Monday, October 29, 2007
Last time, I discussed John Templeton's investment strategy of investing in the world and stocks where there was the most pessimism. He practiced this strategy because he believed that as an economy, industry sector, or individual stock becomes completely tarred and feathered deeper pockets and steadier hands often step in to buy the stock that the momentum players are dumping. I have noticed that in periods of maximum pessimism there is an equal and opposite force that I will call maximum optimism. In this regard, investing is a zero sum game. If the momentum crowd bails out of bank stocks, as they have, the money has to go somewhere. If it goes to cash, it drives down short-term interest rates. If it moves to bonds, it drives down longer-term interest rates. Finally, if it goes into stocks in different industry sectors or even different countries, it will tend to drive the stocks in those new areas higher. In the recent sell off, some money has gone into short-term, high quality bonds, but it is clear that little has gone into longer term bonds because bond yields have not moved much. To my eye, it is clear that the money that has left the bank and financial stocks has moved to energy, consumer staples, and commodity related stocks. Now guess what? Stocks in those sectors are now reaching fair value and, indeed, energy has pushed into overvalued territory. So, does that mean that under John Templeton's investment strategy we should be selling the energy stocks? Good grief, that is nuts, isn't it? Doesn't everyone know that oil prices are going to continue to go higher through the end of the 21st century? The new middle class of China, India, Eastern Europe, and South America are going to drive Lexi, aren't they? Aren't they going to end up consuming about the same per capital amount of energy as, for instance, the middle class of Europe? My answer is -- not by a long shot. Motorola had incredible success in China in the 1990s selling pagers. There were few telephone land lines in most areas of the country, so the early form of communication in China was by pager. Gradually pagers gave way to cell phones. Land lines are still in short supply in the country, but second and third generation wireless telecommunications are filling the needs of many of the new middle class in the nation. The same thing is going to happen in transportation. Second and third generation modes of transportation are and will continue to explode. Intra-city public transportation is growing at a high rate, and high speed bullet trains are in the works. You can bet that these "centralized" forms of transportation will be the rule in the country because that is the one area where the old Communist mindset makes sense. The same goes for India and South America. They know they cannot rely on the suburban American model of 2.2 cars for every household and ribbons of high-speed asphalt highways connecting every city in the country. Public transportation is how the Communist leaders can maintain a modicum of relevance. Communications in most of these countries will continue to be like the wild west, but transportation will be more controlled, more out of those famous Communist five-year plans. As the world comes to understand the "new world" model, it will become more clear that natural resource consumption will not grow at geometric trends, as is now feared. In short, oil prices are not going up as far as the eye can see, or the mind can think. Energy stocks are overvalued, but we are not selling yet. Indeed, we would be foolhardy to announce in advance that we think oil stocks have reached their peaks. Just say that oil stocks are fully prices, and we will be keeping a keen eye out for prices that factor in oil prices rising "forever." We think that is what Mr. Templeton would have done. He knew that the "crowd" often gets it wrong. But, why take your profits too early when the crowd will always push prices beyond reason, both in sectors where the news is bad as well as where the news is good.