This is a stock picker’s market, as long as you can find companies with earnings that can hold up in this recession.  We are not looking for a further value correction.  If companies maintain their earnings, we expect that P/E ratios will stay about the same. The other safety measure that’s applicable is Graham and Dodd-type balance sheet investing.

There is a large difference between this year and last year.  Last year, there was no safe haven.  Only a few companies, like Wal-Mart, Johnson and Johnson, and Baxter, offered decent returns.  This year, the thing to do is to buy cheap stocks.

Right now the market is on the high side of normal.  This is like the difference between being obese and merely overweight.  There are Graham and Dodd stocks with very attractive valuations, but you have to look hard for them.  I can’t say what we are buying now, but I will tell you some of stocks we have sold recently.  For example, we sold a number of retailing stocks, like Insight Enterprises and Dillard’s Stores, and we sold Avnet and Agilisys in the tech area.

We look for companies with net-net working capital (NNWC) that is close to market value.  The NNWC is current assets less all liabilities, while working capital is current assets minus current liabilities. Graham and Dodd will allow a valuation of 100% of NNWC but will apply a discount to the long term assets that make up book value.

We are worried about deflation first and inflation later.  We are on a knife’s edge.  We own a number of gold stocks plus a bear fund to hedge our inflation fears.  Of the two scenarios, deflation is the greater fear.  The Fed has been pumping money into the system to increase money supply.  But the velocity of money is slowing because of de-leveraging, the collapse of many hedge funds, and overall consolidation in the financial industry.  These all slow the velocity of money, and that is not good news.  That is why deflation is the concern for this year. 

Inflation will happen once the velocity of money improves.

There is no risk of hyperinflation, but there is a risk of a decline in the dollar.  Hyperinflation could occur only if the dollar ceased to be the reserve currency.  The world’s central banks will stabilize the US inflation rate.  But after such a stabilization program, the dollar will have to fall vis-a-vis foreign currencies.

Gold and some sliver are our primary hedges.  Silver has not kept up with the rate of inflation, but both are probably cheap right now.  We own both gold and sliver stocks.  Some would say I am not being cautious enough about inflation.