"The best time to buy is at the point of maximum pessimism."
-Sir John Templeton
. . .
Jesse Livermore was an early twentieth-century investor who made and lost several fortunes.
As speculators go -- and speculation and investing are distinctly different pursuits -- Livermore was among the finest. He made fortunes short selling stocks when everyone else was long during the crashes of 1907 and 1929.
The consummate market historian, much of Livermore's success was attributed to his dedicated research into the human condition.
Livermore once wrote, "All through time, people have basically acted and reacted the same way in the market as a result of: greed, fear, ignorance and hope. That is why the numerical formations and patterns recur on a constant basis."
In other words, history repeats itself. Because human beings never change. Our emotions, and the means by which they drive behavior in various situations, remain as much a part of us as they were thousands of years ago.
As equities continue their four-week slide, investors have reacted as Livermore might have anticipated. Fearfully.
Is the EU breaking apart? Will China's slowdown affect portfolios? Has the Fed lost control? Is this the start of something bad?
Anecdotally, investors are shooting first and asking questions later. ICI reports that mutual fund outflows have dramatically increased. Nervous investors are going to cash. Which is the opposite tract to take.
Let's begin by looking at valuations.
Analysis of traditional S&P 500 valuation metrics reveals that the market is not drastically overvalued, as some nattering nabobs report. While the P/E ratio sits 30 basis points above the 25-year average (hardly wildly overvalued), the price-to-book and price-to-cash-flow ratios are beneath their 25-year averages. And the index's earnings-yield spread (earning yield minus Baa bond yield) is still 1.7 percent. Revealing a favorable disposition towards stocks. Moreover, even if equities were a touch overpriced (they're not), that would be understandable given the historically low interest rate environment. Which -- given the lack of pragmatic investment options -- permits a bit of P/E multiple expansion.
Even given the multi-quarter earnings drought, American companies have proven themselves to be extremely capable of getting the most from their income statements. Cost cutting and technological advancements have seen companies enhance margins. We've reason to believe that they will continue to do more of the same. Especially as the energy sector -- which has been a huge drag on earnings yet appears to be recovering -- begins to revert to the mean. So helping earnings per share growth across the board.
Investors, practicing the herd mentality, tend to do precisely the wrong things are the worst of times. In this case, investors are getting out of the markets even as stocks become more attractive. And seasonality begins to provide tailwinds into the market's sails.
As stocks become cheaper, investors typically become more pessimistic. Equities fall in price, dividend yields become more attractive, yet the public piles out of stocks and into bonds, even as the 10-year Treasury yield a meager 1.65 percent. Stocks are the only product I can think of around which consumers become more comfortable the pricier they become.
Think about it. I can buy McDonald's stock, which recently hit an all-time high, and get paid a 3.31 percent yield for doing so. And possible incur some appreciation when the stock bounces. Or, I can buy ten-year Treasury bonds and make 1.65 percent.
Warren Buffet recently said that "Bonds today should come with a warning label." They yield nothing. And when interest rates inevitably rise, investors will be trapped as the value of their funds drops like an Aroldis Chapman fastball.
Moreover, seasonality has kicked in.
Historically, September has been terrible for stocks. As have the first two weeks of October. But after that? The remaining two-and-a-half months tend to be manna from heaven where equities are concerned.
"But, isn't debt safer than equities right now?"
Perhaps you're considering a mezzanine debt opportunity. Some of which are currently attractive. Otherwise, you should always defer to ownership, as opposed to creditorship. Participate in the growth of great enterprises will always be preferable to lending to them.
"But aren't risk-free Treasury bonds a safe bet during unsafe times?"
Last time I looked, McDonald's was turning record profits. The U.S. government was running an $18 trillion deficit. Hardly a flight to safety.
So, will markets decline further from here, or will valuations hold and opportunistic buyers step in?
Short term, who knows? Markets are a pricing mechanism, constantly reconfiguring to adjust to the current fiscal and economic realities. They are capable of drifting lower. Markedly so if geopolitical trouble erupts. But you cannot proactively game that out. You must invest by the most probabilistic odds.
Yet investors, losing sight of that fact, will continue to suffer from data disconnect. The public, confronted by headline risk, will sell stocks every time CNBC reports the day's headlines. Leaving investors pondering, months down the road, as to when they put their retirement funds back to work. After markets rise by 5 percent? 10 percent? 15 to 20 percent?
While the world is, at the moment, economically challenged, investors believe that every data point will send them headlong back to Q4 2008.
These cycles of panic and euphoria get us nowhere. In order to create wealth and maintain our fiscal independence, cooler heads must prevail.
Do yourself a favor. Utilize the fear and paranoia to your advantage. Take the ICI fund flow data, and when the public is piling out of equities, buy. When the public is pouring into equities, sell (or hedge).
Run opposite the herd. Because the public is much like every horror movie heroine you've ever known. Forever doing the wrong thing at the worst moment. Doomed long before the opening scene.
The best financial advisors are those who bolster the courage of clients during the most difficult times. Who can convince clients to do that which they should be doing, as opposed to that which they want to do. Who can steer clients' thoughts away from the media frenzy, and back towards mid- and long-term objectives.
Even in the darkest of times, opportunities arise. In 2008, Treasury bonds. Managed futures. Cash. These asset classes prevailed amidst the carnage. As did McDonald's (+5%), Wal-Mart (+15%), Dollar Tree (+57%), Ross Stores (+15%), EZCorp (+31%), DeVry (+10%), Amgen (+24%) and Genentectch (+23%), among others. Among others.
As Jesse Livermore said, the human condition will never change. Investors will continue to vacillate between despair and euphoria. Markets will rise and fall. Only the means by which you respond to these movements will your fate be determined.
Because lemmings never die alone. They follow each other, one by one, over the cliff. Yet, for those forward thinkers, opportunity awaits. Opportunities to step away from the herd. To back away from the cliff. To take advantage of the opportunities that arrive with every sunrise.