The world once again seems to be plunging into crisis.
Just a year ago Wall Street was going broke, taking the U.S. banking system with it. Now it's Greece, Spain, and Portugal about to bite the dust, taking European banks with them.
Next month (or next year) it might be the U.S. Pension Guarantee Corp., which backstops obligations of bankrupt U.S. companies, and which now resembles a mini Fannie Mae. And after these, perhaps China would crash (as Marc Faber insists must happen)? Or maybe the Mideast would erupt again? The world, it seems, is lurching from crisis to crisis. How can anyone invest like this?
The answer is: Very well, thank you. As all grizzled investment veterans know, crises have always been with us and always will be. They are the equivalent of forest fires in the market, helping take out the old and usher in the new. Yes, crises may cause collateral damage, but they're often the only way to fix large problems - in a firestorm of panic. If you understand this, you can start profiting from crises. If you don't, you risk being collateral damage yourself. It's therefore worthwhile going a bit into the mechanism of panics, before noting what you can do about the crise du jour.
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The first thing to understand is that huge problems - such as Wall Street's junk mortgages, Greece's lingering bankruptcy, the Cuban missile crisis, even ending the Second World War - can be fixed only during an overwhelming panic, because the chiefs of large organizations often can't move unless they can show their constituents that they really had no other choice.
Congress signed a trillion-dollar cheque to prop up banks stuck with junk mortgages only after the financial system visibly risked crumbling. The German government might agree to pay for Greek retirees only after they start rioting in the streets, and the riots risk spreading. President John F. Kennedy confronted the Russians only when faced with nukes in Cuba. And the Japanese emperor agreed to capitulate only after two Japanese cities were annihilated with the threat of more to come unless he did. All these were decisions done under duress.
You see, the common myth is that good decisions are made in a rational, calm, calculating manner. This may be true for individuals. (Well, for grizzled ones anyway.) But it's definitely untrue for large organizations, whether financial or governmental. There, good decisions are often made in a noisy, panicky, desperate manner where there's fear that if the decision is not made, a much worse outcome would take place. The fear must be real or the fix won't be made. If the crisis is financial, the resulting panic often infects the populace, which sells massively.
So why am I going into this in such detail?
Because most value investors mention only the first half of the panic mechanism - that falling prices mean a better buy if the underlying business has not been impaired. Or, as my friend Mark Gaskin of Manitou Investment Management said succinctly: "I know quality, and I know value, so I buy quality whenever I can get it cheap."
For individual stocks truer words were never spoken. However, there's a second part to it: In a large-scale panic, quality may actually improve as the painful fix is finally made. Just as a company's chief operating officer can fire the CEO's cousins only when the alternative is real bankruptcy, an entire country can cut civil servants' pensions only when the alternative is the country's bonds going no-bid, and the electricity grid going dark.
It's thus important to understand that a crisis is an opportunity not just because the panic cuts prices, but also - and often mainly - because the quality of the underlying purchase may actually go up.
As for Europe: It's a political entity somewhat larger than the U.S., full of contradictions, wastes, and inefficiencies, some of which now come to the fore - mainly small countries living beyond their means, whose wasteful governments lied about their finances. But so what? As crises go, this one is pretty mid-scale. Yet it hit the markets hard.
Should you then see the Greek firestorm as an opportunity to buy?
As my colleague Brandon Osten says, a Goldilocks mentality helps: never be as gloomy as others, nor as optimistic, and stick to fundamentals. Sticking to individual valuations, I think it's still early in the crisis - based on the level of panic, which is just not yet high enough, nor hysterical enough - to push governments and banks to splash money around with abandon.
How to know when that time has come?
If it comes, you'd know. The gloom would then be so deep, and the panic so high, that it might remind you of Wall Street last year. I'd therefore repeat what I said a few weeks ago: I'd rather be at least partially hedged here - and yes, keep a list of quality stocks and their bargain prices handy, just in case.
Avner Mandelman is a director of Venator Capital Management and author of The Sleuth Investor. Amandelman@venator.ca
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