Dear Investors,
As we are now more than eight years into a bull market, I’m struck by how different the psychology is of most market participants now, compared to just a few years ago. In Europe, we have seen a significant referendum vote, where the affluent region of Catalan proclaimed their interest in breaking away from Spain. Such a move would have enormous ramifications for Spain, Europe, and sovereign debt, yet the stock market shows no signs of stress. Compare that to 2011 or even as recently as June of 2016 after the Brexit vote, when complications in Europe rattled stocks across the globe with major panics. I’m not going to pretend to know what will happen with Catalan, but it is important to understand how this change in psychology is impacting asset prices. Just last week, the volatility index (also called the fear index) for the S&P 500 set an all-time low. Market participants everywhere are loading up on risk assets with very little regard to valuations, which are at some of the most extreme levels we have ever seen.
It is human nature for market participants to chase past returns and it is only the most successful investors, that are able to really teach themselves to go against those emotions, and stay disciplined when everyone is seemingly making money hand over fist. It is not just mere intellectual mortals that fall prey to these emotions. During the 18th century, the South Sea Company was established and was granted a monopoly on trade in the South Seas in exchange for assuming England’s war debt. Many market participants, including Isaac Newton, who is universally acknowledged as being one of the most intelligent people in history, jumped on the stock and made money. After selling his stock at a great profit, Newton got immensely frustrated as the stock continued to go higher making others rich despite a valuation that made absolutely no sense. Newton couldn’t control his emotions any longer and decided to repurchase a great deal more South Sea Company shares at more than 3 times his original price. When the stock inevitably crashed, Newton lost just about his entire life savings! This horrendous experience prompted Newton to say “I can calculate the movement of stars, but not the madness of men.”
- How many people and institutions do you think are buying index funds based on past performance?
- How many of these buyers are factoring in that interest rates likely are not going to go lower?
- Is it intelligent investing to buy something with zero regard to value whatsoever?
Almost anyone that has been managing money for a long time would tell you that this bull market and index buying phenomenon is likely to end very badly. However, there is massive pressure to try to outperform each quarter or year, because that is what most market participants want, despite the fact that there is absolutely nobody who has ever done that. The smart investors with the best track records, focus on value and on maximizing returns over the long-term. They do this by taking advantage of the massive disconnects between price and value that occur. When a stock is mispriced, it is nearly impossible to predict the timing of when the mispricing will be corrected, thus patience is imperative to generating good long-term returns. It is very easy to show positive returns when everything is going up. It is much harder to protect those gains and also make money when the inevitable correction occurs.
Our focus at T&T Capital Management is 100% on generating long-term investment returns and protecting capital. We do this by attempting to avoid permanent losses of capital. To me, buying an index fund at current prices is basically guaranteeing horrible returns for the next 5-7 years, and very possibly losing substantial sums over that period. That would be highly unsatisfactory and I’d rather not try to chase silly behavior, even if it means short-term underperformance. We said in the beginning of the year, that if the market was down, flat, or slightly up, we would expect to outperform. If it were up dramatically, we’d expect to underperform. We are taking far less risk than an index fund in our opinion and we have a high degree of confidence that we should be able to continue to meet our goal of outperforming over the long-term. For those of you that are retired or are close to retired, I’d urge severe caution in being aggressively exposed to mutual funds and index funds at current prices. Below is a link to an article that really discussed the temperament necessary to post great long-term investment returns. I hope that you enjoy and as always, if you need anything at all, please don’t hesitate to call me directly at 805-886-8140.
Charles Munger – Big Gains Invariably Mean Long Periods Of Underperformance
Sincerely,
Tim Travis