Monish Pabrai: A Sustainable Rally Won't Start Until Mid-2010

On Bloomberg: Stocks Recovery Won’t Start Until 2010, Pabrai Says

• April 21 (Bloomberg) -- U.S. stocks won’t begin a lasting rally until at least mid-2010 because the economy will be mired in a recession for the next two years, predicted Mohnish Pabrai, founder of Pabrai Investment Funds.
  
  The hedge-fund manager, who produced annual returns exceeding 28 percent between 1999 and 2006, is betting commodity producers will gain after the U.S. government’s $12.8 trillion pledge to boost the economy spurs inflation. He also recommends investors stick to companies such as Wal-Mart Stores Inc. and Costco Wholesale Corp. that sell goods people need as unemployment rises and consumer spending weakens.
  
  “The market can’t really go anywhere until the economy is clearly back on track,” Pabrai, 44, said in a telephone interview from Irvine, California. “Where I’m positioning my portfolio, given the next two years of morass, is on the essentials.”
  
  The Standard & Poor’s 500 Index, still down 5.9 percent for the year, has surged 26 percent since reaching a 12-year low on March 9. Pabrai’s outlook is more dismal than the median economist estimate in a Bloomberg survey, which calls for economic growth in the fourth quarter and a 2.5 percent drop in the consumer price index, a gauge of inflation, followed by a 1.9 percent increase in 2010.
  
  Pabrai, burned last year by his concentrated equity holdings, says he’s shifted to a strategy of owning smaller stakes in a greater number of stocks. The investor, whose prior goal was to own only about 10 stocks in a fund, now targets positions as small as 2 percent of his assets.
  
  ‘Swimming Naked’
  
  “Buffett has this saying that only when the tide goes out do you know who’s been swimming naked,” Pabrai said, referring to billionaire investor Warren Buffett. “I don’t think I was swimming naked, but I had my shorts a little bit lower than where they should have been.”
  
  In June 2007, Pabrai and fellow money manager Guy Spier spent $650,100 to win a charity auction for lunch with Buffett at New York’s Smith & Wollensky steakhouse.
  
  Pabrai declined to give performance figures for his funds, except to say returns in last two years were “very low.” His funds were once the second-largest owners of Delta Financial Corp., a specialist in fixed-rate subprime mortgages that sought bankruptcy protection in 2007.
  
  The Pabrai Investment Fund 3 Ltd., which managed $51 million as of February, sank 61 percent in 2008, compared with the S&P 500’s 38 percent loss, according to data compiled by Bloomberg. Equity hedge funds have lost 22 percent in the past 12 months, according to Hedge Fund Research Inc. in Chicago.
  
  Inflation Trades
  
  Pabrai, who oversees $200 million, has purchased shares of Teck Cominco Ltd., a Vancouver-based copper producer, and Pittsburgh-based Horsehead Holding Corp., which makes zinc, on the prospect inflation will surge as efforts by federal agencies to unfreeze credit markets boost money supply. The $12.8 trillion spent, lent or committed by the government and Federal Reserve to end the recession works out to $42,105 for every man, woman and child in the country, according to data compiled by Bloomberg.
  
  Food makers and discount retailers will maintain profits in the recession, while sellers of luxury goods struggle to cope with decreased spending from unemployed consumers, Pabrai said.
  
  The U.S. jobless rate climbed to 8.5 percent in March, the highest in 25 years, and is projected to rise to 9.5 percent in the fourth quarter, according to the median estimate of 59 economists surveyed by Bloomberg.
  
  ‘Serious Problems’
  
  “I wouldn’t say I’m completely confident that by 2011, we’re out of the woods,” said Pabrai, who seeks investments that are cheap relative to their earnings or assets. “The economy has serious problems.”
  
  Still, even as companies like Charlotte, North Carolina- based Bank of America Corp. forecast rising loan losses, Pabrai said there are “fantastic” opportunities to buy financial stocks. Record low interest rates from the Fed and decreased competition among lenders will drive shares of some banks up as much as 10-fold by 2014, he estimated.
  
  He favors Wells Fargo & Co. and Goldman Sachs Group Inc. because they have few rivals and widely known brands. Wells Fargo, located in San Francisco, and New York-based Goldman Sachs rallied more than 16 percent in March as both reported first-quarter profit that beat analysts’ estimates.

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