The Globe and Mail, Report on Business
Published June 23, 2012
By Tom Bradley
A greed moment?
So here we are. The economic outlook is bleak. Systematic risk is high. Investors are scared. And Warren Buffett’s words are ringing in my ears, “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”
After living through the crash of 1987, the tech wreck and the 2008 banking crisis, I have a good sense of how opportunities come out of distress. Markets always overreact and go to mouth-watering extremes. I learned from some great investors I’ve worked with (Bob Hager and Art Phillips, to name two) that when markets are down and the news is ugly, you don’t go away and hide. You need to draw on your best valuation work and act decisively. Concerned clients, uncertain staff and a shrinking net worth can’t get in the way of pursuing risk/reward situations that are jumping off the screen.
So have we reached Mr. Buffett’s moment of greed? Obviously, we won’t know until later. We may have more bad months ahead, or already be near the bottom in some asset classes. In any case, it’s not too early to explore what a great investing opportunity might look like.
The bad stuff
Every greed moment comes with a wall of reasons not to invest. Markets wouldn’t be down without a recession looming, profit estimates being reduced and a lack of trust in the financial system. At the time of maximum opportunity, we’re always going to feel lousy after reading the Report on Business.
The other thing to remember is that a substantial part of any market recovery will come before the news and economic statistics improve. The market cycle will be well ahead of the news cycle.
But beyond the usual concerns, are there elements of the current predicament that negate the investment opportunity? Every period has its “world coming to an end” feel, but this time the sheer magnitude of the debt burden stands out. As we’ve seen, it’s causing short-term shocks and will undoubtedly slow the economic recovery.
Another scary feature is that we’re operating without a net. Governments, our usual safety value, have no extra money to spend and their go-to strategy of lowering interest rates is used up. Indeed, rather than being our saviour, governments are at the core of the problem.
In the shadows
For current stock prices to represent a special opportunity, there has to be plenty of room for the fundamentals and investor sentiment to improve, and conversely, limited scope for them to get worse. Certainly, the debt burden will get worse, but in the shadows is a long list of factors that are turning favourable, or at least have a bias to the positive.
The developing world, with its unlimited room to grow, is playing a larger role in the global economy. While we sit mired in the slow-growth, debt-burdened West, there is plenty of activity elsewhere.
With new-found natural gas, technological advances in oil, cleaner coal and more fuel efficiency, we’re heading into a period of cheaper energy.
Related to energy and emerging countries, the ever-accelerating pace of innovation is making economies more adaptable and resilient than ever. In many cases, the developing world won’t try to recreate what we have, but instead skip ahead to new ways of doing things.
And importantly, much of the prep work has been done on the next cyclical recovery. Inventories are down and pent-up demand is building due to restricted spending. The housing market south of the border has found a bottom. And takeover activity, which spurs investors to action and improves stock valuations, has nowhere to go but up (European companies are now in acquirers’ sights).
The one truly reliable thing we can latch on to in times like this is intrinsic value – an assessment of what a company’s long-term cash flows are worth. On this and other valuation measures, we’re most of the way to a Buffett moment. The price-to-earnings multiples in North America have come down over the past decade to where they’re nearing 1982 levels, without the help of double-digit interest rates. European and Asian stocks are already there.
The well-publicized bad news, hidden upside, depressed stocks prices and intense fear tell us we’re entering an interesting place. At a minimum, we have to start getting ready for the opportunity. Being greedy requires careful planning.