Market prices for common stocks and bonds are at historically high levels in today’s market. This fact by itself is not important, at least to us. What is more important is that market prices relative to investment value are also at very high levels. All publically traded securities have an investment value and a speculative value. It is our job to attempt to separate these two elements, for both the price of each individual security and for the market in totality. Determining an investment value is easy. It is the speculative value that is near impossible to measure. Most of our attempts to do so have taught us a good lesson, and have thus influenced our approach to portfolio management.
A diversified portfolio of common stocks has a rich history of performance, both in preserving wealth and increasing it over a lifetime. This fact, plus our belief that it is impractical and impossible to determine future highs and lows of market prices, has led us to conclude that a portfolio for individual investors should always include some common stocks. Of course the weighting of common stocks in a portfolio is subject to each individual’s needs as well as their emotional ability to withstand large fluctuations in prices. In a non-restricted investment portfolio, the percentage of common stocks held should be adjusted downward when the degree of speculative value exceeds an estimate of investment value inherent in the current market price. This percentage should continue to decrease as the speculative value increases. I mentioned earlier that we learn the most from our mistakes, and I learned an important lesson many years ago: it is easier to buy and sell than to just sit tight.
In the story, Harwood, a broker, had given Mr. Partridge a tip to buy Climax Motors. Old Turkey had purchased 500 shares of Climax. Mr. Harwood, after a seven point rise in the market price, told Turkey to sell his shares. The rest of the story follows:
“My dear boy,” said old Partridge, in great distress—“my dear boy, if I sold that stock now I’d lose my position; and then where would I be?”
Elmer Harwood threw up his hands, shook his head and walked over to me to get sympathy: “Can you beat it?” he asked me in a stage whisper. “I ask you!”
I didn’t say anything. So he went on: “I give him a tip on Climax Motors. He buys 500 shares. He’s got seven points’ profit and I advise him to get out and buy ‘em back on the reaction that’s overdue even now. And what does he say when I tell him? He says that if he sells he’ll lose his job. What do you know about that?”
“I beg your pardon, Mr. Harwood; I didn’t say I’d lose my job,” cut in old Turkey. “I said I’d lose my position. And when you are as old as I am and you’ve been through as many booms and panics as I have, you’ll know that to lose your position is something nobody can afford; not even John D. Rockefeller. I hope the stock reacts and that you will be able to repurchase your line at a substantial concession, sir. But I myself can only trade in accordance with the experience of many years. I paid a high price for it and I don’t feel like throwing away a second tuition fee. But I am as much obliged to you as if I had the money in the bank. It’s a bull market, you know.” And he strutted away, leaving Elmer dazed.
And right here let me say one thing: After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight! ….That is why so many men in Wall Street, who are not at all in the sucker class, not even in the third grade, nevertheless lose money. The market does not beat them. They beat themselves, because though they have brains they cannot sit tight. Old Turkey was dead right in doing and saying what he did. He had not only the courage of his convictions but the intelligent patience to sit tight.
Currently, our research is telling us that from this price level, the return of the S&P 500 (SPY), including dividends, will be a little less than 6% annually for the next five years. This is our estimate of investment value as calculated today, not future market value. That value will be set by others, both speculators and investors. As you know, 6% total return is well below historical levels, including those of the last ten years, which produced a 7.25% return. A 6% return is enough to preserve wealth, but with a limited margin for error once we account for cost, taxes, and inflation. On the other hand, interest rates paid on US Treasury obligations and FDIC insured certificates today offer little hope in preserving wealth. Given that, we must “sit tight” and wait for the change that will surely come, reallocating portfolios when opportunities arise.
We were being good tourists, and had purchased day tickets for the on and off bus line. This not only gave us a tour of Nashville, but also allowed us to jump off and spend time walking around and visiting sites at our leisure. As you all know, it’s always five o’clock somewhere, and at one point we jumped off the bus directly in front of a local joint advertising itself as the original home of the Nashville Bushwacker. The Bushwacker is a drink that tastes like a milkshake but carries a great big punch. We would not be much of Nashville tourists if we did not sample this yummy drink.
But alas, it was only 11:00 AM Nashville time, and while not too early for a Bushwacker, lunch was calling us. We decided to go across the street to a little Mexican Restaurant. We were enjoying our meal with just a few others who had opted for an early lunch when in walks Billy Gibbons, the bearded musical great of ZZ Top.
Not being one to pass on an opportunity to visit with one of the creators of great music, we introduced ourselves and had a short conversation. He was kind enough to let me take a picture of him with one of his longtime fans, my wife.
Until next time,
Kendall J. Anderson, CFA