We are value investors. That means we tactically look for the chance to buy investments when we think they are cheaper than their true inherent value. It also means that we need to ready to act because whole asset classes can move from expensive to cheap and back again in a matter of weeks.Our outlook over the next 5-7 years is for lower than average GDP growth and a slow grind back to normal employment levels. Over that same time horizon, we expect the nation to gradually come to grips with the fact that the federal government (in the form of Medicare) and state/local governments (in the form of pensions and health benefits) have promised more than they can afford to pay. Something’s gotta give and, whichever form that giving takes*, it will put downward pressure on consumption.

(*higher taxes, shrinking government, higher private savings, etc. “Austerity Measures” is the best catch-all phrase.)

Along with slow GDP growth comes slow earnings per share growth, the two being inexorably linked. During eras of slow earnings growth, stock investors must rely on dividends for much of their returns, and on P/E expansion for the rest. Unfortunately, P/Es are today rather expensive and don’t provide much room for rational investors to expect expansion. The market is today priced at a normalized P/E ratio of around 20; the historic average is around 15-16.

We like to think we are rational investors, and we too are looking to P/E expansion for decent returns. That means we are looking to buy stocks at cheaper prices than today. With the S&P500 at around 1100, we’re not quite there yet. With another 100 point drop…we’re going to buy some stocks. Another 50 more points and we’ll buy more. And so on. With one eye on the important dividend stream, we will focus our purchases on large global companies flush with cash and a demonstrated willingness to hand some of that cash over to shareholders on a regular basis.

As we are fond of saying, we’re not economic forecasters and we are certainly not currency forecasters. We don’t know what will happen among the world’s major currencies, and neither does anyone else. But we don’t have to get the timing right for all these macro events. All we have to get right is the purchase price of our investments. If we get the price right, time and macro cycles will do their thing and we will come out just fine.

We look at the California state budget crisis this way. We don’t know if the legislature will pass a good budget, a bad one or none at all. We don’t even know if the state will attempt to default on debt. We do know one thing however: If we buy the right type of bond at a fair price, we will get paid a fair return. The chance that the State of California (or any local government) defaults on voter-approved general obligation debt and stays in default is about the same as me pitching for the Giants this summer.

So, that’s where we are. We are waiting and we have trades that we are ready to make. If the next year or so is anything like the last couple of years, windows of opportunity will open and shut quickly. Stocks were overpriced for about a dozen years. They got cheap last winter for about a month and are now expensive again. Similarly, muni bonds got very cheap for about six weeks in late 2008. We bought bunches of them and are now waiting for the next panic attack.

In an environment where no conventional investment offers the prospect of satisfying returns, investors need to think ahead and have a plan of action. We have a plan in place, and we are patiently awaiting windows of opportunity.