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Bear Markets: Your Gift From The Financial Gods?

by Alexander Green, Chairman, Investment U
Investment Director, The Oxford Club
Monday, July 21, 2008: Issue #824

Although we saw a furious short-term rally late last week, we have entered into official bear markets territory as of early this month. (Bear markets are defined as a drop of 20% or more from a previous high.)

This is a good thing. Legendary investors understand this. Ordinary investors don’t.

If you haven’t spent much time buying stocks getting excited about a bear market doesn’t just sound counter-intuitive, it sounds nuts. After all, how can you feel appreciative watching the value of your life-savings grind lower?

But try thinking like a chess player, a few moves ahead.

Every stock investor knows that you’re supposed to buy low and sell high. Bull markets give you a chance to sell high. Bear markets give you a chance to buy low.

If you want to prosper during the next bull market – the one that will propel the averages to new highs in the years ahead – now is your chance to pick up some bargains…

Investors – Don’t Let Bear Markets Scare You

Unfortunately, too many investors are lulled into complacency during bull markets and scared out of their wits in bear markets. So they do just the opposite, buying high and selling low.

Yes, the market has fallen sharply over the past nine months. And it may fall further in the weeks ahead. Still, this is an enormous opportunity for long-term investors. Too bad most of them don’t see it that way.

As Jason Zweig wrote in last weekend’s Wall Street Journal, “The people who so far this year have yanked $39 billion out of U.S. stock funds, and $6 billion out of exchange-traded stock funds, do not understand this. But if you are still in your saving and investing years, a bear market is a gift from the financial gods – and the longer it lasts, the better off you will be. Instead of running from the bear, you should embrace him.”

Dr. Jeremy Siegel, author of “Stocks for the Long Run,” concurs. Last week he spoke at FreedomFest in Las Vegas, pointing out a few essential facts.

U.S. stocks are undeniably cheap, selling at just 15 times prospective earnings. That’s the cheapest the stock market has been since 1991.
Take any rolling 5-year period over the last 200 years, and stocks have outperformed bonds and bills 70% of the time.
Take any 10-year rolling period and stocks outperformed approximately 80% of the time.

Yet we just finished one of those odd 10-year periods when stocks have actually done considerably worse. With stock dividends reinvested, the S&P 500 has compounded at a scant .65% over the past decade. History shows that when investors buy after a long period of underperformance, they are generally well rewarded.

Bear Market Stocks Return 5.6% Annually

For example, in the last long bear market, 1969 to 1982, stocks returned just 5.6% annually. But that mauling set us up for an 18-year bull market where stocks compounded at 18.5% a year, enough to turn $10,000 into more than $200,000.

Bear in mind, no one when can tell you when the next bull market will begin, how long it will last, or how high the market will ultimately go.

But, as you have probably heard your entire life, the shortest route to financial freedom is to own a business. And it is safer to own a portfolio of businesses than a single one. Hence, every long-term investor needs exposure to stocks. When do you get to buy them cheap? During a bear market.

At Berkshire Hathaway’s annual meeting in May, Warren Buffett said “I would offer you a significant sum of money if you could give me the opportunity for all of my stocks to go down 50% over the next month.” Why? He knows he owns great businesses. He would like to own them even cheaper.

Legendary investor John Templeton, who died last week, often said the four most expensive words in the English language are “this time it’s different.” He also said the best bargains are found at the point of “maximum pessimism.” You don’t get maximum pessimism during bull markets. You get them when the world looks like it’s falling apart.

Times like now, for instance. Govern yourself accordingly…

Good Investing,

Alex

P.S. I have more about John Templeton’s world-beating investment approach in a Spiritual Wealth issue from Friday, July 18, 2008 called “Discovering the Laws of Life.”

Today’s Investment U Crib Sheet – John Templeton’s 5-Step Strategy for Building Wealth

Here is Templeton’s five-step formula for financial independence and building wealth, based on almost a century of experience:

Strategy # 1: Take Calculated Risks
John Templeton started off by taking significant risks in his business and investments. He was a serious poker player in college, and in 1939, he borrowed $10,000 from his boss to bet on 100 stocks listed on the NYSE selling for under a buck. A high percentage of these companies were close to bankruptcy, but Templeton reasoned that they would recover during a wartime economy. In four years, he sold all the stocks, paid off the debt, and pocketed $40,000 in profit. He was on his way to success.

Strategy # 2: Save, Don’t Spend
Templeton started out poor, but through the principles of thrift and hard work, he was able to get ahead. When he married, he and his wife set a goal of saving 50% of their income. He avoided consumer debt. In fact, Templeton bought his first home with cash. He carried his “cheap” approach into later life when he bought his Rolls Royce used.

Strategy # 3: Shop for Value Investments
Templeton followed the fundamental “bargain-hunting” approach to investing. “The long-range view requires patience.” His Templeton Growth Fund, which he ran for 50 years before turning it over to the Franklin Group, held stocks for an average six to seven years. He always searched for companies around the world that offered low prices and an excellent long-term outlook.“It’s not easy,” he stated, “but if you’re going to buy the best bargains, look in more than one industry, and look in more than one nation.” Under Templeton’s managing skills, the Templeton Growth Fund averaged a 14% annualized return over 50 years, far outperforming the stock market indexes.

Strategy # 4: Take Advantage of International Free Markets
Templeton believes a “free enterprise” approach is mandatory when investing overseas. “Avoid investing in those countries with a high level of socialism or government regulation of business,” he said. “Business growth depends on a strong free-enterprise system.” He was a follower of free-market economists Ludwig von Mises, Friedrich Hayek and Milton Friedman. “Governments should stop interfering with what people want to do.”

Strategy # 5: Minimize Your Taxes
In the 1960s, John Templeton made a controversial decision. He decided to renounce his U.S. citizenship and move to the Bahamas, where there is no income tax or investment tax. He became a British citizen, and then a Bahamian citizen, and lived tax-free (the Bahamas gets its revenue from high import duties and corporate/trust fees.)

Interestingly, his investment record improved markedly after he stopped worrying about the tax consequences of his investment decisions.Minimizing taxes and expenses is one of The Oxford Club’s “Four Pillars of Wealth”. There’s more on this proven investment philosophy and steps to take for long-term investing success in Investment U Issue #812, The 4 Pillars of Investing: Don’t End Up as Stock Market Road Kill.