“I think it was Ben Graham who said, ‘This, too, shall pass.’ I think the same applies now…this, too, shall pass.”
That’s what David Dreman told me last Friday.
We talked about an hour after the markets closed. At the time, a Reuters headline proclaimed, “Worst January Ever for Dow, S&P 500.” The Dow sat at 8,000.
It was a pretty brutal week for the markets. But here’s the thing, Dreman didn’t seem too worried. I’d even go as far to say he was upbeat.
Why wasn’t Dreman too worried?
You see, he’s the contrarian’s contrarian. Some call him the “dean” of contrarian investing. He literally wrote the book on contrarian investing – Contrarian Investment Strategy – back in the late 70’s.
And the late 70’s was a time, much like now, when no one wanted to buy stocks. A decade of sub-par returns had every investor and speculator paying top-dollar for Chinese vases, gold coins, and California real estate…practically everything but stocks.
Here’s what he wrote in his book about the markets back then:
“…individuals have exited en masse from the marketplace. Brokers too have suffered. Scores of [NYSE] member firms, some dating back a century or more, have gone out of business or been forced to merge. To date, over fifty thousand jobs have disappeared on Wall Street since the beginning of the decade. Harvard Business School graduates, those supposed savants of where opportunity lies, now shun Wall Street like the plague.”
Wall Street’s oldest firms are going out of business or merging. Financial sector jobs are disappearing. And those “Harvard Business School savants” – they’re behind some of the biggest problems. Rick Wagoner (GM), John Thain (Merrill Lynch), Jeffrey Immelt (GE), Hank Paulson, and George Bush are all Harvard MBA’s.
Of course, Dreman’s contrarian thesis wasn’t about how bad everything was in the late 70’s. It was about how a shift in investor attitudes towards stocks was about to change. On the last page of the book Dreman says (this is the last quote I promise – I have a copy right behind my desk):
“Institutional concentration, conformity pressures on professionals and overreactions to the current economic problems seem to me to present the investor with some of the greatest stock market opportunities in decades.”
Now it’s pretty easy to see why Dreman was fairly upbeat. He’s been through tough markets before. And when stocks did come back, as he predicted, they came back in a big, big way. When Contrarian Investment Strategy was published, the S&P 500 was sitting around 100 and the Dow was trading around 900.
So when we started talking about what opportunities he is finding out there, he really got me thinking. Dreman talked positively about financial stocks, with a caveat of diversification and a truly long-term outlook. (Note: A full transcript of our talk will be available to Prosperity Dispatch readers soon)
I know, I know…What on earth could he be thinking? Financial stocks – now?
But hey, that’s a debate for another day. For now, I just want to focus on how some of the world’s greatest investors are finding opportunity.
You see, there are a few truly great money managers out there. Many of them, we hardly ever hear from. I realize Warren Buffett practically can’t buy a share without sparking a dozen headlines. And every sentence Jim Rogers says travels at light-speed throughout the blogosphere. So we know what they’re up to. But what about the others? What are the less-publicized, yet equally successful professional investors finding?
Well, I delved into it a bit and it turns out they’re finding a lot including “a $10 trillion opportunity” and “a very rare opportunity…one not seen in 30 years.” Let’s have a look at what the best of the best are finding.
David Swenson – The man who grew the Yale Endowment Fund from $1 billion to $22 billion has been eyeing up one sector of the market. Swenson says, “There are some really extraordinary opportunities in the credit world.” As to which companies you want to look at buying the distressed debt of, Swenson says, “You want to make sure you’re with companies that have the ability to survive in a really tough economic environment.”
Of course, investing in debt in a downturn can be tricky and timing is important. The best time to buy is when default rates peak. Default rates peak along with pessimism so that’s the best time to buy. Right now default rates are still rising.
Dr Edward Altman, creator of the widely used Z-score model to evaluate expected default rates, says, “The default rate in 2009 could be as high as 11%-to-15%. The best time to buy distressed securities is after default rates have peaked, so the best opportunities probably won’t arrive until later this year or even 2010.”
It looks like we’re facing a good opportunity now and a great opportunity could be on the way soon.
John and Nick Calamos – The “Kings of Convertibles” must be having the time of their lives. As we mentioned a few months ago, convertible bonds are selling at a significant discount to their underlying value.
Nick Calamos summed it up best in a late December interview when he said, “The marketplace has presented us with an opportunity to buy a lot of convertibles below what their fixed income values would be, and with embedded equity options which are free.”
Remember, convertibles are securities which have two parts. They are a bond or preferred stock which carries an option to buy common stock. This is how you get to collect interest or dividends just like a bondholder, but also get to cash in if the company’s common share price increases.
Convertible bonds have always been one my favorite investments if you can get them at a good price. Right now they are at great prices and the Calamos brothers are aggressively buying them up.
It appears investors are starting to warm up to convertible bonds again. The Calamos Convertible & High Income Fund (NYSE:CHY) and Calamos Convertible & Income Opportunities Fund (NYSE:CHI) have held up very well during the worst January on record.
John Paulson – The man who bet against subprime mortgages and personally walked away with $3.7 billion when it all came crashing down is now looking for the next big thing. He may have found it in what he calls “a $10 trillion opportunity.”
In a recent interview with CNBC, the “Man who Made Too Much” passed on this advice (my notes):
1. Cut leverage and build cash
2. Eliminate exposure to equities (i.e. get out of stocks)
3. Maintain short-term securities (buy T-bills, cash, or cash equivalent)
4. Prepare for bargains in debt securities of distressed companies— “a $10 trillion opportunity”
Paulson is clearly getting ready to bet big once again, but this time on corporate debt. He just started the Paulson Recovery Fund to do just that.
Jeremy Grantham – The manager of more than a little over $100 billion and who has been pretty much out of stocks for the past decade or so is turning bullish once again. He is, however, not focusing his efforts on a recovery in the United States. Not one bit. Jeremy Grantham said in a recent interview, “I expect emerging markets to do much better and become the only game in town.”
His rationale probably sounds familiar to Prosperity Dispatch readers. Grantham cites growing populations, improving education, younger populations with more workers for every retiree, and high savings rates.
I hope all of these themes the masters are focusing on sound familiar. It’s where we’ve been focusing our efforts.
Now, I realize there will be a lot more ups and downs. U.S. consumers have turned into savers all at the same time. Unemployment is still rising. China’s current economic situation is truly a mess. Worst of all, a bit of protectionist language made its way into the U.S. stimulus package (I’m sure it’s about to get deleted though).
In the end though, there’s no reason not to believe – “this, too, shall pass.”
By Andrew Mickey