Field of play
October 24, 1907 will be repeated again and again
As of last Friday, the S&P 500 is down 17.41% from its high in February. This is a good time to reflect on what some legendary investors have said about dealing with market plunges.
Some things never change. In our lifetimes we will experience several severe market smashes.
Jean de la Fontaine, who lived from 1621 to 1695 wrote: “Patience and passage of time do more than strength and fury.”
Amputation without anesthetics
In 1923 Edwin Lefevre, a newspaper reporter, published a book called Reminiscences of a Stock Operator. In the book the operator was named Larry Livingston. In real life he was Jesse Lauriston Livermore, one of the most extraordinary stock market and commodities speculators of all time. The book is a delight to read and one of the most popular investment books of all time.
Lefevre, ghost writing for Jesse Livermore wrote: “Things got worse and worse. Finally, there came the awful day of reckoning for the bulls and the optimists and the wishful thinkers and those vast hordes that, dreading the pain of a small loss at the beginning, were now about to suffer total amputation – without anesthetics. A day I shall never forget, October 24, 1907.” (Lefevre, 1923,1993) p113
October 24, 1907 will be repeated again and again and the psychology that led up to it and through it will be largely the same.
Personal capital down 62%
Biggs recounts Keynes experience in the late 1930s. In mid-1937 Keynes suffered a heart attack. By the end of 1938 his personal capital had shrunk substantially and was down 62% from the end of 1936. At the time he was continuing to manage money for, or give investment advice to, several institutions. Biggs writes: “In 1938, with the bear market still in full force and even though still convalescing, Keynes found himself in the uncomfortable positions of having to justify his bias for equities to the investment committees of the institutions he advised and who had also suffered heavy losses. ‘I feel no shame at being found still owning shares when the bottom the market comes. I would go much further than that. I should think it is from time to time the duty of a serious investor to accept the depreciation of his holding with equanimity and without reproach himself.’” (Biggs, Hedgehogging 2006) p301 (Emphasis Added)
The maynardkeynes.org website outlines Keynes investment philosophy: “The investment strategy Keynes finally adopted is, in many respects, remarkably similar to Warren Buffett’s. Buffett has acknowledged Keynes’s influence on his thinking. In 1991 he said Keynes was a man, “whose brilliance as a practicing investor matched his brilliance in thought.”
The level of his success is suggested by the investment performance of the Kings College Cambridge investment fund he managed. During the years from 1927 to 1946 the Chest grew at an annual compounding rate of 9.1 per cent while the general British stock market fell at an annual compounding rate of slightly under 1 per cent.
Darkest before the dawn
Peter Lynch remembers the early 1980s: “There was a 16-month recession between July, 1981 and November, 1982. Actually, this was the scariest time in my memory. Sensible professionals wondered if they should take up hunting and fishing, because soon we’d all be living in the woods, gathering acorns. This was a period when we had 14 percent unemployment, 15 percent inflation, and a 20-percent prime rate, but I never got a phone call saying any of that was going to happen, either. After the fact a lot of people stood up to announce they’d been expecting it, but nobody mentioned it to me before the fact. Then at the moment of greatest pessimism, when eight out of ten investors would have sworn we were heading into the 1930s, the stock market rebounded with a vengeance, and suddenly all was right with the world.” (Lynch, One Up on Wall Street. 1989,1990) p75
You did not misread and it was not a typo. There really was 14 percent unemployment, 15 percent inflation and a 20 percent prime rate. The world was going to hell in a handbasket. It was a great time to buy stocks.
It was in the early days of my investing career. In the fall of 1982, I received an analyst’s report from a reputable firm which recommended short selling a particular stock at about $12. The market environment was decidedly bearish as stocks had been in full retreat for many months. I had never seen a recommendation to short sell a stock and I found it noteworthy that this was being recommended. The stock went down to about $11 in the next few weeks and then began a steady climb. Within a year it had topped $30. I have remembered that incident as a good example of how stock market professionals are perfectly susceptible to being caught up in the market mood of the moment.
The stock analyst whose report I had read in that time of great pessimism was caught up in the pessimistic mood. It was a cheap lesson for me as I didn’t sell anything short at the time.
22.6% plunge on just one day
For decades the most popular investing show on television was Louis Rukeyser’s Wall Street Week on Friday nights on PBS. John Templeton appeared frequently on the show.
Sir John Templeton was educated at Yale and Oxford and founded the Templeton Growth Fund in 1954. Templeton pioneered global diversification in the mutual fund industry. He was one of a tiny group of the greatest investors of the 20th century.
Templeton was the featured guest on the Friday following October 19, 1987 that saw the Dow Jones Industrial Average decline 22.6% on just that one day. This is a partial transcript of the show:
“Louis Rukeyser: What is your advice to people in terms of the stock market now?
Sir John: Patience. Be a long-term investor. Be prepared financially and psychologically to live through a series of bull markets and bear markets because in the long run common stock will pay off enormously and the next bull market will carry prices far higher than this one.
Louis Rukeyser: Why?
Sir John: Because the whole nation is growing more rapidly. Gross national product of the nation will double at least in the next ten years. We think the gross national product of the nation forty years from now will be sixty-four times as high as it is now and that will be reflected in sales volumes and profits and share prices….” (Proctor & Phillips, The Templeton Touch, 1983, 2012) p222 (Emphasis Added)
John Templeton was able to quietly and confidently say that when the stock market had just suffered a 22.6% one day plunge!
Lauren Templeton is John Templeton’s great niece. She became a hedge fund manager. When she was twenty-four John Templeton seeded a hedge fund that she was to manage with $30 million. He set up very specific constraints as to what she could do and not do as manager. She says: “…so he set many investment parameters up in a way that made me stay the course and ride out any volatility. Volatility tends to unnerve investors, and he was not concerned with volatility. Basically, he was dismissive of discussions regarding standard deviation and similar measures. I believe he prized the market’s volatility because he saw it as creating bargains and opportunities, but this is not how most people think about the phenomenon.” (Proctor & Phillips, The Templeton Touch, 1983, 2012) p386 (Emphasis Added)
Templeton was famous for his maxims. Maxim 4. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.
Volatility and risk
Warren Buffett is reported to have written in the Outstanding Investor Digest August 8, 1997: “Finance departments teach that volatility equals risk. Now they want to measure risk. And they don’t know any other way, they don’t know how to do it, basically. So, they say that volatility measures risk. I’ve often used the example of the Washington Post stock when we first bought it: In1973, it had gone down almost 50%, from a valuation of the whole company of close to say $180 or $175 million, down to maybe $80 million or $90 million. And because it happened very fast, the beta of the stock had actually increased. A professor would have told you that the stock of the company was more risky if you bought it for $80 million than if you bought it for $170 million, which is something that I’ve thought about ever since they told me that 25 years ago. And I still haven’t figured it out.” (Emphasis Added)
An irresistible urge
Philip Fisher points to the “… inherently deceptive nature of the stock market. Doing what everybody else is doing at the moment, and therefore what you have an almost irresistible urge to do, is often the wrong thing to do at all.” (Fisher, Common Stocks and Uncommon Profits and Other Writings. 1958,1996) p32
Who was Fisher? On November 15, 2013, Warren Buffett met with University of Maryland MBA Students. In notes taken by Professor David Kass, Buffett acknowledged that along with Ben Graham, Fisher was one of the great influences on his approach to investing, particularly as to how he viewed companies.
Regarding being a contrarian, Fisher wrote: “Contrary opinion, however, is not enough. I have seen investment people so imbued with the need to go contrary to the general trend of thought that they completely overlook the corollary of all this which is: when you do go contrary to the general trend in investment thinking, you must be very, very sure that you are right.” (Fisher, 1958,1996) p243 (Emphasis Added)
Umbrellas on rainy days
The main downside to an equity weighted portfolio is that from time to time one’s investment assets may, on paper, shrink by in the order of 50%.
There are various strategies that can be adopted to somewhat mitigate this, but the truth is that one must be prepared for such volatility. Few are mentally equipped for such a roller-coaster ride. For those that have the stomach, the rewards can be substantial. It is worth noting that indexing does not remove volatility. All successful strategies revolve around distinguishing between price and value. In volatile times investors can buy shares at prices substantially less than fair value.
Conclusion
My own thinking is that volatility, in itself, is neither bad nor good. It simply happens. Like rainy days, we simply have to prepare ourselves and put up with them. And like rainy days, if we are in the umbrella business, we can take advantage of them. Not all agree.
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