February Financial Pondering

At the end of December I wrote about four strategies to invest well in 2009.

Since January is now behind us it is time to add more detail since there is a lot of recent positive news. During the past two months the markets have been fairly stable and corporate paper is beginning to return. The prime rate and LIBOR are extremely low and overall banks are feeling better than many businesses: banks which are not bogged down in the mortgage crisis (able to value their books) are cooperatively poised for a quick and confident recovery. The CBO estimates the recession will be over within a year. The Stimulus Plan is now moving forward, which may not be good news but in any case the market will probably still decline for about a year. Finally, no large acts of terror happened in the days of uncertain consequences as one president's term ended, or as a commentary on a new president being inaugurated.

So, how to invest now? Again I present the wisdom gleaned from discussion with family members more economically literate than I.

One strategy would be to find investments that are "the diamonds in the rough". This must be done by sector. For example, sound banks are currently undervalued since all banking is in disfavor. Perhaps it is still early for any bank stock. But if you know of a small, local bank that is sound it might be worthwhile to support it.

(Here in Eugene the bank Pacific Continental is well rated and has good numbers; I might make a few phone calls to learn more.)

A second strategy is to trust the holding companies to spot the diamonds in the rough. As examples, Berkshire Hathaway (growth) and Haven Capital Trust II (dividend) are currently undervalued. Good holding companies have experience making use of others' luck.

A third strategy is to use mutual funds to avoid fees when purchasing or selling. After all, if it costs you $10 to buy a stock and then $10 to sell it, those fees total 2% of a $1,000 investment. If you are investing amounts of that size you might not be confident that any particular company will outperform its sector's minuscule-fee mutual fund by more than 2%. During a recession consumer staples normally do well. The Stimulus Plan is expected to cause materials to do well for at least a year. Internationally, India is expected to do better than average this year.

Finally, as mentioned in December, no matter how you invest be ready for inflation (and liquidity) with a mortgage and investing some in gold.

No matter which strategy you use, note two things about analysis statistics.

First, realize that Price/Earnings (P/E) ratios are subject to economic fads. For example, after Enron and Sarbanes-Oxley it was fashionable to understate earnings and P/E ratios all rose; then it became fashionable to show high earnings and P/E ratios all fell. Today P/E ratios all tend low because the market is down (low Price), but also because companies are eager to appear healthy (report higher Earnings). During a recession do not trust a low P/E ratio to be meaningful until you have compared it to other companies in that sector.

Second, Earnings Per Share (EPS) is only estimated by analysts for less than a year forward. (Any report of a long term EPS estimate is merely scaling up the short term analysis.) During a recession this is too short a time frame and the analysis is too uncertain.

(These two details explain my above-mentioned inclination to call some of the local Pacific Continental managers rather than trust that the analysis statistics--P/E, EPS, and one-year Target Estimate--are now very meaningful.)