Fairholme: Keep Calm and Carry on; Pzena: Value Abounds in Large-Caps

The news speaks to both bull and bear market–but in a counterintuitive way. Here is a definition from Harold Ehrlich, who was with Shearson at the time and later became president and then chairman of Bernstein-Macaulay: “A bull market is when stocks don’t go down on bad news. A bear market is when stocks don’t go up on good news.”

Long cycle bottoms can be particularly hard to fathom. One famous story is that in the year 1938, when the stock market was still recovering from the crash of 1929 and had lurched along for years and years and years, essentially doing nothing, only three members of the graduating class of Harvard Business School went to work on Wall Street.

To bring this into a contemporary context (2012), my friend Dean LeBaron has said publicly, referring to the more than 100,000 members of the Financial Analysts Federation: “That’s too many analysts; by the time this is structural bar market is over, there will be only 50,000.” History thus suggest that by the time this structural bear market is all over, it may not be socially acceptable to be seeking a career on Wall Street. (Deemer on Technical Analysis by Walter Deemer)

Second Quarter (June 2012) Letters from Investors

Fairholme Stays the Course July 2012

Pzena’s 2nd Qtr. 2012 Letter:Pzena 2Q 2012

Editor: In my opinion, the edge you can gain in large-caps is in the behavioral area based on what embedded expectations are in the current market price rather than expecting an informati0nal edge. What gain can you have in understanding Coke’s operations in 150 different countries and several divisions rather than determining if you believe the market is too pessimistic or optimistic based on current prices? 

Note the differences in expectations between the price of Coke in 1998 vs. 2009 or 2012. KO_VL.

Muddy Waters Releases a New Short Recommendation

A thorough discussion of the risks in Chinese stocks (investing outside your circle of competence):MW_EDU_071812_Sell Short

More videos/Readings of interest

Use your gifts: Video http://www.foxbusiness.com/personal-finance/2012/07/18/all-have-gifts-but-question-is-are-using-them/?link=mktw

A research firm for assessing your aptitudes (natural gifts) is http://www.jocrf.org/

Herd mentality video: http://www.youtube.com/watch?v=xU0cq3UvLaM

Barton Biggs (R.I.P.): http://www.thestreet.com/story/11618931/1/kass-rest-in-peace-barton-biggs.html

Chart Book: http://blog.haysadvisory.com/ (click on JP Morgan link for charts)


Melvin: The Art of Being Cheap

By Tim Melvin07/14/12 – 06:00 AM EDT  Real Money

Last week, a reader chided me for having an overly simplistic approach to investing. He pointed out, quite correctly, that the old Wall Street mantra of buying and holding quality stocks has not worked for investors for nearly a decade. Those who took it on faith have taken dramatic hits to their net worth.

My approach is not buy-and-hold as traditionally defined. I do not blindly buy or sell anything. I really do try to exercise the discipline to buy what is cheap and sell what is dear. I focus on valuation first — always. I use tangible book value as my chief measure of value but I also calculate intrinsic value and liquidation value for certain situations. I also do comps on takeover and merger situations by industry group to keep a constant measure of what rationale buyers are paying for companies similar to those I own. When a stock I own trades at a significant premium to its underlying value, I sell it regardless of market conditions. If the fundamentals change materially for the worse, I sell the stock. My approach is to buy what is cheap and sell what is expensive.

While it is a very simplistic strategy, that does not mean it is easy. Buying truly cheap stocks generally means you will be underinvested until the market undergoes a serious decline. You will be shopping in segments of the market that everyone hates and that attract negative commentary in the media. Your ideas will not be popular and will often be met with stunned disbelief. During those annual 10% declines and the meltdowns that occur every three years or so, your list of cheap stocks will be long and opportunities will be plentiful.

When everyone loves a stock and your nephew with the 600 SAT scores is racking up triple-digit returns by day trading, your stocks will be overvalued and there will no new opportunities. You will be selling stocks and holding a lot of cash. Even the most disciplined of us will start questioning our process when the hot stocks are jumping several points a day. I have seen the same cycle many times over my career. It always ends the same way: After a significant inventory creation event, stocks become cheap enough that I am a busy buyer once again, and the nephew goes back to waiting tables.

So, you will find yourself completely out of step with conventional wisdom. Buying a stock such as Kelly Services (KELYA) right now when the economic outlook is somewhat dire takes backbone and discipline. You have to ignore the market and focus on the fact that it is cheap. Being underinvested when the talking heads are screaming “Buy!” is not always easy. Neither is reading piles of 10-Qs and 10-Ks to find quality cheap stocks with the potential to recover. Running endless credit tests on companies that appear cheap is not exactly fun for most of us.

Buying the few stocks that are “too cheap not to own” until the stock market stages a sharp decline to create inventory requires discipline and patience. Holding stocks that are cheap when all the news appears negative requires mental toughness and belief in your approach — try being long natural gas stocks and small banks over the past year. The news flow could have you questioning your sanity if you did hold to your belief in asset-based investing.

During my lifetime, owning “too cheap not to own” stocks and waiting for inventory creation events has been exceptionally profitable for those few investors who practice the art of being an owner of assets purchased on the cheap.

At the time of publication, Melvin was long KELYA, although positions may change at any time.Tim Melvin is a writer from Stevensville, Maryland, who spent 20 years a stockbroker, the last 15 as a Vice President of Investments with a regional firm in the Mid Atlantic area.

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