Weighing Both Sides of the Story

 | Dec 14, 2011 | 1:00 PM EST  | Comments
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We have learned in life that there are usually two sides to every story, which holds true for our personal lives as well as for investing and the economy. If you focus on only one angle, you're playing the game with one hand tied behind your back. Charlie Munger, Warren Buffett's partner and Vice-Chairman of Berkshire Hathaway (BRK.A), often likes to say, "Invert, always invert." I believe what Munger is suggesting is that when looking at making an investment or assessing the stock market, you should always consider both sides of the equation.

For instance, many analysts and economists cite the growing numbers of college graduates choosing to migrate back home to live with mom and dad instead of living independently a strong indicator that housing will remain weak for years to come. As a result of that migration, the economy is suppressed because fewer people are shopping at Home Depot (HD) or Beth Bath and Beyond (BBBY) or calling the cable guy to for cable installation. The argument is valid as these events are indeed having an effect on the economy.

But the other side of the story is that those returning home are saving money, which they are using to pay off student loans and build nest eggs for the eventual home purchases. Further, without the burden of rent or a mortgage payment, disposable income is increased, sending these young adults out shopping and spending. In essence, the future homebuyers of America are both helping to stimulate the economy and deleveraging their balance sheets. This, too, is a valid argument.

Another argument is that the unemployment needs to get back to 6% to 7% for the economy to really improve. While true, waiting for unemployment to drop will keep many investors on the sidelines for a long time. Capitalism, by nature is a disruptive process. Innovation increases productivity. The U.S. Post Office is a current case in point. As the world continues to embrace a cashless way of life, the need for postal carriers diminishes. It is quite possible that the U.S. economy can perform quite well with an 8% unemployment rate: As businesses become more efficient, margins expand, which in turn can lead to expansion in the valuation multiple that boosts the stock price. I don't think the fortunes of Apple (AAPL) or Visa (V) would differ much in a world of 8% or 10% unemployment.

Back in 2006 and 2007, when everyone was waiting in line to buy a house, the main selling point was the historical claim that real estate prices rose, on average, 2%-3% a year. With only that piece of information, everyone rushed to buy. Few people looked at other side and asked what would happen when this historical price appreciation came to an end. Those individuals with names like Kyle Bass, Michael Burry, Prem Watsa, and John Paulson, all made a fortune by looking at both perspectives.

What if big banks aren't really dead fish? What if Citigroup (C) or Goldman Sachs (GS) continue to keep improving their balance sheets? And, what if in the next year or two, profits start to grow again because the current turmoil in Europe doesn't lead to financial Armageddon? The answer is a good chance of 100% returns -- a performance I'm convinced the overall stock market will not produce.

The prudent investor must always consider how bad things can get if the optimists are wrong or what opportunities exist if the pessimists are wrong.

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