Hello Everybody,
Needless to say, the last 30 days have been quite dramatic for world markets. In China, roughly $4 trilling in equity value was wiped out in a crash that has many similarities to that experienced in 1929, partly for the interventionist policies that transpired as a result. This story is likely not over in my estimation, but whether it impacts the actual Chinese economy is much more important.
A deal ultimately was reached between Greece and EU. Basically, Germany called the Greek leader, Tspiras’ bluff. Tspiras understood that although he is highly popular in Greece, the will of the people was to stay in the EU. The cost of his “game theory” diplomacy was unfortunately very bad for the Greek people. Ultimately, the Greek debt will be restructured in some way, with the most likely first steps being extensions and interest rate reductions. It was a sad weekend for the EU project as a whole though, as Germany really bullied to some extent, leaders in countries such as France and Italy. They did it to make an example out of Greece and the Leftist rhetoric of the Syriza party. How this plays out nobody knows, but macroeconomic news offer more noise than anything, when it comes to actually investing in equities. Far more important are developments within individual companies and of course paying the right price.
Earnings season has now begun and we look forward to seeing the progress of our portfolio companies. The big banks’ are off to a great start, with Bank of America in particular showing very strong profit growth. We started buying Bank of America in 2009 when the stock was in single-digits. We’ve added consistently over the years and have sold thousands if not tens of thousands of puts. While the stock has fluctuated greatly, including a slide to around $15 in April of this year, the price has eventually gotten closer to its growing intrinsic value, which we peg around $23-25 conservatively. Now in these instances when the stock has sold off, in some cases quite dramatically, the investments have looked like a mistake. The puts we’ve sold have increased in value, causing short-term mark to market losses. This is why we stress taking a long-term investment approach. Doing otherwise is not really investing. None of those put sales, or stock purchases has been proven to be a mistake and instead we have made a great deal of money for investors on the stock. The same can be said for most of our large long-term holdings in stocks such as Citigroup, AIG and AGO.
By understanding intrinsic value and doing the research, we are able to buy and add to our positions when stocks get cheaper. In April, we added to Bank of America and have been rewarded as the stock nearly trades at $18 now despite all of this volatility. We did the same thing when AIG traded below $50 earlier in the year and now the stock is at $64. We’ve made a lot of money on AGO over the years and this recent selloff due to fears about Puerto Rico have created another stellar opportunity. Once again, we have bought more stock and sold more puts. Sure, some of the puts we sold when the stock was a few dollars higher are showing short-term mark to market losses, but these are irrelevant as we plan on holding the stock until it converges with our target price which is above $40. There are a variety of catalysts that can work in our favor and keep in mind that we are talking about an AA rated company, so financial strength is not an issue!
Energy is an attractive opportunity for us 3-5 years out. Some companies such as National Oilwell Varco have incredible competitive advantages, which lead to high returns on invested capital. Sure demand for drilling equipment is down materially, but long-term, it will come back as will the stock. We’ve been able to buy the company at attractive prices and have sold puts with great premium. The situation is not unlike that which occurred with financials in 2011 during that European Crisis. I believe we are planting the roots for some of the next big returns in a market where opportunities are few and far between. The last thing that I want to leave you with is an excerpt from the Berkshire Hathaway’s 2014 shareholder letter where Buffett talks about volatility. I hope that you’ll find his words helpful in maintaining that disciplined, long-term perspective, which so very important in achieving investment success.
“Our investment results have been helped by a terrific tailwind. During the 1964-2014 period, the S&P 500 rose from 84 to 2,059, which, with reinvested dividends, generated the overall return of 11,196% shown on page 2. Concurrently, the purchasing power of the dollar declined a staggering 87%. That decrease means that it now takes $1 to buy what could be bought for 13¢ in 1965 (as measured by the Consumer Price Index).
There is an important message for investors in that disparate performance between stocks and dollars. Think back to our 2011 annual report, in which we defined investing as “the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power – after taxes have been paid on nominal gains – in the future.”
The unconventional, but inescapable, conclusion to be drawn from the past fifty years is that it has been far safer to invest in a diversified collection of American businesses than to invest in securities – Treasuries, for example – whose values have been tied to American currency. That was also true in the preceding half-century, a period including the Great Depression and two world wars. Investors should heed this history. To one degree or another it is almost certain to be repeated during the next century.
Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.
It is true, of course, that owning equities for a day or a week or a year is far riskier (in both nominal and purchasing-power terms) than leaving funds in cash-equivalents. That is relevant to certain investors – say, investment banks – whose viability can be threatened by declines in asset prices and which might be forced to sell securities during depressed markets. Additionally, any party that might have meaningful near-term needs for funds should keep appropriate sums in Treasuries or insured bank deposits.
For the great majority of investors, however, who can – and should – invest with a multi-decade horizon, quotational declines are unimportant. Their focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime. For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities.”