The Mission of a Long-Term Investor

 | Dec 19, 2013 | 3:00 PM EST
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On Wednesday, we once again learned the value of reacting rather than predicting. An early announcement that the Fed would taper its quantitative easing (QE) program was thought to be bad for stocks and would also cause a selloff in bonds. I have no idea how many people bet in that way yesterday, but those who did got absolutely scorched by the quick and strong rally that ensued.

For now, the market has embraced the path the Fed has laid out and buyers are in control. It is just the latest example of how the market rarely, if ever, behaves in the way the majority anticipate.

Yesterday was just the latest example of the market trapping the predictors. Earlier this year, everyone was sure that the markets would react negatively to the government shutdown. It ignored it. The re-election of President Obama was supposed to be horrible for the stock market, according to the pundits. It was not.

I have almost 30 years of examples of the stock market rarely, if ever, behaving in a manner that the gurus and pundits have forecast. Trying to predict events and how the market will react to a given set of circumstances is a fool's errand at best and a wealth destroyer at worst.

Keep in mind that December is the month of stock guessing and prognosticating. Everyone has a forecast and opinion about what stocks and bonds will do next year and how the economy will perform over the next 12 months. But they are just guesses. Investors who use the prognostications as a framework for their investment activity in the year ahead are just fooling themselves that the alleged experts know more than the rest of us do about future market behavior and direction.

Most of the dividend-paying, blue-chip stocks are overvalued by a very large degree and are not great deals. Larger real estate investment trusts (REITs) are dangerously overpriced as asset allocation flows into REIT ETFs and indices have dangerously distorted valuations. The hot stocks of the day, such as Netflix (NFLX) and Amazon (AMZN), look ridiculously overpriced on any measure you can use to value a business.

On the flip side, many smaller banks are still very cheap on a price-to-tangible book-value basis. In fact, 65% of community bankers surveyed by KPMG earlier this month expect to be involved in a mergers-and-acquisition (M&A) transaction in 2014. We know that there is no organic growth in banking system and it is not liley there will be for some time to come. Therefore, the only real path to profit growth for many regional banks is by acquiring additional assets. The easiest way to accomplish that is going to be buying community banks operating within their desired footprint. We can use these facts to put together a portfolio of cheap well capitalized banks and be confident of long-term profits regardless of market direction.

Energy stocks are underpriced. Companies such as Swift Energy (SFY) and WPX Energy (WPX) are trading at a fraction of their book value and have solid balance sheets that should allow them to thrive in the future. In spite of all the chatter about alternative and green energy, oil and gas will be the dominant source of global energy for many years into the future. We can use this information to find oil and gas stocks that are safe and cheap and anticipate profits no matter what course the stock market takes over the next few years.

If we stay disciplined and buy stocks for less than asset value and pay attention to maintaining a margin of safety, then it is unlikely that the short-term gyrations of the market will cause us to suffer a permanent impairment of capital. Stock prices can be volatile in both directions but, eventually, the value of the underlying businesses will be recognized and we can to profit from that recognition.

I have no clue what the Fed will do next year or what geopolitical events will rattle the stock market. I could not begin to estimate where interest rates will be at this time next year. I do know that putting the concept of value and margin of safety first means that it is highly likely that I will accomplish the most important mission of a long-term investor: Survive long enough to thrive in the markets.

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