But as the markets work their way back into health and investor confidence continues to creep up month after month, we risk throwing away the lessons of the Subprime Crash of 2008:

Lots of very intelligent investors got embroiled in huge losses last year. Bernie Madoff fleeced scores of wealthy, well-informed investors – many of whom lost everything they had built up over a lifetime. The collapse of some of the biggest financial institutions, including Lehman Brothers and Bear Stearns, thinned out the Wall Street crowd by the millions. And underperforming fund managers hit close to home by taking a bite out of out 401Ks.

In fact, over the course of the last year, the average mutual fund lost 20.95% of its value according to Morningstar. That’s a shock for investors who were used to raking in double-digit gains year after year.

If nothing else, there should be some pretty big takeaways from this financial fiasco. Here are three that you should be walking away with:

1. Know What You Own

Knowing what you own is one of the tenets of stock investing. But it means more than being able to name the holdings you have in your portfolio. In late 2007 and early 2008, the general consensus on stocks was that the bullish tone of the market was set to continue.

But in reality, stocks had been expensive for quite some time. Just how valuable were stocks before the bottom fell out of the market? Here’s a look at historical P/Es of the S&P 500 every quarter since 1936:

The consensus is generally that the average P/E of the S&P 500 is around 10; it’s not. Since 1936, the S&P 500 has averaged 15.8.

But in late 2008 the S&P’s price to earnings ratio had risen to the mid 20s. In fact, they hadn’t touched that 15.8 average in 13 years. For the first two quarters of 2008 before stocks went into freefall, the S&P’s P/E ratio averaged just over 23… 45.5% higher than the historic average.

Now, there are a lot of reasons why the market should have a higher P/E than it has in the past – constituent companies have changed pretty dramatically in the last 73 years, for starters – but that still doesn’t explain why companies delivered investors with 39% less earnings bang for their buck between 2005 and 2008.

The information suggesting that the market might be overvalued was easily available, but the investor sentiment told us to buy full steam ahead.

2. “The Market Can Stay Irrational Longer than You Can Stay Solvent”

That famous quote from economist John Maynard Keynes resounds just as true today as it did in the 1930s. Keynes was qualified to make a statement like that – he was one of a few prescient investors who made a fortune by avoiding the great depression, and picking up undervalued stocks dirt cheap in its aftermath.

Markets tend to overreact to important news. They overreacted to the subprime crisis by slashing stock prices by an average of almost 50%, and they’ll likely overreact again as we recover from March 9’s market lows.

Those overreactions are only magnified when it comes to penny stocks. Because the smallest companies have the smallest trading volumes, their true values and share prices are often not reconciled. And while that can provide penny stock investors with a huge buying opportunity, it can also provide us with a huge headache as we wait for our valuations to come to bear.

3. Don’t Believe the Hype

The mainstream financial media deserves a share of the blame too… Traditionally, the tone at the major financial networks has been pretty predictable – their pundits sing the market’s praises when things are good, and solemnly decry the dangers of stock investing when things turn sour.

And as the first signs of the subprime collapse started rearing their ugly head, the pundits were in full perma-bull mode…

It’s time to take what we hear on the financial news with a grain of salt.

Cheers,
Jonas Elmerraji

June 16, 2009

Three Lessons Learned from the Subprime Crash was originally featured in the Penny Sleuth.

If we all had time machines, we would be millionaires. But we have not had the luxury of playing Monday morning quarterback with our investments. Until now, that is…

Thanks to the recent stock market crash, we have the opportunity to pick up seriously cheap shares that were flying high until mid-September. In some cases, this is a chance to hop into a time machine and buy these stocks before they became household names. Until recently, these stocks were the darlings of Wall Street. And when the market stabilizes, these stocks could quickly return to favor…

There are few defensive plays like health care – after all, people don’t stop getting sick, and health benefits aren’t something that cost-conscious employers can cut without enduring the wrath of angry employees. But despite health care’s promise for weary investors, the sector hasn’t been immune from the losses seen across the board in the last year.

As a whole, the health care sector has fallen almost 30% since the beginning of 2008. Health insurers have had it worse – these names dropped 40% in the last quarter alone.

If you’re wondering why one of the most regularly profitable sectors in the market has taken such a beating, you’re not alone. Billionaire Carl Icahn is among the many investment pros that have seen their health care losses mount this year. So are Warren Buffett and George Soros.

Explains BusinessWeek’s Ben Steverman:

“On a basic level, investors are worried that Democrat-led health care reform in Washington is going to shake up the health care sector and hurt profits. But it’s actually more complicated than that. The U.S. health care system is astonishingly complex and few people know exactly what President-elect Barack Obama may propose nor what Congress would approve. And few can predict how that legislation (if it passes at all) would impact particular subsectors, industries and individual companies.”

That doesn’t mean that moves in Washington won’t impact the health care sector – they will, though not necessarily in a bad way. Analysts recognize that whatever plans are put into place will most likely involve the private sector. Government changes could actually be good for scores of health care companies, especially health insurers.

Best,
Greg Guenthner

January 5, 2009

Buying into the Health Care Comeback was originally featured in the Penny Sleuth.

“Yesterday is history. Tomorrow is a mystery. But today is a gift. That is why it is called the present.”— Old saying, recently revived in Kung Fu Panda

I watched Kung Fu Panda last weekend as part of my son’s 10-year birthday party. There were some good quotes in it, including the one above. Another one I liked, also from the wise old turtle Master Oogway: “Your mind is like water. When it’s agitated you can barely see clearly. But once you become quiet and are in peace, then everything becomes clear…”

Certainly, the market’s recent dramatic swings have scrambled the heads of many investors. Mostly, it’s been a nasty slide down — a history-making drop. And that will make a lot of people give up. (From the November 24 issue of Wall Street Journal, “‘I just don’t have the stomach for it anymore,’ says [semiretired computer programmer Eugene] Hibbs, 66 years old… Now, Mr. Hibbs is sitting on Treasury bills.”) But now is the time to really pay attention. It’s been a history-making drop, and it may also seed some equally breathtaking opportunities.

Last week’s rally notwithstanding, this bear market has few precedents. Really, you have to look back to the 1930s. According to Barron’s, at the low on November 20, the S&P 500 has given back a decade worth of gains. Even after surge on Friday, November 21, 2008 would still be the worst year for stocks since 1931, when they dropped 53%. In the whole of the 20th century, no decline has exceeded 50%, save for the 1929-32 bear market. The S&P 500 is off 45% from its October 2007 high — that’s after last week’s rally.

Whether our bear market looks ultimately more like 1929-32 or 1937-38 is an open question, of course. The former went on to post a total loss of 86% top to bottom. The latter, though, rallied and made up 50% of the losses in the next six months. Another hopeful message: The average time to recoup a bear market loss has been 22 months, excluding the 1929-32 collapse. As with the big crash, so with the rebound — it will come when people least expect it.

Resource stocks look like they’ve already had their 1929-32 style crash in just the last few months. Many resource names are already down 80% or worse from top to bottom. It’s incredibly ugly out there. Even companies that looked like they were in decent financial shape only a few months are now scrambling to raise liquidity and stave off a financial crisis.

A strong balance sheet means that financially, you are in control of your own destiny. It means you don’t need to raise money, nor do you have a looming debt coming due soon. It means you’re going to be a survivor.

It’s going to come down to the survivors. The upside could be spectacular on the other side for them.

Regards,
Chris Mayer
December 1, 2008

Bear Market 2008: What the Crashes of the 1930s Reveal about the Present was originally featured in the Penny Sleuth.