This may seem counter-intuitive, but as an analyst, I often become more excited when the market is bearish, as opposed to when it is bullish.
Don’t misunderstand me; I obviously enjoy seeing my stocks appreciating in value…that is of course the objective of my research. However, what I do notice is that when the market is overly bullish it becomes more and more difficult to find what I am looking for – real value.
When it comes to making macro-economic market calls, I try to continuously remind myself of a very clever maxim made by Warren Buffet – “Be fearful when others are greedy and greedy when others are fearful.” I believe, more than any other, that this is a rule that should be a guiding light to anybody’s investment decisions.
If we cycle back to almost exactly one year ago, the market was singing a very different song than it is today. The world was literally falling apart and international markets were only too happy to display this sentiment. People were fearful, yet opportunities were abundant. Some of the markets most stable, cash producing machines had stock prices that were almost falling off the chart. The fundamentals had not changed, but investors were running for cover.
At KeyStone, much like the rest of the world, we were apprehensive as to where the market was heading. But aside from that apprehension there was also some excitement. We were seeing opportunities like we had never seen before. Nobody, including ourselves, knew where the market was heading or where the credit crunch was going to take us. We did however, remind ourselves of two things…we knew that as long as there were still people on the planet, there would be some specific services that would survive and even thrive….and we also knew that even in a horrible market, pockets of strength can be found.
So rather than being fearful while others were fearful, we scoured the markets in search of our prize opportunities. In the beginning of October we recommended Orvana Minerals (ORV: TSX), a gold producer with assets in the precarious country of Bolivia. Sure it was part of an industry that was being sold into the toilet, but it was a profitable producer of gold with more cash in the bank than the total value of all of its shares. Since then, the stock has moved up nearly 80%. In mid-October, we recommended K-Bro Linen Income Fund (KBL.UN: TSX). Like everything else, nobody wanted to touch it, but we knew that a very large portion of their revenues were derived from cleaning linens at hospitals and that recessions did not preclude people from getting sick. They paid a distribution and the balance sheet looked great. Since then, the company has maintained its distribution (which was 13.2%) and the shares increased 45% (total return of 58.2%). In November, we recommended Boyd Income Fund (BYD.UN:TSX), a restructured auto body franchise focused on insured auto repairs (once again recessions don’t mean people don’t get into fender benders). Not only has this stock since moved up 76%, it has also since increased its distribution on four separate occasions (total return of 86%).
I could go on, but I think I have delivered my point…which is not that we are great stock pickers (that goes without saying), but that the level of opportunities is typically a function of the magnitude of fear or greed in the market. When the market is fearful, we are usually in a ‘bear’ and opportunities expand. When the market is greedy, we are usually in a ‘bull’ and perhaps counter-intuitively, opportunities can contract.
Keeping all this in mind, where do you think we are now? At this point it is fairly obvious as to the point I am trying to make. These days, when I scroll through my financial statements and news releases, I have to be more selective of the opportunities that I find. They are still out there, but they are definitely presenting themselves in shorter and shorter supply. What I am finding is a lot of companies, often good companies, with stock charts that look steeper than the summit at Mt. Everest and what worries me is that there is often no fundamental driver as to why they are moving.
Sure the government says we are on the cusp of a recovery, but let’s not be so naïve as to think that the old problems have just disappeared. At a basic level, too much debt (particularly south of the border) got us into this mess to begin with. For years, consumers were financing elaborate lifestyles with borrowed capital. This lead to a period of very robust economic growth, but when the party ended (and it always does), the tent came crashing down. This problem has not disappeared. Simple common sense tells us that if we over consume and over leverage for years, to rebuild our balance sheet, we have to under consume and deleverage for years. Since over 2/3 of the U.S. economy is based on consumer spending, I am having a hard time figuring out where all of this future (short term) growth is going to come from.
It may seem that I am overly negative, but the truth is I am not. I am just cautiously sceptical. As an analyst, my job is not to sit on my hands because I think that the market may be overvalued. My job is to work (harder if need be) to find what opportunities exist in any market. Almost as dangerous as irrational exuberance is consistent apprehension…always thinking the market is going to fall or has further to fall. The truth is the market is too difficult (if not impossible) to time and if you want your investment portfolio to grow, you have to take the risk of getting involved.
Being cautiously apprehensive does not mean that you should avoid the market entirely; that you should liquidate your positions and wait until whatever you think is going to happen transpires. No…but it does mean that you need to be even more selective than usual about the companies you invest in and how you manage your investments.
In the spirit of cautious apprehension, I have provided a couple of simple strategic suggestions that I hope will help you to manage your way through this, or any other investment climate.
- Layer Into Your Positions – when filling a position in a stock, you don’t have to fill it in a single trade…you do have the option of breaking the trade up into two or more pieces. If the price is great, go ahead and fill the position. If the price is questionable or starts to move away from you, be patient. There is a good chance that it will come back down to your target level.
- Buy Strong Balance Sheets – the balance sheet provides a very good picture of the company’s financial risk. Does the company have too much debt? Is it just meeting its interest and principle payments? Does it have a reasonable strong cash balance? A strong balance sheet can mean the difference between life and death when the market eventually heads south
- Buy Resilient Business Models – as we covered earlier in the article, there are business models out there that will prosper even in tough times. No business model is without risks, but you can reduce your risk by investing in companies that serve customers who will dry up at the first sign of economic woes.
- Stick to Profitable Companies and Don’t Pay Too Much – buying profitable companies is the cornerstone of KeyStone’s investment strategy. Remember, when you buy a stock you are a part owner of the business. Think of it as buying a private business that you planned to manage. Would you buy a company that has never generated a profit? Would you pay so much that what profit there was would barely squeak out a return?
