I wanted to pass on a very interesting article that I thought you might enjoy and which contains some valuable lessons of the past that are just as applicable today. Here is the link to the article and below are my comments on the subject:
2017 has some strikingly similar characteristics to what we saw in the late 1990’s, prior to the tech bubble’s collapse. In those years, it was any stock with a “.com” in its name and little to no earnings, that could attract valuations that didn’t make sense to any reasonable financial analysis. During that time, “old economy” companies such as Gillette, American Express, and even Warren Buffett’s Berkshire Hathaway, had fallen out of favor as they couldn’t keep up with the “.coms”. Valuations were the highest in history and were rationalized by the notion that “this time is different.” Investment managers in their 20’s and early 30’s were generating record returns outpacing legends of the industry, because these old-timers supposedly just didn’t understand the impact of the internet.
In today’s environment, the stories are different but the unbridled enthusiasm and absence or risk management is quite similar. Speculative bets such as Bitcoin are being labeled as eventually being on par with currencies or stores of value such as gold. I see some pretty big differences between Bitcoin and gold personally. One reason that gold has been a good store of value is that if prices are down on it, the metal can be manipulated to create
jewelry that has been prized for millennia. Bitcoin’s attractive characteristics are that there theoretically will always be a limited supply, it can be fractionalized much more efficiently, and it doesn’t have the same risks of having the government inflate away your currency. The negatives are that there are very few limits on how many digital coin offerings there can be, so there is no guarantee that Bitcoin will ultimately be the long-term winner. It is incredibly inefficient as a means to engage in actual commerce. Last, but not least, it is obviously being used as a way to evade taxes and government surveillance, all of which are likely to lead to increased regulation.
“The thing about risk is that it is usually highest when nobody is thinking about it.”
It isn’t just Bitcoin that has market participants so exuberant. Stock and bond valuations offer no margin of safety whatsoever, yet it is almost unanimous that analysts expect continued gains. Keep in mind that many of these analysts had been far more bearish when valuations were dramatically cheaper in prior years. Volatility has been at all-time lows, highlighting how little perceived risk that there is. The thing about risk is that it is usually highest when nobody is thinking about it.
One of the major reasons the Financial Crisis was so terrible was because there was this perception of fact that real estate prices couldn’t go down on a national basis. The whole financial sector had created an ecosystem of securitization reliant on this incorrect notion, which of course resulted in trillions in global losses.
When the tech bubble crashed from March 11, 2000 to October 9, 2002, the Nasdaq lost 78% of its value. Even the most successful technology businesses got absolutely creamed because their valuations had gotten so stretched. Cisco for example dropped 86% during the period and there were many other lesser companies that got completely wiped out.
Those value investors such as Warren Buffett, Martin Whitman, and Bruce Berkowitz that stuck to their guns and didn’t get sucked in by the bubble, showed exceptional performance even when the market overall was crashing. Many of the young growth managers were forced out of the industry as their funds collapsed. There also was a breed of value investors that tried to change their strategy in the face of short-term underperformance. They ended up taking huge losses as the tech stocks they bought at inflated values crashed and the old economy stocks they had held before shifting strategies rallied.
This is why at T&T Capital Management, we are firm believers of focusing on deep value. We follow cash flows and we follow facts. It is impossible to predict the timing of when stock prices will hit intrinsic value, but history shows that it generally occurs within about 3-5 years at the most. We’ve seen some good successes this year with stocks such as: ALLY, GGP, QCOM, C, BAC, GM, MS, VOYA. The seeds of our core successes were planted years ago, as we buy things when they are in seeming distress, and sell when they are polished up a bit.
Despite being great investments for us long-term, stocks such as AGO and MBI got hurt quite badly over the last few months as a result of the hurricanes that are impacting the bankruptcy process in Puerto Rico. These short-term mark to market hits should ultimately lead to exceptionally large long-term gains as we have been able to add materially to our positions, particularly to AGO at bargain basement prices. Both companies are buying back stock aggressively at huge discounts to book and intrinsic value, which ultimately increases both metrics.
The ability to buy a best-in-class insurer with a fortress balance sheet and attractive growth prospects at a 50% discount to adjusted book value; is an opportunity that simply cannot be passed up. This type of core holding will be immensely valuable to us as its future stock performance should not be too closely correlated with that of the overall market, which is overvalued.
As we get more clarity and ultimate resolution, we should see very large gains, but we don’t control the timing of when that occurs of course. The key is patience and maintaining a strict discipline when everyone around us is euphoric, just like we do when everybody is overly pessimistic.