Today's bunker mentality has the stock market looking cheaper relative to Treasury bonds than it has since 1978
To many panicky investors, it feels like financial Armageddon. But decades worth of investing precedent suggest otherwise. And investors who bail on stocks now might come to regret it.
Make no mistake: The freeze in the credit markets is frightening. "People don't have any experience with this kind of thing happening," says Martin Barnes, managing editor of Bank Credit Analyst. "People can't look back at previous episodes and take comfort and say, 'I've been here before.'" And so, almost by default, we are given to extreme bearishness—invoking the Great Depression and Japan's lost decade is all the rage. "Sure, these things are possible," says Barnes. "But not likely."
Sept. 29's 778-point drop on the Dow doesn't even rank among the top 10 in percentage terms—it was 7%, compared with 22.6% in 1987. Yet the very system that rewarded risk taking for years is now holed up in the closet under a security blanket. Hedge fund traders, banks, individual investors, small businesses—you name it—have been piling into ultrasafe short-term Treasuries, which now yield close to 0%.
We've felt the sky was falling before. Recall that one-day panic on Oct. 19, 1987, or the savings and loan crisis of the early 1990s, or the Asian meltdown in 1997, when Koreans lined up on the streets of Seoul to donate jewelry to shore up their currency. The markets took big hits in all of those cases, but ultimately bounced back. By the beginning of 1989, for example, the Dow had returned to its pre-crash levels.
The smart money knows that banking crises are par for the course. According to the International Monetary Fund, the past quarter century has seen at least 124 banking crises around the world. "It is important to recognize that this isn't the first time the U.S. financial system has experienced—and survived—a financial crisis," says Eric Bjorgen of Minneapolis-based Leuthold Group, an investment research firm.
BARGAIN INTERNATIONAL STOCKS
The time to panic, if there ever was one, was a year ago, when stocks were hitting their highs—not now, when they are hitting their lows. Today's extreme bunker mentality has the stock market looking cheaper relative to Treasury bonds than it has since 1978.
That's precisely the environment in which savvy, patient investors make their fortunes. Case in point: legendary cheapskate Marty Whitman of Third Avenue Funds, an octogenarian who lives for volatile times like these. "Right now is a time when deep value investors excel," he says. "People like myself got rich in '74 and '87, unlike those who tried to pick bottoms." The common stocks of companies that need access to capital markets are "toast," he says. "The common stocks of companies that can finance themselves have never been more attractive."
Whitman says that many international shares in particular have never looked so cheap: "There are unbelievable bargains. It's terrific for us." Stocks he thinks are especially cheap include Hong Kong-based real estate investment holding companies, including Cheung Kong Holdings, Hang Lung Group, Henderson Land Development, and Wharf Holdings.
Even Rob Arnott, chairman of investment advisory firm Research Affiliates and a bear long before it became fashionable, says the current panic "is creating some really spectacular opportunities for those who are nimble and weren't overly aggressive." The reaction in financial-services stocks is overdone, he says. "We have an anti-bubble—when a sector of the market falls to levels that no plausible scenario would justify." Arnott also sees "great bargains" in convertible bonds and says the debt of "many emerging markets is more creditworthy than U.S. Treasuries". The broad U.S. stock market, however, has a chance of falling further as consumers begin tightening purse strings, he says. Arnott thinks investors should lower their long-term expectations of stock returns to about 6%.
Of course, bargain-hunting always sounds great in theory. But people have shown time and again a predilection to sell low—just as they tend to buy high. Princeton economics professor Burton Malkiel, author of the best-seller A Random Walk Down Wall Street, notes how much hot money piled into equity funds in early 2000, just as the market was about to peak. Then, as stocks were nearing the bottom in the third quarter of 2002, that money fled in droves. The timing couldn't have been worse. "One of the things we know about individual decisions in markets is that people generally do the wrong thing," he says. "I know money is coming out now. I don't know whether this is the bottom. But taking money out now, when things look horrible, is almost always the wrong thing to do."
Business Exchange: Read, save, and add content on BW's new Web 2.0 topic network
Research from Ibbotson Associates shows that returns from both growth investing and the Standard & Poor's 500-stock index are trumped by long-term gains from value investing, especially in recessions, according to a Sept. 30 article on the Motley Fool Web site. In the seven periods of recession since 1970, value stocks returned an average of 3.1%, vs. a loss of 0.8% for growth stocks. To read the Motley Fool story go to http://bx.businessweek.com/value-investing