In short, people seem to have had enough of stocks. They’re moving into bonds. Oddly, and as strange as it sounds, this inflection point just might be the turning point for stocks. Put another way, investors as a group just got the last 10 years wrong. Thinking in contrary fashion, they may get the next 10 years wrong as well.

Stocks, as a group, have not done well now for 10 years. As of yesterday, if you had put $10,000 in the S&P 500 10 years ago, you would now have about $6,200 — a loss of 38%. And it’s worse than that considering the effects of inflation.

If you look at bonds, they’ve done much better. The Merrill Lynch U.S. Corporate Master index, a measure of high-grade debt, for instance, has gained 58% in the last 10 years.

You can hear the gears turning. Stocks have not done well, investors reason, and bonds have done much better. Therefore, buy bonds.

That’s what they are doing in large numbers. Here are some telling quotes from a recent Wall Street Journal article. From a manager of $185 million in individual accounts:

“I think a lot of investors have just had it with the equity markets… The baby boomers are saying, ‘I’m too old to make up these losses… I’m not going to risk it.”

Another, who has $414 million in assets under management:

“The credit markets are the market, and the stock market is a sideshow, period.”

One more, from a money manager of $900 million in assets:

“The debt markets seem pretty well understood, while the outlook for equities is still murky.”

Even the Journal itself waxes on about the simplicities of bonds. You only have to figure out if the company can meet the minimum payments of the bonds. You don’t have to worry about figuring out growth rates or what earnings per share may be. “With no end to the recession in sight,” the Journal sighs, “logic for buying equities is wavering.”

(If you’re like me, you’re probably suspicious of someone who repeatedly says “equities” when the plain-old word “stocks” suffices.)

So the stock market has been cut in half… and NOW these advisers are all cheerleaders for the bond market. Already this year, bond funds have added some $15 billion to their assets. Last year, investors took out nearly $200 billion from their stock mutual funds.

Going with what’s worked well in the past sounds reasonable, but investing is an odd thing. It’s not like many other areas of life.

If you get a bad haircut after going to the same barber for a few times, you stop going to that barber and find another. You don’t stick with bad barbers and you don’t go looking for bad barbers.

And if you get a good meal at a restaurant, you keep going back. You don’t worry about the restaurant getting too popular. You don’t look for a dive where hardly anyone goes, thinking you’ll get a better meal.

Investing is almost the exact opposite — which is one of the things that make it so hard. The best way to make a lot of money in stocks is to buy something good that few people seem to want. Then you sit on it, and when people get excited about buying it again, you gladly sell at a premium price and make some multiple on your initial investment.

All the greats made most of their hay in just this fashion — John Templeton buying up small-cap stocks in the Great Depression… Warren Buffett picking up The Washington Post and adding shares of GEICO in the depths after the 1973 market tank… and on and on…

The best deals become available during times like now. That much is a fact. I’m not saying it’s easy. I’m not saying all stocks will rise. Some of them are going to go to zero. Some of them are never going to come back. But some of them are great businesses and have great assets that will certainly come back at some point.

I know it can be tough when stocks you own are down so much. But looking ahead, I can’t help but be more optimistic…

Regards,
Chris Mayer

February 27, 2009

Why You Shouldn’t Move to Bonds was originally featured in the Penny Sleuth.

*** “James, did you know that $153 million was dumped into the IJR exchange-traded fund (ETF) yesterday? That’s $153 million in one day. Not a week or a month…but one day!”

That’s what my colleague and good friend Dan Denning told me when he called this morning from London.

This is incredible information for us small-cap investors. You see…

IJR is an ETF that tracks the S&P 600 – one of the most popular small-cap indexes. And yesterday alone, institutions and retail investors dumped $153 million bucks into the small-cap fund. That’s huge!

(In case you aren’t familiar with ETFs, they are “baskets” of stocks that track the performance of a specific index, sector or country. They are similar to mutual funds in that regard. But unlike mutual funds, you actually buy and sell ETFs like stocks. In other words, they trade on a major exchange. You get updated bid and ask prices. You can trade them intraday. And they even have ticker symbols.)

So why should you care that major financial institutions spent $153 million to buy shares of IJR yesterday?

It says the hedge funds and financial institutions, the “smart money,” are betting that the small-cap rally will continue. It says the professionals want to pad their returns heading into the last month of this year — and are looking to the small-cap market for results. And it says there is still money to be made in the small-cap market — especially in small-cap value funds. That’s good news for you and me!

Dan went on to show me some more jaw-dropping stats…

*** Another popular small-cap ETF is IWN. It tracks the value stocks on the Russell 2000 (the other major small-cap index). And folks, just like the S&P 600 fund, the major institutions can’t buy into it quickly enough.

In November alone, $250 million poured into IWN. To give you an idea how much that is, check this out…

In the entire second quarter of 2004, institutions invested $207 million in IWN. In other words, more money was dumped into this small-cap value fund in November than in all of the second quarter. Amazing. Think Wall Street thinks this rally is hot now?

You bet they do. In fact, Wall Street is so sure this small-cap rally isn’t over with that it is actually putting more money in small-cap funds like IWN and IJR than into large-cap value funds.

*** As Dan pointed out, investors only spent $47 million on the IWB exchange-traded fund in November. That’s the fund that tracks the Russell 1000 — the 1,000 largest companies on the market. If I am doing my math correctly, that means…

Investors put 5.3 times MORE money in small-cap value funds than in similar large-cap funds last month alone.

Folks, I don’t know how much longer this rally will last. But it sure as heck isn’t going to end right now. People are dumping millions of dollars into the market. And it shows…

As I type, the Russell 2000 is trading for 644 — a new all-time high!

By the way…

I’ve said it before, and I’m gonna say it again. Dan Denning is one smart guy. If you are into macro analysis, ETFs and great stock advice outside just the small-cap market, I STRONGLY encourage you to sign up for his service, Strategic Investment. You won’t go wrong with it at all.

Use this link to get quite a deal…

http://www.agora-inc.com/reports/DRI/chinaB33

*** I asked Chris Mayer, editor of Fleet Street Letter, to share a small-cap story with you. It’s one of my favorite stories of all time. And it goes to show you how profitable small-cap stocks can be. Chris, all yours…

Secrets of the Templeton

“I want you to buy me a hundred dollars’ worth of every single stock selling for no more than one dollar a share on both major exchanges.” In 1939, a young man from Tennessee gave just such an order to his broker.

He was sure that the stocks were cheap, and he reasoned that the best values must be in the most neglected and misunderstood part of market — the smallest companies trading on the exchanges. He bought about $10,000 worth of penny stocks. He borrowed all of the investment money from his boss.

Four years later, he sold the stocks for about $40,000.

The young man was John Templeton, and he was well on his way to becoming one of the most successful investors of the 20th century. His bold stroke in 1939 set the blueprint for his career. If you had to sum up Templeton’s investment credo in one sentence, you would have to say this: He bought only what was cheap. He insisted on value, and he often found that in small companies.

The Templeton Growth Fund was a small fund. Templeton liked it that way, because he wanted flexibility — the flexibility to buy the stocks of small companies. An investor who put $1,000 in his fund at inception had $20,000 20 years later, making it one of the best performing funds of all time and putting Templeton among the all-time greats in the pantheon of great investors.

What can small-cap investors learn today from the career of the old master? What follows is a short review of Templeton’s investing secrets.

First, it must be said that Templeton was a rover — his interests ranged over all markets, in a variety of countries. He loved small specialty companies and showed no desire to stick with well-known names. He owned dozens of small companies that his clients never heard of.

Investment writer John Train talks about the time he went to see Templeton and the old man challenged him to see if he knew even one-third of the names in his portfolio. Train did a bit better than that, but not by much. Nevertheless, Templeton had made his point — profits are to be found not in the main streams where the mob swims, but in the shallows where most people don’t think to wander.

A fondness for bargain prices in small companies and a willingness to invest internationally were hallmarks of Templeton’s style. He was also patient, holding on to his investments for several years.

Templeton also had a standard list of questions he liked to ask companies. Why should the future be different from the past? What are your problems? Who is your ablest competitor? Why? My favorite is this one: If you couldn’t own stock in your company, which of your competitors would you want to invest in…and why? Try that next time you talk to an executive whose company you are interested in.

When a stock Templeton bought got expensive, he found a better buy, then sold the expensive stock and bought the other. This kind of continuous comparison shopping was another of Templeton’s methods.

Today, Templeton (who turned 92 on November 29) lives in Nassau in a stately white house overlooking the serene grounds of the Lyford Cay Club. His surroundings reflect his desire to stay off the beaten path, to stay away from the noise of Wall Street. Instead, he finds time to study and think in the quiet confines of his library.

Not that the foregoing snapshot will make you into the next Sir John Templeton.
Nonetheless, there is no better way to learn to invest or improve your own results than to study the methods of the most successful investors.

For Penny Sleuth,

Chris Mayer
Editor, Fleet Street Letter

December 03, 2004

P.S. Three of my last four picks have been small-cap stocks in companies with global businesses. I’ve not followed Templeton’s model consciously, but in reading about the old fellow, I am reassured about the direction I’m taking Fleet Street Letter. The idea I’m working on now is also a global small cap, a specialist in its field with big opportunities in front of it.

Secrets of the Templeton was originally featured in the Penny Sleuth.