The latest from Mason Hawkins of LongLeaf
“I think the future of equities will be roughly the
same as their past; in particular, common-stock
purchases will prove satisfactory when made at
appropriate price levels. It may be objected that it
is far too cursory and superficial a conclusion;
that it fails to take into account the new factors
and problems that have entered the economic
picture in recent years — especially those of … the
movement towards less consumption and zero
growth. Perhaps I should add to my list the
widespread public mistrust of Wall Street as a
whole, engendered by its well-nigh scandalous
behavior during recent years in the areas of
ethics, financial practices of all sorts, and plain
business sense.” — Excerpt from June 1974 speech
by Benjamin Graham, printed in Financial Analyst
Journal, September/October 1974
The opportunities created in the equity market
disarray of the early 1970’s cited above
precipitated the 1975 founding of Southeastern
Asset Management. Similarly, uncertainty relating
to various global economic conditions has created
numerous opportunities for today’s long-term
investor. We have endured material stock price
declines in the last few months as macro fear
around well-known issues of European sovereign
debt, U.S. deficit reduction, and Chinese inflation
control rendered company fundamentals
irrelevant. As evidence of how little the market
discriminated among businesses, stock price
correlations in both the U.S. and Europe
surpassed the level experienced in 2008 after
Lehman’s collapse. The closer correlation moves
to 100%, the less differentiation there is in how
individual stocks trade. Correlation in September
reached 85% for the FTSE 100, and the S&P 500
hit 90% compared to its historic average of 30%.
In other previous periods of high correlations,
including 1982, 1990, and 2008, Southeastern
suffered short-term underperformance. The third
quarter of 2011 was no different. Out of favor
companies became more disdained, and any
perceived challenges became magnified in
people’s minds. Similar to past periods, the
companies that most negatively impacted results
were economically sensitive businesses and/or
those with some financial leverage. Following
these periods, Southeastern has posted
substantial outperformance when company
fundamentals return to the spotlight and
correlations fall back to normal levels. Severely
discounted prices tend to snap back like a tightly
compressed spring.
If we know this common refrain, why not alter
our investment strategy to avoid the types of
companies that suffer when pessimism and
correlations rise? Warren Buffett commented on
this idea in his July 1966 Partnership Letter.
“I am not in the business of predicting general
stock market or business fluctuations. If you think
I can do this, or think it is essential to an
investment program, you should not be in the
partnership… We don’t buy and sell stocks based
upon what other people think the stock market is
going to do, (I never have an opinion) but rather,
upon what we think the company is going to do.
The course of the stock market will determine, to
a great degree, when we will be right, but the
accuracy of our analysis of the company will
largely determine whether we will be right… Who
would think of buying or selling a private
business because of someone’s guess on the stock
market?”
We are incapable of knowing what stocks will do
in the short run. To make investments based on
correlation changes would require two correct
calls — when to sell and when to reinvest. Being
accurate in either prediction is a low probability,
but when the two probabilities are multiplied, the
chance of success is remote. Patience and
discipline historically have rewarded our partners
who believed in intrinsic value-based investing
and who stayed owners through full market or
correlation cycles. Price declines are painful, but
do not equate to capital losses if investors stay
long-term and business values remain intact.
Full letter below:
11q3letter LongLeaf(function() { var scribd = document.createElement(“script”); scribd.type = “text/javascript”; scribd.async = true; scribd.src = “http://www.scribd.com/javascripts/embed_code/inject.js”; var s = document.getElementsByTagName(“script”)[0]; s.parentNode.insertBefore(scribd, s); })();
H/T http://www.cornerofberkshireandfairfax.ca
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