Warren Buffett once said:
Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel. These once unthinkable dosages will almost certainly bring on unwelcome after-effects. Their precise nature is anyone's guess.
I recently stumbled upon this quote and it forced me to pause and think about what Buffett means by economic medicine. Clearly if something requires medication, it is safe to assume that it is or was not well. But the quote continues and highlights something that is equally disturbing; being sick is one thing, becoming an addict of the medication is another. Our economy has been sick for quite some time and last week learned that its doctors continue to put a Band-Aid on a compound fracture.
In an effort to control inflation and spur our economic recovery, the Fed decided to keep interest rates “exceptionally low” for the next two years. As with Buffett’s quote above, the Fed’s timing was precisely what the doctor ordered. I couldn’t help but wonder where the market would have ended had the Fed not interceded following a correction that lasted two weeks and incited fear of a double-dip recession. The question I keep asking is, will this be enough? Are we still in the cycle of prescribing medication while continuing to ignore the ultimate cure for our economic malaise? This would be a great article if it were discussing drug stocks, but unfortunately it’s not, so bear with me.
I drew the ire of several of my readers recently when I called “the bottom” on four stocks that I have followed very closely in Sirius XM (SIRI), Level 3 (LVLT), Cisco (CSCO) and Research in Motion (RIMM). My call was considered somewhat premature and “irresponsible” by several readers. But one in particular took exception to my opinion. He said the following:
Yesterday's trading indicates a bearish sentiment on both stocks. Yes, both stocks have rebounded from their lows, but under extreme macroeconomic circumstances with these huge market run-ups and rundowns. Hardly balanced market conditions to make the predictions you make in your article.
With the kind of volatility that still exists, two up days in the market does not mean the winds have changed. You are either clouded by your desire for happy returns for yourself and investors or you're just not seeing the situation through unbiased eyes. Both SIRI and LVLT are not out of the woods just yet.
So to say that SIRI and LVLT are worth $2.50 a share in this market environment is very premature, if not irresponsible. Don't give hope to shareholders of these stocks when there is obviously something more sinister going on. Give them the real possibilities so they can protect their investments. Give them the truth. What a concept, huh?
I felt these comments were very articulate, thoughtful and based on sound logic. But I simply disagreed. The reality is, I feel we have seen the worst. The market has already been reacting to every new piece of information that hits the wire. I feel that our market has reached the point where the bad news is already priced in, where investors are starting to take the stance that this bad news isn’t so bad after all.
We have heard of the debt ceiling deadline, S&P’s debt rating downgrade, poor job reports, rising unemployment and a possible recession across the globe, all of which have caused the declines in the market that investors have witnessed over the past couple of weeks. But at the moment, the only thing that is of any importance to American’s is the economy, which (correctly so) is the chief concern of the market and will likely maintain that ranking at least for the next two years. I guess you can say that the Fed gave the economy 24 months to heal.
Corporate health and economic health
Whether one realizes this or not, there is a distinct difference between corporate health and economic health. While the economy can indeed play a significant role in the equities market, its causes and effects may not always be automatic events. The same way certain stocks can continue to go down even in the most thriving economic times, it is possible for stocks to thrive even in economic sickness.
Take Cisco for example. Its stock surged 15% after the company reported better than expected earnings results. On Wednesday, Cisco reported profits that beat several analysts’ estimates. Excluding some costs, profit was 40 cents a share compared with the expected 33 cents. It is clear that Cisco is now in the early stages of a remarkable recovery. These numbers proved that the magic that the company once had as the darling of Wall Street had never left and Cisco could once again regain its status as a growth company. So should value investors ignore a company that can easily surpass $20 per share by the end of the year because our economic health continues to generate fear? This would be a mistake.
Another example is Research in Motion. The stock closed up 12 percent for the week. It is hard to not value RIM after seeing it bounce off of $21.60 the way that it did. I can now say with some conviction that it is no longer a falling knife. It will be a while before I start singing its praises due to its management structure and what I think has been a series of poor execution, but I will be hard pressed to find an equity with the fundamentals that is currently trading at such a low premium. I am a bull on the valuation, not the company. So to think that I might get a better entry point than the $21.60 due to prevailing economic sickness would be asking for a bit too much -- or, as Buffett would call it, “being greedy” when I shouldn’t be.
The reader also did not appreciate my $2.50 price targets on both Sirius XM and Level 3. He felt my opinion was misleading. As an investor, I see the real possibilities for both Sirius and Level 3 as being their improving fundamentals and diligence in extinguishing their debts. Remarkably, both company graphs appear similar and they both have had “near-death” experiences. To have an appreciation for the direction of both companies, one must seek to understand from whence they came. Inciting fear when one can simply apply logic is counter-intuitive.
Fear is a great investment strategy only when the market is not already fearful. In market declines as we are witnessing, greed is the only tool to deploy to help build both shares and value. As sick as our economy is at the moment and likely will be for the next 24 months, it will require the sound minds of investors to help restore it back to health. While economic medicine may continue to prove as useful as a Band-Aid, the collective mental health of investors will be what ultimately cures our addiction to reactionary dosages and restores our economy to health.