Value is proving to be just as elusive as the Scarlet Pimpernel.
It is being sought here and being sought there, but cannot be found.
Highly respected value investors — those who’ve been there, done that and have the track record to prove it — are coming up empty-handed in their pursuit for investments offering less risk and more reward.
The markets are expensive and getting more expensive with every new high on the S&P 500 index and Dow Jones.
Prices, driven by momentum and a TINA (there is no alternative) mentality, are not reflective of value. Rather, it’s an all-too-familiar reflection of the madness of men.
Will we never learn?
Jean-Marie Eveillard is not as well-known as a Warren Buffett or Charlie Munger, but is just as respected.
Eveillard commenced his investment career in 1962. With 55 years of experience, he’s earned the title of ‘market veteran’.
Eveillard outlined what value investors must be prepared to accept…
‘By being a value investor you are a long-term investor. When you are a long-term investor, you accept the fact that your investment performance will lag behind that of your peers or the benchmark in the short term. And to lag is to accept in advance that you will suffer psychologically and financially. I am not saying that value investors are masochists, but you do accept in advance that your reward, if any, will come in time and that there is no immediate gratification.’
You have to accept that being fearful when others are greedy comes with a psychological and financial cost. Markets can continue to rise on nothing more than investor optimism (also known as ‘stupidity’). You wonder what could have been if you’d stayed in for the ride.
That’s only human nature…focusing on what we haven’t got rather than being grateful for what we do have.
Unless you’re the only person in the world who’s gifted with the power of perfect timing, you have to accept that you cannot have it both ways.
There are only two types of investors in this world: those that are humble, and those that are going to be humbled.
Better to be the former…all it costs is a little pride.
Two of the best in the value investing business have expressed their views recently on the state of markets.
Bloomberg reported on 9 September 2017: ‘Seth Klarman’s $30 billion Baupost Group plans to return some capital to investors by year end because the hedge fund doesn’t see enough opportunities in the market.’
Klarman is a seriously smart and wealthy guy.
At present, Baupost has more than US$12 billion (of its US$30 billion fund) invested in cash. That’s putting your money where your mouth is.
In his recent letter to investors, Klarman wrote (emphasis is mine):
‘Investors must choose between two alternatives. One is to hold stocks and bonds at the historically high prices that prevail in today’s markets, locking in what would traditionally have been sub-par returns. If prices never drop, causing returns to revert to more normal levels, this will have been the right decision. However, if prices decline, raising prospective returns on securities, investors will experience potentially substantial mark to market losses, thereby faring considerably worse than if they had been more patient.
‘The alternative is to remain liquid [in cash], defy the steady drumbeat of performance pressures, and wait for the prices of at least some securities to drop. (One doesn’t need the entire market to become inexpensive to put significant money to work, just a limited number of securities.) This path also involves risk in that there is no certainty whether or when this will occur; indeed, securities prices could rise further from today’s lofty levels, making the decision to hold cash even more painful.’
What a refreshingly humble assessment…especially when compared to the rubbish (that’s supposed to pass as informed opinion) you get from most investment institutions.
Another highly respected value manager is Oaktree Capital’s Howard Marks.
In July, he wrote a cautionary memo:
‘…my response would be that it’s essential to take note when sentiment (and thus market behavior) crosses into too-bullish territory, even though we know rising trends may well roll on for some time, and thus that such warnings are often premature. I think it’s better to turn cautious too soon (and thus perhaps underperform for a while) rather than too late, after the downslide has begun, making it hard to trim risk, achieve exits and cut losses.
‘Since I’m convinced “they” are at it again — engaging in willing risk-taking, funding risky deals and creating risky market conditions — it’s time for yet another cautionary memo.’
There’s a familiar theme in both outlooks: It’s better to err on the side of caution and forsake some short term performance, rather than chase returns and suffer serious losses.
Giving up a few percent of return is far better than losing 50% or more of your capital.
Both Klarman and Marks have been around long enough to know that if it smells, looks and tastes like ‘it’, then it probably is ‘it’.
Marks put the current investment climate through the ‘smell, look and taste’ test and these were his findings:
‘The uncertainties [we face] are unusual in terms of number, scale and insolubility in areas including secular economic growth; the impact of central banks; interest rates and inflation; political dysfunction; geopolitical trouble spots; and the long-term impact of technology.
‘In the vast majority of asset classes, prospective returns are just about the lowest they’ve ever been.
‘Asset prices are high across the board. Almost nothing can be bought below its intrinsic value, and there are few bargains. In general, the best we can do is look for things that are less over-priced than others.
‘Pro-risk behavior is commonplace, as the majority of investors embrace increased risk as the route to the returns they want or need.’
Let’s distill this into a simple narrative.
The world is facing disruptive challenges on many fronts. Against this background of serious uncertainty, asset prices are sky high, prospective returns are the lowest in history, and complacency is high.
What could possibly go wrong?
Watching and waiting for the predictable and all-too-familiar outcome of this madness is an exercise in frustration. The market, against all reason and logic, could continue much higher.
That’s the price prudent long-term investors must pay.
Staying true to your principles requires discipline.
That strength of conviction is best summed up by Jean-Marie Eveillard: ‘I would rather lose half our shareholders…than lose half of our shareholders’ money…’
Over 30 years in the investment business has taught me the value of humility. The Gowdie Letter is my weekly discussion with readers about the need for caution in these uncertain times. If you’d like to find out more, go here.
Editor, The Gowdie Letter