Reflecting on Buffett's advice

Warren Buffett wrote an article - which he seldom does - in the New York Times last year (October 17) advising investors not to turn away from the markets and in fact to share in his optimism going forward. Basically, Buffett's credo is: "Be fearful when others are greedy, and be greedy when others are fearful."

Certainly at that time fear had gripped the markets and investors were fleeing equities into cash. Zacks Investments Research evaluates Buffet's advice against the backdrop what subsequently happened during the past year:

1. The Markets Rebound Long Before the Economy

Buffett believed that equities would far outperform other asset classes, especially cash, over the next 5, 10 or 20 years as the stock market rises in anticipation of an economic recovery, even if we weren't in one yet.

A perfect example is the Dow's behavior during the Great Depression. Buffett wrote that it took several years for the Dow to hit its low of 41 on Jul 8, 1932. But you wouldn't have known that that was "the bottom" based on economic conditions. The economy continued to worsen until March 1933, when Franklin Roosevelt took office.

Meanwhile, from the market lows in July 1932 to March 1933, the Dow rebounded 30%. We've seen a similar rebound in the last 5 months but no one knows how long the rally will last or if it's the start of a new bull market. Still, while your cash is getting virtually no interest in this zero-rate interest environment, equities are paying a dividend yield and have the possibility of more upside. In this kind of environment, cash is not king.

2. Long-Term Outlook For Equities Is Good

The stock markets have been around much longer than any of us. During that time, the world suffered through world wars, influenza outbreaks, terrorist attacks, recessions and one depression but still, businesses created new products and made profit. They will continue to do so in the future.

Consider Apple and the iPhone. Even in the midst of this recession, millions of people bought the iPhone around the world. Investors who understood that Apple was still selling its products at a fast clip were rewarded with a stock that jumped over 90% from the beginning of the year. Apple won't be the last company to cash in on its powerful brand and host of good products. The key for investors is to find other companies that will be next to do the same.

3. Prepare for Inflation

Buffett wrote that greater inflation was a possibility as the government printing presses work overtime to alleviate the recession and liquidity enters the economic system. Cash is where you will NOT want to be. The value of your cash will actually decline under those conditions.
There are now exchange-traded funds (ETFs) and other instruments available to investors to prepare for inflation including owning TIPs, Treasury-Inflation Protected Securities, and the precious metals through the gold or silver ETFs or precious metal mining stocks.

4. Finding Great Stocks

The great thing about being an investor is that there are always hidden gems to be uncovered in any kind of market. Despite the massive rally we've seen on the markets in the past few months, you can still hunt for undervalued stocks that will see a big upside when investors figure out that the fundamentals are great and the stock is cheap.

5. It's Not Too Late to Invest

By March, it seemed that Buffett's advice to buy equities was very, very wrong. But that was his point. You can't time it. He said he had no idea what stocks would do in the short term. But it's not too late.