Tuesday, October 11, 2011

Stocks No Good? (Superinvestors)

Continuing on the "stocks are no good" theme, it is interesting to look at what the Superinvestors did during the long flat market period between 1965 and 1982.  I think the Dow hit 1,000 back then and didn't go above it for good until late 1982.

The talk now is that the U.S. may go down the path of Japan since 1989, or that the U.S. stock market is in a period of going nowhere for another decade like back in the late 1960s, 1970s in the U.S.

Also, there is so much risk out there that it is suggested that one shouldn't be invested in the stock market.

Should we just give up on stocks for now?

Well, you could have made a pretty persuasive case to stay out of stocks in the late 1960s too.  There was plenty to worry about.  Vietnam seemed to go on and on and it was much bigger than the recent Iraq wars.  Johnson was going to destroy the economy with government spending.  The U.S. and Russia were a single button away from total destruction.

In fact, a lot of the gloom and doom predictions of the late 60s / early 70s came true.  The U.S. had to get off the gold standard.  Bretton Woods was dead and the dollar crashed. Gold prices spiked. Oil prices went through the roof.  Inflation went into double digits as did interest rates.

Anyone who would have predicted that accurately would surely not have been invested in stocks since 1966, or certainly not since 1972.  If you went back to any investor and told them exactly what was going to happen over the next decade, most would have opted out of the stock market.  Can you imagine telling someone back in the late 1960s that the U.S. would delink the dollar from gold and all the major currencies would float freely, and that the then $2.00-3.00/barrel crude oil price will work it's way up to the $20-$40 range, and that inflation and interest rates would go up for many years?

It is a nightmare scenario that would surely put most investors in cash, gold or something other than stocks.

But back then, there was a small group of investors that ignored that stuff and kept their nose to the grindstone and did what they did best.  Did they blow up? 

The following investors are some of the Superinvestors from Buffett's 1984 essay "The Superinvestors of Graham and Doddsville".  It's one of the best things written about investing (so make sure read it here for free if you haven't already). 

These superinvestors are traditional value investors.  Nothing fancy.  No leverage, derivatives or long/short or anything like that at all.

If you told them of all the trouble in the years to come, they wouldn't have cared.  Luckily for them, they just kept doing what they are good at.  Here are their returns:

The Dow hit 1,000 back in 1965, and didn't break above it permanently until late 1982.  Until then, it got up to or slightly above 1,000 and then fell back again, for 17 years.

And in this market, notice how Schloss did.  Between 1966 and 1982, in a pretty flat market (excluding dividends), Schloss returned 21%/year. 

Tweedy Browne was also a hard core value shop and they earned +19%/year in the fifteen years between 1968 and 1982.

The Sequoia Fund gained +16%/year from 1969 through 1982. 

These are some pretty bull marketish figures.  Again, this was done in a pretty flat market with horrible fundamentals as stated above.  Just look at the years between 1966 and 1982 and think about what the newspaper headlines were like.  They were pretty dreadful.

The peak sometimes is marked as late 1972.  This was right before the market collapse, when the nifty-fifty party seemed to end.   The market went straight down into late 1974 after that.

Let's see how the above investors did after 1972.  Below are their returns for the ten-year period between 1972 and 1982:

                                   1972-1982 return
Schloss                       +27%/year
Tweedy Browne         +21%/year
Sequoia Fund             +16%/year

Again, these are some pretty incredible figures.  Very bull market-like in a completely flat market.  What's astonishing is that late 1972 was the end of a bull market of sorts, and 1982 marks the end of a bear market, so the end points are as unfavorable as can be (unlike mutual fund promotional literature that likes to start at 1982 for long term returns).

Did these guys buy into levered bear funds, oil ETF's and gold futures to generate these returns?  Nope.  They did it with plain old stock-picking and pretty much from the long side.

Perfect Hindsight?
Is this a case of perfect hindsight?  In a bad period, there will always be a few funds and people who did really well.  And these people tend to become stars.  Is that the case here?    I think not.

First of all, these investors are investors Buffett has known for a long time.  When Buffett closed his partnership in 1969 or so, he told his clients to put their money with Sequoia.  So Buffett knew early on that Sequoia was going to do well.

In fact, after the 1984 essay "Superinvestors of Graham and Doddsville" came out, the superinvestors continued to outperform the S&P 500 index. 

This is not a case of just cherry picking with perfect hindsight the lucky few who did well during bad times.

This is a testament to the approach more than anything else.

But we are not superinvestors!
When you show the above table to someone, they will go, oh yeah.  If you're a superinvestor, you'll be fine.  Sure.  But how many superinvestors are there? So I think I'll stick with my gold.

Well, in order for them to be successful with gold in the longer term, they will have to acquire George Soros-like sense of timing to get out of gold and into stocks at the right time.  How many people can do that?

Let's put it this way; the gloom and doomers in the 1970s were right, but how many of them have made money over the long term?

There are guys that were dead right on making macro calls but couldn't make any money at all (see this post: Perils of Trying to Time the Market).  I think that was probably true in the 1970s too.  There were probably some people who made tons of money for a while and then either gave it all back or suffered decades of subpar returns since then. 

The superinvestors, however, were probably wrong on their macro calls (or were agnostic) and have pretty much made good money every single year through the 1970s and since then.

So which is more important?  Getting the macro right and timing the market?  Or just picking the right stocks?   (Maybe the subject of another post is the complexity of macro-guessing and market timing; you have to get at least two things right:  The macro call AND the timing of the market.  If one or the other is wrong, your performance can suffer).

The market doesn't always go up
This is also not to be confused with the argument that the stock market always goes up, or that as long as you invest for the long haul, everything will be OK. 

The stock market does not always go up, as can be seen in the 1966-1982 flat period and the flatness we've had in the U.S. in the past decade.  Japan has been flat for a long time too. 

To say that investing in stocks is a good idea is not the same as to say that the stock market always goes up. 

Also, investing for the long term only works if you are invested in the right things.  People always point to Japan and the recent U.S. market as proof that buy-and-hold is dead.

Buy and hold is only good if you buy the right thing at a reasonable price.  If not, it doesn't matter how long you own something (Japanese stocks are a great example; subpar businesses for high prices is what kept the market flat for so long).

So don't get confused about that.  Some people equate "stock market is a good place to invest" with "the stock market always goes up".  So when they see evidence that the stock market always doesn't go up, they conclude that the stock market is NOT a good place to invest. 

This is the same with buy and hold.  There have been so many articles in the past few years about the fact that buying and holding is dead, but they all seem to miss the point.  Buy and hold is no good if you buy and hold something that is not a good investment.  If you own a great business and paid a good price for it, it's fine to hold it for the long term.

So again, people seem to equate "Buy and hold is a good strategy" with "The stock market is a good place to invest".  When they see evidence that buy and hold doesn't work too well, they conclude the stock market is not a good place to invest.

Even worse, they conclude that the only way to make money in the stock market is to trade, or day-trade it.  I don't even want to get into how much money is lost by people trying to trade in the stock market.

Let's not confuse these issues. 

Sometimes, the alternative is even worse than the disease (that people fear).  Don't forget, the housing bubble was partly fueled by the need to replace stocks as an investment vehicle.  They figured the stock market is no good (due to the 2000-2003 bear market) and figured housing prices will never go down (because it has never gone down), and that the Fed's pump priming will eventually fuel inflation which will push up housing prices even more.  It's a 'hard' asset, right?  I remember people screaming and yelling on TV that you can't sleep in an IBM stock certificate. 

(Now you have these silly Lind-Waldock (futures broker) commercials telling people to invest in commodity futures, because with commodities, you don't have to worry about corporate scandals and p/e ratios.   I kid you not.)

One other thing
Oh, and there's one other thing I noticed when I look at the table above.  A lot of people these days seem to think that the key to investment success is to buy stocks during panics and then get out when the market bounces back.

I remember reading about how people bought stocks in 2008 and early 2009 and then just sold out in mid-2009 saying that the market is no longer cheap.

If you look at the table above, you will notice that the superinvestors probably didn't do that. They probably owned stocks in 1970, 1971, 1972 etc... and they may have bought a bunch if they had cash in 1974 as the market bottomed out. But when the market came back in 1975/1976, you will see that their returns continue unabated, indicating that they didn't just buy in 1974 and then sell in 1975 or 1976. 

This is true for all of these investors.  Look carefully at the table and look at the Dow chart during this period below.

Dow Jones Industrial Average 1966 - 1982

So I don't think timing the market was the major contributor to the high returns.  To learn (or relearn) how these returns were achieved, read the "Superinvestors" essay.

Being distracted by overall market valuation and macro concerns, I think, are usually way more detrimental to investment performance than not.  (But you do have to pay close attention to valuations of stocks you own!)

No comments:

Post a Comment

Note: Only a member of this blog may post a comment.