It may bother some of you to think that your portfolio manager also worries during the difficult times. However, I too am human, and also experience the fear that this time is different, and that the recent decline in market prices is more than just an irrational market. A brief reminder from my favorite psychologist of similar past situations renews my strength in combating these fears, and reminds me that I can rely on my experience and training in order to make difficult decisions. If you find yourself worried, please feel free to call us. Although we can’t provide you with the same level of comfort that a professional psychologist can, we just might be able to ease your mind a little regarding your portfolio, and let you know why we are not concerned with the recent decline.
Other than relying on my experience and help from the home front, I also find it useful to reconnect with one or two of my mentors. I consider Sir John Templeton a mentor even though we never met in person. He gave me a few words of encouragement many years ago when I took the step to leave the safety of the brokerage industry and pursue investment management. My “training” came from the many interviews he gave over the years, including one with William Proctor, the author of The Templeton Touch. We will share Proctor’s list of traits that he believed made Sir John great in a moment, but first I’d like to discuss the recent market decline a bit further.
A Month of Declines
During August, the Dow Jones Industrial Average declined more in a single month than it has in years. That it took just one week to decline more than 10% was a shock. Most declines of 10% or more take much longer. I remember reading somewhere that there have been over 90 times where the market has fallen 10% or more since the great depression of the thirties. Even if this memory is far from fact, it has been enough times in my years as a professional that it surely feels true. I received a little help from Morningstar in seeing just how often during my decades of investment management the market has actually fallen 10% or more in five trading days. Low and behold, it has only happened six times.
Dow Jones Industrial Average - Five Day Losses of 10% or More Since 1976
Will this year’s decline take months or years to recover? Although no one knows for sure, I would say it will more than likely be months. Virtually all bear markets, with declines of more than 20% from peak to trough for an extended period of time, are the result of recessions. During a recession, cash flows decline, asset values decline, and common stock prices react accordingly to these lower business values. The current economic environment does not indicate a recession, let alone a world-wide depression. The US is showing strong growth, with last quarter’s reported GDP a positive 3.7%. The unemployment rate is low, and the underemployed rate is dropping compared to the last few years. Personal income is growing at a slow rate, but it is growing. The worries about China, in our opinion, are overblown. China’s GDP may not be growing at the same pace as a few years ago, but it is still growing.
Economists talk a great deal about “real growth,” which is growth after inflation. Average individuals, however, are more concerned with nominal growth. The nominal growth in the US has resulted in the highest GDP and per capita GDP of all time. It doesn’t seem as if a recession is on the horizon. Without a recession, common stock prices should recover as they have in the past. Time will tell.
Sir John Templeton
Most of you know that I am a great fan of Sir John. Recognized as one of the greatest mutual fund managers of the last hundred years, I first discovered his wisdom shortly after I entered the business of investment advice. His name surfaced during my self-directed research into the wisdom of Benjamin Graham and value investing. Sir John was a student of Graham. Although his investment approach differed from Graham’s, he shared the universal belief of all value investors that market prices vary from business value. While Sir John provided insight into security selection, it was how he lived his life and shared his beliefs with others that I believe made him a great individual and a great investor.
In The Templeton Touch, William Proctor shared fourteen character traits that he believed were John Templeton’s reasons for success as an investment manager:
- Reasonable risk-taking
- A sense of stewardship
- A drive toward diversity
- A bargain-hunting mentality
- A broad social and political awareness
- A willingness to devote large quantities of time to studying potential investments and developing sound moneymaking strategies
- An ability to “retreat” periodically from daily pressures
- An ability to develop an extensive friendship network
- Thought control
- Positive thinking
I want to share my own thoughts on two of these traits. First, stewardship, as there is an attempt by the Department of Labor to somehow legally enforce it upon the investment industry, and second, a bargain-hunting mentality.
The Department of Labor (DOL) has recently proposed a change in the way brokers, insurance agents, and investment advisors serve their clients. The DOL, along with the current administration, is under the belief that the financial service industry’s sales practices, products, and costs are harming individual investors. Although I am in agreement with many of their claims, I do not think that imposing a series of new rules and regulations will result in achieving a better retirement for the citizens of this country. It will take more than a forced fiduciary rule to accomplish that. Even with rules, there will always be individuals who lack any sense of stewardship towards their clients. For those few, the only reason to be in the business of advice will be to create personal wealth for themselves. Individuals will always need to keep their guard up when it comes to investment advice.
We believe it is a great privilege to have been entrusted with the management of your savings. We have a great respect for what those savings represent, and we hope that our work rewards you with preservation of capital and, more importantly, preservation of wealth. Although we work towards that goal, there is no assurance that it will happen. Years ago one of our clients decided his investment returns would be substantially better with another advisor. I am not sure if his results were what he expected, but some years later he decided to re-employ us. He told us this was because we always did what we said we would do and, in his words, “always told the truth, good or bad.” I can pledge to you that this will continue in the future, with or without a new series of rules placed on us by the powers that be.
Over the past year we have mentioned more than once that we believe prices for common stocks have not been cheap. They were not overly expensive, but still not cheap enough for us to fully invest your accounts. Because of our belief in buying great companies at low prices, we have held far more cash in our portfolios than we have at any other time in the past ten years. This current decline in prices has given us an opportunity to seek out bargains. Many companies have declined far more than the general level of prices. It is these companies that we are spending extra time analyzing. We have found one or two that meet our requirements which you will notice on your statement. We hope that over the next month or two a few more bargains will be made available for purchase.
Until next time,
Kendall J. Anderson, CFA