1973-1974 - Why was it so bad?

[BG2008]

In Buffet's Superinvestors of Graham-and-Doddsville, I've noticed that many value investors got "slaughtered" in 1973-1974.  The S&P was down 14.8% in 1973 and 26.4% in 1974.  Walter Schloss was down 8.0 and 6.2% respectively, Tweedy Browne gained 7.5 and 1.5, Sequoia was -24 and -15.7, Munger was -31.9% and 31.5%, Pacific Partners (Rick Guerin) was down 42.1 and 34.4, Perlmeter Investments was down 28.1 and 12.0, Berkshires Book Value grew 4.7% and 5.5%. 

 

1)  I'm trying to figure out, why was 1973-1974 so bad?  I've spoken to someone who was an investor during that time period and he mentioned high inflation, tough economic environments in general, and oil prices that in essence increased by 10X due to the embargo.  Can anyone comment on why that was a perfect storm of a sort. 

 

2)  I can understand why Pacific Partner was down so much, due to the fund's use of leverage.  But why was Munger down so much?  Munger is universally beloved.  But, I'm not sure if being down 53% in 2 yeas is acceptable as a value investor.

 

3)  How did Berkshire manage to increase book value during this time period?

 

4) Does anyone have access to the old investors letters of the funds mentioned in Superinvestors of Grahams and Doddsville 

[twacowfca]

In Buffet's Superinvestors of Graham-and-Doddsville, I've noticed that many value investors got "slaughtered" in 1973-1974.  The S&P was down 14.8% in 1973 and 26.4% in 1974.  Walter Schloss was down 8.0 and 6.2% respectively, Tweedy Browne gained 7.5 and 1.5, Sequoia was -24 and -15.7, Munger was -31.9% and 31.5%, Pacific Partners (Rick Guerin) was down 42.1 and 34.4, Perlmeter Investments was down 28.1 and 12.0, Berkshires Book Value grew 4.7% and 5.5%. 

 

1)  I'm trying to figure out, why was 1973-1974 so bad?  I've spoken to someone who was an investor during that time period and he mentioned high inflation, tough economic environments in general, and oil prices that in essence increased by 10X due to the embargo.  Can anyone comment on why that was a perfect storm of a sort. 

 

2)  I can understand why Pacific Partner was down so much, due to the fund's use of leverage.  But why was Munger down so much?  Munger is universally beloved.  But, I'm not sure if being down 53% in 2 yeas is acceptable as a value investor.

 

3)  How did Berkshire manage to increase book value during this time period?

 

4) Does anyone have access to the old investors letters of the funds mentioned in Superinvestors of Grahams and Doddsville

 

 

Guerin was down so much because he was levered.  Munger was also levered at times, but he may not have been as subject to margin calls as others because he was a member of the Pacific Stock Exchange.  BRK didn't have to mark it's portfolio to market, and the portfolio recovered substantially by the end of 1974.

 

1973 1974 was a perfect storm of negative factors.

 

[ap1234]

BG2008, I wasn’t investing in the early 1970s so I can’t comment on the other points. But here are my quick thoughts on your point # 2 re: Munger’s performance.

 

1. Everyone has a different definition of value investing. My version of value investing is focusing on avoiding permanent impairment of capital (not even at the individual stock level but on the portfolio level). I don’t spend anytime thinking about avoiding volatility but I spend a lot of time thinking about margin of safety. Your reference to Munger's 50%+ drop in ‘market’ prices is a question of high volatility not high risk. 

 

It is true that some value managers tend to perform very well in down markets (ex. Buffett or Klarman). Other value managers tend to perform poorly in down markets (ex. Chou or Pabrai). It’s not as simple as saying one type of value investor is more authentic than the other. All four of the managers above are value investors. All of them believe in having a margin of safety. But some approaches lend themselves better to low volatility than others.

 

2. Munger has actually specifically addressed your comment in a BBC interview in October 2009.

 

Q: How worried are you by the declines of the share price of Berkshire Hathway?

 

Munger: "This is the third time Warren and I have seen our holdings in Berkshire Hathway go down, top tick to bottom tick, by 50%.  I think it’s in the nature of long term shareholding of the normal vicissitudes, of worldly outcomes, of markets that the long-term holder has his quoted value of his stocks go down by say 50%.  In fact you can argue that if you’re not willing to react with equanimity to a market price decline of 50% two or three times a century you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get compared to the people who do have the temperament, who can be more philosophical about these market fluctuations.”

 

[Cardboard]

Some additional reasons:

 

Watergate and the resignation of a President.

 

Yom Kippur war and risk of potential escalation during the cold war.

 

And of course, high priced stocks or nifty-fifty to begin with.

 

Cardboard

[jberkshire01]

I think high valuations (largely because of Nifty Fifty thinking) and high inflation expectations were two big culprits. Sequoia specially pointed those things out in the attached letter (from April 1974).

Sequoia_Fund_-_April_1_1974_letter.pdf

[Vish_ram]

The fed was also confused. you had high inflation due to oil shock, fed increased rates. Then economy tanked, Fed dropped the rates. All this happened in a span of 1-2 years.

 

[BG2008]

BG2008, I wasn’t investing in the early 1970s so I can’t comment on the other points. But here are my quick thoughts on your point # 2 re: Munger’s performance.

 

1. Everyone has a different definition of value investing. My version of value investing is focusing on avoiding permanent impairment of capital (not even at the individual stock level but on the portfolio level). I don’t spend anytime thinking about avoiding volatility but I spend a lot of time thinking about margin of safety. Your reference to Munger's 50%+ drop in ‘market’ prices is a question of high volatility not high risk. 

 

It is true that some value managers tend to perform very well in down markets (ex. Buffett or Klarman). Other value managers tend to perform poorly in down markets (ex. Chou or Pabrai). It’s not as simple as saying one type of value investor is more authentic than the other. All four of the managers above are value investors. All of them believe in having a margin of safety. But some approaches lend themselves better to low volatility than others.

 

2. Munger has actually specifically addressed your comment in a BBC interview in October 2009.

 

Q: How worried are you by the declines of the share price of Berkshire Hathway?

 

Munger: "This is the third time Warren and I have seen our holdings in Berkshire Hathway go down, top tick to bottom tick, by 50%.  I think it’s in the nature of long term shareholding of the normal vicissitudes, of worldly outcomes, of markets that the long-term holder has his quoted value of his stocks go down by say 50%.  In fact you can argue that if you’re not willing to react with equanimity to a market price decline of 50% two or three times a century you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get compared to the people who do have the temperament, who can be more philosophical about these market fluctuations.”

 

I agree with most of what you said.  But there is an opportunity risk associated with being down a lot even if none of your positions suffered permanent impairment.  For example, if you were down 50-60%, you're stuck with those positions as you do not want to liquidate them during the worst condition.  My issue is that people put themselves in a position where they have no liquidity/cash to invest when the market is awash with bargains.  Berkshire's float and operating companies generate cash that can produce 10% capital to reallocate into very depressed opportunities at the right time.  If you're managing a fund, you do not have the luxury of deploying operating cashflow toward investments.  Hence, there needs to be some sort of liquidity generator that will pay out during distressed times.  I believe that allocating capital towards cash, workouts, bonds etc also means there's less to allocate towards generals.  This forces you to focus on your better general ideas. 

 

 

[Guest wellmont]

look at the sequx holdings at the time...I believe they would do things somewhat differently now. I think they are much more a great business at a fair price type of shop now than they were then. but I imagine some of those industrials were incredibly cheap in early 1974. And they were about fully invested, which is exceedingly rare for them. they never got close to being fully invested in the 2008 denouement, which in hindsight was a mistake. this leads me to believe that Sequoia expected a kind of elongated 1973/1974 style malaise which of course never happened.

[dowfin1]

Here are more excerpts from Sequoia letters that provide contemporaneous explanations.

Sequoia_1973-74_letters_excerpts_WSJ_5-7-01.pdf

[dcollon]

dowfin1,

 

Thanks for posting the article from the WSJ.  Very interesting snapshot.

 

[fareastwarriors]

Here are more excerpts from Sequoia letters that provide contemporaneous explanations.

 

That was a gem. Thanks for sharing.

[matjone]

I wonder what Tweedy was holding prior to the crash?  Did they have a lot of cash?

[Liberty]

Here are more excerpts from Sequoia letters that provide contemporaneous explanations.

 

Thank you for posting, that was great!

[Kiltacular]

look at the sequx holdings at the time...I believe they would do things somewhat differently now. I think they are much more a great business at a fair price type of shop now than they were then. but I imagine some of those industrials were incredibly cheap in early 1974. And they were about fully invested, which is exceedingly rare for them. they never got close to being fully invested in the 2008 denouement, which in hindsight was a mistake. this leads me to believe that Sequoia expected a kind of elongated 1973/1974 style malaise which of course never happened.

 

I remember reading -- a long time ago now -- Bill Ruane saying that they waited ever after that period for another big correction and it never came.  I always remember that.  It is very difficult to get the timing right and it is human nature to fight the last war.

 

It's interesting to pull up an annual letter for Berkshire -- the most recent one will do -- to see just how incredibly the S&P 500 performed after 1974.  From the beginning of 1975 to the end of 1999, the S&P 500 (with divies) had just three down years.  -7.4% in 1977; -5% in 1981 and -3% in 1990.  All the other years were positive and many of them were simply huge up years (13 years where S&P did over 20%).  If you were a manager and vowed never to get caught in a '73-'74 episode again, your entire career passed you by while you waited for the big crash to happen again.  One can see where the advice from some of the greats is to buy good investments when they come along and not worry about volatility...I suspect convincing your investors of same is a more difficult task!

 

Good thread