Anyone who looks at the economic headlines sees nearly uniform bad news, and the word pessimistic doesn’t begin to capture the level of fear investors have at this time. As anyone who has read the reports from Secure Retirement since September knows, I have been more than a little negative since that time.

That being said, at this time it appears likely that the negative sentiment is beginning to go overboard. This is actually a good sign, for in terrible times the market never begins to stabilize until nearly everyone becomes sure it won’t recover for years – if ever. For example, by the end of 1974 the stock market had crashed, losing 50% in two years (the same our market has gone down). One leading financial publication ran a headline reading “The Death of Stocks.” But in Forbes magazine, Warren Buffett said, “Now is the time to invest and get rich.” The following two years, after “the death of stocks,” the stock market gained over 60%.

As mentioned above, I have also been quite negative – up to this point. In fact, over the holidays my brother asked me what I thought a likely low would be in the stock market. My guess was that the Dow Jones Industrial Average might go down to 7,000. It ended the day on Friday at 7,365. At the same time, I stated that another market plunge would actually lead to our clients making more money over time. This is because we would then have the opportunity to use our cash to make purchases at exceptionally low prices.

So is the stock market low-priced at this time? With the market cut in half since its high in October of 2007, it is safe to say the answer to this question is yes. What do most investors do when the market is low? They sell. But if we asked these same people if selling low was a key to their investment discipline, all of them would say the opposite. They would all say they know they should either hold or buy when prices are low, but their emotions get the better of them. They sell, thereby making one of the biggest mistakes any investor can make. I do believe it was a very good idea to have made the sales we did in early September. And yes, I certainly wish we had sold everything then! But selling now, after the stock market has gone down 50% from its high, and 33% since September, is very bad investing indeed.

Evidence that people are now beginning to make serious investment mistakes abound. For example, today I looked at General Electric, one of the best companies in the country. Now the most common number used to measure the value of a stock is the p/e, which is the stock price relative to a company’s earnings. The p/e shows how much you are paying for a company’s earnings, with a high number meaning the stock is expensive, and a low number indicating it is cheap. Historically, large U.S. stocks have had an average p/e of 12-15. But right now General Electric’s p/e is 5. This means General Electric is selling for between one-half and one-third of its value. (P/E is a shorthand way to value a stock, but a company like General Electric appears similarly undervalued using more in-depth analysis.) Assuming a person intends to invest in this company for more than a few weeks or months, the people buying this stock are making an excellent decision, while the sellers are making a big mistake.

In times like these, I find it useful to be reminded of sound investment principles. And of all investors, Warren Buffett remains the best. Here are a few quotes from Mr. Buffett that are directly relevant to our current situation:

“ Great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause the stock to be misappraised (i.e. priced too low).”

“ Most people get interested in stocks when everyone else is. The time to get interested is when no one else is.” “ We buy when the lemming are heading the other way.”

And finally: “The fact that people will be full of greed, fear, or folly is predictable. The sequence is not predictable.”

You may have noticed that Berkshire Hathaway stock has been going down a good amount in recent weeks. This is one of those examples where the investing public is missing the point entirely. In the next week Mr. Buffett will be sending out Berkshire Hathaway’s annual report. It will, once again, show that this investment remains the best in the country. While not as cheap right now as General Electric, Berkshire Hathaway is worth twice as much as its current stock price. The following two quotes from Mr. Buffett help explain why I personally have no concern about Berkshire Hathaway:

“ If the business does well, the stock eventually follows.”

“ Overall, Berkshire and its long-term shareholders benefit from a sinking stock market much as a regular purchaser of food benefits from declining food prices. So when the market plummets – as it will from time to time – neither panic nor mourn. It’s good news for Berkshire.”

Looking forward, we still have a substantial amount in cash in most of our accounts. I know, with certainty, that this is a remarkable time to buy. And I definitely plan to invest the money we sold from the stock market in September back into this depressed market. However, I’m still not convinced we have any need to hurry. I am also having a difficult time determining which fund to buy next. The problem is that the Fairholme Fund is significanlty better than every other fund I can find, but it is already our largest stock holding!

In order to understand my dilemma, you need to know how I research stock mutual funds. Over time, I have discovered that the key to analyzing a mutual fund involves reading the financial statements of the stocks they own. In particular, I look at the after-tax profit of the companies owned by a fund over the last ten years. I want to own the stock of companies that have grown their profits, preferably remarkably, and very steadily, for a minimum of 10 years. And I want these to be conservatively-managed companies, i.e. using debt sparingly if at all. They should also have an unusually strong position in their market that would be very difficult, and preferably prohibitively expensive, for any competitor to overtake.

When I look at the financial statements of the stocks Bruce Berkowitz owns at the Fairholme Fund and compare them to others, it is hard to find funds that can compete. Of course, the search isn’t over. I have been looking at other legendary investors who run funds and have been buying stocks, then analyzing the financials of their purchases to see if what they are buying is as good as what Mr. Berkowitz is buying.

So while we are still not ready to make additional stock fund purchases, in the near future we do plan to make an additional bond fund purchase(s) in client accounts that are underweight in our two primary bond holdings, TCW Total Return Bond and Hussman Strategic Total Return. TCW has never lost money in any year and is now paying 6.91% a year in interest. The Hussman fund has also never had losses in any year, and has safely made 7% a year over the last five years.

These are clearly difficult times, for investors and the entire country. At Secure Retirement, we will continue to follow the best investment discipline, cautiously and patiently. And as always, do not hesitate to call me if you have any questions.

Sincerely,
Richard Morey