Thinking long term right now is hard--which is why it's worth doing

08/24/2010 9:00 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Vacation’s over. Sigh. But I remember…

We had just passed the solar farm—acres and acres of solar cells pointed toward the hot Puglia sun when we hit the traffic jam. A shepherd and his two dogs were guiding about 100 sheep down the road and that had stopped traffic—all two cars of it. We were on our way to lunch in Mesagne where nothing much has happened, it seems from the architecture, since the eighteenth century, and then on to Manduria to look at the remains of the great stone walls the Messapians had built around 700 B.C. to protect them from the pesky Greek newcomers.

Italy makes you think in long runs of years. Here’s a road that once connected Otranto, then the great eastern port of the empire, with Rome and now a town where the dock area is an Italian version of Ocean City, Maryland. Here Domenico, our host for two weeks at the agriturismo Serra Gambetta near Bari, apologizes because his oldest olive trees—still producing—go back only 400 years. And over the border in Basilicata, the cave houses built in the soft cliffs for protection back in the Middle Ages, are now being reclaimed as shops and hotels.

The perspective is useful in today’s stock market.

No, I’m not going to preach some thread-bare advice about investing for the long run. Nor am I going to tout the shares of an up and coming asteroid miner or of a vineyard on the slopes (the lower slopes) of Olympia Mons.

But I do think it’s important to think about time in relation to the current market.

Right now the stock market is hung up on the short term.

Will the U.S. economy slow significantly in the second half of 2010? Is the current slowdown in growth just the normal slump that characterizes many recoveries when companies have finished rebuilding inventories that were drawn down during the recession and that boost to buying disappears? Is the decline in home prices near an end? Will companies start hiring by the end of the year?

All important questions—if you’re trying to hit quarterly performance numbers or catch the exact bottom in the market.

But not so important if you’re investing for five years or longer.

If you’re investing in that kind of time frame what you really want to know is what economies will outperform in the long run. You want to identify the growth industries of the next decade. You want to know where global demand is going to squeeze global supply. You want to know where the global financial power is ebbing and where it is flowing.

You can place your bets on the answers to those questions at reasonable prices right now. Companies such as Intel (INTC), Vale (VALE), HSBC (HBC), and Coach (COH) are all selling at low multiples given their probable growth rates (and, especially for technology companies, even lower multiples once you subtract the big piles of cash that companies such as Intel and Cisco Systems (CSCO) have in the bank.)

Some of the likely emerging market leaders of the next ten years look like they will pull back to reasonable prices (China’s stocks already have and Australian stocks look like they’ll wind up in a 10% to 15% correction) in the weeks ahead. Companies such as Lan Airlines (LAN) or Li & Fung (LFUGF) or Cosan (CZZ) or HDFC Bank (HDB) aren’t necessarily cheap on current earnings but the future frequently looks pricy from the present because it’s so hard to value potential.

What you can’t do at the moment is be sure that you won’t be able to buy the stocks that you want in your portfolio for the long term at lower prices in two months or four or six. The fear is that after the big rally that began in March 2009 and stretched to April 2010 buying now is buying at a top. That worry has kept the market range bound. Investors are looking for some guarantee that buying now isn’t going to be like buying in December 1999 before the NASDAQ market topped out in March.

But there are no guarantees. If the future for every promising stock was guaranteed, the shares would sell at prices much higher than today’s prices.

Except that in one sector, raw materials, there is a kind of guarantee right now. We’re in the middle of a surge in mergers and acquisitions in that sector of historic dimensions. BHP Billiton (BHP) bids $40 billion for Potash of Saskatchewan (POT). Vedanta Resources bids for Cairn India. Korea National Oil launches a hostile offer of almost $3 billion for Dana Petroleum (DNPXF).

Partly this is a result of the mountain of cash that corporations have accumulated. Globally the 1000 largest companies are sitting on $3 trillion in cash, Bloomberg calculates. With interest rates near historic lows all that cash is making close to nothing.

And partly because an acquisition in the natural resources sector is the perfect long-term bet that avoids the current short-term uncertainty. Buy a competitor’s potash mines, for example, and if fertilizer demand and prices rise as predicted, sit back and rake in the cash. But if the increase in price and demand is something less than anticipated, well at least you’ve eliminated a competitor that might have undercut prices. And with the acquired assets in hand, your company can avoid the risk involved in sinking capital into a new mine that might not go into production until price and demand have plunged.

So expect more buy-instead-of-build acquisitions in the sector. The combination of long-term potential and limited downside if the long-term doesn’t turn out quite as rosy as expected make this kind of deal very, very attractive in the sector right now.

So much so that with a big contribution from the natural resource sector August is on track—with more than $175 billion in deals announced so far—to beat out March for the biggest merger and acquisition month of 2010. At this pace the August total would reach $285 billion. That would make August 2010 the second busiest August on record ever just behind August 2007 at $297 billion.

Of course, most of the rest of us can’t pursue this strategy since we don’t own natural resource companies. (Although we can invest in potential takeover candidates. I’ll post some names in that category later this week on Friday.)

The best we can do is watch the market indicators for signs that the risk of buying has ebbed to a reasonable level—not yet I’d say with the indexes threatening to fall through resistance. And to pick the stocks with the most long-term potential we can find when that risk level seems right.

Of course, that means that when you do buy you may still wind up taking on more risk than you’d like. There’s no getting around the fact that this U.S. economy is indeed uncertain. But there is one advantage to a market that on most days seems volatile and unpredictable: there’s not a lot of competition if you’re an investor thinking long term about stocks.

Full disclosure: I don’t own shares of any stock mentioned in this post in my personal portfolio.

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