of 1988, when pessimism ruled the day, he gave a speech called, "The Next Bull Market", and made the case for how the next bull market could be far bigger than the last one because:
1. corporate profits were projected to be as much as 40% higher
2. there was a ton of cash on the sidelines
3. there was a shortage of shares due to all the mergers and acquisitions in the 1980's.
I don't know when the next bull market will start, but I do know there will be one, and when it starts it will pull all that cash off the sidelines, and that cash will be chasing far fewer shares in the financial sector in particular, and that will eventually lead to higher prices. It always does.
Someday I hope to look back on this period, and know that my decision to buy BAC and WFC was the right one, even if it made me sick to my stomach when I clicked "buy" on Monday, March 9th, 2009.