First of all, let us start by saying we hope this finds you healthy and well. A clear silver lining to this topsy turvy market environment is that we’ve been in frequent touch. Hopefully you’ve found our weekly letters helpful and we’ve very much enjoyed the recent phone calls and emails where we get to hear how clients and friends are navigating this adventure. You inspire us.
Two weeks beyond closing the books on a historic first quarter for the market, there’s still much we don’t and can’t know. Seems an odd thing to say as an advisor but to deny this reality wouldn’t be honest. The good news is that admitting we don’t know is often where progress and growth begins. And though there’s much that’s unknowable, we believe we have an investment discipline that’s stood the test of time and will continue to deliver for our clients. We are directing every bit of our effort and experience—many decades through all types of markets—toward moving our clients’ investments and financial plans forward into a future that remains bright.
This letter will run a little longer than most, but we think it timely and important to provide some perspective on the current investment environment and how we’re responding in portfolios. In particular, we hope to illuminate three things:
- A LOT is in motion
- It’s weight, not votes, that matter
- Patience is likely to be required, and rewarded
A LOT is in motion. In short, we’ve seen an astonishing amount of global change in a short period of time. Here’s what we see today: The world’s gravest health pandemic in over a century; prompting a global quarantine/social distancing effort that’s produced immense job loss, business disruption, and economic contraction; which has resulted in a massive and unprecedented response from central banks and governments around the world ($2.3 Trillion and counting in the U.S. alone).
We are collectively struggling to make sense of it all because it’s happened so fast and we would point out that most of what we’re reacting to and dealing with is still first order effects. Our experience tells us that any one of these things will have important ripple effects to consider. Imagine throwing a rock (boulder?) into a pond and now put that scene in slow motion. What we’re suggesting is that we’re still just witnessing the splash with the ripples (waves?) still to come. Whether ripples or waves depends on answers to many questions whose answers we don’t have yet, like: when will we have effective treatments or a vaccine?; When can we safely restart the economy?; and what implications will this unprecedented government and central bank response have for national debt levels and the financial system?
At this point we imagine you might be tempted to feel overwhelmed and that’s certainly not our intent. These are questions and realities it would be foolish for us to ignore; and periodic recessions and bear markets are a very normal part of a well established economic and market cycle. Furthermore, we can take comfort knowing that answers will come, it will just take time. Which is a good lead in to our second point and how we think it best to respond as disciplined, long-term investors.
It’s weight, not votes, that matter. First of all, this isn’t a political statement even though we ARE in an election year. Phew! No, we are referring to an idea originally proposed by Benjamin Graham and David Dodd in “ Security Analysis ”, their classic book on value investing, originally published in 1934 and perhaps made more famous by Warren Buffett. Our paraphrase:
In the short run the market is a voting machine, but in the long run it is a weighing machine.
It’s a fundamental economic principle that the price of anything is driven by supply and demand for that thing. If lots of people want something and it’s in short supply, the price goes up. Think hand sanitizer and toilet paper! Likewise, some combination of low demand and oversupply tends to make prices fall. The same is true for stocks and other securities traded in the public market and every day market participants cast their yea or nay “votes” with orders to buy and sell respectively. More buy votes than sell votes, prices go up—and vice versa. The goal of a well-functioning market is to set a price through these “votes” that is a good reflection of actual value, or the “weight” alluded to in the axiom above. We’re admittedly simplifying, but these are important concepts and hopefully they are clear.
There are many factors that can influence market votes in the short run and during times of market turbulence and great uncertainty, like we’re experiencing now, the voting machine can go a little wonky. We believe it’s during these times of exceptional voting wonkiness that we may see some of the greatest disconnects between price and value, creating opportunity. Voters may make decisions out of fear or other factors unrelated to a clear-headed assessment of value. We briefly saw this kind of panic selling leading up to the recent market low on March 23rd. Since then the market has rallied strongly even as business and economic fundamentals have deteriorated and 22 million Americans have filed for unemployment.
We’ve said it countless times but we believe the best way to grow wealth over time is to pay reasonable prices for good investment assets—businesses, real estate, etc.—and hold them for the long run. Paying a reasonable price requires weighing long-term prospects (assessing value) and comparing that to prices being offered by the market. This remains our focus and we’d encourage you to make it yours too. It helps us stay centered and secure when the voting machine goes rogue from time to time. Because while the market is a voting machine in the short run, we’re indeed still confident it’s a weighing machine in the long run.
Specifically, our work in the early stages of this pandemic and resulting market turbulence has been to re-weigh the long-term prospects of the investments in client portfolios in light of the enormous amount of new information presented by the “events in motion” we described earlier. Thankfully, we’ve found the majority of our portfolio investments to be sound. As we look at our top individual stock holdings, we see rock solid companies—financially strong and fundamentally well positioned to weather the storm and deliver the attractive long-term investment returns we’re aiming for. Our top five firm-wide individual stock holdings: Apple (AAPL); Microsoft (MSFT); Berkshire Hathaway (BRKB); Intel (INTC), and Weyerhaeuser (WY). This doesn’t mean they are immune to being punished by the voting machine in the short run. We also found a few investments around the edges that did not meet our standards in light of new information and in those cases we’ve sold them to redirect to better opportunities. As we’ve already said, we don’t pretend to have perfect vision and we certainly won’t get everything right, but we believe in our process and think we’ve improved the long-term positioning of our client portfolios in light of current events. Please, as always, feel free to call if you’re curious about the specific risks and opportunities we’re seeing in this market.
Of course this is much like the constant tending of a garden (hopefully relatable to many of you as an acceptable quarantine activity in this beautiful spring weather!) and we will continue to do our best to continually evaluate our investment positioning as events unfold.
Patience is likely to be required, and rewarded. With the strong market rally we’ve seen over the past few weeks, we’d like to believe that the worst of the market turbulence is behind us. However, our experience tells us that it would be wise to expect that it will continue for a while. Like we mentioned earlier, a lot of uncertainty has been set in motion in a very short period of time and we think it is reasonable to expect that ripples, or in some cases powerful waves, are forming that will take time to recognize and play out.
We do generally still have cash in our clients’ managed accounts, which is available to capitalize on bargains that almost undoubtedly will emerge. And, in light of this market context, we would encourage you to also ensure you are appropriately positioned, especially if there are any significant changes in your financial situation. If you have experienced a temporary loss or reduction in income, you may want to reevaluate your cash and liquidity reserves. Or on the other hand if you have the good fortune of having more reserves than you need, we would encourage you to consider that this may be a profitable time to add more money to your portfolio. Either way, please do not hesitate to reach out and we would be happy to review with you. Let us help you capitalize on some great long-term buying opportunities that we believe will present themselves before all is said and done.
Let us end where we began, wishing you and yours continued health and well-being. You always have been and remain the inspiration for everything we do here. And if there’s anything more we can do for you or someone you know, please let us know. We’d be happy to help.