Asset Allocation in 2009: Best to Go with the Devil You Know

The stock market ended the year of 2008 posting one of its worst annual price performances ever. The Standard & Poor's 500 index dropped 38.5% for the year marking its worst performance since 1937’s 39% drop in the index. In fact it was the first time the index saw a 30% or more drop in price in those 71 years. So if you survived this year, give yourself a pat on the back.

Investors over the past year made many wrong moves, paralyzed by fear, they drove down stock market prices to unreasonable levels. One bright spot is patient investors could invest in stocks very cheaply. Valuation levels had not been at those levels since the early 1980s. Although the S&P 500 has advanced more than 20% from its low of November 20^th, there remain bargains to be had.

With so many bargains to choose from, some investors may experience paralysis because of greed. Which stock does one pick? In such an instance, it is best to invoke the spirit of Charles Munger, co-chairman of Berkshire Hathaway (BRK.A). In an Outstanding Investor Digest article some years back Munger was quoted as saying:

For an ordinary individual, the best thing you already have should be your measuring stick. If the new thing isn’t better than what you already know is available then it hasn’t met your threshold. This screens out 99 percent of what you see.

Although I picked up a few new positions for myself and my clients’ portfolios, in following Munger’s advice I found that the positions already in the portfolios were of solid companies that were similarly beat down as the market. Every nook and crannie of the market was hurt this year. It couldn't be avoided. And the potential of being hurt further is still present. However, when choosing where to allocate funds, sometimes it is best to go with "the devil you know".

Instead of scouring the investment universe for the new thing, I simply averaged down. The following chart marks the return of a few positions from the beginning of the year to the S&P 500’s low on November 20^th and then the return to the end of the year from that November date compared to the market’s return.

Although as a group the stocks of these companies declined to a similar degree as the market, their rebound so far has been nearly 50% greater. Although it is too soon to say, I believe superior companies will bounce back to a greater degree than the average stock. I think this is what we are seeing in the chart above.

Disclosure: I and the clients of Brick Financial Management, LLC owned shares in all the companies mentioned in this post at the time of this writing. But positions may change at any time.

Comments

[Paul Price:]

The real lesson here is that the best returns come from buying (or buying more) at or near the bottom.

Many times we hear people say that after a 50% drop it takes a 100% gain to get even.

We rarely hear, "Buy after a 50% drop and a rebound to just the old starting price is a 100% gain."

Jan 04 11:08 AM

[redbaron:]

My group of small cap value stocks have all done better since the 11/20 bottom than the stocks on your list. I own Baldor (BEZ), Carpenter Technologies (CRS), FLOW International (FLOW), Joy Global (JOYG), Layne Christensen (LAYN), Manitowoc (MTW), Timken (TKR), Tyson (TSN), Archer Daniels Midland (ADM), Alcoa (AA), Ultralife Batteries (ULBI), Twin Disc (TWIN), and a few others. Many of these have already doubled, but then low priced stocks will always out-perform from an 'initial' bottom.

Jan 05 12:03 AM

[redbaron:]

I should also add that I was not wise enough to buy at the lows on the list of small cap value stocks shown above, but instead bought on the way down before the bottom. Regardless, the positions have still done very well. (So Far!)

If there is a lesson, it is that small cap low-priced, value stocks will usually outperform in a recovery phase of the market. In addition, one has the January effect that can also add to small cap value stocks performance in the first part of the year, and also the nice dividends that most of these stocks still pay.

Jan 05 10:06 AM