The Wild Circus of Lunacy
The following commentary was originally posted on FoolFunds.com, the website of Motley Fool Asset Management, LLC, on Feb. 19. With permission, we're reproducing it here in its original form.
Value investing ultimately wins, but in the process it passes through a wild circus of lunacy.
-- Ron Suskind
January 2013 has gone down in the books as having the highest levels of inflows into U.S. equity mutual funds since March 2000, the dying days of the dot-com bubble. The week ended Jan. 11 alone saw net inflows into funds of $8.9 billion -- the fourth-largest amount ever recorded, according to B of A Merrill Lynch Global Investment Strategy, EPFR Global, and Lipper FMI. This, of course, came right on the heels of the legislative agreement to avoid the fiscal cliff that solved the most recent in a too-long series of macroeconomic crises that threatened the global economy.
Well, consider us saved -- at least for a few months.
Take a look at that opening paragraph again and consider the implications. The last time so much money came pouring into stocks (using stock mutual funds as a reasonable proxy), valuations were really, really high. About that time, Warren Buffett said stocks were so richly priced that he expected the overall market returns for the decade to be in the low single digits. For this, and for his unwillingness to buy into the "New Economy" companies, Buffett was derided as having lost his touch. The scoreboard suggests otherwise.
It's my observation that intelligence and analytical firepower are less important for long-term investing success than simply having the confidence to invest when others are fearful. Those who bought in March 2000 have, on average, suffered more than a decade's worth of negative returns. Because so much of that money went into tech stocks, the market averages in some ways fail to convey just how costly following the general consensus has been for those who thought that Pets.com, eToys.com, and the like were sure bets.
In the past five years, the market has pounded out a consistent drumbeat. We have seen what may truly have been once-in-a-lifetime bargains in many stocks, while trillions of investing dollars have fled to the "safety" of bonds and near-zero-yielding Treasuries. Yet now, with the S&P 500 at its highest point since late 2007 and well more than double its March 2009 lows, funds come pouring back in? Fear and greed are real, and left unchecked, they can be extremely costly. It is no coincidence that most mutual-fund investors tend to generate returns well below those of the very funds they've invested in.
So you're saying I should sell everything?
That disparity is one reason we take such a full-contact approach to communicating with our members. We want you to know what we're thinking, in the hope that, at the margins, we can help people take a more even-keeled approach to the market's inevitable rises and falls. I say "hope" because whether we're succeeding or not is almost impossible to measure. That said, at a time when there have been massive outflows from mutual funds, it's my observation that there have been fairly consistent inflows into Fool Funds. And, at least as measured by our daily investment reports, our shareholders show a low propensity for panicking. For this I salute you.
It's also true that in the time we've been in operation, the markets have generally been in "fear" mode as we have strode from one crisis to the next. While many markets are far more expensive than they've been in years -- and, almost by definition, offer less opportunity -- the more interesting question becomes what will happen to all of those trillions that have been stashed away in the fear trades, most notably in gold and Treasuries. Many Wall Street strategists expect that 2013 will be the start of a "great rotation" out of bonds and into equities as the evidence of equities' superior yields and returns over the past four years finally becomes too painful to ignore.
Does this mean that stocks will go straight up from here? Heavens, no. It's also not what we're paying attention to as we make our own investing decisions. But it does show, once again, that fear and greed are deeply complicit in investors' extremely costly investing decisions.
Roger Friedman is one of my favorite people working at The Motley Fool. You probably haven't heard of Roger (unless you were an enormous Who Wants to Be a Millionaire fan back in the day), but he runs the Fool's blogger network. Roger is great to be around, not because he's a particularly cheerful type, but because he is extremely entertaining -- especially when he is exasperated by something. As a result, it has become sport among many of us to attempt to exasperate Roger.
A few years ago, I was driving into the parking garage at Fool Global HQ, and I noticed Roger walking toward the elevator, facing away from me. When I got about 15 feet behind him, I blared my horn, causing him to jump and spin around in absolute horror.
And then the horror was mine -- for the person whom I'd nearly scared to death was not Roger, but rather some innocent yet increasingly angry person who kinda looked like Roger. I rolled down my window, lamely said, "Uh, sorry, I thought you were someone else," and kept going.
Now, who among us has not at one time or another confused someone for another person? It happens. My bigger mistake was to take a fairly risky approach of "greeting" Roger before I was certain it was he. This action compounded what would have otherwise been a small mistake. I was "all in" on believing that person was Roger, and it wasn't. I was fortunate that the person I had scared didn't track down my car and do very bad things to it. In investing, we make decisions all the time based on incomplete information, as most of a company's value tends to be based on things that have not yet happened.
The real mistake is making a large bet on a bad analysis. It has happened with us in the past -- we underestimated the damage that Telefonica's European operations would suffer, for example, and compounded our mistake by making the stock a fairly large position in one of our portfolios. We had Telefonica placed much higher on our "awesomeness continuum" than it deserved to be, and it cost us. (Read more about the awesomeness continuum here.)
Here's the thing about mistakes: They are valuable. At least, they can be. Our foray into Telefonica cost us some money (just as my mistake in blaring my horn at someone left me at a higher-than-average risk of getting my car keyed). We are not going to be perfect investors. No one is. But we have taken some real lessons from Telefonica, and we have, in fact, created a culture at Fool Funds in which it is OK for our analysts to make mistakes. The truth, in many occasions, hides just behind those mistakes. If you create an environment where mistakes are not tolerated, you're essentially creating an environment where the truth isn't tolerated, either.
The fallen star of Dell
Just as the month was ending, rumors swirled about computer hardware giant Dell that its managers, led by founder Michael Dell, were thinking of taking the company private. [Note: A $24 billion deal had been announced by the time we published this letter.] If so, this is a somewhat sad denouement for a company. It may seem bizarre today, but at one time Dell, with its revolutionary direct-shipping business model, so dominated the personal-computer industry that it could push around suppliers at will. In 2006, Dell's announcement that it would begin installing AMD chips in its computers sent shock waves across the industry, leading to questions about the staying power of AMD's rival, Intel.
Dell long ago lost its edge to more forward-thinking companies, in particular Apple. But to hear managers and analysts tell it, getting Dell out of the klieg lights of the Wall Street quarterly-numbers game is a key determinant of its potential for future success. Put another way, it's those outside shareholders and their short-term focus that are holding Dell back from recapturing greatness.
As Sherman Potter might have said: "Mule muffins!"
We believe that corporate behavior patterns determine what kinds of investors a company attracts. Managers all seem to want long-term shareholders who focus more on business performance and less on quarterly numbers, but many sure don't act like it. By giving guidance, by playing the game of "guide and beat," and by making corporate decisions aimed at making shareholders happy, rather than serving the best interests of the business, they get shareholders who focus on the same thing.
Strong management teams -- like the ones at Berkshire Hathaway, Loews, Innophos, Shimano, and Markel -- force Wall Street to deal with them on their own terms. This process is a signal to the types of investors that every company on Earth claims to want. Why other companies don't, or can't, do this is beyond me. Companies get the shareholders they deserve. Maybe Dell will be a better private company than it was a public one, but Dell's weakness isn't in its corporate structure; it's in its corporate culture. And that's not changing.
Editor's note: Bill Mann is not able to engage in discussion on the boards or in the comments section below. Bill owns shares of Berkshire Hathaway.
The Motley Fool owns shares of Berkshire Hathaway, Apple, Loews, and Intel. Motley Fool newsletter services have recommended buying shares of Markel, Intel, Loews, Innophos Holdings, Apple, and Berkshire Hathaway. Motley Fool newsletter services have recommended creating a covered bull call spread position in Apple. The Motley Fool has a disclosure policy.
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