As the economy has rallied from the March lows, analysts have become increasingly bullish and investment managers have been growing greedier by the day for every last point on the S&P 500. Unfortunately, many of these people have forgotten one of the key tenets of asset management – Capital Preservation. I will illustrate this point with a simple graph and some sage words of wisdom from legendary investor, Warren Buffett.
“You only have to do a very few things right in your life so long as you don’t do too many things wrong.” – Warren BuffettMr. Buffett must have had this graph in mind when he said that but you don’t need a chart to know that bigger losses mean longer required periods of time to break even. What is interesting though, is that the relationship between losses and years to recover is not linear. This means that each percent of lost money requires an even greater percent gain to get back to even. You can see this effect at work on our portfolio performance as well. We have outperformed substantially on the downside so that we are not forced to take on too much risk by investing aggressively on the upside. This bring us to the next point.
“Be fearful when others are greedy and be greedy only when others are fearful.” – Warren E. Buffett
At the peak of market excess in 2007, we began pulling client money out of equity markets and putting it into fixed income and high yielding stocks. We felt that overall economic fundamentals were deteriorating and took pause with how investors were scrambling into the riskiest stocks to get out sized returns but with no regard for the downside potential. In other words, the entire market was pricing in only the rosiest of potential outcomes which left little room on the table for additional gains.
Market pundits are now saying that the recession is over for good and that we are in a new bull market. While this is possible, we remain somewhat skeptical because once again, analysts are pricing in increasingly rosy forcasts and investors are rushing to ‘catch the rally’ with little regard to what could happen if the forecasts don’t come true.
We remain well positioned for a wide range of market outcomes and we will continue to closely monitor the markets and make adjustments to our strategy as new information emerges and the situation evolves.
All the best,