If, after 2008, you still expect the stock market to fund your retirement, most people probably consider you a few Congressmen short of a bailout. (Zing!) Yes, it was tough being openly optimistic after a year in which every bull became a steer.
But there are a few perks -- like profiting from buying stocks at what could be some of the best prices you'll ever see.
A brief history of 2008
Last year was a fantastic demonstration of what happens when, in a highly leveraged world, everyone needs liquidity at the same time.
Anyone who borrowed to buy mortgage-backed securities needed cash when mortgage values plummeted. Investment banks like Morgan Stanley needed cash as the mortgage-backed securities on the companies' books began to fall. Retail banks like Citigroup needed cash to maintain capital ratios as defaults escalated. AIG needed cash to balance its losses in credit default swaps. Hedge funds needed cash to fund redemptions and reduce leverage when assets declined. American Express (NYSE: AXP), JPMorgan (NYSE: JPM), and Capital One (NYSE: COF) faced exploding default rates as consumers had trouble meeting their debt obligations.
That's not to say that the market collapsed simply because everyone cashed out. The problems in our economy are real. We've seen huge bankruptcies, the unemployment rate has risen to 10.2%, and consumer confidence remains low.
But the carnage in the market isn't limited to the shaky companies that are likely to suffer the most. The S&P 500 contains the biggest, most successful, and most stable businesses in America. Yet despite the recent market run-up, more than 82% of the companies in the S&P 500 are down from the start of 2008. Some 15% lost more than half their value!
Certainly, deteriorating business prospects are responsible for some of that drop. But based on valuations, it seems likely that stock investors sold because they had to. Like everyone else, they needed the cash.
And that's a really great thing if you're not one of Wall Street's forced sellers, because it means that some of those companies remain deeply undervalued -- for now.
The sweet spot
Large-cap value stocks could be the best way to exploit this opportunity. I'm not just talking about slow-growing companies trading at low single-digit earnings multiples, but also compellingly cheap growth stocks.
For instance, these days, the universe of large-cap value stocks includes eBay (Nasdaq: EBAY). eBay has a strong competitive advantage, $3 billion of net cash on its balance sheet, a 12% estimated annual growth rate going forward, and is trading for an enterprise value-to-free cash flow multiple of 12. At these prices, eBay is a large-cap value stock.
So why are large-cap value stocks a great investment these days? Not because these stocks are certain to outperform the other categories under all circumstances, but because they present the ideal trade-off between risk and reward in these troubling times.
While there's a good chance that the economy will continue showing signs of life this year, there's a possibility that things will get even worse. When you're betting your retirement, you should own businesses that can survive the worst-case scenario.
Low risk, high reward
Generally, large-cap stocks fit that criterion. They have the most stable cash flows, the most well-known brands, the greatest economies of scale, and the best chance of recovering from mistakes.
Would you put your money on Best Buy (NYSE: BBY) to withstand a depression, or Radio Shack (NYSE: RSH)? Would you bet on Amgen (Nasdaq: AMGN) or Discovery Laboratories? These two examples may be somewhat hyperbolic, but it's absolutely true that powerhouses like Best Buy and Amgen are far more likely to survive than companies with smaller moats -- because they have the financial clout, the economies of scale, and the proven, winning business models.
In normal times, you'd really have to pay up for these sorts of dominant companies. But thanks to forced selling from investors struggling to raise cash, right now you can still find some excellent businesses extremely cheaply.
What's more, thanks to the poor economy, the earnings of these powerhouse companies have been depressed this year, which means that their normalized earnings multiple is even more compelling. Large-cap stocks are still cheap, and I believe they will offer superior returns over the next few years.
© 2009 UCLICK, L.L.C.