Commentary

Jay Kaplan

No Bells Will Ring

When stability returns to the stock market, there won't be a sign. They never ring a bell at the top, and they never ring a bell at the bottom. We won't know until we can look backwards with hindsight and say, "Oh, that's when it turned." No one knows when that will be, and there's still plenty to worry about. The panic took over the news cycle for a while; then the election took over the news cycle; and now the focus has been put on the realization that we are in a recession. Earnings estimates are coming down. Stocks really can't perform in the near term while analysts are bringing their estimates down, so stock prices are following earnings down.

Looking ahead, it's going to be important to watch Washington. Once in office, will the new President govern the way he campaigned? Will he deviate based on circumstances? Will there be changes to how capital is taxed when capital is scarce? Will the reality meet the rhetoric? An even bigger looming concern—the elephant in the room if you will—is unemployment. It's already becoming significant in the housing and financial services areas, and could well ripple its way throughout America. If that happens, it's unlikely that the market will improve any time soon. When people aren't working, that's a problem.

Of course, the market has historically been a leading indicator, so it's likely that the market will rebound before it's obvious that the recession is over.

Strong Balance Sheets Are Still A Good Idea

When we look at stocks, we focus primarily on companies with strong balance sheets. Although this approach doesn't appear to be giving us protection now, we think these businesses will be a good place to be invested over the long term. Companies with little to no debt don't need capital and can eventually take market share from those competitors that do. Since for all intents and purposes there's no capital market now, companies that need external financing are out of luck. That's a big problem for many companies, but conversely, the companies we focus on, those with strong balance sheets, should hold us in good stead because they tend to be self-financing and aren't relying on the capital markets to grow.

Trading Up On Quality Is A Good Idea

One thing that we are doing now is attempting to upgrade the quality of the businesses that we own, given that everything is being discounted. The market is currently ruled by fear and liquidity, as well as deleveraging, which is part and parcel of the liquidity challenge. We have had massive deleveraging, including margin calls for hedge funds and others, as well as redemptions, mutual fund tax selling, individual tax selling, etc.—and we're probably going to have more hedge fund liquidations. So there is a lot of selling, and a lot of panic. Stock prices and company fundamentals are decoupled; they have no correlation to each other at all. Prices are moving in waves as the herd goes up, and then as the herd goes down. Prices of "bad" companies are down a lot, but prices of what we think are good companies are down a lot, too. Since all stocks are "on sale" right now, we are looking for opportunities to sell the less good ones, and buy the better quality companies. It's a "quality trade."

A Good Idea For Investors Right Now

A systematic investing program like dollar-cost-averaging at a time like this is probably not a bad idea. Stock prices are low—and could go even lower. By continuing to invest a set amount of money at regular intervals, your average cost basis per share could be pretty good when this thing turns around. Of course, dollar cost averaging does not assure a profit nor protect against loss.