Agora Financial’s Rude Awakening

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Laguna Beach, California

• Bottom fishing in Japan – Bargains in Asia’s forgotten economy,
• When is a bear market a buying opportunity?
• Tracking down this summer’s beach talent with Ethan Fry and more…

Eric Fry, reporting from Laguna Beach, California…

“It’s gonna be a long summer,” your editor’s 9-year old son, Ethan, sighed during dinner last night.

“Why’s that?” his Father asked.

“No girls,” he said. “I won’t be talking to girls every day like I do in school. In the summer, you just hang out with dudes.”

“That’s rough,” his Father replied. “Don’t some of the girls go to the beach? Can’t you find them there?”

“Yeah, sometimes,” Ethan replied. “But it’s harder to find them.”

“Yes, but when you do find them, you can talk to them as long as you like. There are not any school bells or teachers to cut short your conversation.”

“True,” he said.

Ethan’s summertime blues are not so very different from the attitudes that most investors exhibit during bear markets. Attractive investments are not easy as easy to find as they were during the preceding bull market. And rewarding investment opportunities seem much less plentiful.

But there is another side to the story: Bear markets create opportunities. In fact, they create much better opportunities than the preceding bull market could have ever created. In a bull market, stocks are expensive, even though they may rally for a little while longer before topping out. But in a bear market, stocks are cheap, even though they may continue drifting lower for a while before bottoming out.

The long-term investor recognizes these tendencies. But bottom-fishing is an inexact science. In fact, it’s not a science at all. It’s an art form that relies on judgment, luck and patience…especially patience.

Patient investors tend to be luckier than most. That’s because they care less about capturing the first 20% of the upside than they do about avoiding the last 40% of the downside. It’s true that the early bird gets the worm, but the second mouse gets the cheese. Buying into a young bear market is a great way to lose a fortune.

So how does an investor distinguish between a beaten-down stock that’s a great buy and a beaten-down stock that’s going to get beaten down some more? Judgment, luck and patience…especially patience.

A little bit of common sense also helps. For example, housing stocks and Japanese stocks are both “beaten down.” But which one is a buy? Your editors do not know the answer. But we do know that during the last 12 months, many “smart” investors loaded up on shares of “beaten down” homebuilding companies or investment banks or mortgage REITs, only to see these beaten down shares get beaten into a pulp.

Eventually, these sectors will bottom-out. But why bother trying to be the first investor to catch the ultimate low? Why not wait for a legitimate indication that underlying financial trends are improving?

Homebuilders are not yet beginning to sell more houses. In fact, Toll Brothers, the largest luxury-home builder in the U.S. just reported its third straight quarterly loss. CEO Robert Toll blamed the company’s dismal results on a “downward spiral” of home prices.

“Demand continues to be weak in most markets as our clients worry about selling their existing homes or entering the market before prices stabilize,” Toll explained.

Here in Orange County, California, home sales volumes are plummeting. Therefore, homebuilders are mothballing their development projects. “Orange County is on track to build about 4,500 new homes by year’s end,” the OC Register reported yesterday. “That would be the smallest number of building
permits here since 1949, when O.C. had just over 200,000 residents (or one-fifteenth of today’s population)…Permits for single-family homes fell 66% in the first five months of this year from the same period in 2006…”

These data points do not seem like the kind that would produce a sustainable rally in the homebuilding sector. Meanwhile, a steady stream of grim headlines continues to pour out of the U.S. financial sector.

So why bother trying to catch the bottom in either sector? Sure, housing and finance stocks will be a buy one day. But why mess around with companies that are ensnared in an epic, non-quantifiable crisis? Instead, why not seek out the cheap shares of healthy companies and industries?

Just a thought.

In the column below, Chris Mayer, editor of Capital & Crisis, identifies one particular opportunity that has emerged from a long, slow crisis.

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See Trouble? Think Profits
By Chris Mayer

“I’m approaching my 95th birthday,” Sir John Templeton, the great old investor writes in the foreword to a new book about his methods put together by his great-niece (Investing the Templeton Way). The short foreword has some words of advice. One that stuck with me: “Throughout history, people have focused too little on the opportunities that problems present in investing and in life in general.”

I think that is true. Water crisis, energy crisis, food crisis, whatever… There are always opportunities on the other side of these things. That’s why I started my investment letter, Capital & Crisis back in 2004, and that’s the idea I had in my head when I came up with the newsletter’s name.

A crisis is an opportunity for you to put your capital to work. At least, that’s what the greatest investors have always done.

If anyone knows about the relationship between trouble and profits, it’s Templeton.

Templeton spent in his young adult years in the Great Depression, which surely left its marks on his psyche - as it did on many others’. Templeton, for instance, paid cash for his first house. He never had a mortgage and never borrowed money to buy a car. These thrifty attitudes carried over to his investing style. He gravitated toward cheap stocks. As a result, he was a buyer during the Great Depression, when most people wanted nothing to do with stocks.

Templeton picked up many steals. For instance, he bought shares of Missouri Pacific Railroad for 12.5 cents per share, selling them some years later for $5 per share. He had many other successes.

But out of all that, Templeton’s fame may rest more on the fact that he was something of a pioneer when it came to investing overseas. The early success of his Templeton Growth Fund in the 1950s was, in part, due to his early identification of overseas opportunities.

Among those opportunities was Japan, a market he rode to great riches - and which he also exited before it all fell apart in the late 1980s. He first invested there after World War II.

Today, Japan is an economy with lots of problems. It is not at all like the war-torn nation of the 1950s, but it’s suffered through years of bear markets and other economic setbacks. Today, reflecting all that ill sentiment, the Japanese market hovers near two-year lows.

That’s just the way a Templeton-style investor likes it. Templeton liked to invest when there were few interested buyers, during times of “maximum pessimism,” as he liked to say. Japan must fit the bill. And there are interesting opportunities here…

Japanese small caps trade at price-to-earnings ratios not seen since 2003. And about 53% sell for less than book value. About 15% sell for less than net current assets, a rare financial sight not seen in great numbers on our shores since the Great Depression. The so-called Jasdaq, a Japanese equivalent to our own Nasdaq, trades for only 12 times next year’s earnings.

Cat Fund AG, in a recent note on Japan, opines, “Balance sheets of companies are the healthiest they have been in the past 40 years.” Cat also points out that the dividend yield on stocks is now higher than the 10-year Japanese government bond yield. This has, in the past, signaled a bottom. “This situation,” Cat notes, “[also] occurred in 1998, 2003, 2005 and was usually followed by a rising market in the following months.”

Japanese management teams seem to realize their shares are awfully cheap. Companies are buying back stock. For the 12 months ending March 2008, there was some $46 billion in stock buybacks. This is something Japanese companies don’t usually do much of, preferring to sit on cash or waste it on uneconomic projects.

Perhaps more important than the lively buyback market is the anecdotal evidence from investors working that market. Symphony Financial Partners has found even more compelling values than the surface statistics indicate. Witness the case of Nippon Ceramics. Symphony reports that at one point in March, it traded for 90% of cash in the bank and half book value. All while still earning 20% pretax profit margins. Again, you just don’t find those kinds of values in the U.S. markets.

There are a variety of ways to play the small caps in Japan. One is to buy the Japan Smaller Capitalization Fund or the Russell/Nomura Small Cap Japan ETF. Both of these funds can get you exposure to cheap Japanese shares. In my investment service, Mayer’s Special Situations, we’ve had some success in Japan. We own Kurita Water, which is up 87% for us - even though the Japanese market hasn’t done much. We also recently picked up a cheap Japanese real estate company.

“The 21st century offers great hope and glorious promise,” Templeton predicts, “perhaps a new golden age of opportunity.” He can say that because where he sees problems, he also sees opportunity. I see lots of problems today, too… and many opportunities. Japan’s small-cap market is just one interesting possibility.

[Joel's Note: With an “capital from crisis” approach to investing, and a wave of crisis still brewing in the economic cauldron, guys like Chris Mayer are bound to enjoy a smorgasbord of exciting opportunities as markets around the world ebb and flow. Already, readers of Chris’ newsletter have bagged some incredible gains where others saw only catastrophe. If you’d like a little investing optimism in your portfolio, Chris’ Capital & Crisis is a great place to start. Click here for his latest report:

Capital & Crisis – Seeking Opportunity Where Others See Calamity

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You could do the same thing right now with this $7 billion “Golden Quadrilateral” — and all you need is this $17 stock. Read On

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[Rude Endnote: Today’s market is due to open in a couple of hours, a smidge ahead of yesterday’s open. The Dow stands at 11,811.83 points, up 4 points during yesterday’s trading. The S&P 500 and the Nasdaq faired much better and begin today’s session on 1,321.97 points and 2,401.26 points respectively, up 0.58% and 1.39% during Wednesday’s action.

Oil lingers around $134.50 and gold, after a $9 rally overnight, sits pretty at $892 as of this writing. The greenback’ll buy you 0.6365 euros or 0.5044 British pounds - or about half a scone…without tea.

Until tomorrow…

Cheers,

Joel Bowman
Rude Awakening

aussiejoel@the-rude-awakening.com