There are some prominent commentators these days, even an economist that runs a mutual fund based on his econometric analysis. The newsletter is a great read and I assume he is correct. But this reminded me of another manager that still writes great reports and is totally convincing, and as far as I'm concerned is 'correct'.
In any case, I mention these guys in my original post back in 2011:
Perils of Trying to Time the Market
The two mutual funds I mention in the post is the Comstock Capital Value Fund (DRCVX) and the Prudent Bear Fund (BEARX). Prudent Bear also has a nice website with some scary reports. Again, the information there too is well written, convincing and scary. And they are probably correct.
But here is what those insights have done for them over the years:
Just for reference, here's the blurb on what the Capital Value Fund is about (from their website):
Investment Philosophy & Comstock Partner BiosThey have been bearish for as long as I've known about them, and it's a little scary because even when they turned out to be right and the market collapsed after the internet bubble in 2000, their gains barely recovered losses incurred during what I'm sure they considered an irrational bull run in the 1990s. Even at the bottom of the worst financial crisis, the gains they had still barely recovered losses of earlier years.
Comstock’s approach is wide-ranging, including the analysis of specific equities, general stock market strategy, interest rates and real estate as well as long term macroeconomic themes centering on the interaction of inflation, debt, interest rates, economic growth and their effects on the stock, bond, commodity and currency markets. Comstock Partners started implementing these strategies when they began managing the Dreyfus Capital Value Fund (presently the Comstock Partners Capital Value Fund) in 1987 and launched the Comstock Partners Strategy Fund in 1988. In May of 2000 the Shareholders of Comstock Funds voted to join the Gabelli Family of Mutual Funds.
Comstock Partners, Inc. analyzes economic and financial conditions from a long-term macro-economic perspective and makes adjustments based on cyclical and shorter-term considerations. In pursuit of its goals, the firm invests in various asset classes including domestic and foreign stocks, bonds, currencies and derivatives including indices and options. For the Capital Value Fund, Comstock Partners can buy or sell short and make use of leverage in order to maximize returns under various market conditions. In effect, we believe our operation resembles a modern-day hedge fund in its scope of activities.
For each of its asset classes, Comstock adheres to macro-economic themes while also utilizing a disciplined investment philosophy that attempts to remove the emotional element of investing by focusing on data that, in the past, has exhibited a correlation with an asset’s future price movement. Such data may be fundamental or technical and includes indicators relating to the economy, money and credit, valuation, price momentum and investor sentiment. While each of these indicators may provide some degree of insight into the future performance of a particular investment, Comstock believes that an appropriate combination of these tools provides the highest probability of accurate market timing and security selection. Investing, of course, inherently involves subjective judgements and there can be no assurance that Comstock’s investment approach will prove successful.
The scary thing here is that if you read any of the reports going back in any given year you would nod along and agree with what they're saying. Yes, too much debt, too much leverage, Fed pump priming too much etc. And yes, the housing market collapsed, the internet bubble collapsed, valuations getting high etc. And yet they weren't able to make money on those astute insights.
Here is another fund that was initially supposed to invest 'prudently'. The original intent was to be short the market when the dividend yield was lower than a given level and then long when the dividend yield was higher than a certain level. I think it was 3% and 6% or something like that. But the dividend yield has never gone back up so they have been short since inception. The idea sounded good on paper.
Their website too has some very interesting reports, but again, their insight isn't turning into profits. They couldn't recover earlier losses even after the worst financial crisis since the great depression.
I don't mean to pick on these guys. They seem to be honest, hard working, decent people. And these funds may serve a purpose in some portfolios; maybe people want to allocate capital to these funds as a sort of a disaster hedge. Who knows.
And I am not cherry-picking funds to make my case. I have known about these funds in real time for a very long time; I don't know others that run their portfolios in a similar manner with long term records going back this far.
Of course there are some successful macro hedge funds, but those are different; they are more engaged in leveraged futures, bond and foreign exchange trading and other things like that so they don't focus just on trying to call the stock market.
This is a cautionary story for people who are interested in investing in mutual funds that promise to make money in all market environments, hedge their equity or whatever. Alarm bells should go off if there is a claim that they could do that successfully over time and through cycles. And as someone once said, the bear argument is always going to be more sophisticated and smart-sounding. Listen to Buffett on his bullishness on America, for example. He just sounds pollyannaish.
(OK, I know some of you will say, but what about Fairfax/Prem Watsa?! I also tend not to like the extent of his hedging of the equity portfolio, but he has a proven track record of outperformance even including hedging. Of course I would prefer the BRK, MKL or Y model of no hedging, but Watsa has performed over time with these decisions so...)
Back to Buffett
So let's go back to Warren Buffett for a second. He was kind enough to give us his thoughts on investing in the recent letter to shareholders.
He starts the section off with a Graham quote:
Investment is the most intelligent when it is most businesslike. -Benjamin GrahamAnd here are some of his thoughts; what he feels are certain fundamentals of investing:
Note the second bullet point:
If you instead focus on the prospective price change of a contemplated purchase, you are speculating.So if you are looking at the market overall p/e ratio and deciding that stocks are overvalued and they must go down, then you are speculating. Even if you are just pricing the market and getting out so that you can get back in cheaper, you are still speculating. (If something gets really expensive/overpriced, then by all means sell!)
His two purchases were in 1986 and 1993. Both were times that were considered bubble-ish. After black monday, the outlook was horrible; people called for the coming of another depression. What happened in 1987 and 1994 "was of no importance to me in making those investments".
He says thinking about macro is a waste of time and is indeed "dangerous because it may blur your vision of the facts that are truly important". I think the above two mutual funds are perfect examples of this danger.
As he says, "games are won by players who focus on the playing field - not by those whose eyes are glued to the scoreboard".
Value investors shouldn't care about the fluctuations in the market (except to the extent that they can take advantage of it); they keep their focus on the business (playing field) and not the stock price (scoreboard). The above two funds seem to focus a lot on the scoreboard, setting up positions so their profits will be based on the accuracy of their market predictions (and not on the evaluations of businesses).
Stocks Don't Always Go Up
All of this is not to say that valuations don't matter. They matter a lot. We are "value" investors, so of course "valuations" matter. When we say don't worry about warnings about overvalued stocks, bears will call us perma-bulls; that we bulls think markets always go up. Well, they don't. They will go up and down as they always have. My argument is that it's going to be hard to predict the market based on it.
Higher valuations will mean lower prospective returns but higher valuations don't necessarily lead to an imminent bear market or correction. A bear market or correction will always be inevitable, but it's hard to say when it will happen. And if you don't know when it's going to happen, it's going to be very hard to capitalize on it (as we see from the DRCVX and BEARX examples).
Other Alarm Bells
This goes off a little on a tangent, but I was browsing through a presentation of Brookfield Asset Management and I almost fell out of my chair. I have always thought that this alternative asset thing is getting a little bubbly. Over time, I guess it can grow as an asset class. But a lot of this movement into alternatives seem driven more by fear and seems like a kneejerk reaction to the financial crisis; people got hurt so badly in the financial crisis that they don't want a big allocation to stocks anymore.
Also, it is driven by pension needs as interest rates are too low; they need to invest in higher return asset classes to meet their expected returns. Bond yields are too low and stocks have done nothing over the past decade.
The AUM growth at the listed private equity companies (most of which are really well run by really good people) always scared me a little bit because of this.
What happens when interest rates start to move back up? Some of these assets can get hit by a double whammy; once because capital moves out back into higher yielding bonds, and then again as cap rates go up because of higher rates (even though there is some cushion there as spreads are apparently still wide).
Anyway, first of all, I have to say that Brookfield is an amazing entity and is well run and they do have some of the best reports to read; very detailed and everything well explained. So this is not a judgement at all about Brookfield or any of it's entities.
Here are some interesting slides.
If you look at Buffett's third bullet point above, it says, "...the fact that a given asset has appreciated in the recent past is never a reason to buy it".
Of course there are many good reasons to get into "real" assets but:
Great ten year return is good, but I've seen this sort of thing in the past with all sorts of asset classes. The U.S. stock market looked good on this basis back in 1999/2000 too.
And here's the all too familiar chart and table:
I've seen (and created myself too) the exact same sort of charts/tables but instead of agrilands/timberlands, the asset classes were (at various different times) managed futures accounts, hedge funds, Asian equities, Japanese equities, global equities, emerging market equities and commodity indices (and others). Some of these asset classes looked the best at various points on a five or ten year lookback basis, and almost always, things didn't really work out too well going forward.
I remember strategists running around with presentations showing Asian equities in the late 80's and early 90's saying that you had to be there. Owning them would lower volatility of your portfolio and increase your returns. I've seen the same argument about Japanese equities in the late 80's, emerging markets in the 90's, commercial real estate, commodity indices in 2006/2007 etc...
I wasn't in the business back then, but people used to show a similar table showing how adding managed futures accounts (CTA) would increase returns and lower volatility of institutional portfolios in the late 1970's/early 1980's. Slightly different, but option overwriting strategies were hot too at some point in the 1980's; if you hire an options overlay manager to write call options on your equity portfolio, your return/risk would be enhanced. And if you can lower volatility and improve the risk/return, maybe you can lever up too!
And now we have this added fear of perpetual, QE-infinity creating inflation down the line. So this slide adds to the excitement of the above slides:
So how can you lose? It's a no-brainer, right? Good Sharpe ratio, low correlation to conventional asset classes and it even acts as an inflation hedge!
But again, I have the highest respect for Brookfield Asset Management. I've never written it up here as I never got the chance to or there was no 'trigger' to make me do so. Plus, I personally am not too big on infrastructure / real estate. But I have owned it in the past and may do so in the future. It's really a high quality organization, so none of this is a reflection on Brookfield, but more of a commentary on what's going on overall.
So are stocks the best place to be? I don't know. I have no idea which asset class will perform the best over the next few years. I have no idea if this is the tippy top of the bull market (even though my recent posts might be indicative of at least a short term top!). I really don't know.
And I don't say all of this to say that we won't enter a bear market soon or anything like that. We will certainly have another bear market, and I have no idea when. Buffett said that he would be very, very surprised if we had another 2008 soon. He thinks that won't happen for a very long time because when people go through an experience like that, they tend to be cautious for a long time after.
But my comments are not so much defending the market so much as warning about trying to get too smart and trying to dance around avoiding what might or might not happen. Also, running to other asset classes just because it has a better 10-year rear-view mirror return with lower volatility and is uncorrelated to the stock market and bonds is not necessarily a great idea either.
This is not to say those other asset classes are bad. It's just that people might run into them for the wrong reasons. And that would be the mistake.