The Handwriting On The Wall
Although I’ve been helping people with their investments for twenty-five years, I know there’s always going to be something new to learn so I regularly attend conventions and participate in asset manager’s conference calls. A few years ago, I was on a call hosted by Christopher Davis, a third generation money manager from the Boston area. Money managers try to buy investments that will go up in value but all of us occasionally buy ones that go down instead. Generally, it’s our strategy to prune them as soon as we understand that the story has changed but Chris goes a step further. He takes possession of a single share of the losing stock, has it framed and displays it in the hallway by his office as a reminder of his mistakes.
Taking a page from his playbook, I’ve lined the hallway of our office with a range of investment-related quotations. Each one has a touch of humor but also contains an important financial truth. In today’s article, I thought I’d provide a brief tour for those of you who haven’t visited us or may have forgotten what we have on display. It might make sense to begin at one end and go to the other but my brain works in a slightly different way, so I’d like to begin with the first one I see when I leave my office.
Offering an important perspective as we enter the seventh year of market gains, the first quote I see says: Don’t confuse brains with a bull market. The provenance of this saying is unknown but its message is clear to any investor: Don’t be quick to claim unique insight when the market’s up – everybody else is doing well too. At Warren Ward Associates, we construct portfolios to take advantage of up markets while being prepared for those inevitable downturns. Our intent is to capture most of the upside during good years and lose less during the corrections.
The next quote comes from one of our best known economists, John M. Keynes: Markets can remain irrational longer than you can remain solvent. Although we are generally believers in the efficiency of markets, sometimes we locate a stock or bond we think is underpriced. When that happens, we’re counting on the rest of the market’s participants to eventually learn what we already know, then bid up the price so we can sell at a profit. Not surprisingly, we’re don’t always interpret those pricing inefficiencies correctly, meaning the market was right all along. As alluded to in the first paragraph, when we realize that the story has changed, we sell the position as soon as we can because we know that the market as a whole can easily outwait us.
Ronald Reagan once said that the most dangerous words in the English language were: I’m from the government and I’m here to help you. British investment manager Sir John Templeton saw things a bit differently, finding danger in the wall’s next saying: This time it’s different. When tech stocks were booming in the late 1990’s, some were selling at what seem unreasonable levels based on classic measures like their Price-to-Earnings ratio. When this question was raised, promoters of the boom responded by suggesting that different metrics be used. One I remember was measuring a tech company’s worth by counting the number of eyeballs a web page attracted. True believers maintained that new forms of measurement were necessary because something new was going on: this time things were different. Many of you will remember how that worked out – quite well for a few years followed by a sudden drop when reality set in.
Somewhat controversial in his time, businessman and banker Andrew Mellon provided our next quote: Gentlemen prefer bonds. A twist on the better known title of a book, movie and stage play, his version seems to reflect a banker’s likely preference for an investment with a known maturity and rate of return. While there have been several wonderful times to own bonds in the past, today is not one of them. The Federal Reserve continues to hold rates down in hopes of encouraging people and businesses to spend more and thus enhance the recovery. At some point, rates will rise and when they do, bond owners will suffer losses. Statistics suggest that a very large number of people have looked to bond funds as a higher paying alternative to money market funds, perhaps having heard that bonds were a safe investment. We think the rush to sell will become a stampede when those folks learn they can lose money in a bond fund. This is definitely a time for bond prudence.
Over the years, I’ve been approached by people who know absolutely nothing about investing but want to learn. I’m always glad to chat with them but I usually begin by loaning them one of a couple of books written by Peter Lynch, the amazingly successful manager of the Fidelity Magellan mutual fund. Under his guidance, the fund achieved the best twenty-year performance of any mutual fund in history. Lynch’s books suggest that investing is best kept simple and that people should stick to things they know and/or that are easy to understand. His contribution to the wall is: Never invest in any idea you can’t illustrate with a crayon. Lynch generally avoided technology stocks, having lost money on several computer companies in the 80’s and early 90’s. Instead, he made money for his shareholders in automobiles, insurance, manufacturing, consumer products and other very basic businesses.
This brings us to the half-way point of the tour so I’ll take a break here and return with a quote from the other Warren (Mr. Buffett) in my next article.