Subscribing to the tenets promulgated by the late Benjamin Graham we direct our “worrying concerns” to the macro perspective level but we invest on a discrete individual security level seeking specific companies that are selling for compelling discounts from their appraised enterprise value. Commitments are typically most appealing when most are despondent and all appears bleak. Here’s how outstanding investor Richard Rainwater explained this approach, “Most people invest and then sit around worrying what the next blowup will be. I do the opposite. I wait for the blowup, then invest.” Those following the rigors of Graham’s investment discipline resonate with Mr. Rainwater’s remark.
The ranks of the true intellectual followers of Graham are not crowded – lonely may be a more suitable description. The fact remains, few professional investors have the courage and conviction to stand apart from the herd, tolerate short term underperformance (and the accompanying criticism), all the while undermining their asset gathering efforts. Taken together, Graham’s intellectual framework all too easily courts a pink slip.
Unlike most others, we focus on process and reject the seduction of short term performance. (I believe it was Bruce Berkowitz who coined the term “performance envy” – referring to the short term relative performance derby in which most impostor investors are engaged.) Short term underperformance is an anathema to asset gathering, but mediocre performance is not. Given this reality one should not be surprised that most firms embrace trend-following mediocrity. The only way to achieve our enviable long term performance experience is to be willing to stand apart from the crowd – something few are able or willing to do.
What Has Been Learned?
Blink and you may have missed the financial crisis of 2008-2009. But is the financial crisis truly behind us or has Bernanke and Co. simply kicked the can further down the road? “Kick the can” has become the preferred term of art to describe the misguided (reckless?) actions of Fed policy. I prefer a different metaphor which I believe more accurately depicts reality; pushing a snowball up a mountain. With each advance the snowball grows and the amount of potential damage grows disproportionately. At some point the Fed will be unable to advance the snowball to higher ground. We can ultimately expect an out of control earthbound projectile flattening everything in its path. Only time will tell.
It is likely that the capitalist model may come under increasing criticism if the actions of Chairman Bernanke and the Fed turn out to be more illusion than substantive. Notwithstanding, we continue to believe the capital market system remains the fairest and most efficient means to allocate society’s capital. My wife, Bj, and I recently watched Meryl Streep in her portrayal of former British Prime Minister Margaret Thatcher in “The Iron Lady.” As I was watching this film I was reminded of one of my favorite Margaret Thatcher remarks, “Socialist governments do traditionally make a financial mess. They always run out of other people’s money.”
Market prices are the final arbiter of value under an unfettered capitalist system. When the market is distorted by extra-market intervention (engineering below market interest rates by the Fed, for example) the unintended consequences are as unpredictable as they are unavoidable. As Bob is so fond of explaining, “Squeeze a balloon on one end and it pops out somewhere else” (or it simply bursts, I might add). Clearly the interventionist measures of the Fed have postponed dealing with the reality of our unimaginable debt burden. Unfortunately, this massive liability will not magically disappear.
When the dot.com bubble held investors emotionally captive we repeatedly sounded the alarm that all was not right and, notwithstanding client concerns that we were going to miss an opportunity, we held fast – and dodged that bullet. When the real estate and financial bubbles similarly held investors emotionally captive we were again sounding the alarm that all was not right and, notwithstanding client concerns that we were going to miss an opportunity, we held fast – and dodged that bullet as well.
I believe a more wealth threatening bubble is now underway as bond investors, desperate for income, are sacrificing quality and extending maturities. Even highly respected firms are now offering new products – pandering to the clichéd free lunch – to satisfy investor income cravings. Beware of depictions of safety, particularly when the safety is affirmed by flawed risk models – like the bell shaped curve which is mistakenly believed to be the best gauge for the distribution of risk. It may be instructive to think of a financial crisis not as an “extreme” event, but rather as an extreme result from a normal event. I repeat, it may be instructive to think of a financial crisis not as an “extreme” event, but rather as an extreme result from a normal event.
“Contributing to… financial euphoria” explained John Kenneth Galbraith, “are two further factors little noted in our time or in past times. The first is the extreme brevity of the financial memory. In consequence, financial disaster is quickly forgotten. In further consequence, when the same or closely similar circumstances occur again… they are hailed by a new, often youthful, and always supremely self-confident generation as a brilliantly innovative discovery… There can be few fields of human endeavor in which history counts for so little as in the world of finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have insight to appreciate the incredible wonders of the present.”
People tend to forget the cyclical nature of the world, extrapolating past trends to excess, and ignore the likelihood of regression to the mean. Another tech bubble may not occur anytime soon but there is sure to be another cycle, another bubble of some sort, and another collapse. Investors will again overpay as prospects appear almost limitless, and leverage will be embraced as people fantasize the possibility of extraordinary profit. “History doesn’t repeat itself,” explained Mark Twain, “but it does rhyme.”
The end is near when investors believe that rational valuations have become irrelevant, that an industry, product, asset class, or market is invincible and will provide superior growth and profitability in perpetuity. The opposite side of that same coin is when investors believe that Wall Street is dead. We currently appear to be somewhere between these two extremes.
People are fast to argue that history always repeats, or never repeats; that stocks, or gold, or fixed income is headed higher, or lower, etc. If there is but one lesson to be gleaned from history, just one takeaway, it would be this: trends are cyclical and trends have a profound way to influence, and precipitate, poor judgment and sub optimal behaviors. Nowhere is this more evident than in publically traded markets. Most investors become too exuberant when all is well and too despondent when matters of the economy appear bleak.
The financial crisis of 2008-2009 notwithstanding, I submit nothing has been learned.
Buffett and Graham Weigh In
In his 1964 letter to partners Warren Buffett opined:
“It is unquestionably true that the investment companies have their money more conventionally invested than we do. To many people conventionality is indistinguishable from conservatism. In my view, this represents erroneous thinking. Neither a conventional nor an unconventional approach, per se, is conservative.
“Truly conservative actions arise from intelligent hypotheses, correct facts, and sound reasoning. These qualities may lead to conventional acts, but there have been many times when they have led to unorthodoxy. In some corner of the world they are probably still holding regular meetings of the Flat Earth Society.
“We derive no comfort because important people, vocal people, or great numbers of people agree with us. Nor do we derive comfort if they don’t. A public opinion poll is no substitute for thought. When we really sit back with a smile on our face is when we run into a situation we can understand, where the facts are ascertainable and clear, and the course of action obvious. In that case – whether conventional or unconventional – whether others agree or disagree – we feel we are progressing in a conservative manner.”
In The Intelligent Investor (1949), Benjamin Graham affirmed: “Have the courage of your knowledge and experience. If you have formed a conclusion from the facts and if you know your judgment is sound, [then] act on it – even though others may hesitate or differ. You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.”
In his Preface to the 1973 edition of The Intelligent Investor, Buffett admonished: “to invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.”
To learn more about Marshall Serwitz view his Paladin Registry profile.