Brent’s Newsletter

DEAR CLIENTS:

There are two Wall Street maxims that have never failed me: “Every trend lasts longer than common sense says it should” and “The stock market will do whatever it has to do to make the largest number of people feel foolish”. The strong steady rise of stock prices this past year has surprised most everyone. Given the volatility of world events the market has had every excuse to be equally volatile. Perhaps, for just that reason, it decided to be calm, strong, and confident; the opposite of what most everybody expected.

For several years much of the “smart money” has been betting against a rising stock market and the error has been costly. Don't believe the populist notion that the big guys on Wall Street make all the money while the small investor gets suckered out of his. Being a sucker is an equal opportunity occupation. Wealthy sophisticates with “inside information” are just as good at losing their money as the little guys. Experience has persuaded me that conscious sophistication is a virtual guarantor of substandard returns. It is astonishing to see what educated folk do with their money. This applies to professors of mathematics at big name universities who pride themselves on their market insights. Several have received awards for sterling investment theories backed by complex mathematical proofs. That their theories don't work with real money doesn't seem to matter.

THE COST OF BEING WRONG...

How do you bet against a rising stock market? There are lots of ways. Short-selling and options contracts are the most common. These pay off when the market declines….IF it declines. But the strategies can be costly if stocks continue to rise. The widely held expectation of a big downdraft has driven billions of dollars into “hedge funds” that incorporate these techniques. Most of them have grossly disappointed. Worse still is the “opportunity cost” since the chance to profit from rising stocks was also lost.

Another way to bet against the market is the simplest and most widely practiced: sit on cash and do not invest while you wait for a big correction before buying. Millions of people have been doing exactly that. The opportunity cost to those investors has been gigantic.

Betting against the market is a disguised form of market timing; and market timing is the most tempting, insidious and perennial fallacy investors face. No matter how much we think we know, it is absolutely impossible for anyone to predict market moves with any useful degree of accuracy. (Refer back to the two maxims in paragraph one. They are as reliable as death).

HOW TO SUCCEED BY NOT TRYING.

Together you and I have profited from this recent market expansion. Why? Did we see it coming? No. We didn't see anything. We couldn't, so we didn't try. Since we can’t do the impossible, we never attempt any form of market timing. Time, not timing, is our trusted agent. Measurable facts about individual companies can dictate buy or sell decisions. But forecasts of market movements dictate nothing. This fundamental discipline has failed us only when we’ve deviated from it, or acquiesced to clients who insisted on doing so.

SO, WHAT DO WE MANAGE?

Do we just buy stocks and hold on for dear life? Not exactly, although it can look that way at times. Years back a client was angry with me about losses in his account. I encouraged him to stay the course. “Is that all you can tell me? Just buy and hope!” It really wasn't all I had told him, but it was all that he heard. He cashed out his securities at a painful loss and left. I was saddened and frustrated. Inadvertently I had hurt him. He would have been better not to have invested at all. The problem was not the investments. They turned out just fine. And it was not solely his knee-jerk reaction to stop the bleeding…..from his vantage point he behaved rationally. The real problem was my failure to effectively communicate the nature of what we were doing. We had two different ways of seeing the same thing. He saw money lost to a gamble with no way to recover without further risking what was left. I saw a collection of great companies temporarily selling at a market price well below their present and future value. Could they go lower? Yes. Was it wise to sell? Absolutely not.

That, and similar incidents, have driven us almost obsessively to find better ways to teach our clients the why and how of value investing. When the markets take a fall, we never lose sleep over our own money. So why should you? Our investment methods and principles are sound (there are plenty out there that aren't), so the number one challenge has been to communicate….to teach. We are called money managers but that doesn't quite get it. In the investment world there is not much of anything that is manageable anyway. Better to call us behavior managers. When we prudently manage behavior, yours and ours, things seem to have a way of working out very well. That's why the longer clients have been with us the more comfortable they have become….emotionally and financially. I'm not aware of anyone who has been with us for fifteen years or longer who has not enjoyed substantial profits along with increased peace of mind during rough times. (I think this is the place where I’m obliged to say: Past performance is no guarantee of future returns.)

SO, DON'T WE EXPECT A BIG DOWNTURN?

Yes, we do. Emphatically. In our relatively brief careers we’ve suffered through three massive crashes, more than ten “corrections” …down at least 20%, and dozens of mini-scares with pullbacks of better than 10%. They are an unavoidable part of the journey and they are extremely unpleasant. But when and in what shape they come is not even as predictable as South Texas weather. We can't bank on any forecast up or down. We can, however, know what we own, why we own it, and at what price it is trading relative to profits and prospects. And that is enough.

I will say that stocks of many popular companies, especially in the U.S., look pricey to us. The mania that is flooding trillions of dollars into “passive” portfolios i.e. ETFs and other index funds has exacerbated an imbalance in prices. This is not sustainable and in some way will unravel. Because our fund managers do not buy indexes, but rather select stocks individually, we believe we are best positioned to survive and ultimately profit coming through whatever tumult there may be.

GAMBLING VERSUS INVESTING

My grandfather used to say you should only put into stocks the money you can afford to lose. For those who speculate, and they are legion, that is wise advice. But for investors of our type it is not so much a gamble as a process… like growing crops and timberland. What money can you invest this way?…..most all of it that you can afford to leave alone for a while.

HOW IS THE NEW GUY WORKING OUT?

Anders Storvik joined us in June last year. Most of you have met him. Though not yet thirty, he is a remarkably mature and intelligent man. Most important, he has integrity. Anders came to us fully licensed and credentialed. He had passed one of the toughest licensing tests imaginable, and the most important one in our eyes. A Registered Investment Advisor serves as a fiduciary (We’ll activate his license January 1), having the highest ethical standard for conduct in our industry. He lacks nothing except long experience. Cilla and I are working hard to “download” ours to him. We see Anders as the leader of our firm one day when our greying hair overtakes us.