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Melvin: An Utterly Frightening Market

Some of the smarter guys in the investment world are getting as nervous as I am. Sam Zell flatly said that stocks remind him of the 2007 real estate market, and that it's time to sell. At the Milken Conference In April, Leon Black of Apollo Global Management (APO) has said that, after market rallies, the firm sells everything that's not nailed down. At that same conference, Wilbur Ross warned of a bubble in junk bonds and said sometimes it is just better to hide. Seth Klarman's recent comments to a private business group have been widely quoted, and are the stuff of sleepless nights. He calls the current economy a house of cards that will eventually implode.

One thing all of these men have in common is that they agree with my basic premise that things are dangerously overinflated, and that the market and the economy are running on an addiction to cheap money and quantitative easing. I have no idea when this silliness will end, or of what may happen between now and then. But I do know that, when it does happen, I don't want to be caught massively long a bunch of overpriced stocks or 5% junk bonds. The red flags are flying if you take your eyes off the screen long enough to look at the window -- and, in my opinion, this is a time for extreme caution.

I put together two new money portfolios the a few weeks, one of which concentrates on just plain ordinary cheap stocks. I ended up finding enough opportunities to become about 35% invested in this portfolio, buying names like MultiFine Electronics (MFLX). Arcelor Mittal (MT - Get Report), Pericom Semiconductor (PSEM) and Volt Scientific (VISI on the "pink sheets"). The rest is in cash and staying there for now. The same is true of my portfolio of small banks, a sector in which we are able to find enough stocks to get close to 50% invested, based on my strict criteria. Most of these names were well below $50 million in market capitalization.

What if I am wrong? What if all this financial chicanery and money-pumping actually works and reignites the economy? Here is the beauty of the deep-value investing approach. If you look back at the archives, you'll see we own things like steel companies, iron ore producers, coal companies, silver miners and banks, all bought at fractions of book value. We have been buyers of energy companies at a fraction of their net worth. Even with new portfolios at less than 50% invested and older ones at something around 70% invested, we are going to have a monster return from those stocks.

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