Going into a stock market bubble

[AzCactus]

I think the key question to ask is not is your cash level at 0---we should be asking if the market dropped 20%-25% would you be  caught flat footed or have the ability to go on offense.  If someone has a $100K portfolio and is fully invested than their cash level maybe at 0.  However, if this same individual has $50K in cash that does not have a designated purpose than they would still have the ability to go on offense if prices dropped.

 

David

 

That's exactly what we've been talking about here and in Racemize's thread.

 

It's easy to posit a single event where one approach of the other would be bad.

 

The reverse is equally true, but not as visible because sins of omission always less noticed. What if the market goes up rapidly for years while you hold a large amount of cash (this has just happened to many people over the past 5 years)? Many people never stopped being bearish after 2009 and missed multi-baggers. When they buy in the next downturn, it might not make up for their missed opportunities, but most of that will be pushed under the rug. Or maybe there's a drop, and they expect the apocalypse, but it's just a mild one and they never actually buy because they're so sure it'll go much lower...

 

What truly matters IMO is over long periods of time. I might not be able to buy as much during dips, but I will participate more when things go well. If the businesses that I pick have more attractive characteristics than the market overall, and are more attractively priced, and they can live through almost any crisis and deploy capital opportunistically (buybacks, M&A), then holding them seems quite safe to me and I feel like they can create more value for me than I could with cash.

 

If I could predict general market moves, I would. But I've been hearing people call for huge drops for years, and if I had listened to them I'd be poorer, and there would be the very real risk that I would stay bearish through the bounce off the bottom anyway and miss the following recovery (this seems to happen frequently even to very good investors). Timing is hard.

 

Liberty,

 

I think you and I are saying something similar but not the same.  You mention sins of omission and people who held lots of cash and missed multi-baggers.  While I agree that this is true I would suggest to you that if someone held cash and could not find a way to deploy it in late 2008 or 2009 than they are not suited to be invested at all. 

 

In terms of being invested in good businesses versus having cash all time---you are absolutely right.  It is much better to be in a good business for an indefinite period of time than try to time things and hold very large % of cash for extended periods of time.  However, one does not need to be able to time the market perfectly to realize that cash has value during a downturn for what it does do (allow an investor to go on offense) and what it does not do (drag down returns). 

 

To give an example:  If you look at Mohnish Pabrai's 13F between 6/30 and 9/30 of 2014 the value went from $481 MM to $414 MM.  This is roughly a 16% increase.  I would not say that Pabrai is timing the market.  I would say that he is currently not able to find investments that meet his criteria at the present time. 

 

 

[frommi]

Learning from that the answer is maybe be 100% invested but invest into companies that are cheap and where the business is not under pressure in a recession or perhaps even profits from a recession.

 

Well… that’s much easier said than done!! ;)

 

Gio

 

FFH, Intralot, OUTR, 9628.JP, EDHN.CH are stocks in my portfolio that shouldn`t be impacted by a recession, thats already more than 55% of my portfolio. Cable companies, utilities are probably not a bad choice either. Has anybody more ideas?

[AzCactus]

This link shows the best performers for the S&P 500. 

WMT and FD along with a couple of healthcare related stocks did well. 

 

http://www.reuters.com/article/2008/12/31/usa-stocks-sp-stocks-idUSN3135725620081231

[Liberty]

Liberty,

 

I think you and I are saying something similar but not the same.  You mention sins of omission and people who held lots of cash and missed multi-baggers.  While I agree that this is true I would suggest to you that if someone held cash and could not find a way to deploy it in late 2008 or 2009 than they are not suited to be invested at all. 

 

That's what I'm saying. Yet the Schiller CAPE said that the market was only "slightly undervalued" at the bottom, which is why I'm saying that using these macro indicators often doesn't help much and can actually do more harm than good if it keeps you from buying what you would otherwise buy. Many good investors didn't buy as much as they could have or stayed hedged for way too long after the crisis because they had made certain macro predictions and were waiting for something that never happened. The problem with predicting the future is that there's an infinity of wrong predictions and only one version of events that actually happens.

 

And keep in mind that most markets environments are not early-2009. I think there are too many generals fighting the last war out there, expecting these "once-in-a-century" events to happen every 5 years. As Buffett likes to say, if you could have told someone in 1900 all the big events that were going to happen during the 20th century (depression, WW1, WW2, cold war, vietnam war, inflation, famines and purges in Russia and China, oil shocks, double-digit interest rates, countries defaulting, large banks failing, US president assassinated, epidemics, etc), they'd think that nobody could possibly make money, yet the Dow went up something like a zillion times and living standards multiplied.

 

In terms of being invested in good businesses versus having cash all time---you are absolutely right.  It is much better to be in a good business for an indefinite period of time than try to time things and hold very large % of cash for extended periods of time.  However, one does not need to be able to time the market perfectly to realize that cash has value during a downturn for what it does do (allow an investor to go on offense) and what it does not do (drag down returns). 

 

Of course. And if I can't find anything that is attractive enough for me, I'm ready to go 100% cash. But if I do see things that are attractive enough, I won't hold cash just to hold cash. I'd rather miss some buying opportunities here and there than have significant cash in my portfolio for the next 30 years, because missed opportunities compound too.

 

And if there's a buying opportunity that comes along and that is truly juicy enough that I can't miss it, it'll be more undervalued than what I hold by definition (otherwise it wouldn't be particularly juicy, right?), so I'll just sell some of the less undervalued thing I own to buy that very undervalued thing. Or I'll go on margin and delever later.

 

To give an example:  If you look at Mohnish Pabrai's 13F between 6/30 and 9/30 of 2014 the value went from $481 MM to $414 MM.  This is roughly a 16% increase.  I would not say that Pabrai is timing the market.  I would say that he is currently not able to find investments that meet his criteria at the present time.

 

Who knows, there are all kinds of reasons why one could hold cash. I'm not saying that everybody who does is timing the market - especially not those with funds managing other people's money, with peak redemptions always happening at market bottoms, or with operating businesses that might need big cash cushions. I'm speaking as an individual investor, only managing my money,  with a long-term horizon, and seeing enough opportunities to fill a portfolio.

[vinod1]

The question is what is "very cheap"? A couple of years ago, the weighted average of my portfolio (just a rough estimate) price/IV would have been below 50%. Right now it is likely above 70%. This is even if you ignore the much higher quality of the investments available a couple of years ago.

 

In addition, the number of ideas that meet the criteria are below the level that would provide adequate diversification for putting 100% of the portfolio.

 

Would you be willing to say put near 100% of the portfolio when you have say only 3-4 ideas that are say around 75% of IV? Would love to hear your perspective on this.

 

Vinod

 

That's for each investor to determine. Some have very high hurdles, some are looking for 10%.. But whatever your target is, you have to ask if holding lots of cash helps you get closer to that target over long periods of time or if it holds you back.

 

Thanks Liberty!

[vinod1]

Would you be willing to say put near 100% of the portfolio when you have say only 3-4 ideas that are say around 75% of IV? Would love to hear your perspective on this.

 

That’s the very same question I had already asked! And let me tell you what I think: if I were to decide the level of cash I hold only on the basis of “very cheap” opportunities, I would always be 100% invested. In fact, right now I would be 100% invested.

 

Following the pendulum is nothing but to heed Buffett’s warning:

The less prudence with which others conduct their affairs, the more prudence with which we should conduct ours.

And of course also the opposite is true. And imo the level of cash plays a big role!

 

Gio

 

If say your  favorite stocks, FFH, LMCA and BH close today at $380, $25 and $250 and S&P 500 at 2500, would that change your allocation?

 

I have come to peace with the fact that there are a few things I would not know in this world: The meaning of life; If there is God; Your investment in BH.

 

But I would love to understand how the above would change your allocation.

 

Vinod

[jay21]

Another counter to economic bears:

 

And even that might hide the strength of the recovery this year. GDP growth has exceeded 3% in four of the last five quarters. In two of those quarters, growth was in excess of 4%. It is simply reasonable to believe that the first quarter GDP report was largely an aberration. Do not dismiss the real improvement in the economy since 2009. It is not unimportant that 2014 is likely to be the biggest year for private sector employment since 1999 and that auto sales will reach a level not seen since 2001. It is not unimportant, in contrast to the conventional wisdom, that "in the post-Great Recession era, the growth in full-employment is, without a doubt, way out ahead." These are just three of many genuine signals of economic strength. It seems to me that in the effort to find what is wrong with the economy, everyone misses what is right.

 

....

 

As long as people have babies, capital depreciates, technology evolves, and tastes and preferences change, there is a powerful underlying (and under-appreciated) impetus for growth that is almost certain to reveal itself in any reasonably well-managed economy. This ultimately is the reason that despite the seemingly persistent belief that the recessionary bogeyman is just around the corner, recessions are remarkably rare events.

 

Since 1983, the US economy has been in expansion for 350 months. Recessions account for just 34 months, less than 10% of the time. In any given month, the probability of recession is certainly less than 10%. Recessions are concentrated in a handful of periods. If you are not in a recession this month, it is almost certain that you will not be in a recession next month. Consider that only three times since 1983 has a recession occurred in a month preceded by an expansion.

But this makes it seem as if recessions simply spring out of thin air, which they do not. Even if you thought the conditions for a recession were currently brewing, it is highly unlikely that the momentum of the US economy will turn in twelve months or less. Even if you thought, for example that the financial sector could not absorb any losses that stem from a decline in energy prices and thus be faced once again with crisis (unlikely, in my opinion, especially in the wake of regulatory enhancements since the last crisis), it would still take months for that shock to propagate throughout the economy.

 

....

 

To be sure, improvements were not as quick as many had hoped, but the shortfalls can largely be traced to two sectors – housing, in which the financing mechanism was damaged, and the failure of the fiscal authorities to adequately plug the hole. But the resilient economy continued to march higher nonetheless. And now fiscal policy is no longer a drag; the bottom in government jobs has likely been reached. Moreover, there is one silver lining in the relatively low pace of new housing activity – such activity has room to run. I expect that over the next two years housing will become an increasingly strong force in the US economy. Nor will the economy likely be impeded by monetary policy, which even if tighter than expected is likely to remain more accommodative than traditional metrics of appropriate monetary conditions would suggest.

Bottom Line: Perhaps, just perhaps, the US economic expansion has been consistently undersold, and continues to be undersold. It is worth considering that maybe it is time to just accept the good news without the desperate search for every dark cloud.

 

http://economistsview.typepad.com/economistsview/2014/12/fed-watch-yes-i-am-optimistic.html

[Happy]

Isn't the opportunity cost to hold cash is higher the better you are as an investor because the stocks you pick have a higher expected return while cash earns the same for everyone? One could say that the better investor also deploys his cash better later, but if he finds a 4x to me the right consequence then is to be willing to sell your least attractive existing position (even if at a loss) so by being fully invested you don't really have to miss out on those great opportunities (at least in theory).

Basically you are earning "extra profits" by being fully invested and those could be counted as "cushioning" the blow when the inevitable downturn comes and you lose more on paper than someone who was less invested. Unless the market goes down fairly early there probably will be a point where your "extra profits" already cover everything you would additionally lose in a downturn so you are better off even when it comes.

 

In the end it seems mostly about risk-preference. If all you care about is maximizing expected return being fully invested should be the way to go (unless you are that very rare investor who can time the market which I can't) but if that feels too risky when the market is no longer cheap it is a perfectly fine choice to sacrifice some expected return for lower volatility. People have different tolerance levels for risk so they should do what they feel comfortable with.

I think someone like Klarman so frequently holds cash because he is a) extremely risk-conscious and b) has clients.

[giofranchi]

I have come to peace with the fact that there are a few things I would not know in this world: The meaning of life; If there is God; Your investment in BH.

 

Ahahahah!!!!... It is a great business, led by a great entrepreneur!... Much easier than the meaning of life, or the existence of God! ;)

 

But I would love to understand how the above would change your allocation.

 

Yes! My allocation would change. But I like to read “fantasy” novels… I don’t invest in a “fantasy” world! ;D ;D

 

I am sure my holdings will experience volatility, irrespective of what the general market does. And that’s a big reason why I hold some cash: to take advantage of downside volatility. If FFH were at $380, LMCA at $25 and BH at $250, all the volatility they would experience would be on the upside! ;)

 

Gio

 

[giofranchi]

Most of all I think it is a great fallacy to believe good investment results can be achieved only being 100% invested all the time.

Icahn has great investment results, while being concerned that a major market correction might soon come our way:

 

http://www.reuters.com/article/2014/11/17/us-investment-yearend-icahn-idUSKCN0J127Y20141117

 

And cash might be a drag on results 99 times out of 100, but the single instance in which it truly matters might represent the difference between anguish and peace of mind.

 

So, great investment results + peace of mind always, or even better investment results + a very remote probability of anguish? To each one the answer he/she prefers.

 

Gio

 

[Happy]

Most of all I think it is a great fallacy to believe good investment results can be achieved only being 100% invested all the time.

 

Holding some cash certainly doesn't kill the record of a great investor. If you could outperform by 10% p.a. being fully invested, but choose to sacrifice maybe 1% (just making up numbers) in long-term outperformance by holding cash while significantly reducing your downside, you'd still have a great record. I guess it depends on how much you worry about that 1 time out of 100 versus wanting to maximize long-term expectation. As you say, to each one the answer he/she prefers.

[giofranchi]

I guess it depends on how much you worry about that 1 time out of 100 versus wanting to maximize long-term expectation. As you say, to each one the answer he/she prefers.

 

Well, that single time out of 100 ruined Ben Graham’s investment experience for at least 10 years… And he has written very clearly about the anguish he felt… If such a thing happened to the teacher of us all, it might happen to anyone… At least, that’s my thought! ;)

 

Gio

 

[Liberty]

Most of all I think it is a great fallacy to believe good investment results can be achieved only being 100% invested all the time

 

Who argued for that?

[giofranchi]

I have just changed the asset allocation of my firm’s portfolio this way:

36% Fairfax Financial

17% Liberty Media

17% Biglari Holdings

8% Oaktree Capital

22% Cash

 

First, I am a moody guy… ;)

 

Second, I think that Packer’s argument makes a lot of sense! Taxes be damned!

I remember Buffett saying something like this: if you have a great business, led by a great entrepreneur, and bought at a good price, and you don’t want to hold it for tax reasons… just let me know, I will be very glad to relieve you of such a burden!

12 times earnings imo is a very good price for an high quality business like OAK.

 

You see? How could any statistical analysis take into consideration such a move?! It cannot.

 

Gio

 

[giofranchi]

Another (small) change today:

 

36% Fairfax Financial

17% Liberty Media

17% Biglari Holdings

10% Oaktree Capital

20% Cash

 

:)

 

Gio

[james22]

Damn K-1.

[giofranchi]

Damn K-1.

 

???

 

Gio

[giofranchi]

Another change today:

 

36% Fairfax Financial

17% Liberty Media

17% Biglari Holdings

14% Oaktree Capital

16% Cash

 

Vinod, Liberty,

You see what I mean when I say I don’t think investing should be something static? In a matter of just 4 trading days I have practically halved my cash reserve.

And now I think I will gradually build it up again! ;)

 

Gio

 

 

[writser]

A week ago you predicted a market crash, now you're almost fully invested. Good for you. How on earth did this thread get so much attention ..

[tombgrt]

What is your portfolio turnover Gio? Must be in the high 100's if you ask me? You speak of looking to invest with "great entrepreneurs" for 10-20-30 years but seem to jump in and out of those long term holdings all the time. I would question my personal conviction in my holdings if I traded that much.

[giofranchi]

A week ago you predicted a market crash

 

???

 

Gio

[giofranchi]

You speak of looking to invest with "great entrepreneurs" for 10-20-30 years but seem to jump in and out of those long term holdings all the time.

 

I think I have explained why I sold out of Oaktree Capital almost an year ago, and also why I think my reasoning was wrong back then, and why now I have invested again.

With the only exception of GLRE and TPRE, which I intend to buy again in the future, OAK is the first company I have bought back once I sold it.

I am not invested in GLRE and TPRE right now because through FFH I think I have more than enough exposure to the insurance and reinsurance markets. This also I have already pointed out many times! ;)

 

Gio

 

[stahleyp]

A week ago you predicted a market crash, now you're almost fully invested. Good for you. How on earth did this thread get so much attention ..

 

This might be the sign of the top.  :P

 

Messing with ya, Gio!

 

On another note, I was talking to my girlfriend and her "financial advisor" at Merrill Lynch has her all in...cash. He things it's going to drop. However, he lost around 35% in 2008 which is barely better than the market. This makes me a little less fearful. But, I'm still going to maintain my decent cash position...fully aware that it's probably a mistake.

[yadayada]

https://www.youtube.com/watch?v=DB_BRy0pOuo

[giofranchi]

A week ago you predicted a market crash

 

Anyway, let me explain just a little:

Imo Fairfax and Oaktree share this feature: although for different reasons, they both will make money if the current cycle goes on, and they both will make much more money if the current cycle ends and the stock markets start going south.

 

Of course, you never know what happens to stock prices… And in a stock market correction both Fairfax and Oaktree stock prices might get hurt. But, when people realize they are making lots of money, while others don’t, who knows what might actually happen to the price of their stocks?

 

Original mungerville said he thinks about Fairfax as cash… If the same is true for Oaktree, my asset allocation has not changed at all! ;)

 

Gio