Lessons From 2008: Invest in Pessimism

 | Jul 24, 2012 | 2:00 PM EDT
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In my first installment of valuable lessons to be taken from the 2008 market collapse, lesson number one was about the importance of cash management, without which you expose your portfolio to the maximum degree of risk, regardless what investments you hold. Lesson number two is learning to invest during times of maximum pessimism.

By avoiding leverage and keeping plenty of cash on hand, you stand ready to take significant advantage of opportunities that only a pessimistic market environment can provide. Teck Resources (TCK) is a diversified commodity producer that fell below $5 a share during the depth of the market selloff. I examined it in more detail on Real Money when the shares were around $15, still an attractive price given the company's assets and earnings power. Two years later, shares were trading above $60. Interestingly enough, Teck shares have fallen back to $29 today and trade for 7x earnings, along with a decent yield of 2.6%. Perhaps the opportunity to take another swing is forthcoming. 

It's safe to say that any investor who either took a nibble or bet big on stocks at the end of 2008 experienced a nice return. After all, the S&P 500 more than doubling since then has created some huge winners. And therein lies another very important lesson for investors. Many are so quick to remember the pain from the market selloff, yet few want to recall the prolific opportunity that emerged as a result. The reason is the pain of loss resonates more deeply than the pleasure of gain. A poker player can accurately recall the painful lost hands, but rarely remembers the big winning hands. British Open runner-up Adam Scott will never forget his agonizing loss last week, no matter how many more golf tournaments he wins until he wins a major championship. 

The greatest predicting factor of future stock market returns is not the economy but valuation. From 2009 to 2011, investors experienced one of the strongest bull markets in history against backdrop of high employment, declining housing prices and modest economic growth because pessimism created very attractive prices.

Today there are pockets of pessimism that are likely to provide fantastic future returns. I have written several times about the large-cap financials, so there's no need to repeat myself here. Another area of pessimism is natural gas, which today sits at $3 compared with $13 in 2008. That means names like Chesapeake Energy (CHK) and Calpine (CPN) that could do very well in the years to come. Over time, capitalism creates an attraction towards the lowest cost of production and there continues to be a shift towards natural gas over coal. 

Prem Watsa, the head of Canadian insurer Fairfax Financial Holdings and considered by some as the Warren Buffett of Canada, recently doubled his equity investment in BlackBerry maker Research In Motion (RIMM). He's now the largest shareholder, with a 10% stake, and has been a member of RIMM's board since January. Watsa's success is attributed to his ability to make big bets in the most pessimistic of circumstances. 

Do not be afraid to concentrate your efforts in the most-hated areas of the market. Tremendous investment upside reside in the most pessimistic waters.



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