Gurus grab bargains amid lingering fear

While individual investors remain skittish, several top strategists, including Warren Buffett, are sounding optimistic.

By John Reese Jul 16, 2010 5:50PM

As Friday's market tumble demonstrated, there's still plenty of fear to go around in the current market. Yes, sentiment had improved markedly earlier in the week as the market continued to bounce off its early-July lows, but all it took were a couple iffy earnings reports and some bad consumer sentiment data to send investors heading for the hills.

 

With fears of a double-dip recession or another bear market running high, it's not surprising that many of the stock market gurus I keep an eye on are finding opportunity. As Warren Buffett has said, the time to be greedy is when others are fearful.

One top mind finding bargains amid the fear: Bruce Berkowitz, who was recently named Morningstar's domestic equity fund manager of the decade. Berkowitz, whose Fairholme fund has averaged 12.7% annual returns over the past decade while the broader market has lost money, is loading up on some of the market's most fear-inducing stocks. This past week, he disclosed new or increased stakes in much-maligned insurers American International Group (AIG) and MBIA Incorporated (MBI). Berkowitz, who mitigated losses during the  2008 crash by avoiding financials, now apparently thinks better of them -- much better. About 70% of his portfolio is now in financials, according to GuruFocus.com.

 

Another fund manager with a stellar long-term track record, Bill Nygren, said this week that the market could double over the next five years -- even if real economic growth is zero. “I don’t for a minute concede that we are condemned to that [economic] future,” Nygren, whose Oakmark fund is in the top 2% of funds in its class over the past decade, wrote in a column for Morningstar.com, “but for kicks let’s run the math." If inflation runs at 1.5% and real growth is zero, Nygren says, corporate sales and profits would also probably average about 1.5% growth. "In a no-real growth mode, companies won’t need to spend much more than depreciation, which leaves them with an after-dividend free cash flow yield of about 6%," he says. "With corporate balance sheets already cash heavy, let’s assume excess cash is simply used to reduce shares outstanding.”

That, Nygren says, would mean that in five years corporate earnings would be up 8%, common shares outstanding would have declined by 27%, and EPS would be up 47%, Nygren says. With the S&P 500′s current P/E ratio at about 11 using estimated 2011 earnings, Nygren says a rise in P/E to the long-term average of 15 would mean the S&P would about double in five years. And, with the index currently yielding 2.2%, it would also have provided dividend income greater than the interest income from a five-year Treasury, he says.

 

Nygren seems to think things will be even better, saying that such a no-real-growth scenario is too pessimistic. And other top strategists are also sounding optimistic on the economy. Charles Schwab's Liz Ann Sonders, whose calls on the start of the Great Recession and the ensuing turnaround were right on, said this week that it’s more likely we’ll see a “melt-up” in the market than a “melt-down”. She told Yahoo! TechTicker that she thinks earnings estimates are still “marginally low” for the second quarter, and that she doesn't expect a double-dip recession. She also says that, based on her favorite valuation metric, stocks are on the cheap side.

 

Another guru not seeing a double-dip is the man many consider the greatest guru -- Warren Buffett. Buffett told The Huffington Post this week that he doesn't think we're on the verge of a depression, and he doesn't see signs of a double-dip recession. It takes a while to come back from a crisis like the one we saw in 2008, he says. “But we’re coming back,” he adds. “There’s no question in my mind we’re coming back.”

 

While the gurus I follow leaned to the bullish side this week, there were some who disagreed. John Hussman, whose Hussman Strategic Growth fund is far ahead of the broader market over the past decade, says the market is now trading at levels about 40% above historic norms. Hussman says in his latest market commentary that he continues to observe “pointed recession risks”, and thinks that the market is a ‘rent, not own’ market being driven by technical traders “who uniformly and somewhat predictably pile on to the sell side or the buy side when particular levels are hit.” Unlike many analysts, he uses as-reported earnings rather than operating earnings in calculating valuations, one reason for his assessment of stocks as overvalued. And, he warns that current earnings estimates for the S&P 500 include profit margins that are almost 50% greater than historical averages -- which likely aren't sustainable and are inflating earnings estimates. 

 

John Reese is founder and CEO of Validea.com, a premium investment research site, and Validea Capital Management, a separate account advisory firm. He is author of the new investing book, "The Guru Investor: How to Beat the Market Using History's Best Investment Strategies".

 

 

 

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