I love the process of investing — all the thinking about the craft itself and the fun of rummaging around looking for interesting stuff to buy. So naturally, when I get a chance to hear successful investors chat, I go out of my way to grab a seat. You never stop learning.

So I headed up to Manhattan recently with Dan Amoss, who writes the Strategic Short Report. We met in Baltimore and caught a train north to attend the 2008 Columbia Investment Management Conference. There, an all-star cast of successful investors assembled to speak about this crazy craft we all find irresistible — and to offer some ideas.

Richard Pzena’s opening talk was the most interesting to me. In part, because what he had to say was timely, yet full of timeless wisdom. His title: “Surviving the Cycles of Investing.”

Good topic, considering the stomach-churning price action on Wall Street lately. And with the cloud of recession thick in the air, investors seem awfully full of worry. Pzena had some soothing words.

Pzena says there were only eight years in the last 40 when you would’ve been down 20% using a simple value approach. (For purposes of his discussion, he used a simple value strategy of buying stocks only in the lowest quartile of the market ranked by price to book. But the point applies to all us cost-conscious investors.) One obvious conclusion from looking at his data — if you are a value-minded sort like me — is to shrug off the bad times and say, “Who cares?”

“The problem is,” Pzena notes, “when you’re losing 20%, it doesn’t feel very good.” It’s no accident, therefore, that most people can name the big bear market lows of the last four decades (1974, 1982, 1990…). That’s because these lows are relatively infrequent, but very painful. Amidst the pain of a prolonged bear market, Pzena relates, “you start to question what you’re doing. You start to wonder, Can I avoid those 20% down periods? Should I avoid them?”

To the first question, Pzena rolls out the shopworn, but time-honored wisdom that trying to predict exactly when these downdrafts will happen is impossible. And selling after the market has already taken its tumble is a sure loser.

Therefore, “riding through them is the smarter thing to do,” he advises. “The quest to get the timing right is what trips up most investors,” Pzena says. The best investors buy value when it’s offered and don’t worry about timing the market or fretting about recessions.

Many investors think that with a recession looming, or already here, it may be best to sit on the sidelines. One problem with this tactic is that economic health is extremely difficult to gauge. It’s not as if you can slap on a pair of latex gloves and say to the economy, “Turn left and cough.” So it’s very possible we would not know we were in a recession until it was almost over.

Furthermore, recessions tend to be good times for investors to buy value stocks. “How do you explain this phenomenon?” Pzena asks.

Here’s his answer: At the beginning of recessions, investors tend to continue buying the stocks that were acting well when the economy was growing. That means momentum stocks, or stocks that have gone up. But as you get into the recession, people start to think about valuation again. Momentum stuff starts to not make sense.

Are we in a recession now? Pzena didn’t hesitate to make a guess. “Anecdotally, yes. Toward the end of 2007, we had, at least, a major slowdown.”

And, not surprisingly, the stock market is beginning to offer some attractive bargains. Pzena points to price-to-book indicators. Right before 2007, there was a narrow gap between the lowest-valued quartile of stocks (based on their price-to-book) and the S&P 500. Meaning, the cheapest price-to-book stocks were only slightly cheaper than the rest of the market. But now, that gap is wide, Pzena says.

So parts of the market look attractive again. But what about those ugly headlines, you say? “This is why value works,” Pzena says. “Because when you see the list of stocks you own, you want to throw up.” It’s what gets you the pricing you want.

The savvy group at the conference was excited about the opportunities the market has given them. They are not alone. Several great mutual funds, long closed to investors, are now open again for new investors. These include the Tweedy Browne Global Value Fund, the Longleaf Partners Fund, the First Eagle Global and Overseas funds, the Third Avenue International Value Fund and the First Pacific Crescent Fund. They’re open because they have more ideas than they have money. They want to buy.

I’d give these funds a look, because they don’t tend to stay open for long. The opening of these funds, captained by investors with long track records of success, is also an indicator that the smart money is buying.

Sincerely,

Chris Mayer
March 28, 2008

Chris Mayer

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