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April 15, 2009
Returns from stocks over very long periods of time (we used to just say long periods of time) exceed returns from bonds. That is the reason investors allocate part of their portfolios to stocks and in many cases dedicate a very large percentage of the portfolio to stocks. The recent performance of the stock market is testing today’s investors. Many question if they have the stomach to ride through this vicious downturn. It’s one thing to say you are in it for the long-term and another to experience a market that fell 57% in a seventeen month period (10/9/07 to 03/09/09). One additional concern is the low return offered in the fixed income universe. Treasury and tax exempt yields are below 2% for maturities out to 5 years. Money fund yields are near zero. There is a tendency to say “all is lost” while prices are falling and to forget that there will be a brighter day in the future.
We have heard from people who can’t take the volatility any longer and are losing sleep worrying about their portfolio. We certainly encourage those investors to lighten up on stocks to the point where their health isn’t a concern. Those who will need cash in a few years or less should look to fixed income. The tougher call is what to do when someone gets out of stocks and wants to get back in when the “all clear” sign goes up. Quite candidly, we won’t know when to put up the “all clear” sign and we can’t forget the saying that you pay a steep price for a cheery consensus. By the time the economy rebounds, stocks will have long since left the station. Rather than wait for a clear signal, the best suggestion we have is to have the discipline to start buying stocks when they are selling far below where you sold. This doesn’t mean prices won’t continue to decline, but it may be the only way to get back into stocks at reasonable levels.
What should investors who are committed to stocks be doing today? We can tell you what we are doing. We continuously review our existing portfolios (stocks and bonds). Our time is spent checking assumptions we made when we bought a stock with the subsequent financial results of the business (note we did not say the stock price). Before buying a stock, we always think about what a severe economic decline would do to a business. We think even harder about it today. Sometimes we have discovered that a business isn’t as strong as we thought, but most of the time we have been pleased to note that the results are within the range of our previous expectations. In a nutshell, many stocks that we felt were cheap or reasonably priced a year ago have become much cheaper. The second thing we do is look around for new ideas. Our general observation is that a unique opportunity to purchase world-class businesses that pay good dividends exists today. You can buy great businesses today at the prices mediocre companies traded for a year ago. Many of these companies have dividends that exceed the ten-year treasury yield and, unlike the treasury bond, the dividends may increase over time. It’s possible that businesses such as these may get even cheaper. However, these companies are almost certain to be survivors. We live in a time of extraordinary uncertainty and it is best to emphasize top-quality businesses with bullet-proof balance sheets that can withstand even the most severe external stresses.
We head off to Omaha on May 2 for the Berkshire Hathaway annual meeting. We look forward to the comments of Messrs. Buffett and Munger and will send you our analysis shortly after we return.
Mark Hughes Larry
Judge Rob
Noyes Ric
Ordway
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