A Rising Tide Lifts All Ships!

[txitxo]

WHY IS IT TIMING? ? ? ? ? ? ?

 

Buffett liquidated in 1969/1970 bc he could not find bargains - in other words, the risk/reward was poor - yet the market didn't tank until 1972-1974. Do you honestly think he was timing?

 

If you change your exposure to stocks/cash depending on the overall level of the market, valuation or other indicators, it is timing. If you cannot find anything to invest which meets your standards, well then it is obviously not. And by the way, the fraction of bargains in the market is actually a mildly useful timing indicator. 

[onyx1]

From 1997:

 

 

 

Thanks for posting!  This was just about the time I remember listening to plumbers and painters argue about the merits of EMC vs Cisco vs. Microsoft.  Optimism run amok.  But what happened to the Dow after this was filmed?  In 4 years it doubled.

[txitxo]

txitxo appears to have developed an incredible tool for assessing the risk/reward equation of the market by looking at the "junkiness" of the market. Why gum up the model's conclusions worrying about "when" the market will decline?

 

If you've done wonderful analysis on BAC and it's worth $20 but currently sells for $12, why should I care "when" it will reach $20?

 

If BAC is at $20, i.e. fair value, and I sell it b/c I want to buy it back with better upside and a more favorable risk/reward equation, why should I care "when" it declines to a more favorable level?

 

Bmichaud, actually how long BAC takes to go from $12 to $20 makes a big difference in your return. If it takes 5 years to get there, you make 10.7% per year. If it takes 2 years, then you make 29% per year. That's why stock screens which include mild momentum indicators do better than those which don't. The absolute gain may be smaller if you buy at 52-w highs than at 52-w lows, but it comes about much faster.

 

  Regarding timing indicators, I think I've found a very good one, but I don't dare to use it to play at being in/out of the market. It makes lots of sense (it measures optimism in a quantitative way) and the previous two signals were spot-on but how can I be sure it will work now? The study that Plan Maestro has posted (thanks, extremely interesting stuff) shows timing to be a losing strategy in the long term. I've done many simulations, with all the possible timing systems I could find which show the same. You can reduce volatility, but you cannot increase returns significantly. At least I don't know how to do it, perhaps there is some black box somewhere at Medallion's or GS which manages to do it successfully.

 

  What you can do is use those timing indicators, which are always probabilistic, to choose which market you are invested in. Europe looks very bad right now from the macro point of view, and because of that stocks are statistically very cheap. So I am fully invested in Europe except for 20% in FFH.

 

[Kraven]

From 1997:

 

 

Thanks for posting.  Fascinating stuff.  Brings back a lot of memories.  I laughed when they showed the ubiquitous Kaufmann Fund ad "Tough Guys Finish First" with the 2 of them standing there with sunglasses on. 

[mcliu]

If someone thinks that BAC's intrinsic value is as low as $20

 

Was merely illustrative. If it's worth $40 and you sell it at $40 waiting for it to get back down to $20, that's not timing....which was my point.

 

I think we all agree on the micro on this point; the issue is applying it to macro (at least if I understand what you are talking about well enough).  From my point of view, it is hard enough to figure out IV for an individual company--attempting to know IV on a market level seems very hard, and I certainly don't think I could profit from my own market calls very well (e.g., you can be wrong for a long time before the market corrects).  If your system works at a macro level, then I'm glad for you!  (As a side question, haven't you been concerned at the macro level for more than a year at this point?  Did this cost you gains in the short term that you are hoping to recoup if/when a market correction happens?  Basically, is your system yielding you more gains than you otherwise would have?)

 

As to calling it "timing", I think that just comes from a heavy skepticism about whether such macro calling systems are reliable and/or profitable.  Micro calls are tricky enough as it is.  My attraction to value investing is its simplicity in concept--making macro judgements takes me well out of the simple concept and into areas where we can be easily fooled by trends/models/etc., at least in my opinion.

 

Awesome response, seriously. Yes I effed up early last year. Fortunately, I reversed course quite quickly and learned from it. In a nutshell, I was purely looking at the broad market valuation and concluded the risk/reward was highly unfavorable. What I did not take into account was sentiment (of various forms....). So the overall risk/reward was not in my favor - valuation was, but everyone was so negative that there were only buyers remaining in the short-run. So now I look at both.... Lesson learned - sentiment rules in the short-run....

 

For example, sentiment became extremely negative after the election. And even though valuations still weren't favorable, I was loading up in order to take advantage of the extreme pessimism.

 

Right now every single aspect is lining up in favor of being defensive (extremely?)...

 

1. valuations suck - GMO is projecting less than 3% per annum over next seven years

2. optimism is at absurd levels

3. Citi Economic Surprise index is plummeting - i.e. the market is highly susceptible to downside surprise at the moment.....

 

Not saying BAC and AIG are not cheap long-term....I just think things are lining up for a very ugly sell-off that will provide many more opportunities in aggregate that will supercede whatever is available right now.

 

Don't you think there's a certain speculative component when you make the comment that things are lining up for a "sell-off" that may or may not come?

 

I guess you really should take a probabilistic view on if/when/magnitude of a downturn, and the expected returns between now and then.

[LC]

 

 

Thanks for posting.  Fascinating stuff.  Brings back a lot of memories.  I laughed when they showed the ubiquitous Kaufmann Fund ad "Tough Guys Finish First" with the 2 of them standing there with sunglasses on.

I did a double take on that too! Back when Larry Auriana had some hair!

[PlanMaestro]

Thanks for posting!  This was just about the time I remember listening to plumbers and painters argue about the merits of EMC vs Cisco vs. Microsoft.  Optimism run amok.  But what happened to the Dow after this was filmed?  In 4 years it doubled.

 

Hey, you are right onyx. And let's not forget that many large caps were cheap in 1997-2000, like Berkshire Hathaway, because most were distracted by these new economy stocks.

[Christopher1]

From J. M. Keynes "Memorandum for the Estates Committe, King's College, Cambridge, 8 May 1938":

'In fact the chief lesson I draw from the above results is the opposite of what I set out to show when, what is now nearly 20 years ago, I first persuaded the College to invest in ordinary shares. At that time I believed that profit could be made by what was called a credit cycle policy, namely by holding such shares in slumps and disposing of them in booms...Since that time there may have been more numerous and more violent general fluctuations than in any previous period. We have indeed done well by purchasing particular shares at times when their prices were greatly depressed; but we have not proved able to take much advantage of a general systematic movement out of and into ordinary shares as a whole at different phases of the trade cycle.'

[Kraven]

 

 

Thanks for posting.  Fascinating stuff.  Brings back a lot of memories.  I laughed when they showed the ubiquitous Kaufmann Fund ad "Tough Guys Finish First" with the 2 of them standing there with sunglasses on.

I did a double take on that too! Back when Larry Auriana had some hair!

 

Exactly.  There are so many things in here that are great.  The whole Iomega craze from Motley Fool.  I remember all anyone wanted to talk about was their zip drive or whatever it was called.  What was it, the "Jazz" or something?  People standing in the lobbies of brokerages just watching the ticker symbols go by.  Of course the more things change, the more they stay the same.

[boilermaker75]

 

 

Thanks for posting.  Fascinating stuff.  Brings back a lot of memories.  I laughed when they showed the ubiquitous Kaufmann Fund ad "Tough Guys Finish First" with the 2 of them standing there with sunglasses on.

I did a double take on that too! Back when Larry Auriana had some hair!

 

Exactly.  There are so many things in here that are great.  The whole Iomega craze from Motley Fool.  I remember all anyone wanted to talk about was their zip drive or whatever it was called.  What was it, the "Jazz" or something?  People standing in the lobbies of brokerages just watching the ticker symbols go by.  Of course the more things change, the more they stay the same.

 

That period led to some entertaining commercials,

 

 

[writser]

2. optimism is at absurd levels

 

I'm not so sure about this. Maybe it is because I am from Europe, but afaik most people are highly sceptical about the stock market. All I hear (on tv, in the grocery store, whatever) are stories about the US deficit, the China slowdown, the Eurozone breakup, currency devaluations, the terrible housing market and unemployment rates. People do not trust any financial institution or government and prefer to keep all their money in their savings account. I work in the financial sector but most people I know there are not invested themselves in the stock market. There are a few niches in the market in which optimism reigns (cloud computing, 3d printing, social networking) but overall the market is pretty pessimistic I'd say.

 

Of course this is just a gut feeling and I cannot quantify this, so any data would be appreciated.

 

Also, there might be a significant difference between Europe and the US of A.

[Palantir]

^ I agree with writser. Don't see much optimism or reason for it. Even when the market goes up, the bears say, "It will be coming down soon....irrational exuberance".

 

I think in their zeal to be contrarians, many bears are really herding together. (Like hipsters  ;D).

[bmichaud]

I'm not at a computer right now, but if you go to the "how much are you allocated to cash" thread, I posted some sentiment charts.

 

Investor allocations and sentiment levels in the US do not at all reflect pessimism. The bull case is stocks are cheap relative to bonds and the only possible thing to hold in this environment...

 

 

[hyten1]

another interesting article related to great depression and stock market

 

http://www.nytimes.com/2009/04/26/your-money/stocks-and-bonds/26stra.html?_r=1&

[txitxo]

I understand his point of view, and I think he understands mine. I judge both of them to be valid, they are just different.  :)

giofranchi

 

 

Thanks, Gio. Yes, it is obvious, from an empirical point of view, that there are several strategies or styles, all loosely based on value, which work. Cigar butts, which is basically what I do, with a few added twists, can be reproduced mechanically for statistically literate and disciplined retail investors. However buying large quality companies with moats, a la Buffett...that's an art. There are people who have tried to code that, of course, but getting Buffett's numbers with companies of that market size...I don't think you can do that with a formula, too many intangibles there. 

 

So those of us who are not artists have to hire one. If I had to forego mechanical investing I would be perfectly comfortable putting 100% of my money on something close to your selection of owner-managers. The main difference is that I would not short nor hold cash (because I am convinced that they hurt long term performance) and I would be more diversified geographically, investing in value-oriented mutual funds if I cannot find owner-managers.  Then I would just rebalance the portfolio once in a while using P/B as a guide, nothing fancy, basically trying to avoid extreme situations. With such a portfolio I would sleep very well at night and be absolutely sure of beating the market 10 years from now, come what may. 

 

 

[giofranchi]

The main difference is that I would not short nor hold cash (because I am convinced that they hurt long term performance) and I would be more diversified geographically, investing in value-oriented mutual funds if I cannot find owner-managers. 

 

Well, actually I hold very little cash. But I do hold some short positions. Maybe, you are right from a statistical point of view. But the businessman perspective that I always hold very dear (because is what I think I really know and understand) advise me otherwise… Never, not in a single instance, my firm’s engineering works caused any problem from inception (2004). They always adhered to the highest quality standards, and were always delivered on time. Yet I have always bought insurance, which has always been a net loss for my firm, and I will continue to do so nonetheless. I will never do anything (at least not in this world  :) ) without buying some insurance.

 

Generally, I don’t like the mutual-fund business model. I think it has some serious flaws. I look for great businesses that I am sure I understand much better than the market. The fact is simply I am convinced great businesses are always led by outstanding capital allocators. Because I understand and believe in “opportunistic and strategic thinking”, while vice versa I don’t believe in “business-plans” or in “star CEOs”.

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

 

[txitxo]

The main difference is that I would not short nor hold cash (because I am convinced that they hurt long term performance) and I would be more diversified geographically, investing in value-oriented mutual funds if I cannot find owner-managers. 

 

Well, actually I hold very little cash. But I do hold some short positions. Maybe, you are right from a statistical point of view. But the businessman perspective that I always hold very dear (because is what I think I really know and understand) advise me otherwise… Never, not in a single instance, my firm’s engineering works caused any problem from inception (2004). They always adhered to the highest quality standards, and were always delivered on time. Yet I have always bought insurance, which has always been a net loss for my firm, and I will continue to do so nonetheless. I will never do anything (at least not in this world  :) ) without buying some insurance.

 

Generally, I don’t like the mutual-fund business model. I think it has some serious flaws. I look for great businesses that I am sure I understand much better than the market. The fact is simply I am convinced great businesses are always lead by outstanding capital allocators. Because I understand and believe in “opportunistic and strategic thinking”, while vice versa I don’t believe in “business-plans” or in “star CEOs”.

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

 

I usually buy insurance too, for peace of mind. I love to chop off probability tails. For companies or individuals it makes absolute sense to buy insurance if the maximum expected loss is larger than what they can absorb. But when you are investing, the net effect of cash and shorts is reducing performance, unless you can time the market very well, which, as we have seen, it's very difficult, independently of what intuition tells us.  Of course you can hold both for peace of mind too, since they will reduce the depth of drawdowns too. 

 

I don't like mutual funds in general, but sometimes it is the only reasonable vehicle you have to invest in a certain market. For instance Bestinfond has returned about 10% after fees over the market during the last 15 years, doing Graham and Dodd text-book value investing. Even if you take into account market dividends that's a pretty nice overperformance. With those numbers, you know that they have to be good at estimating the IV of companies, and right now they think that their portfolio is selling 50% below IV. Other companies we have mentioned here, as Groupe Bruxeless Lambert have much worse numbers and other problems. I'd love to diversify into the Eurozone equivalents of  LUK, L, MKL, FFH, BRK...but there doesn't seem to be anything like them here...

 

[jmaes]

I'd love to diversify into the Eurozone equivalents of  LUK, L, MKL, FFH, BRK...but there doesn't seem to be anything like them here...

 

I didn't look into it but Bollore (XPAR:BOL) might be an option. David Marcus from Evermore Global Value Fund has invested in it. In this interview he talks a little bit about Bollore: http://finance.yahoo.com/news/evermore-global-value-fund-portfolio-235900501.html

[giofranchi]

Of course you can hold both for peace of mind too, since they will reduce the depth of drawdowns too. 

 

Some short positions not only might limit drawdowns, which don’t concern me a lot, since I work only with equity, they also diminish opportunity costs. And that, as far as I am concerned, is key! Listen, I think the art of Buffett and others, you referred to before, is really nothing but a deep and “intimate” knowledge about how some businesses work. If you possess that knowledge, you can judge their future prospects better than the market, and therefore take advantage of the fact that the market might repeatedly price them in a wrong way. For instance, I am truly convinced the market is unable to price correctly “machines that can compound capital at high rates of return for many years into the future”, to pay BV for something like FFH is madness. Now, let’s say that I know more or less 20 of those compounding machines very well. With the only exception of FFH, I believe all of them will see the price of their stocks come down in a market correction. And here is my current allocation of capital: 100% of what I would like to have invested in FFH, 50% of what I would like to have invested in other compounding machines. You see? It is the opportunity to buy more of an outstanding business at even lower prices, that I don’t want to give up! I don’t care about drawdowns! The insurance I buy is against opportunity costs that might be too high!

Now, let’s say Mr. Buffett and others know 1000 compounding machines, instead of 20. If I know 1 in 20, that I have the confidence to be already 100% invested, Mr. Buffett would at least know 1000 / 20 = 50, let’s say 30 such companies! More than enough to fill a whole portfolio of long only investments. That’s why I think that the so-called ‘circle of competence’ is very important. The wider your circle of competence, the less your need for insurance buying. Because, if you have a portfolio of investments, the return of which will be almost unaffected by whatever the market does in the future, you will incur no opportunity cost. When the opportunities arrive, you just might switch from your current holdings to those new and better bargains. For instance, right now I am 50% invested in LMCA. Should a market correction come, I am positive the LMCA stock price will decline, offering me an even better opportunity. Vice versa, the FFH stock price might hold its current level or even rise a bit in a market correction. Therefore, I will be able to shift some capital from FFH to LMCA.

Actually, if I knew 5 FFH, I would not need any insurance at all. And I would be invested 100% long.  :)

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

[giofranchi]

Once again I know many of you will boo me… but once again I must acknowledge how much in fact I do agree with what Mr. Biglari writes and with how he operates. Take, for instance, the following quote from his latest shareholders letter:

 

The term entrepreneur was best explained around 1800 by French economist Jean-Baptiste Say, who is attributed as saying that an entrepreneur is someone who “shifts economic resources out of an area of lower and into an area of higher productivity and greater yield.”

 

That’s exactly why I understand and believe in “opportunistic and strategic thinking”.

Now, another quote from the same letter:

 

Therefore, we limit our appraisals and allocations to businesses we can rationally assess, immersing ourselves in understanding a business rather than attempting to study many shallowly. As a consequence, our range of investments may be narrow, but within it we must be supreme.

 

That’s exactly how I think about my still very narrow ‘circle of competence’.

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

[LC]

I'd love to diversify into the Eurozone equivalents of  LUK, L, MKL, FFH, BRK...but there doesn't seem to be anything like them here...

 

I didn't look into it but Bollore (XPAR:BOL) might be an option. David Marcus from Evermore Global Value Fund has invested in it. In this interview he talks a little bit about Bollore: http://finance.yahoo.com/news/evermore-global-value-fund-portfolio-235900501.html

 

What about Lancashire, they're popular around these parts as well...

[writser]

yeah, or maybe Pargesa / Groupe Bruxelles Lambert? I've been looking at that as well to diversify. A primer: http://seekingalpha.com/article/277018-pargesa-and-gbl-a-tale-of-two-discounts

[mikazo]

I think in their zeal to be contrarians, many bears are really herding together. (Like hipsters  ;D).

 

Awesome, that would make for a good quote! :D

[txitxo]

Of course you can hold both for peace of mind too, since they will reduce the depth of drawdowns too. 

 

Some short positions not only might limit drawdowns, which don’t concern me a lot, since I work only with equity, they also diminish opportunity costs. And that, as far as I am concerned, is key! Listen, I think the art of Buffett and others, you referred to before, is really nothing but a deep and “intimate” knowledge about how some businesses work. If you possess that knowledge, you can judge their future prospects better than the market, and therefore take advantage of the fact that the market might repeatedly price them in a wrong way. For instance, I am truly convinced the market is unable to price correctly “machines that can compound capital at high rates of return for many years into the future”, to pay BV for something like FFH is madness. Now, let’s say that I know more or less 20 of those compounding machines very well. With the only exception of FFH, I believe all of them will see the price of their stocks come down in a market correction. And here is my current allocation of capital: 100% of what I would like to have invested in FFH, 50% of what I would like to have invested in other compounding machines. You see? It is the opportunity to buy more of an outstanding business at even lower prices, that I don’t want to give up! I don’t care about drawdowns! The insurance I buy is against opportunity costs that might be too high!

Now, let’s say Mr. Buffett and others know 1000 compounding machines, instead of 20. If I know 1 in 20, that I have the confidence to be already 100% invested, Mr. Buffett would at least know 1000 / 20 = 50, let’s say 30 such companies! More than enough to fill a whole portfolio of long only investments. That’s why I think that the so-called ‘circle of competence’ is very important. The wider your circle of competence, the less your need for insurance buying. Because, if you have a portfolio of investments, the return of which will be almost unaffected by whatever the market does in the future, you will incur no opportunity cost. When the opportunities arrive, you just might switch from your current holdings to those new and better bargains. For instance, right now I am 50% invested in LMCA. Should a market correction come, I am positive the LMCA stock price will decline, offering me an even better opportunity. Vice versa, the FFH stock price might hold its current level or even rise a bit in a market correction. Therefore, I will be able to shift some capital from FFH to LMCA.

Actually, if I knew 5 FFH, I would not need any insurance at all. And I would be invested 100% long.  :)

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

 

I understand your point, Gio, intuitively, if you expect a market drop it makes sense to hedge (via cash or shorts) and wait to buy your companies at lower prices. But unfortunately that  doesn't seem to work in practice (although perhaps you are an artist in that area; northern Italy has produced some of the best in the world :)).  Not only that; I haven't tested it thoroughly, but I have the impression that it would work even worse with companies as BRK, L, etc. I remember Peter Lynch telling that many  of his clients in the Magellan fund did actually lose money because they tried to time the behavior of the fund.

 

  I don't have to track any index, and I hate crashes, but all the work I have done on market timing shows that the best strategy is to be 100% invested at all times (if you can find suitable investments, of course) but choosing those markets least likely to have a crash based on the best timing indicators you can muster. My stomach often disagrees with my physicist's brain on that issue. But the numbers offer no hope. 

 

It could be that Buffett's art is a profound business instinct, as you say. My particular take is that value investing works by finding market failures. Markets usually are extremely rational and smart machines, but which tend to err in certain corners, in predictable ways. For instance, they tend to undervalue small companies. They also tend to overextrapolate extremes, both at low and high valuations. And one of the most well know market failures is the existence of private quasi-monopolies as Coca-Cola, AMEX or Heinz; that's what moats are all about. Buffett and Munger are extremely adept at spotting and specially, valuing these quasi-monopolies. Doing that involves assessing many intangibles as the company culture, leadership quality, competitive position and extrapolating them into the future. That's like solving geometry problems in 15-D space, even if it is done all intuitively and explained in a folksy manner. 

 

 

 

[giofranchi]

I remember Peter Lynch telling that many  of his clients in the Magellan fund did actually lose money because they tried to time the behavior of the fund.

 

...

 

  Buffett and Munger are extremely adept at spotting and specially, valuing these quasi-monopolies. Doing that involves assessing many intangibles as the company culture, leadership quality, competitive position and extrapolating them into the future. That's like solving geometry problems in 15-D space, even if it is done all intuitively and explained in a folksy manner.

 

Well, you know I invest like I do business, because that is what I understand and that is where I think I have an edge on other people. To rely too much on numbers simply is not my game. On which numbers, anyway? Peter Lynch managed his fund right at the beginning of the most fantastic secular bull market in history… Are his numbers really reliable for what might happen in a secular bear? Not any secular bear, but a secular bear at the end of a 70-year debt super-cycle? I am skeptical…

You have compared, what I called “a deep understanding of a business”, to “solving geometrical problems in 15-D space”… But that’s just because “to do business” is not your game… and so you cannot really be confident to have any kind of edge in taking business decisions! How could it be different?

But, listen, I feel exactly the same about your statistical way of choosing investments! Because I know I could never compete with someone like you at that game!

A businessman would never invest in a company based on some statistical analysis, exactly the same way a statistician would never invest in a company based on some deep knowledge of how it truly operates and creates wealth… it seems obvious to me! Like it is obvious that both a businessman and a statistician can be very successful, each one playing his or her game!

I am confident I can have at least a moderate amount of success, even if I confine my investing to a still narrow circle of competence: 1) it was Mr. Buffett himself, who advised that what really matters is not the ampleness of one’s circle of competence, but the knowledge of its boundaries and the discipline not to stray outside of them, right? 2) I hope my circle of competence will get larger and larger in the future.

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes