Actions Taken Before The Previous Two Declines
What I Saw In 1999
As 1999 progressed it became obvious to me that we were experiencing the greatest euphoria for stocks in history. Brokers were making too much money, average people were touting stocks, and the parabolic arc of the NASDAQ coupled with its leverage was frightening to me. I knew a crash was imminent. Everything that I had learned about investing intelligently since 1976 said that we were in deep trouble.
What I Did
I raised cash levels to well above 50% and hunkered down. As the tech sector imploded, the risk reward characteristics in areas like REITs, utilities, high yield bonds and small cap value were compelling.
What We Achieved
We created portfolios of these securities which enabled us to make money for our managed accounts in 2000, 2001 and 2002. In our opinion, this success came from understanding bubbles, being willing to stand apart from the crowd, and identifying value with risk reward characteristics that could be held through a turbulent market until they worked out.
What I Saw In 2007
In 2007, it was obvious that a new simple concept had taken hold of investors – asset allocation. Hedge funds were heavily committed to leveraged credit purchases and other strategies that depended on the lowest levels of volatility in decades. The complacency among retail investors was widespread.
We saw that the real estate market had cracked and the financial industry was vulnerable. Our experience from the early 1980s taught us that a weak financial industry could create a dangerously volatile market because banks pull back levels of credit granted to speculators. The principles of investing intelligently are clear that speculation is unsustainable.
What I Did
We exited our investments in REITs, utilities and high yield bonds in late 2006 as their yield relative to treasuries dropped to historic lows. We were early but managed in 2007 to beat the return of the S&P 500 by investing in certificates of deposit for the first time in our career. As 2008 began, we did commit a bit early to closed-end funds that invested in floating rate bank loans but we were able to hold these investments through the debacle and added to them near the lows in early 2009 because of their outstanding value, stable yield, and senior secured nature. For aggressive accounts, we shorted the financial sector throughout 2008 and early 2009 and the S&P from 2/08 – 10/08. This was the first time in my career that I took such an aggressively negative position. It was my opinion that the emotional low for the market was reached in October 2008 although the price low was not achieved until March of 2009.
What We Achieved
All of our managed accounts had more money at the end of 2009 than they did in 2007.
What did we learn from these two massive declines?
- Pay attention to risk.
- Be an investor.
- Be patient
- Be contrary
- Be diversified
- Focus only on value that is present
- Observe what drives market behavior…
- The flow of funds of the average investor and the actions of the largest institutions.
- The status of investor enthusiasm.
- The strength of the economy and the financial system.
The principles we learned in 1976 finally paid off during these big declines. We could show that our advice helped people when markets got into trouble. How did your advice fair?
Now after the two closest 50% declines, we look to the future. The key factors that drive the markets, in my opinion, are weaker now than they were prior to the two previous declines.