Men will be men and the investors will be investors. These past couple of weeks they (investors) haven’t been able to decide whether the world is coming to an end or getting better. And so the market’s daily roller coaster continues.
But let’s step back and look at things a bit logically. It was always naïve to believe that a financial crisis so deep was going to go away so quickly. It was only that the way the markets were so positive in the past one year, it would have been easy to believe that the problems of 2008-09 were now something for our kids to learn in their history classes.
I don’t believe it is that way. And it is not about Hungary or the PIIGS or Japan. There is a large and growing list of member countries in the “Stretched Economies of The World Club”.
I also think that bailouts (or promises of bailout) for any country in trouble MAY well mean that we end up stretching the problem – basically because the ones providing the bailout are not in the pink of financial health themselves (as I read an apt comment somewhere, “…distressed eurozone borrowers are to be saved by more borrowing by … er … the distressed eurozone borrowers.”).
But I must say that I do see it from their point of view also – after all it can’t be an easy decision to allow a country to go bankrupt and let the banks take a huge charge off. See the following that I picked up from a report which shows the extent of foreign bank ownership in European debt. Any mess up on one – and who knows what it may lead to:
Source: “Avoiding the Sovereign Avalanche”, Citigroup Global Markets, May 2010
So while the world leaders can talk of the ‘growth agenda’, I suspect that ‘de-leveraging’, by which process the countries (and individuals) start to show some fiscal prudence and cut down on their debt levels, will impact the world’s growth in the next few years. And fortunately or unfortunately, as the above picture shows, the world is so inter-woven today that this will impact all countries and all humans.
So how do we react to the uncertain times as investors?
Well, since this is the season of half year close and every CEO and CFO face their investors armed with a list of possible Q&As and FAQs, I decided to make one myself.
Except, that to get the answers to the questions, I picked up verbatim, from my usual haunts: Ben Graham’s ‘Security Analysis’, Warren Buffett’s annual letters and a few other books. Here goes..
As a value investor do you care about the macro-economic conditions?
We do not believe that short run price movements – the day to day or month to month variations – are a valid or profitable concern of the security analyst. But the broader fluctuations of the market, which tied in with the accepted concept of business cycles, should not be left out of reckoning. (Ben Graham)
OK. So which way do you think the market is headed?
We make no attempt to predict how security markets will behave; successfully forecasting short term stock price movements is something we think neither we nor anyone else can do.
“Forecasts”, said Sam Goldwyn, “are dangerous, particularly those about the future.”
Even now, ..... I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.
What we do know, however, is that occasional outbreaks of those two super-contagious diseases, fear and greed, will forever occur in the investment community. The timing of these epidemics will be unpredictable. And the market aberrations produced by them will be equally unpredictable, both as to duration and degree. Therefore, we never try to anticipate the arrival or departure of either disease. (Warren Buffett)
But surely it is difficult to remain aloof when there is chaos all around! How should one react to market ups and downs?
Our brains have undergone millions of years of evolution, yet they are poorly evolved to deal with the vagaries of the stock market. When the lion roars, our brains tell us to start running. We don’t process; we just run. When stock prices drop dramatically, the fear that sets in is similar to hearing the lion roar. Our first instinct is to sell the turkey, purge the memory of ever having owned it, and run away. (Mohnish Pabrai)
Our goal is more modest: we simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.
Investors who expect to be ongoing buyers of investments throughout their lifetimes should adopt a similar attitude toward market fluctuations; instead many illogically become euphoric when stock prices rise and unhappy when they fall. They show no such confusion in their reaction to food prices: Knowing they are forever going to be buyers of food, they welcome falling prices and deplore price increases. (It's the seller of food who doesn't like declining prices). It's only when the tide goes out that you learn who's been swimming naked. (Warren Buffett)
But surely, you would care if there are no buyers in the market?
I buy on the assumption that they could close the market the next day and not reopen it for five years. (Warren Buffett)
Do you believe that a stock is good or bad?
Almost any security may be a sound purchase at some real or prospective price, and an indicated sale at another price. (Ben Graham)
How relevant is the past to what happens in the future? Some people say that this cycle will last 2 years, some say 5-10 years. We are confused.
Gentlemen, listen to me slowly. Flashbacks are a thing of the past. (Sam Goldwyn) History does not repeat itself, it rhymes. (Mark Twain)
OK, so if the past is not necessarily a reflection of the future, how do we guard against the hazards of the future?
The hazards of the unknown future may be met by the security analyst in several ways. He may place his prime emphasis upon the presence of a large margin of safety for the security, which should be able to absorb whatever adverse developments are reasonably likely to occur. In such cases he will be prepared to see unsatisfactory earnings for the issue during depression periods, but he will expect that 1) the company’s financial strength will carry it unharmed through such a setback and 2) its average earnings will be enough to justify full the stock purchase he is recommending. (Ben Graham)
Any special technique of analysis if the situation does become dire?
The technique of valuing or appraising common stocks becomes more dependable in the frequent cases .... when shares can be purchased at a figure which is well below a) earning-power value, b) book value, and c) average market quotation in the past, the combination of elements holds good promise for the investor. (Ben Graham)
Is a good company still good when the market falls?
Managers .... should never forget one of Abraham Lincoln's favorite riddles: "How many legs does a dog have if you call his tail a leg?" The answer: "Four, because calling a tail a leg does not make it a leg."
Is it important to do what we think is right? Or should we be listening to the big investment professionals?
You might think that institutions, with their large staffs of highly-paid and experienced investment professionals, would be a force for stability and reason in financial markets. They are not: stocks heavily owned and constantly monitored by institutions have often been among the most inappropriately valued.
Ben Graham told a story 40 years ago that illustrates why investment professionals behave as they do: An oil prospector, moving to his heavenly reward, was met by St. Peter with bad news. “You’re qualified for residence”, said St. Peter, “but, as you can see, the compound reserved for oil men is packed. There’s no way to squeeze you in.” After thinking a moment, the prospector asked if he might say just four words to the present occupants. That seemed harmless to St. Peter, so the prospector cupped his hands and yelled, “Oil discovered in hell.” Immediately the gate to the compound opened and all of the oil men marched out to head for the nether regions. Impressed, St. Peter invited the prospector to move in and make himself comfortable. The prospector paused. “No,” he said, “I think I’ll go along with the rest of the boys. There might be some truth to that rumour after all.” (Warren Buffett)
So you think there is scope for the small investor in a market that is dominated by big players?
Many commentators .... are fond of saying that the small investor has no chance in a market now dominated by the erratic behaviour of the big boys. This conclusion is dead wrong: Such markets are ideal for any investor - small or large - so long as he sticks to his investment knitting. Volatility caused by money managers who speculate irrationally with huge sums will offer the true investor more chances to make intelligent investment moves. (Warren Buffett)
If I invest in the way that you recommend, how long will it take for the value to appear?
No matter how great the talent or effort, some things just take time: you can’t produce a baby in one month by getting nine women pregnant. (Warren Buffett)
I am impressed, you seem to have a good answer to all my questions! And it seems you are looking forward to the market to move downwards. Are you holding cash?
Our basic principle is that if you want to shoot rare, fast-moving elephants, you should always carry a loaded gun. (Warren Buffett)
Hey, I just figured that whatever you have said is all copied from other people’s sayings! There is nothing extra-ordinary in whatever you have told us today.
Ben Graham taught me.. that in investing it is not necessary to do extraordinary things to get extraordinary results. You only have to do a very few things right in your life so long as you don’t do too many things wrong.
So smile when you read a headline that says "Investors lose as market falls." Edit it in your mind to "Disinvestors lose as market falls -- but investors gain." Though writers often forget this truism, there is a buyer for every seller and what hurts one necessarily helps the other. (As they say in golf matches: "Every putt makes someone happy.") (Warren Buffett)
