Win -- Loss -- or -- Push

[rayrohn]

October 20, 2008

Buy It Like Buffett Part I
By Doug Kass , The Edge

The Oracle of Omaha says it's time to buy, and I agree with him.
Focus will now shift toward conventional recession risks and away from unconventional credit risks.
After it has gotten as dark as it has, one can finally begin to see the stars.

"I feel like an oversexed guy on a desert island. I can't find anything to buy.
-- Warren Buffet, 1973

"I feel like an oversexed man in a harem. This is the time to start investing."
-- Warren Buffett, 1974

Which Warren Buffett should investors follow today?

Buffett's Three Buy Calls
Based on my analysis of his public quotes and opinion, the Oracle of Omaha has made only three boldly positive market calls in his career; the latest one was on Friday.

The first two calls were prescient.
* Bullish call No. 1, 1974: Over the two-year period following Warren Buffett's 1974 call(see above quote), the Dow Jones Industrial Average and the S&P 500 soared by 86% and 70%, respectively, over the next two years.
* Bullish call No. 2, August 1979: In an interview in Forbes, Buffett stated,

Stocks now sell at levels that should produce long-term returns far superior to bonds. Yet pension managers, usually encouraged by corporate sponsors they must necessarily please, are pouring funds in record proportions into bonds. Meanwhile, orders for stocks are being placed with an eyedropper.... Can better results be obtained over, say, 20 years from a group of 9.5% bonds of leading American companies maturing in 1999 than from a group of Dow-type equities purchased, in aggregate, at around book value and likely to earn, in aggregate, around 13% on that book value?... How can bonds at only 9.5% be a better buy?
Over the next two decades, the S&P achieved an annualized return of 17.3%, nearly twice the average 9.6% return for bonds.

* Bullish call No. 3, October 2008: Buffett writes an upbeat New York Times op-ed. Only with the benefit of time will we know whether Warren Buffett's market call on Friday will be proven correct. What we do know is that he rarely makes this sort of pronouncement -- most of his calls have been downbeat -- and when he has waxed enthusiastically, he has proven to be correct in the passage of time. I would also observe that the widespread dismissal of the Oracle's positive remarks by so many (including the typically permabullish media) is classic evidence of an inflating negativity bubble, which encourages me into thinking an advance might be closer at hand. After all, if Buffett wrote the New York Times op-ed with the DJIA at 14,000, many of the same naysayers would be throwing a parade for him!

Shifting Back Toward More Conventional Risk
"I find nothing more depressing than optimism."
-- Paul Fussell

Over the past several years (and only until recently), I have felt that optimism was the opium of investors. I have been negative about housing (residential and nonresidential), credit, the economy and the world's stock markets over the past several years. My observations and warnings have been well-documented on these pages.

Arguably, the 25%-plus market schmeissing over the last few weeks represented a confluence of fear, margin selling and forced liquidations more than discounting the economic slippage and corporate profit worries.

Last Monday in "Baby, It's Cold Outside" my views became more positive, and, within the context of the dramatic drop in the indices, I am now inclined to be more optimistic than even a week ago. It should be noted, however, that my optimism is for the intermediate term, as the indigestion of the hedge fund industry has created an unpredictable shorter-term market setting, serving to produce an even more complicated investment mosaic than usual.

I am not a Pollyanna. There are headwinds, many of which I outlined in Tuesday's column, "Somewhere Over the Rainbow" in which I presented a realistic analytical view, suggesting a ceiling to any material market advance (to a level for which too many seem to still hold out hope).

At the core of my intermediate-term optimism is that, as a result of the unprecedented policy moves, investors soon will be less preoccupied with unconventional credit risk and will move back towards conventional recession concerns. (This development is fully documented in this weekend's Barron's column, "A Thaw in the Freeze" written by Randy Forsyth.

My more optimistic tone stems from the following items:

* Credit mending. The credit markets are beginning to (and will continue to) thaw. Three-month Libor is improving and has traded down to about 4.00% this morning, down from 4.20% at Friday's close and from a 4.50% peak earlier. Three-month Treasury bills have increased, doubling on Thursday and Friday. As a result, TED spreads contracted to about 3.60% on Friday and have improved further today. Friday's close was their first close under 4% in six trading days and the third lowest close of the month. Also improving this morning are the Libor/overnight rate spread, the mortgage rate/Treasury yield spread and the two-year bank swap spread (now back to pre-Lehman levels).
* The banking fix is going global. Over the weekend, officials from South Korea ($130 billion in state guarantees and capital injections), the Netherlands (through an infusion to ING) and Latin America have joined the global rescue efforts.
* Corporate balance sheets are healthy. Excluding financials, the balance sheets of American corporations are relatively healthy and less dependent upon the short-term debt markets than at any time in history. Moreover, unlike in prior cycles, it is important to recognize that there have not been the excesses in capital spending that have threatened previous cycles.
* Inflation has peaked. For now, the broad-based drop in commodities is being largely ignored, but, over time, this serves as a tax cut to the consumer and will likely buoy historically high corporate profit margins.
* Housing has hit bottom. Though a recovery in housing has been delayed until 2010 (at the earliest), the rate of decline in home prices is decelerating (albeit from low levels).
* Consumer confidence has also hit bottom. Again, it will be a long road back, but the bottoms are being put in.
* Takeover activity is on the rise. Very quietly, merger and acquisition volume is on the ascent and occurring at substantial takeover premiums through the use of cash (not Chinese paper) as deal currency. This morning's announcement that Exelon (EXC) is offering over $6 billion for NRG Energy (NRG) is another step in the right direction.

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