Tuesday, October 14, 2008

The New Buffettology: Chp 9: Solving the Puzzle of the Bear/Bull Market Cycle

Certain repeatable market patterns offer fantastic buying opportunities for Warren. One of Warren's best buying opportunities is available during the bear market phase of the bull/bear market cycle.

Devastating bear markets occur after protracted bull markets and are easily identifiable because the media announces it. During bear markets, financial markets become overly pessimistic and access to capital is severely restricted because banks are wary of making loans. However, it is during bear markets that practitioners of the selective contrarian investment strategy can buy excellent companies at a fraction of their real value. Warren sold out at near the top of the bull market in the 1960's, and bought back in during the devastating bear market of 1973-1974. He also sold large positions of stock during 2000 (before the crash), and bought back in during the bear market of 2001.

During a bear market, stocks with durable competitive advantages like Coca-Cola might be trading with a P/E ratio's in the low teens. Also, during bear markets, value-oriented investing becomes popular once again. New fund managers invest in "value plays", and often buy companies for less than their book values.

Typically, a lowering of interest rates by the Fed stimulates the economy and brings stock prices higher and starts the next bull market phase. A bull market following an economic recession can bring the price of companies like Coca-Cola back up to where the P/E ratios can be 30x or higher. A rise in the stock prices will 1) reward value money managers for their picks and 2) cause the reappearance of the momentum managers.

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