To help explain how stocks become mispriced, the late Benjamin Graham introduced a metaphorical business partner, Mr. Market, in his classic book The Intelligent Investor. Every day, Mr. Market tells you what he thinks the business you jointly own is worth and offers either to buy you out or to sell you an additional interest on that basis.
"Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them," wrote Graham. "Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly."
Mr. Market's bipolar nature has been on display recently. In the six months that ended March 9, as fear about the global economy reached fever pitch, Standard & Poor's 500-stock index fell a bone-chilling 46%. But from March 9 through June 5, investors regained their enthusiasm for stocks, driving up the S&P by 39%.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Tough road ahead
Just as we were convinced that the market's fear had reached absurd levels in March, we think the enthusiasm evidenced by the rebound will likely prove to be overdone as well. The reason is simple: We think the financial system has many years of significantly higher than normal losses to work through. As the greatest bubble in history deflates, it will continue to affect the economy, corporate earnings and the stock market.
Valuations had fallen so low by March that stocks offered investors the opportunity to reap excellent returns with much lower risk than had been the norm in recent years. Today, if things don't improve relatively quickly, the risk of a pullback in share prices is high.
In particular, stocks of companies closely tied to a revivified economy have gotten much riskier. These volatile stocks have been Wall Street darlings of late. In one indication of the distinctions the market is making, non-dividend-paying stocks in the S&P 500 were up an average of 24% this year through May 31, while the typically more-defensive dividend payers declined 2%, on average.
Our response to sizzling stock prices has been to shift somewhat from offense to defense. We've trimmed positions in cyclical companies whose stocks have run up quickly, and we have added positions in high-quality companies in less economically sensitive businesses whose stocks have foundered. Examples of the former are American Express (symbol AXP) and Wells Fargo (WFC), which we analyze in our new book, More Mortgage Meltdown: 6 Ways to Profit in These Bad Times. We considered both stocks to be screaming bargains when they were about $10. But with both their prices at $25 (as of June 5), we began to trim our positions because the risk-reward ratio had become less favorable.
A more defensive idea, in keeping with the times, is pharmaceutical giant Pfizer (PFE). Because of concerns about Pfizer's pending acquisition of Wyeth, the loss of patent protection for Lipitor in 2010 and the effects of possible steps by the Obama administration to rein in health-care costs, the stock sits at $15, a level it first reached more than a dozen years ago. It trades at a mere seven times estimated 2009 earnings of $1.95 per share.
We believe the administration will take steps that will impact Pfizer's profitability. But at today's price we've being more than compensated for this and other risks. We also believe the market is failing to appreciate the value Pfizer can create through its sales and distribution system (the world's largest), and its ability to cut costs. Even if it takes time for our scenario to play out, we'll earn a 4.3% yield while we wait.
The uncertainty of the times suggests that the market's mood swings are likely to be frequent and pronounced over the coming year. That should create opportunities for investors who are able to maintain a more even keel.
Columnists Whitney Tilson and John Heins co-edit Value Investor Insight and SuperInvestor Insight. Funds co-managed by Tilson own shares of Amex, Wells Fargo and Pfizer.
-
Why Taiwan Semiconductor Stock Is Falling After EarningsTaiwan Semiconductor beat expectations for the first quarter but its stock is notably lower. Here's why.
-
Strategies to Optimize Your Social Security BenefitsTo maximize what you can collect, it’s crucial to know when you can file, how delaying filing affects your checks and the income limit if you’re still working.
-
Best Banks for High-Net-Worth Clientswealth management Kiplinger's 2023 list of the best banks for higher-net-worth clients.
-
Stock Market Holidays in 2024: NYSE, NASDAQ and Wall Street HolidaysMarkets When are the stock market holidays? Take a look at which days the NYSE, Nasdaq and bond markets are off in 2024.
-
Stock Market Trading Hours: What Time Is the Stock Market Open Today?Markets When does the market open? It's true the stock market does have regular hours, but trading doesn't necessarily stop when the major exchanges close.
-
Bogleheads Stay the CourseBears and market volatility don’t scare these die-hard Vanguard investors.
-
I-Bond Rate Is 5.27% for Next Six MonthsInvesting for Income I-Bonds issued November 1, 2023 through April 30, 2024 will have a rate of 5.27%.
-
What Are I-Bonds?savings bonds Inflation has made Series I savings bonds enormously popular with risk-averse investors. So how do they work?
-
This New Sustainable ETF’s Pitch? Give Back Profits.investing Newday’s ETF partners with UNICEF and other groups.
-
As the Market Falls, New Retirees Need a Planretirement If you’re in the early stages of your retirement, you’re likely in a rough spot watching your portfolio shrink. We have some strategies to make the best of things.
