Tweedy Browne Comments Regarding Recent Market Turmoil August 9, 2011
Uncertainty, in our opinion, is one of the most difficult factors for professional as well as individual investors to deal with, and it is dominating the markets currently. Uncertain markets are characterized by increased volatility and correlation between asset classes, as well as increasingly shorter time frames for investment decisions. None of this, in our opinion, will improve the probabilities of earning a satisfactory return over a reasonable period of time. Rather, we think that in most instances, these will improve the odds of the opposite outcome. Emotional and behavioral biases tend to win out over objectivity. Today’s 24-hour news cycle doesn’t contribute much to rational thinking. The adage in the media industry that “airplanes landing don’t make news” has an element of truth. One relatively new factor contributing to this volatility (and we admit that we do not have a lot of empirical data to back it up) is the impact of algorithm driven
trading which, in the U.S. equity markets, is upwards of 60% of volume. It is largely driven by
arithmetic-historical correlations volatility, and holding periods measured in minutes if not seconds.
Couple this with day trading and you end up with completely irrational price movements. By way of example, the price range of Bank of America (a stock that we do not own) from its high to its low on August 5th was 11%, and the company had a market capitalization of $90 billion. Yesterday, the stock was down another 20%. Another example is Royal Dutch Shell with market capitalization of almost $210 billion. The price range of the stock from high to low on August 4thwas about 5%. It is unlikely that the value of those businesses changed by this much in one or two days, in our judgment. There are numerous other examples, some we own and others we do not. The ability to predict this sort of swing movement is virtually impossible and the ability to explain them is equally so. In order to function and make objective decisions you must have other parameters for decision making. In our view, it is ultimately the economics that win out, and in our case, the economics of the underlying businesses we own. It certainly has been the case historically, and in our opinion, profits and cash flow will remain the fundamental long term drivers of equity valuations. The probabilities of objectively valuing the economics and sustainability of a business are far better than the alternative of predicting the movement of “markets” over any given time period and we think the empirical evidence supports this view. This is not to say that we simply ignore “global” questions. We do consider how larger trends will ultimately impact the businesses we own. For instance, what do a large emerging middle class or price controls mean for a business, etc?
So while we don’t enjoy this type of environment – to say the least – we keep our focus on trying to buy a good business at a very attractive price. In doing this, we seek to avoid highly leveraged businesses and businesses with obsolescence risk. These environments create some real cognitive dissonance – the ability to buy into a company at a great price usually goes along with having the ones you own go down in price. Nonetheless, to put it simply, the investment framework at Tweedy, Browne does not change – the number of companies to look at, not surprisingly, has increased and some averaging-in on existing investments is occurring. Most of what we do rests on the process coupled with a realistic time horizon.