Is it safe to go in the water?

It seems that pundits are falling over each other in order to decree that the recession is over. Is Daniel Gross right? I don't know if Nouriel Roubini is right, but then again, I don't care either. All I know is that there are still stocks trading for meager multiples, many of them big caps with tons of cash on the balance sheet. Do not get caught up in timing the end of the recession. We won't know officially until well after it's over. Don't be discouraged that you missed the March bottom. After all, we may re-test it. Even if we don't, there are still great companies that are cheap, some justifiably, some not. In fact, stop reading this blog and start looking amongst the wreckage!

Exploit the election rally

The market has been rallying recently. There's been a lot of talk about whether or not the market has hit a bottom. The C-word(capitulation, not the other one) is on everyone's lips. Perma bears are turning bullish. In boardrooms across America, the phrases "inflection point" and "paradigm" shift are being bandied about like a volleyball by people paid enormous sums and venerated for occasionally outperforming the indexes. As a little red-haired orphan once said, "the sun'll come out tomorrow."

I see the rally and don't believe my lying eyes. I think it's an election-related and typical bear market sucker rally. Still, I'm participating. I'm not smart or agile enough to buy the SPY for a quick gain. I'm also not confident enough that this is a sucker rally to go short the market in any meaningful size. So what am I doing? I'm using the rally to raise cash, rebalance, and reasses.

Speaking of that last verb, I specifically mean E*Trade. I first started touting E*Trade in the low 2s back in November. It went as high as 5 and change, then settled into a a range of the high 2s and low 3s. As I write this, ETFC is trading at $1.95 and is down 50% YTD. It still lessing for less than book value and now for less than the cash on the balance sheet as well.

I'm debating whether or not to buy more. I would like to, but there are less risky bets out there that I'm eyeing. Excel Maritime Parners(EXM)is still selling for 1x earnings with a 14% yield. Altria and Philip Morris has single digit P/Es and juicy yields as well. Rick's Cabaret(RICK), which I think has on the best business models around period, is selling for under book value. The oil services sector has never looked so good. For a long-term value investor, this is better than being a kid in a candy shop. This is like being put in charge of Mars or Hershey.

Decisions. Decisions. I've got a lot to think about.

Hats off to Bill Miller

I have been critical of Bill Miller on this blog. I find it strange that a guy as smart as he clearly is has failed to anticipate the energy bull market and not buy oil stocks. He's not perfect though, and so such a mistake is unavoidable. Friday's Wall Street Journal featured an article detailing his woes owning Bear Stearns(BSC), Countrywide Financial(CFC), Pulte Homes(PH), and Eastman Kodak(EK). So far he has wrong, very wrong on these picks. The streak has been over for two years now, largely aided by these wagers.

Reading his quarterly shareholder letter for Q407 from about a month and half ago really reaffirmed my respect for his intelligence and courage as an investor. First of all, he uses words like alacrity and enantiodromia. That's a tad bit more erudition than you should expect from the typical fund manager, but then again, Miller dropped out of a doctoral philosophy program in order to join Legg Mason(LM). He is also on the board at the Santa Fe Institute.

He flatly states in the opening line, "we had a bad 2007, which followed a bad 2006." He then goes on to say that losses are "unavoidable and unpredictable."

No B.S. No euphemisms. The naked truth. This is a man with whom you can feel comfortable entrusting your investment dollars.

He is not panicking like Stanley Druckenmiller did at the end of the tech bubble. He is sticking to his guns, waiting for the market to come to him rather than chasing it.

What exactly are his guns? Read his Q405 shareholder letter. You will not find a more well-reasoned, humble, or honest account of one's investment philosophy and performance from a fund manager. I mean, he even admits to screwing the pooch when it came to Enron!

Read both of the letters. You'll learn a great deal about investing.

Do you have a mancrush on Warren Buffett?

Do you remember the Seinfeld episode, "The Boyfriend," when Elaine starts dating former Mets great Keith Hernandez. Jerry gets to meet him and beforehand is fretting about his shirt. Jerry worries that it was too early in the relationship to help Keith move.

As with many Seinfeld episodes, it was a very funny rendering of a true life situation. Investors get mancrushes as well, especially value investors. Perhaps you don't have it bad for Buffett, but what about Ben Graham? Do you think that David Dreman is dreamy? Joel Greenblatt? Marty Whitman? Seth Klarman? Eddie Lampert? It goes without saying that you've read the books. Do you religiously read GuruFocus in order to see what these guys are buying? Do you feverishly Google them searching for articles or blog posts for information about their latest moves or philosophical treatises? Have you been to the Berkshire annual meeting in Omaha?

It's good to have heroes or people that you emulate. Reconstructing the rationale behind past investments of the masters of capital allocation can be very instructive. Just don't forget that you are you. Coke or the Washington Post are not selling at a fraction of their intrinsic worth. You can't snatch up KMart bonds right after its bankruptcy. This is not to say that you can't match or exceed their long term records. As Buffett has pointed out many times, he has more money than ideas and he could get better returns if he weren't so big.

Take a cue from the latest Nike basketball commercial featuring Buffett pal LeBron James, "you don't want to be LeBron James, you wanna be better than me." So learn what you can from these masters, but don't be hedged in by their thinking. Just like they did, you'll have to find the style that works best for you.

How do you sit and do nothing?

One of the keys to making money as a value investor is to not be afraid to just sit and do nothing. It's boring. It's hard. It's not remotely sexy. Especially in our age of online trading, it's so easy to update your positions or net worth every minute. It's incredibly easy to hear some bad news on Bloomberg TV, CNBC, or Fox Business News, get frustrated and make a dumb move. So how do you avoid this? Turn off the TV. Don't read message boards. Restrict the amount of sources that you read. Avoid information overload. Don't check your stocks every day. Take the broker off speed-dial. Get away from the market regularly and get some perspective.

The Asch Conformity Experiment, the Milgram Obedience Studies and value investing

Have you heard of this world famous experiments? They're featured in every Sociology 101 textbook. The first experiment deals with the powerful influence of group pressure. Solomon Asch presented showed a group of five students the following figures. Next, he asked a simple question. Which line(A,B,or C) on the right is equal to line S on the left? How could anyone fail this test? After all, the line lengths are clear and unambiguous.
Unknown to the fifth student, the first four students were in league with the Asch. They purposely gave wrong answers. Asch wanted to see, if their wrong answers would influence the fifth student. Well, it did. In 33% of the cases, the fifth student gave the wrong answer at least half of the time. 40% gave "some" wrong answers. Only 25% of the students consistently gave the correct answer.
The Milgram Obedience Studies deal with the tension between authority and conscience. In this series of experiments, test subjects were told that they would act as a teacher and present test questions to another person who was a student. Whenever the person, gave a wrong answer they were to administer an electric shock, one that would increase by 15 volts with each successive wrong answer. As was the case in the Asch Conformity Experiment, the test was simple.
The shock machine bore clearly visible labels that said Slight Shock, Moderate Shock, Strong Shock, Very Strong Shock, Intense Shock, Extreme Intensity Shock, Danger: Severe Shock, and finally, XXX at 450 volts. As the voltage rose, the "student" responded with squirming, groans, and then screams. If the subject wanted to quit, he would be told to continue with the experiment. As was the case with the Asch Conformity Experiment, the test was rigged; the "student" was working with Dr. Milgram.
Before conducting the experiment, Milgram asked psychiatrists, psychologist, philosophers, and sociologists how many subjects they thought would go to 450 bolts. The experts said about one in a thousand. What did Milgram find? He found that 65% of subjects were willing to administer a lethal shock. He later repeated this experiment several times, changing the venue from a science lab to a dingy basement so as to counteract the tendency of some people to defer to a scientist conducting a scientific study. Still, about one half of the subjects were willing to administer a lethal shock. He tried the experiment with women as the teachers. In subsequent experiments, he found that class, race, and ethnicity made no difference.
So how does this relate to value investing? One should be leery of following the herd. How many times have you bought a stock because of a tip, or an article in Forbes, or because some "guru" likes it. There's nothing wrong with taking advice from sources that you respect and trust. You just have to make sure that you're making the decision based on your situation, your financial goals, your risk tolerance, the investment approach that works best for you. The financial press(I am guilty of this as well) is very fond of setting up someone as an unimpeachable authority and then claiming their endorsement. Please remember to do your own due diligence, no matter how trusted the source is. If you lose money, and you will if you invest long enough, let it be by your own actions at least.