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Posted on 20 Mar 2008 by Forager

A sure way to make nothing

Now might not be the time to panic, but why not ride out this period of volatility with a little cash on the sidelines? Here’s some food for thought.

In his Little Book of Value Investing, Christopher Browne points to a US study by Sanford Bernstein & Company which ‘showed that from 1926 to 1993, the returns in the best 60 months, or 7% of the time, averaged 11%. The rest of the months, or 93% of the time, returns only measured around 1/100 of 1%’.

Month All Ords return
Dec 1971 18.2%
Jan 1975 17.4%
Oct 1974 17.2%
Jan 1980 17.2%
Apr 1983 15.4%
Jul 1987 15.1%
Apr 1968 14.1%
Mar 1988 13.2%
May 1980 12.4%
Jan 1974 12.1%

I ran some numbers on the Australian market and the contrast is similarly striking. From February 1960 to February 2008, the monthly return from the All Ordinaries Index averaged 0.70%. But in the best 40 months, or just 7% of the total, the monthly return averaged 10.4%. In the remainder, it averaged zero.

Short sharp bursts

Most of the stockmarket’s returns come in short, sharp bursts and if you miss them you’ll do tremendous damage to your long-term returns. Miss the best 7% of months and you’ll end up with zero.

In Browne’s words, ‘the reality is (and it’s been proven) that the biggest portions of investment returns come from short periods of time but trying to identify those periods and coordinate stock purchases with them is almost impossible’.

Many value investors, such as Walter Schloss, Peter Lynch and the aforementioned Christopher Browne, have generated incredible returns while remaining fully invested 100% of the time. Others, like Charlie Munger and Warren Buffett, have been equally successful keeping some cash on the sidelines and pouncing in times of distress. But the one way to ensure mediocre results is to be fully invested at the top and sitting on a pile of cash at the bottom.

Posted on 13 Mar 2008 by Forager

Now is NOT the time to panic

Occasional contributor to The Intelligent Investor Tony Scenna once remarked ‘if you’re going to panic, panic early’. With the market down 21% from its peak in November last year, now isn’t the time to be switching to cash. In fact, the All Industrials Index (which excludes resources companies) yesterday hit a two-and-a-half-year low.

Screaming bargains are still hard to find. The most significant pain has been in the sectors that were most overpriced – namely insurance and banking. Even in these sectors, though, we have high-quality businesses like QBE Insurance coming back to much more reasonable prices. Overall, industrial companies are 29% cheaper than they were in November.

Sure, there’s plenty to worry about. Credit crises, liquidity crises, a US recession, a global slowdown, Australia’s dependence on the commodity boom – the list goes on. But there’s always plenty to worry about. The time to do something about it is when conditions seem best.

Boom times for big banks

Consider the big banks. For the past two years conditions have been perfect and the banks have been lending money willy-nilly and at prices that in no way compensated them for the risks. That was the time to worry.

Now the big four banks’ competitors are dropping like flies. Macquarie Group has quit the market for mortgages and most of the non-bank lenders are on their last legs if not already dead. Risk is once again being priced appropriately at worst and attractively at best. That’s a recipe for future profitability. And in anticipation of that profitability, you should be considering buying, not selling.

For mine, at two times book, the banks still aren’t screaming value, especially given that some of the stupid loans made over the past few years are yet to manifest themselves as bad. But they’re a lot cheaper than they were.

The same holds true elsewhere. In some areas of the market – particularly among heavily indebted companies – the falls look justified. But many high-quality and well-financed businesses have been dragged down alongside them. Cochlear (-30%), Macquarie Group (-48%), ASX (-38%), Westfield Group (-21%), Aristrocrat Leisure (-39%), Billabong (-34%), Cabcharge (-34%), Computershare (-28%) and Harvey Norman (-51%) are just the ones off the top of my head. Some of these make better buying opportunities than others, but in all cases we’re certainly past the time for panicking.

Disclosure: The author, Steve Johnson, doesn’t own any of the shares mentioned but staff own shares in Cochlear, Macquarie Group, Harvey Norman and Westfield Group.