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Why Today's Market Dictates Pessimism

Posted: Nov 18, 2009 11:21 AM by Sham Gad

Tickers in this Article: JNJ, PFE, FFH, UNH

It's hard to believe that exactly one year ago, nearly everyone was against stocks, investing and the economy. Capitalism was coming to an end, folks were telling us. Today, it seems the good times are here to stay. The S&P is up over 60% since March and up nearly 25% for the 2009 year. Dare I say some people are looking at their investment portfolios and smiling again?

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A Bearer of Gloomy News
No one likes to be the dud at the party, but unfortunately I think investors would be very well advised to view equity investing with a strong degree of caution and a healthy dose of pessimism. Mr. Market is a forward-looking fellow and he has priced nearly all stocks to benefit from a strong economic recovery in 2010 and 2011. So far the recovery has been at the hand of the government and not private enterprise. While I applaud the efforts of the Fed and Treasury, they can't continue to support the economy as they have without dire future consequences.

While it's likely that continued stimulus will propel markets higher into next year, sooner or later, corporate profits will begin to stagnate as businesses run out of cost-cutting initiatives. And these businesses will not be hiring back all of the folks they laid off, which suggests that unemployment will remain elevated for quite some time. This circles back to reduced consumption and reduced earnings. As a result, U.S. equity markets could be in for a nasty correction. (For related reading, check out Which Direction Is The Market Heading?)

Places to Consider
All is not hopeless for investors, however. There are companies that, while not 100% immune to the effects of a sharp pullback, are managed very prudently to survive and even prosper during the not-so-good times. Canadian insurer Fairfax Financial (NYSE:FFH) may be the textbook case. Headed by Prem Watsa, Fairfax was buying equity puts and other derivatives back in 2007 that protected the company during the past couple of years. The result was a huge cash windfall for Fairfax that the company can use to protect and grow the business. Fairfax's equity holdings include some of highest quality names like Johnson and Johnson (NYSE:JNJ) and Pfizer (NYSE:PFE), two names on their own that would do investors well to own over the long term.

Safety is often found in quality, and today's quality names have been outperformed by smaller, more inferior businesses. Health care giant UnitedHealth Group (NYSE:UNH) currently trades for 10 times earnings, almost half of the overall index valuation. No matter what health care bill passes, you can be certain it will translate to more clients for UnitedHealth.

Bottom Line
To invest as if the markets can only go up is a recipe for disaster. Out of prudence, at today's juncture it's wise to embrace pessimism as that mindset will ensure you are around for the next bargain cycle. (For related reading, see Retracement Or Reversal: Know The Difference.)

By Sham Gad

Sham Gad is the Managing Partner of Gad Partners Fund's, value inspired investment partnerships modeled after the Buffett Partnerships of the 1950's. Previously, Gad ran the Gad Investment Group and delivered annualized returns of 22% from 2002 to 2005. Gad is also the author of "The Business of Value Investing" which will be out in the fall of 2009. Gad earned his MBA at the University of Georgia in May of 2007. Gad runs a value investing blog. He can also be reached by visiting the Gad Partners Funds site. When not writing or analyzing businesses, Gad enjoys hanging out with his wife Maggie, reading, golf, and yoga

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