My pal Doug Kass called a “generational bottom” in stock prices in March 2009, and he was right, and the market has soared. In September 2009, Doug called a top. He said that share prices were too high relative to fundamental economic trends, and he did not feel that the recovery was organic nor could it be sustainable long-term. I think he was right once again, but share prices have continued their ascent. Doug got the fundamentals right but the market hasn’t followed. This is not an uncommon experience for investors. John Maynard Keynes explained that, “markets can remain irrational far longer than you or I can remain solvent.”
Enter the supreme importance of having and adhering to a clear, well-articulated investment discipline. Having a proprietary definition of what constitutes value, your personal metrics for assessing risk, and the resolve to dispassionately measure your investments according to your rigorous guidelines will benefit returns more than anything else. Doug has continued to do well in spite of the market’s lack of cooperation since September. His discipline wrought a more defensive posture to his portfolio. Sometimes your portfolio, while adhering to your investment discipline, can be out of step with short-term market activity and momentum. During these out -of-sync periods, it is toughest and most critical to dispassionately adhere to your discipline.
We have agreed with Doug Kass for a long time. Our portfolios have benefited, moreover we are very satisfied with our defensive posture. Gray hair is worth a lot in our business. The experience and wisdom to know what you don’t know is invaluable.
Our first quarter returns were quite positive, but we continue to expect trouble ahead. The economy to date has had a nearly flawless recovery, and markets expect that this will continue well into the future. Trillions of taxpayers’ dollars have revived an economy that was in extremis, but we do not have evidence that the current stasis is sustainable. Maybe the Goldilocks scenario of everything being just right will continue. Greece is evidence that stuff happens. Greece is facing the real possibility of default if they are unable to refinance billions of dollars of bonds. Consequences, predictable and unpredictable, will ripple across the global economic and financial fabric.
Farr, Miller & Washington’s discipline as a “growth” manager ironically hinges on valuation. Strong balance sheets and cash flow are the genesis of our investment process. This focus offers certain protection to client’s principal, and begets more of a ‘get rich slowly’ approach. We will always sacrifice opportunity rather than sacrifice principal. Downside protection is the key to our process and helps clients sleep at night. Because we don’t know if the economic recovery will continue without flaw (which would mean that the unabated rise in share prices was warranted) or if indeed there will be setbacks that cause a step backwards in prices, we remain invested in such a way that hopes to participate in an ongoing climb and protect from potential declines. Going up when markets go up and not going down as much when they go down is every investor’s ideal. We hope we are well positioned. We have no idea how the short-term will evolve. So we adhere doggedly to our proven investment discipline. If our approach doesn’t suit your individual profile, that’s not a problem. But, have a discipline and stick with it.
Hang in there.