Why It's Not Different This Time: Facts for Comfort

Remember when stocks reached average P/Es of 100 or more in 1999-2000? Recall the chorus of voices intoning "this time it's different?" Somehow, the law of regression to the mean had been repealed and trees would grow to the sky.

Except it hadn't and they didn't, as we learned in 2000-2002.

Fine, but how come now, when it's from the other side there are those that believe the same, "this time it's different," and we're all going to Hades in a handbasket? It takes a clear head, but come on. It's not, and that's in our favor this time. 

Unless you know the magic sell moment, momentum investing fails because sooner or later the market regresses to the mean from the upside. However, value investing especially in small caps works because sooner or later, the market regresses to the mean from the downside.

It's simple: If P/Es of 25 or 50 or 100 come back to earth because it's never "different," why should P/Es of 1, 2 and 5 for stocks like net-cash and free-cash-flow positive Premier Exhibitions (PRXI), Aeroquest (AQSFF.PK) and many other of our holdings not return at some point to average, which is multi-baggers higher?

Right. As extreme and scary as things are right now, and subject to the strong caveats that follow, it's not different today. Value will be rewarded. Don't fall for anything else--don't be that person who buys at maximum enthusiasm and sells at deepest pessimism. Don't impoverish yourself. Read on.

U.S. is #2, in a good way

Each week The Economist prints a list of about 50 world stock markets and their performance over the week and year. In the most recent issue, the U.S. was the second best performer worldwide this year in dollar terms. Yes, the dollar has appreciated, but still: second best.

Of course, if your neighbor loses $1 million and you lose $999,999.99, so what? But this is not the case. Take a look because the numbers are quite dramatic. The best is Japan. Go figure.

Patience will be rewarded

In West Texas, we drive long distances. On all such journeys when I'm alone, audiobooks are my comfort.

The latest trip brought more of Barton Biggs' Wealth, War and Wisdom, his effort to determine if stocks--equities--are a way to store wealth over time. He uses WWII history and stock market performance as the test but ranges over the entire 20th century in support.

I'm only 60% through but that's enough to state 100% that this will help you stay optimistic. Biggs is a clear-eyed realist--you get such wonderful dark humor along the way when Biggs cites Ambrose Bierce for "Patience is a minor form of despair disguised as a virtue"--but facts are facts. Biggs notes that the stock market is a remarkable predictor and that at maximum despair, it's astonishing what lies ahead.

In at least two market periods in the late 1930s and then early 1940s, the largest 100 stocks declined to an average P/E just over a five, with many selling for less than net cash. Sound familiar? True, the S&P 500 today is not yet even in the five neighborhood, but small caps are. And each time that stocks reached these nadirs, small caps doubled the returns of large caps coming out of it. In the mid 1940s, according to Ibbotson, small caps doubled large caps' gains each year for the next three years after a bottom. This, and their inherent larger risk, is why small cap equities in the U.S. have outperformed all other asset classes on average since the 1920s.

Second, Biggs also determines that even in a century that included WWII with its severe dislocations of all kinds and stock market closures both temporary and permanent, equities remained a consistent and dependable store of wealth so long as your country did not:

1. Lose a war (U.S. after Vietnam; equities lost 50% in real terms from late 1960s to early 1980s).
2. Endure occupation (France and others in WWII).
3. Experience hyperinflation (Germany after WWI).

All you had to do was be diversified, not have speculated (me 2000-2002, and that still didn't kill me), and have the patience to hang on--not sell or need to sell. For that last it's essential not to have bought on margin (Hello Chesapeake Energy (CHK) CEO McClendon!), and everyone should have learned that in 2000-2002. It was also the great and terrible lesson of the Crash of 1929.

Repeat: Don't have in the stock market money you absolutely positively need to live within five years. Don't speculate with more than a small part of your money, if any. Don't buy on margin. Follow these three rules, and stocks will continue to prove a consistent storehouse of value, unless we lose a war (and even then, we can do all right after some of them eventually), endure occupation, or experience hyperinflation (the wheelbarrow-for-a-loaf-of-bread kind). 

What's more, with Biggs you get great history along the way. (For example, I learned that horrific as the Pearl Harbor sinking of 18 ships was, they were in shallow water and, according to Biggs, repaired in six months. They didn't teach that in my school, or I was absent that day!) Even if like me you already admired Churchill, you will revere the man even more. And guess what the best performing stock market in the 20th century was in real terms: Sweden's! Who knew?

Stay strong and don't change horses in the middle of the stream--unless that horse is named "Short-term speculator on margin."

It's not different this time. And that's a good thing.

Disclosure: Tom and CVI own Premier Exhibitions, Aeroquest and Chesapeake, as well as many other deep values with little to zero bankruptcy risk.

Comments

[Fliujniligui:]

Hehe, If US lose a war, its investor can still have positive gains by buying not more than 33% of American stocks in their portfolios. Add some Canadian Banks, Deutsche stocks, Brazil and Asian stocks.

2008 Nov 23 10:25 AM

[swan:]

PRXI is now trading at 60 cents. What can we possibly learn from a man who rode it down from $12 in January, AND STILL HOLDS IT. Zero money management skills and Clueless. Hope is not an investing startegy.

2008 Nov 23 11:39 AM

[socrateazz:]

most things are usually the same. Some things are often different. The key is to tell the difference between the sames and the differenences and the effects each will have! I do not know all. I think the things most concentrate on are often wrong. whether it be global warming or how financial markets will perform. The fact more folk can change their mind to the other view makes the less popular view more probable. Especially when the opposing view sticks to it's own view dispite it being cramed down their throats

2008 Nov 23 12:00 PM

[curious cat:]

even when big car makers sell less, there are millions of people who buy cars. the same is true of everything else. many millions of customers are drawn out by reduced prices. businesses that are well run can and will survive.

it always amazes me when newscasters report that we will only have one or two percent growth. doesn't growth mean more? if we did well last year without that growth, why can't we continue to do well? in fact, if our economy flourished for a dozen years, all the while increasing its growth, why can't we do just as well going the other way? somebody give these people a game plan, please.

we did not go up fifty percent in one year, so we do not have to go down fifty percent, either. check yourself. if you are business leaders, take a few minutes and call other business leaders, just to let them know that you are all going to go only to the last year's level of productivity. that's not collusion or monopoly. that's sanity. stop freaking out.

people who have a vested interest in calamity and have purchased puts on everything will continue to yell fire in our theater. those of us with a better view and those near the exits have a responsibility to calm the crowd. there is no fire as great as the one they want us to imagine and the firemen have already turned on their hoses.

2008 Nov 23 12:53 PM

[sundrenched:]

Hmmm, that PRXI looks juicy... Think i'll buy a couple of thousand as a lottery ticket.

2008 Nov 24 02:49 AM