Twenty years ago, I began an exercise designed to help clarify our investment philosophy and further refine the firm’s policies. The task was, each day for a month, to write down one “belief”. There was no need to attempt to have any type of progression. The goal was to simply brainstorm different thoughts. In the end, it was remarkable to me how much these beliefs related to each other and how they are just as apt two decades after I put them on paper – even after a 10-year market advance leading to all-time highs and as they also were in the midst of the Great Recession of 2008-09. I believe these tenets have passed the test of time, so I thought that it might be interesting to share a few of these beliefs that undergird our investment philosophy below (text in italics is changes or additions I’ve made to my original commentary).
“Big Sales” really do create big opportunities – lessons from the bear market
We don’t know if the recent temporary market decline is over or just resting, but we are reminded of some important observations such as the fact that bull markets always follow bear markets and typically last much longer accruing the benefits earned during the “big sales” of the past bear markets, especially the biggest sales.
1. In the long run, real wealth comes to the owner, not the loaner.
Over the past 95 years, we see that when we subtract inflation from nominal returns, the owner of common stocks compounds their money 3-5 times as fast as the owner of bonds!
2. The real risk in the new millennium will be to outlive your money.
People are living longer and the relative safety net from government programs is shrinking. Unlike the 20th century when the biggest risk was losing your money, the biggest risk today is not having enough to support a long, comfortable retirement.
All you have to do to be a great equity investor is watch huge percentages of your capital disappear every so often, and have faith that the disappearance is temporary.
This is so simple, yet so difficult. We diversify among various equity classes to smooth the ride to a degree, but cannot completely cushion ourselves from these normal declines. Yet, we know from history that the declines are temporary and the advance is permanent.
Since the end of World War II, the S&P 500 has multiplied more than 213 times adjusted for dividends (Yahoo Finance). Yet, this same period was punctuated with 10 hits of 20% or more with the average being about 35% and lasting an average of 17 months.In 1973-74, the S&P 500 fell 48%, in 2000-2002 the S&P 500 fell 49% and in 2008-2009 the S&P 500 fell 57% (JP Morgan Asset Management “Guide to the Market”, 9/30/19).
Here’s the key: Intellectually we couldn’t know how, when or why any of these declines would end. We could, however, maintain faith that they would end. And that turned out to be all that we needed to do: just hold on. Long-term equity success is not a triumph of knowledge over ignorance, but rather a victory of faith over fear.
• No panic, no sell. No sell, no lose.
Markets create temporary declines.Only people create permanent losses. When we stick with our plans, we never create these permanent losses during the Big Sales.
• You can’t time markets.
The only way to be sure that we participate in every day of the permanent advance is to be in the markets every day of the temporary declines. As long-term investors, we realize that this is a terrific deal that extracts only an emotional price, not a financial one. I might add that technically our decisions to rebalance back to portfolio targets when allocations stray is a very, very passive form of "timing". Though, arguably it is more of an adjustment to keep risk profiles in line with the original intent. Furthermore, as rates went to zero during the Great Recession, seemingly taking away the cushion in balanced portfolios, we have been reminded that even tactically-managed portfolios intending to add the cushion do not succeed in timing markets (even when they look very good when back-tested).
• If the volatility wasn’t there, the returns wouldn’t be there either.
Long-term return is a function of short-term volatility.We have discussed this many times, but in efficient markets, volatility is the answer, not the problem.
• A portfolio matched to important long-term goals is an investment.
Let’s forget about trying to time the next technology (or Bitcoin, Cannabis) stock. Having short-term market opinions keeps us from focusing on the inevitable long-term advance. This “trend is our friend” and allows us to achieve our most important long-term goals.
• Focus on the big picture.
The great story of this era is the victory of capitalism over communism, of free markets over big government. The explosive worldwide growth of capitalism as the guiding principle has unleashed tremendous growth with much, much more promised in the future. Even when we allow for the current climate of populist backlash against some of the ugly sides of capitalism, the worldwide growth in freedom and markets dwarfs what it was when I wrote these just a short 20 years ago.
• Focus on the other big picture.
Technological progress on a speed that until recently would be considered unimaginable. (I wrote this in the infancy of the internet, before the iPhone, before streaming...) And all of it is coming to the private sector, which means that we can own it.
• Try to remember the relative significance of today’s problems.
Over the last century the owners of great companies have been richly rewarded while weathering a global depression, a world war, a cold war threatening nuclear extinction, assassinations, Watergate, double-digit inflation, impeachment, stock market crashes, budget deficits, terrorist attacks on our soil, the worst financial crisis since the Great Depression, another impeachment proceeding...
In retrospect, these were huge, but not insurmountable problems. Today, we are recovering from a huge revaluation of technology companies. We are attempting to stave off a recession brought on by Federal Reserve induced high interest rates (rapidly being reversed as we write this report). We have a temporary imbalance between supply and demand for energy. we are experiencing political discord and polarity on a scale unlike any we have seen in much of our lifetimes, negative interest rates around the world despite rock-bottom unemployment numbers, and a reversion from "free" trade to trade wars. Somehow, these problems don’t seem too significant when stacked against those of the last century.
Big Rallies Do Create Excesses and Diminishing Value … Big Sales!
Markets continue to cycle through good and bad times. Sort of by definition, as prices rise, value declines. Eventually, the levels tend to go too far and a bear market ensues. On the other hand, and much of what I list in the beliefs above, when markets decline, value soars. Thus, it is important to remember that this bull market will end and be followed by a bear market that will end and be followed by... The good news is that over time the market bulls dwarf the market bears and if we keep these principles in mind, our financial futures will be bright indeed