QVMS - Beware Of Cheap Seek Fair Slowly - Weekly Blog # 743

• This coming week, we will get the Fed’s view of the appropriate level of interest rates. Much of the focus will be on the interest rate number. Far less attention paid to the cause of the action.
• Without understanding the causes, it is difficult to comprehend whether the resultant rates and other measures are going to have the desired result.
• After a significant decline, there is a burning question in the heart of every investor about when one should begin buying stocks. The question pivots not on timing, but price.

Current Conditions

This coming week, we will get the Federal Reserve’s view of the appropriate level of interest rates. Much of the focus will be on the interest rate number. Far less attention paid to the cause of the action. Without understanding the causes, it is difficult to comprehend whether the resultant rates and other measures are going to have the desired result.

Not discussed is what I am labeling the “Politicians’ Put”. Where politicians avoid responsibility for causing harm to people’s income, jobs, and capital by making the Fed and Administrative State Commissioners responsible. There is precious little evidence that the Fed and various commissioners have any skills at predicting the future or recommending wise actions.

Part of the fallacy in relying on these individuals is that they tend to depend on numbers questionably put together. Too little attention is paid to the weekly local Reserve Bank presidents’ lunches with business people and consumers. Some presidents are better at asking follow-up questions than others.

I have seen the coming of the recession since last autumn. My source of information was walking various malls, talking with competent people unable to find jobs, and employers failing to find applicants possessing the right attitudes. In many cases, the supply shortages were due to a lack of front-line labor and supervisors.

The following data is mixed in terms of future implications:

• An inverted yield curve with the 10-year rate at 2.78% vs. the 2-year rate of 2.99%
• The JOC-ECRI Industrial Price Index falling -9.5% vs. last year.
• The Labor Force Participation Rate falling -5% vs. 2000.

Start Buying?

The sign a bottom price has been reached is often a surge in transaction volume, signifying massive capitulation. “While everyone is talking bearish, no one selling is being heard”. Stock transaction volume is mild, although bond transaction volume may signify capitulation.

In the weekend Wall Street Journal (WSJ) , there is a headline titled “Business Activity Declined Sharply”. In addition, showing the US and global Purchasing Managers' Index dropping to 47.5 from the prior week’s 52.3, clearly showing a contraction.

After a significant decline, there is a burning question in the heart of every investor about when one should begin buying stocks. The question pivots not on timing, but price.

I have had the extreme pleasure and honor of knowing great investors over 60 years. The first is Charlie Munger, who taught Warren Buffett that it is better to buy a great company at a fair price than a good company at a cheap price. His belief is that a great company gets better over time, whereas a cheap price only goes up for a period.

Before John Neff created a great record with Windsor and Gemini funds. He worked at a mid-western bank where they evaluated corporate loan applicants based on their average earnings power over five years. He applied this process to stock selection at Wellington Management for Vanguard funds, which helped his winning funds during bear markets.

One must be very careful applying the lessons of these two investor giants today. Some pundits are currently recommending so-called fallen angels. These are good or possibly great companies currently trading at depressed or “cheap” valuations. Current prices compared to last year’s earnings or the last period of rising earnings is not particularly relevant. Particularly if we are in a recession that extends beyond a year. It is quite possible with future depressed earnings and today’s prices, some stocks may be selling at record high valuations.

Depressed Earnings

There are two main causes for depressed earnings:

• A fall in demand for their products or services. As demand is a function of people’s attitudes, demand tends to fluctuate fast and cyclically.

• Companies investing substantial resources in future products and services will materially leverage current sales and earnings if successful.

I am following a few financial services companies in the second group. Their earnings are being penalized substantially more than their peers who have only cyclically depressed results in this downturn. My job as an analyst/investor is to attempt to select a company becoming a greater company, by accepting a bigger stock price decline than peers. This approach could lead to a different roster of candidates than held presently.

To some degree, the relative size of a price decline is related to the nature of their shareholder base. That is why I tend to favor institutional quality companies, where a substantial portion of shares are owned by those relying on their own experienced internal analysts.

Question: Have you changed your way of selecting securities due to the changing structure of the market.

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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