David Dreman: Forget Running To Cash

» Kirk - Forget Running To Cash

I just read this on the paper version on the throne. Refreshing to read Dreman said he was too early to buy tech (He had HWP as a cheap value play in the Spring at $33. It should be recorded above.) Dreman advises just what I have been saying here - REBALLANCE NOW to get your allocation to target so you are buying equities cheaply.

Here is the article with editor comments.

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http://www.forbes.com/forbes/2001/1126/2...

Forget Running To Cash

David Dreman, Forbes Magazine, 11.26.01, 12:00 AM ET

Don't allow your portfolio to be dominated by fixed income. You will be sorry.

It never seems to change. Investors--amateurs and professionals alike--raised cash as the market fell sharply this year, and especially following the horrendous events of Sept. 11. The market, while still wobbly, has recovered its losses since the terrorist attacks. Lots of investors, though, continue to shun equities for the safety of money market funds, short-term bonds and other cash-like instruments. Bad enough that the paltry annual yields on some of these things lag or do little better than inflation. Bank money funds, for instance, stood at a miserly 2.4% in early November.

My last column (Oct. 29) showed that fleeing stocks is the predictable response to disturbing news, but is almost always the wrong move. You have about as much chance of timing the bottom as buying the winning lottery ticket. Markets shoot up when least expected, often sharply.

Beware of fixed-income creep. Many investors throw out their portfolios' long-term-equity-to-fixed-income ratios as the equity portion declines. This is precisely when they should be restoring the balance to their portfolios.

Such a step should allow you to make up the bear market damage more quickly when the market turns. Let's say your normal portfolio structure is 65% stocks and 35% bonds and cash, and it has fallen to 50% equity or lower. Bring the equity portion back to 65% by reducing your cash or selling some of your longer-maturity bonds. I would sell further-out maturities because interest rates now are well below their norms and are likely to rise as the economy begins to recover. Even a one-point rise in interest rates on a 20-year Treasury can cost you 11% of your investment.

[EC: Again I agree. In my newsletter and personal portfolio's I've sold 25 yr strip zeros and reallocated cash to equities to get back to my target allocation. It is not too late but the prices were much better just weeks ago.]

With fiscal and monetary stimulation being applied to the economy, there is a good chance it will bottom out in the next six months, if not sooner. While we're unlikely to see a "V" recovery, the market should, as it almost always has in the past, anticipate the upturn in business by four to six months. History also teaches us that by the time the outlook for profits becomes less murky, piling back into equities is usually too late. The market is already likely to have taken off.

What you buy is just as important as reconfiguring your portfolio. Stay away from tech stocks. Sure, many of the leading companies are down 70% or 80% from their highs, but they were grossly overvalued to start with. Mea culpa: I advocated you pick up some good tech issues on the cheap last spring (see my Mar. 5 column), but it was obviously too early. Most are trading lower today, and they may have more disappointments ahead.

[EC: Perhaps he bought the wrong technology stocks?]

One good recovery play should be small- to midcap value stocks. These stocks, which suffered lackluster market performance during the tech bubble, could reap major gains in a rising market. Look at these:

Borg Warner (44, BWA) is a leading supplier of highly engineered components and systems, primarily for the auto industry. Although earnings should be down about 12% from 2000, this is not bad relative to the earnings of other auto suppliers. Moreover, earnings could rise by roughly 20% next year if the economy begins to turn, with further gains following. Borg also sports a strong balance sheet. The stock trades at 16 times trailing earnings and yields 1.4%.

Commerce Bancshares (36, CBSH), whose 340 banks provide a solid Midwest presence, has posted increased earnings in each of the last ten years. This year should be no exception. In fact, earnings have become more stable as fee income forms a bigger part of total revenues. The stock trades at a P/E of 13 and yields 1.7%.

Dana (11, DCN), another auto-parts supplier, has been knocked down almost 60% from its 12-month high as carmakers have scaled back orders. Earnings dipped into the red for two of the last four quarters. The stock should earn only about 20 cents a share next year, but should show strong advances thereafter with a pickup in the economy.

Park Place Entertainment (8, PPE), the world's largest casino operator, has ownership or interest in 28 gaming properties worldwide. With terrorism fears and increased competition in Nevada and Mississippi, the stock is down 40% from its mid-2000 high. Nevertheless, Park Place has one of the strongest balance sheets in the gambling industry and is trading at 16 times 2002 earnings estimates.

Saks (7, SKS) is a storied department store chain that has suffered a couple of recent moneylosing quarters amid tough times for retailers generally. Regardless, the chain's sturdy balance sheet will let it ride out the storm. Saks trades at 17 times 2002's estimated earnings.

[EC: As I emailed my newsletter subscribers last week, I sold some of my large cap growth mutual fund holdings and moved the money into my favorite small cap value mutual fund. Just a small amount to get my LargeCap:SmallCap allocation where I wanted it. Large cap just had a wonderful run and that was like taking profits.]

David Dreman is chairman of Dreman Value Management of Jersey City, N.J. His latest book is Contrarian Investment Strategies: The Next Generation. Find past columns at www.forbes.com/dreman.

-- posted by Kirk