Buffett's Simple Rule For Fearful Markets

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By

Bruce Jackson

Published in Company Comment on 23 February 2009

Last week was tough for stock market investors, with the FTSE 100 slumping over 7%. Whilst it may be tempting to bail out, it's times like these you need to follow one very simple investing rule.

It's tempting to give up and bail out of the market right now. Seemingly every day brings more bad news, and more uncertainty.

Currently, we've got:

  • Eastern European economies in serious trouble and contracting fast. This has a knock on effect, as many Western European banks have lent money into those economies.

  • The ailing health of the global banking system continues to undermine any attempts at a stabilisation of world economies. Banks are not lending, businesses are struggling to renew their critical lines of credit, and the threat of full nationalisation of banks like Citibank (NYSE: C) and Bank of America (LSE: BOA) in the US and Royal Bank of Scotland (LSE: RBS) and Lloyds Banking Group (LSE: LLOY) hovers over the whole sector.

  • The motor industry continues to lurch from crisis to crisis. Without naming any companies for fear of stoking the rumour fire, it's not surprising some are in serious trouble. Most new cars are bought using credit, and credit has dried up, so no new cars are being bought. It's a vicious circle. Like the airline business, there are too many car manufacturers chasing too few customers.

  • The great unknown is the length and depth of this recession. Many are saying this is the worst recession since the Great Depression of the early 1930s. As such, it is unchartered territory for most people. Some are even saying this recession could last for 5 to 10 years. With little or no light at the end of the tunnel, and little or no green shoots of recovery sighted, there is much uncertainty. The stock market hates uncertainty, as witnessed by its 7% fall last week alone.

  • The bottom of this stock market may still be ahead. The FTSE 100's November low of 3,781 is in sight, and 3,000 is not out of the question. It's a scary, fearful time for stock market investors. Some are selling, some are sitting on the sidelines, waiting and watching, and many have simply given up. Deflation has hit the stock market. Why buy today when tomorrow you can buy the same asset even cheaper? It's another vicious spiral.

There Is Hope

Yet there is hope. If the banking system is the problem, there are measures afoot to fix the banking problem:

  • The government has said nationalised bank Northern Rock is to revive its mortgage business by taking on £14 billion in new loans over the next two years.

  • According to FT.com, Royal Bank of Scotland will this week announce plans to create a separate division for assets which will be wound down or sold over the next 3 to 5 years. They are also expected to become the first bank to sign up to the government's proposed asset protection scheme, which will cap the bank's future losses on loans.

  • According to bbc.co.uk, a government minister has suggested that plans to inject more cash into the economy could happen "quite soon". This quantitative easing, also known as printing money, effectively allows the Bank Of England to write cheques to banks in exchange for assets. The hope then is that banks use this additional cash to lend to businesses and consumers, helping kick-start the economy.

Throwing Petrol On The Fire

Of course, for every piece of government action and policy, there is a consequence. Many will argue the banks shouldn't be splashing credit about, as it is akin to throwing petrol on an already burning fire. It's businesses and consumers who took on too much debt, and banks that were only too willing to finance 125% mortgages that got us into this mess in the first place.

Printing money is no economic panacea. The fear it is will stoke rampant inflation. It's one of the reasons why the "safe haven" of gold has just passed back through the US$1,000 an ounce level and the share prices of gold mining companies like Rangold Resources (LSE: RRS), Hothschild Mining (LSE: HOC), Peter Hambro Mining (LSE: POG) and Highland Gold Mining (LSE: HGM) have been on a tear.

The bottom line remains unchanged. This is unchartered territory, and no-one, not me, not Warren Buffett, not Anthony Bolton, not Ben Bernanke, Barack Obama, Gordon Brown nor David Cameron knows what the outcome will be.

The best they can do is to say in 5 to 10 years' time, the recession will have passed, good companies will have continued to profitably grow, and the stock market will have recovered.

The problem is, right now, it's very hard to look 5 days into the future, let alone 5 or 10 years. The game is changing quickly, and for sure, there will be many more casualties coming out of this global economic crisis.

Buffett’s Simple Rule

Your job as a consumer is to stay as optimistically realistic as possible. Your job as an investor is to keep regularly investing in the market, contributing monthly to a cheap index tracker, and/or regularly buying high quality companies. Remember Warren Buffett's great quote…"A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful."

This market is fearful. Your final job as an investor is to decide how greedy you want to be.

If you're feeling greedy, Chief Motley Fool Champion Shares Analyst Maynard Paton is currently seeing some excellent opportunities in medium sized, cash-rich, dividend-paying companies. Click here to take out a free 30-day trial to this premium stock picking service, and get instant access to all his very latest research and share recommendations.

Happy gluttonous investing.

More on the economy, investing and the markets:

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> Of the companies mentioned in this article, Bruce Jackson has a very small beneficial interest in Lloyds Banking Group.

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Comments

The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

Luniversal 23 Feb 2009 , 11:11am

There are no REALLY cheap index trackers retailing over here, alas. I hope Vanguard makes good on its plans to start a UK-oriented range with only 0.1% or 0.2% pa charges. Less of a ball and chain round the investor's leg:

http://news.google.co.uk/news/url?sa=t&ct=uk/1-0&fp=49a282f120c62f7f&ei=4YKiSZOYMYfQwgGz282VBw&url=http%3A//www.thisismoney.co.uk/investing/article.html%3Fin_article_id%3D476269%26in_page_id%3D166%26position%3Dmoretopstories&cid=0&usg=AFQjCNGYW6JOFg9X5yV-_3fu8H2aUB-q5w

BTW, it's time to stop touting pound cost averaging as if it were some sort of panacea for good timing in down markets, instead of just a mathematical phenomenon. Weighting for price only works if the whole shebang goes back up fairly soon; in the long run we're all dead, as the man said. We could wait years for PVA to pay off.

The presumption that the good old midterm bull/bear alternation is bound to kick in again this time ignores the 23 years it took Wall St to bounce back between the Great Crash and the Korean War. Winning WW2 and becoming the global economic hegemon didn't put much spring in America's step. Worse, in 2009 the rebound must bea b against the background of bankrupt USA and the Far Eastern emergent superpowers threatening to take over global leadership. Hillary Clinton was in Beiking begging the Chinese to keep buying Treasury bonds!

The "cult of the equity" is not an eternal thing but a feature of the last inflationary half-century. It has been wheezing since Y2K Day. Get a new crystal ball.

LastChip 23 Feb 2009 , 11:46am

Yep! Just like the Industrial Revolution, the Financial Revolution has passed.

Anybody contemplating stock market investment at the moment, is in my opinion, a fool.

The world is going to be very different in years to come and clinging on to the past will achieve nothing.

Several articles by this author in the recent past have hinted the market is cheap. How do you define cheap? It's all relative and a stock is only worth what someone else is prepared to pay. Stating the obvious? Perhaps, but it seems to have been consistently forgotten at the Fool.

The world is effectively bankrupt. Brought about by greed by a few individuals that had absolutely no morels or consideration for those that believed in their integrity. They have now proven beyond all reasonable doubt, they had no integrity at all. Lessons aught to be learnt, but I doubt they will be. Greed will kick in again and we'll see yet more scams cleverly packaged in legal cloaks ripping off the unsuspecting public at large.

Why? Because as I've said before, they're all in it together. The old schoolboy network controls the slaves at large. They will remain rich and you will all just have enough to keep you from rebelling. That's how it works and it will never change!

They have now instigated a master stroke. The amount of debt they have saddled the country with, will allow complete manipulation of the masses for years to come.

Open your eyes and see through the crap!

angelphish 23 Feb 2009 , 1:40pm

Anybody contemplating stock market investment at the moment, is in my opinion, a fool.

Whilst I disagree, I would be interested to know what you think people should do instead.

LastChip 23 Feb 2009 , 2:03pm

angelphish, I don't pretend to have any answers and that's the whole problem for everyone. But what I'm reasonably sure of, is the stock market is not an automatic panacea for growing your wealth in the future. So for now, other than the devastated remains of my share portfolio, I'm staying in cash.

I accept it probably wont grow in real terms at all, and there is a high probability that it may decrease in real value. But I'd rather suffer that, than take the risks that are inherent at present in the stock market.

All I'm saying is, the wealth warning - (past performance is not etc.) has never been more relevant and is likely to last a lot longer than many anticipate.

The writing is on the wall, when globally billions of dollars are being pumped into economies, with no chance of having any effect. The debt burden is increasing without easing the pain. I said this would happen from the start and so far, I've been proven correct. Until this financial flood finds it's own level, very little will change and that could be many years into the future.

TrustyBadger 23 Feb 2009 , 2:23pm

I think the yield on dividends paid out by holding shares in the index would be a fair way of assessing whether the market is cheap relative to the yield on mid-term gilts.

The problem with this is that there's nothing to prevent companies turning around and cutting/ceasing to pay dividends in the current climates; also if there are inflationary concerns 3-5 years out, making the comparison gets even more tricky.

The reality is that there is too much uncertainty to be sure and it's probably going to remain that way until the 2nd half of this year when we can see how companies have faired over the last few quarters; and have a few more economic indicators to show us where we're heading.

If the US starts to showing signs of recovery earlier than this I'm fairly sure we'll be lifted along with it to a significant degree.

Personally I don't trust myself at market timing so I'm content to drip feed into the index while the FTSE is at a relatively low point in the economic cycle.

irishjohn68 23 Feb 2009 , 2:56pm

Lastchip, you sound like a bundle of laughs, i bet you've been predicting this for years. What else will everyone invest in? World stock markets will continue to fluctuate within reasonably predictable perameters for millenia to come. And in three years time people like you will be predicting another crash, within twelve to fifteen i'm sure there will be one.

jerryrc 23 Feb 2009 , 11:10pm

The paradox of markets is that when "the last bull becomes a bear" is the time to get very interested in equities. Like LastChip (and the other dwindling supporters of the Fool's pro-equities stance) there seem to be more than an abundance of severe bears at the moment, a good sign in my view!

(Not to mention the market's valuation etc etc....)

BigJon3000 24 Feb 2009 , 7:11am

Is this another advert? These articles always seem to end with 'click here for 30 day trial...'
I'm getting a bit tired of it.

david214 24 Feb 2009 , 8:54am

There has not yet been developed any better system for measuring wealth creation than capitalism. The value of a company, however imprecise due to accounting, is the best measure to conclude who's doing something useful in the economy.

Consequently, as we all naturally strive to do something useful in our lives, it is impossible that we will live forever in a recession. What we have seen is a massive reduction in wealth owing to the over-eager selling of financial products and disgusting greed as a result of unjustified incentivisation in marketing dubious risk spreading products globally.

This will pass with a whole host of casualties along the way. However, whilst extremely painful, the point is that the foundations that make capitalism the only realistic answer to wealth creation remain unchanged and, unless we are now all de facto born-again socialists, I believe we will see a strong desire to divest the nation from its bail-out mentality as soon as practicable.

mrbigbathstew 24 Feb 2009 , 8:57am

"The world is effectively bankrupt"

to whom?! if the world is the debtor, then who is the creditor? space?!

stock markets are used to invest in companies of every type. Every type of company exists for a reason, ie sooner or later there is a demand for its product

As long as people continue to exist, there will be a demand for products, be they food, holidays, cars, houses, big guns or anything else. This wont stop just because we had a one year (or even ten year) glitch. Look back in a hundred years and tell me that finance just stopped overnight

"only worth what someone else is prepared to pay". Or, how about for example, the income that it might generate over say ten years or so? (its an "investment" after all...)

Fine, stay in cash if thats what you want. Buy expensive shares, sell them when they are cheap because you got scared, then sit on something that doesnt grow when the recovery starts - and it will, everything is cyclical. Everything. Always has been, always will

Im loving the wild cycles in the finance sector, good old RBS are bouncing up and down 20% at a time, and theres plenty to be made if you're brave enough to do it

Which was, if I recall, the point of the article...

That and the 30 day free trial... ;)

guykguard 24 Feb 2009 , 9:07am

Like arm-chair generals and the Monday morning quarter-back, prophets of doom have an easy time. But their prophecies are unlikely to be any more reliable than anyone else's.
Investing in equities is quite simply an investment in the economy. All economic history suggests that the average real growth rate of the economy is 2-3% per year. While growth over the present period may be less than the average, the phenomenon of reversion to the mean is more reliable than all the prophecies of doom.
As for the present relative value of equities, it may prove true that, in relation to the recent past, prices are unlikely to recover quickly. But that's only one factor in the decision to invest in the economy.
Wise investment decisions are based on relative values of different asset classes: property, gilts, commodities, bonds, equities, cash, ... and the 4:30 at Fontwell Park. The investor must choose between the different classes, and wise investors try to spread their risk across the changing values of the asset classes.
A Buffett quip I like is "Price is what you pay: value is what you get." I think there's a sound argument in favour of equities at present: equity prices are relatively low, and will probably go lower in 2009/2010, but the value of a stake in the world economy is high relative to other asset classes. Trying to pick the bottom of the market is a mug's game: the present price/value measure our only real hope of future profit! Profit is the reward for taking risk. All asset classes, including property and cash, are very risky!

TonyBritten 24 Feb 2009 , 10:45am

When you have read this article and then all the comments you are left "non-plussed". Because it's all hypotheses by a bunch of people who've never ever been faced by such a meltdown NO-ONE here nor in Government has a clue how to deal with.
While everyone is walking around like a bunch of headless chickens there's one thing I do know . . . . everyone is still eating. Let's put this notion into a formula . . . BUY Food shares, as in their Supermarkets. If the yield is over 2.5% then that's fine. WHEN when the market can be seen to slowly rising (just like a submarine does) then that's the time to smile. You can live with hope again, the war is over. Sell your 'food' shares and move sensibly back into the mainstream.
This will be most likely to happen in Springtime 2010. So there!.

Heraclitusll 24 Feb 2009 , 4:05pm

angelphish - there's only one place to be in these dangerous times - the ultimate safe haven - gold.
Better to be in bullion than in ETF's
Try this link www.bullionvault/#COLIN142
In a year you'll be glad you did.
PS Financial advisers don't recommend the yellow metal cos there's no commission in it for them.

Explodey 25 Feb 2009 , 12:21am

Have a look at a chart for the Nikkei from 1970 onwards. What does 1970 to 1990 remind you of? Is it possible that the FTSE or Dow could decline for 20 years? Japan's Nikkei is half what it was in 1990. Japan's house prices have also been falling for 20 years. The Dow chart since 1900 looks great but there have been very long periods of zero growth. We might be at the start of another 20 year bear market. Investing for the long term no longer means 5 to 10 years. By the time this one ends, Buffett will probably be gone.

peepobaby 25 Feb 2009 , 11:56pm

anyone that connot see that all assets are on a downward trend is a complete fool for me. only cash will hold relative value, no matter how unattractive it becomes to hold cash.

RogerGLewis 03 Mar 2009 , 10:28am

Trying to work this market out is a waste of time there are so many circular arguments and so many people with a told you so agenda, so much phantom data. Given a choice I'll always side with the optimists perhaps pessimists are braver people as they really do have to have the courage to overcome their fears to ever invest in or create anything.
It is clear that no market offers a panacea solution, to know it would be to know the answer to life itself. Any market has winners and losers in this market though until some chips are put back on the table by the banker there isn't a card game in town.
The intrinsic capacity of the world economy hasn't changed because a very small cadre of international bankers have assisted each other in sticking both hands in the world counting house till. Temporarily the means of exchange has been removed from all markets for a normal level of economic activity to take place smoothly, quite obviously any market place with as good as no demand will see production of the goods for that market place eventually stop, that isn't a question of say overcapacity in the motor industry, which there probably was, it is an example that where demand all but disappears even the best of companies will struggle with no customers.
Applying old and tested rules to a market that is not acting in a normal way because one fundamental factor has been removed from the mix is not going to provide the solution here. Put the oil back in the engine before we decide how to tune the engine.
Looking at all of the bad that we now can probably agree on, excessive debt, to much emphasis on short term profits, to much capital leaving the system in inflated bonus and pay packages. Could we also agree that there is such a thing as a prudent level of debt, that companies that make solid profits over the long term are run by managements worthy of financial recognition for their prudent management. That longer term accounting horizons for the purposes of measuring performance of managements would be sensible to add into the mix.
The challenge that we all face in the next cycle is to appraise what we value in our public companies and how we want them managed on our behalf, whether we hold shares individually or through investments in financial institutions, we have a right to expect better.
In such a confused situation I take a lot of sollace from the poem desiderata by Max Ehrmann.



-- written by Max Ehrmann in the 1920s --
Not "Found in Old St. Paul's Church"! -- see below

Go placidly amid the noise and the haste,
and remember what peace there may be in silence.

As far as possible, without surrender,
be on good terms with all persons.
Speak your truth quietly and clearly;
and listen to others,
even to the dull and the ignorant;
they too have their story.
Avoid loud and aggressive persons;
they are vexatious to the spirit.

If you compare yourself with others,
you may become vain or bitter,
for always there will be greater and lesser persons than yourself.
Enjoy your achievements as well as your plans.
Keep interested in your own career, however humble;
it is a real possession in the changing fortunes of time.

Exercise caution in your business affairs,
for the world is full of trickery.
But let this not blind you to what virtue there is;
many persons strive for high ideals,
and everywhere life is full of heroism.
Be yourself. Especially do not feign affection.
Neither be cynical about love,
for in the face of all aridity and disenchantment,
it is as perennial as the grass.

Take kindly the counsel of the years,
gracefully surrendering the things of youth.
Nurture strength of spirit to shield you in sudden misfortune.
But do not distress yourself with dark imaginings.
Many fears are born of fatigue and loneliness.

Beyond a wholesome discipline,
be gentle with yourself.
You are a child of the universe
no less than the trees and the stars;
you have a right to be here.
And whether or not it is clear to you,
no doubt the universe is unfolding as it should.

Therefore be at peace with God,
whatever you conceive Him to be.
And whatever your labors and aspirations,
in the noisy confusion of life,
keep peace in your soul.

With all its sham, drudgery, and broken dreams,
it is still a beautiful world.
Be cheerful. Strive to be happy.



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