Buying Maximum Pessimism: Not What You Might Think
One of the most important investing maxims ever uttered came from Sir John Templeton when he told investors to buy at the point of maximum pessimism. He later followed that up by saying that investors should not ask what nation, sector or company had the best outlook but which one had the worst.
That's where there was money to be made for long-term investors. This concept has been around since the Baron Rothschild said that the time to buy was when the blood was in the streets. Many pay lip service to such an idea, but very, very few people actually have the fortitude and discipline to buy at the point of maximum pessimism.
It is one thing to buy the dip and buy shares when the market is down a few percentage points hoping for a quick bounce.
A Personal Note
Someone commented the other day that the market was down a couple of days in a row and he was buying some maximum pessimism. I tried not to laugh out loud, but failed miserably.
Maximum pessimism is not a couple of percent of the indexes.
Maximum pessimism is October 1987, October 2001 and late 2008. The time to buy stock with great enthusiasm is when your college buddy has to meet a margin call that puts him out of business and a big hedge fund or two has collapsed under the 'all assets reaching 100 percent correlation,' as everybody sells everything.
Seth Klarman once refereed to this type of buying as acting as the buyer of last resort. When you are one of the few buyers for an asset, you can pretty much pick your price.
The hard part here is that you are going to be one lonely buyer. People thought considered it insanity to buy beat-up tech stocks and bonds in the aftermath of the internet collapse and subsequent stock market carnage. Strange looks from people ensued when investors bought small bank stocks and REITs in 2009, which garnered a few dire predictions of imminent financial demise. When fear rules the marketplace, being a confident buyer of under-priced securities is not the easiest thing to be.
Buy The Bottom?
Traders also need to know that they are not going to buy the bottom. When buying the point of maximum pessimism, the market is probably going to keep going against the trader.
This is the primary reason activity restriction should be established as a rule of thumb: look to industries that are not disappearing like buggy whip retailers and VHS cassette manufacturers, but rather companies that are financially viable.
Even with those restrictions, it can be psychologically difficult to pull the trigger and buy something everyone else hates and that almost certainly will go down in price in the short-term. The markets will also take longer than most think it will to recover, so limit leverage and be prepared for a bumpy ride.
There is only one reason to engage in such a difficult endeavor, and that is the simple fact that it works. Starting again with the Rothschild's fortunes which have been made by buying the point of maximum pessimism. Warren Buffett's Berkshire Hathaway (NYSE: BRK-A) moved forward by leaps and bounds in the 1970s when stocks were so cheap, he told a magazine reporter he felt like an oversexed man in a harem. Investors who selectively bought tech stocks in 2002 or bank stocks in 2009 have had to withstand some short-term pain, but in the long run, they have made a fortune. It is not easy and requires a great deal of patience and discipline, but it does work.
Maximum Pessimism Today
The problem with applying maximum pessimism today is that there simply is not very much of it around. While markets are far from optimistic, money has been forced into the global stock markets almost against its will. As a result, very few nations, sector or individual stocks trade anywhere near the point of maximum pessimism. There are few, however, worthy of consideration for long term investors.
Materials and resource stocks trade like the world is going to end soon and no one will ever build again. While it is true that there is an oversupply of many fuels, ores and metals, they are slowly being worked down and prices are starting to at least slow their rate of decline if not stabilize.
China and some other emerging markets are showing signs of stabilizing as well and could begin to increase consumption once again. The US is slowly staggering to a recovery and even Europe occasionally shows signs of an improvement. Barring a total global collapse the use of ores and metals will increase and stocks bought at bargain basement levels today will be a lot higher at some point in the next ten years.
Shipping stocks have staged something of a comeback this year but are still down over the last three years. At the height of the boom in 2007, too many ships were ordered and delivered creating an over capacity just as rates went into a free fall. Traders have seen several bankruptcies and will likely see more before it is all over but conditions are improving.
Private equity and distressed funds have entered the shipping sector in force in the past two years, and that usually marks the start of a bottom in a nattered sector.
Brazil looks to be near a point of maximum pessimism as well. There are riots, inflation problems and the government has fallen out of step with the populace. However, this is the fifth largest nation in the world with an average age of less than 30. The Olympics and the World Cup are being put on in Brazil over the next few years, and more importantly an election in 2014. The markets there have been hammered and its worth looking at the banks, electric companies and telecoms for a long term turnaround in Brazil.
Trade Against The Grain?
It is very difficult to buy when others around you are selling. It is called maximum pessimism for a reason. The outlook is cloudy, prices have been collapsing and investors are scrambling to get out at any price.
However, if a trader can function as a buyer of last resort and such times and have the patience to hold onto long enough for conditions to improve you can join the list of investor who have made fortunes buying at Mr. Templeton's point of maximum pessimism.
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