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Investing Specialists

Five Reminders for Market Sanity

Remember these points to keep your head amid the sell-off.

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It has been yet another very rough day to be an investor in stocks, with the S&P down another 7% today and approaching a 50% loss for the year. Let's not mince words. This is literally the worst market crash since the Great Depression. We've been living with the incessant volatility and downward movement in the markets for months now, and I am at a loss for words that I have not already uttered several times before. Here is what I keep reminding myself while trying to keep my head in this difficult time...

  1. The market is inherently volatile, and there is no telling when the volatility is going to stop (or where the bottom is). Only invest money that you will not need for a couple of years.
  2. We are in a recession--one that is going to be more severe and protracted than average. However, that does not mean the end of the world. Our country has lived through many recessions before, and we will live through this one, too.
  3. The intrinsic value of a stock is the value of the discounted cash flow the underlying business will generate in coming years. The cash flows of our companies are not anywhere close to as volatile as stocks have been recently.
  4. While our companies are dealing with the recession and we are likely to see a material contraction in earnings in the coming quarters, this does not mean that the companies are in permanent decline. The market likes to extrapolate recent short-term trends, but those extrapolations lead to wrong conclusions in periods like this.
  5. All the evidence I have points to the fact that very many stocks are ridiculously cheap, assuming we are not headed toward Great Depression Part Two. (An assumption I'm willing to make, given the massive and global government stimulus being applied.) As I've said before, valuation ratios in the modern stock market have never been this low without high inflation, and inflation is the last of our concerns at this moment.

Switching gears a bit... I have received a number of questions about  Berkshire Hathaway (BRK.B), which has gotten clocked with the rest of the market in recent weeks, including a 7% decline just today. I suspect that what is happening is that even the venerable Warren Buffett has lost the confidence of the market. (It's not the first time, and Buffett has always later been vindicated.) His New York Times editorial a few weeks ago about  buying stocks looks to the optimists (like me) as though it was "early," while to the growing legions of pessimists it looks plain wrong, given what has happened in the stock market.

Furthermore, I think that Berkshire's investments in  General Electric (GE) and  Goldman Sachs (GS) have also dented confidence in Buffett, since both firms have seen their stocks continue to slide significantly. The warrants Berkshire received, once in the money by several billion dollars, are now far underwater. Plus, as the recent quarterly results showed, Berkshire's earnings power is somewhat correlated to the stock market's performance, which obviously continues to be quite poor at this moment.

All this said, I am quite comfortable to continue holding the stock. Unlike the market, I have not lost my confidence in Buffett's skills as an investor, or in Berkshire's strong competitive position. Moreover, Berkshire now trades at about 1.1 times book value ($2,586 per B share as of Sept. 30), which, like a lot of things these days, seems to not make a lot of sense.

One final note: Options expiration for November is this Friday, which is likely to only add fuel to the extreme volatility we have already experienced. Buckle your seatbelt. 

A version of this article was originally sent as an e-mail alert toStockInvestorsubscribers on Nov. 19.

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Paul Larson has a position in the following securities mentioned above: BRK.B. Find out about Morningstar’s editorial policies.