Do I trade too much?

water

Buffett: Hold Stocks Forever

One of the most common criticisms I get from other value investors is that I trade too much. This is mainly because value investing has come to mean whatever Warren Buffett says it means.

Buffett recommends that the best holding period is forever. Buy a great business at a fair price and hold onto it for decades. This has become the commonly accepted wisdom among value investors.

Buffett’s views on holding periods is best summarized by the below quotes:

Our favorite holding period is forever.

Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years

My activity is entirely inconsistent with this philosophy.

I argue that Buffett’s approach is only one method of value investing.

It is a perfectly valid approach. But it’s not the only valid approach.

Graham: Two Years or 50%

Graham had a different view. It is also one that makes more sense to me. Graham’s view was that an investor should calculate a stock’s intrinsic value, buy below that intrinsic value, and then sell when it reached that intrinsic value. In other words, Graham believed in simple, easily comprehensible, rules-based value investing.

This is different from holding onto stocks in great businesses for decades on end no matter what.

Graham explained his rules in the following interview:

Q: How long should I hold onto these stocks?

A: First, you set a profit objective for yourself. An objective of 50 percent of cost should give good results.

Q: You mean I should aim for a 50 percent profit on every stock I buy?

A: Yes. As soon as a stock goes up that much, sell it.

Q: What if it doesn’t reach that objective?

A: You have to set a limit on your holding period in advance. My research shows that two to three years works out best. So I recommend this rule: If a stock hasn’t met your objective by the end of the second calendar year from the time of purchase, sell it regardless of price. For example, if you bought a stock in September 1976, you’d sell it no later than the end of 1978.

In other words, Graham recommended that an investor should sell a stock after a 50% gain or after holding for two years, whichever comes first.

This view makes sense to me.

I estimate what I think something is worth, then I sell when it hits that value. I don’t think I’m capable of figuring out which stocks among the thousands available in the investable universe will overcome the odds and compound for decades on end. I do think I’m capable of identifying a bargain and selling when it is reasonably close to its intrinsic value.

There are drawbacks to this strategy. I will never own a stock that compounds throughout the decades. I’ll never buy and hold Nike for 40 years. I’ll never become a millionaire by investing in the Amazon IPO.

I also don’t care. I can achieve perfectly satisfactory results without trying to buy these lottery tickets.

My approach is a high turnover approach, which increases costs and taxes. This is a big deal for someone like Buffett and not so much for me. Buffett is a megaladon and I’m a gnat in the belly of minnow. My trading account that I track on this blog is in an IRA and brokers don’t charge commissions any longer. I have miniscule sums of money and I can’t influence the price of a stock.

My strategy isn’t scalable, either. At least, it’s not scalable to Warren Buffett’s level. Warren Buffett commands the one of the largest pools of investable cash (that is constantly growing!) in global markets. He can’t nimbly move in and out of stocks. It’s like an elephant trying to nimbly move in and out of a swimming pool.

Buffett’s strategy is entirely valid, but it’s not the only valid strategy.

What’s a Wonderful Business?

Buffett recommends buying wonderful businesses. Well, what’s a wonderful business?

A wonderful business is a business that can earn high returns on capital over long periods of time.

This is extremely hard to do. It’s extremely hard to do because we live in a capitalist economy with a lot of competition. If someone has a business where they can earn high returns, other businesses are going to swoop in and do the same thing, which will reduce those returns.

This is why Warren Buffett focuses so much on the concept of a moat. Those high returns on capital can only be sustained if there is something about the business that helps it resist competition.

Where do moats come from? They can emerge from a lot of places. Some businesses might have a geographical moat, like a toll bridge. Others might have a regulatory moat, where government policy helps sustain their advantage. Brands are another form of moat. Are you willing to pay a premium for a Nike swoosh? You likely already have, many times over.

Buffett has identified many moats in good brands. After successes with other wonderful businesses such as American Express and Disney in the 1960’s, Buffett recognized the power of a moat through his investment in See’s Candy in the early 1970’s.

See’s Candy can earn high margins because it has a recognizable and enduring brand. Munger explains the moat below:

“When you were a 16-year-old, you took a box of candy on your first date with a girl and gave it either to her parents or to her. In California the girls slap you when you bring Russell Stover, and kiss you when you bring See’s.”

People are willing to pay a premium for See’s because of the enduring quality of the brand. That’s not something that an upstart competitor can easily disrupt.

The same is true for Coca-Cola. Coca-Cola has a strong brand. If you face a choice between a store brand Cola and Coke, you’re going to pick Coke.

It won’t make much of a difference in your personal finances or grocery bill if you pay 40 cents a can versus 30 cents a can. Why wouldn’t you chose a marginally more expensive quality brand that you’re familiar with over one that you have no familiarity with? Meanwhile, that small difference in price creates large profit margins that are sustainable over long periods of time.

Moats Are Hard to Find

Situations like Coke and See’s sound deceptively easy to identify.

A key problem is that moats are much harder to identify than we realize.

The concept of moats was popularized by Buffett, but it is rooted in the ideas of Michael Porter.

The ideas of Michael Porter have been widely disseminated throughout business education programs. In the 1980’s, it was first taught at the Ivy Leagues. By the 2000’s, it was disseminated and understood far and wide.

My MBA is about as far away from the Ivies that you can go. I earned my MBA at a cheap state school, but even I was taught the gospel of Michael Porter. Much like the efficient market hypothesis, which was drilled into my head during my Finance undergrad degree, Porter’s ideas were treated as gospel truth.

There’s a problem with the ideas of Michael Porter: there isn’t any proof that any of it is true. Dan Rasmussen explains much better than I ever could in this excellent article in Institutional Investor. Rasmussen explains:

Porter’s logic suggests that firms with competitive advantage would earn excess profits, so profitability margins should be a guide to which firms have the most-sustainable profit pools. Yet profit margins have no predictive power in the stock markets. In fact, academic research suggests that margins are mean-reverting and provide little information about future profitability. The implicit certainty of Porter’s view of the world — that margins are persistent, that competitive advantages result from permanent structural features of industries, that “excess profits” come only from distortions in market structure — could lead investors to overpay for current performers. The theory leads not to an investing edge, but to the most common of investing mistakes.

It’s harder than hell to distinguish between a business that is enjoying a temporary edge between one that is an economic franchise.

It’s also hard as hell to figure out if an economic franchise which has endured for decades is about the completely fall apart. One of the best examples of this is Kodak. In the 1990’s, Kodak looked like it had an impenetrable moat. Then digital cameras came along.

Morningstar has put significant resources and intellectual depth into identifying moats. As highlighted in this excellent article by Rupert Hargraves, companies christened as “wide moat” don’t outperform over the long run like they theoretically should. Are you a better analyst of a moat than the talented people at Morningstar who have devoted themselves to solving this problem?

The same phenomenon is also highlighted by Tobias Carlisle in Deep Value. Carlisle cites Michele Clayman’s analysis of Tom Peter’s book “In Search of Excellence” as an example.

In the early 1980’s, Tom Peters identified key attributes of “wonderful” companies and assembled a list of truly wonderful companies. These were companies with high growth rates and high returns on invested capital.

In 1987, Michele Clayman analyzed the stock performance of these “excellent” companies. The portfolio underperformed the S&P 500.

Adding insult to injury, Clayman also assembled a list of companies with the opposite characteristics of excellence – bad returns on capital, low growth rates. Guess what? The unexcellent portfolio outperformed both the S&P 500 and the “excellent” portfolio by a wide margin.

Of course, a modern value investor would argue that they weren’t really excellent companies because they didn’t have a moat to defend those high returns on capital.

These investors would say that the companies that they are purchasing today actually have a moat. Okay. What’s more likely? That these investors have found a moat or a business enjoying a temporarily good situation that will ultimately be eroded by competition? I would say that the evidence suggests they are unlikely to find a moat.

Coca Cola: A Case Study in Moats

The Moat

Buffett gobbled up Coca-Cola shares after the stock market crash of 1987. He knew Coca-Cola was one of the ultimate American brands and had a strong moat which allowed it to earn high returns on invested capital.

A key source of Coke’s moat was its long and successful marketing campaigns. Coke was everywhere for 100 years. Baseball games. Logos printed on every billboard. Indelible images pounded into the American psyche, like Santa Claus drinking an icy cold Coca-Cola and smiling.

The success of Coca Cola’s marketing was best demonstrated during Coca-Cola’s debacle with New Coke. In 1985, Coca-Cola tried to change their formula. They tested out their formula in taste tests and people preferred it.

Once the new flavor was released, the public hated it. Coke executives quickly realized that Coca-Cola’s success had nothing to do with the actual taste: it had to do with the public perception of the Coca Cola brand, which Coke spent decades establishing. The people associated messing with Coke’s flavor with messing with a part of Americana itself. Coke ultimately relented and brought back the old flavor in the form of “Coca-Cola Classic.”

This is a great documentary from 2003 on the debacle, the People vs. Coca-Cola.

I grew up on a steady diet of Coke marketing and Coke products. Coke’s aggressive marketing has made me associate that brand with an image of America itself.

The sugary sweetness was an immediate appeal. The sugar and caffeine high that came afterwards made me feel good. It was usually served to me at happy occasions: family events, movies, birthday parties. My mind quickly associated the taste of Coca-Cola with good times and good feelings.

Generations of children had the same experience. This made for a hell of a moat, probably the ultimate moat in the history of business.

A Wonderful Business at a Fair Price

Modern value investors are obsessed with identifying Coke-like businesses. They want to identify these wonderful businesses at fair prices and hold onto them for decades of compounding success, following Buffett’s example.

As justification for their frothy purchases, they cite Buffett’s transformation from buying stocks below working capital to buying wonderful businesses at fair prices.

Of course, the price of Buffett’s Coke purchase was hardly modern compounder territory. Buffett bought Coke at a P/E of 12.89 in 1989 and 14.47 in 1988.

Furthermore, I think that Buffett holding onto Coca-Cola for decades was a mistake. He should have sold it in the late ’90s.

Coca-Cola has treated Berkshire exceptionally well. Coca-Cola has compounded at a 13% rate since 1986 in comparison to the stock market’s rate of 10% during the same period. In other words, Coca-Cola turned a $10,000 investment into $660,653. The US stock market turned the same $10,000 into $270,528.

What is missing from the raw CAGR is the sequence of these returns. From 1986 to 1998, Coca-Cola grew at an astounding CAGR of 27.68%. However, from 1998 through 2020, Coke has only appreciated at a CAGR of 4.74%. 10 year treasuries have returned 5.31% with a lot less stress.

An investor would have been better off investing in 10-year treasuries in 1998 than investing in Coca-Cola.

Did Coca-Cola’s business change? No. Coca-Cola has continued to be a great business since 1998, growing earnings and earning high returns on invested capital. It didn’t matter for the stock.

What changed was the price. Coca-Cola got up to a P/E of 40x in 1998. The price grew faster than the fundamentals.

The valuation mean-reverted in the 2000’s despite the performance of the underlying business, causing the less than satisfactory result.

Buffett should have sold Coca-Cola in the late ’90s, but he didn’t.

Why didn’t he?

It could be for public image reasons. Berkshire had become so closely associated with the company. If Buffett sold, it would be a blow to the public image of Berkshire and Coke.

He also couldn’t nimbly move out of it, as it had grown into a massive portion of the Berkshire portfolio.

In fact, it’s quite possible that Buffett realized Coke was expensive, couldn’t sell for the public image reasons, and this may have been a major reason that Berkshire purchased General Re, which helped dilute Coke as a percentage of Berkshire’s holdings.

I’d also argue Buffett was in love with the business and couldn’t bring himself to sell.

Problems with Wonderful Businesses

Coke’s price run-up in the ’90s and Buffett’s mistake by holding on outlines a major problem with buying wonderful businesses.

If the business is indeed wonderful, how can an investor bring themselves to sell when the price gets ahead of the fundamentals?

Another major problem with moat investing is that moats are ridiculously hard to identify. I would argue that even Coca-Cola’s moat isn’t certain to persist into the future.

While it was socially acceptable to give children sugar water when I was a kid, that dynamic is different today. Coke has tried to get away from this problem by diversifying into other products. Still, I find it hard to believe that Dasani will have the same marketing grip over future generations that Classic Coca-Cola had over previous generations.

If Coke’s moat is uncertain, then what moats are certain?

If it’s possible that Buffett – the greatest business analyst of the last hundred years – is making a mistake by holding Coke, then what are the odds that you going to make a mistake by buying the business that you think has a wide moat? I am certainly not a business analyst that’s as good as Buffett.

It is also increasingly difficult to acquire these businesses at “fair” prices. Investors fall in love with wide-moat businesses and bid them up to prices which are likely going to create disappointing future results.

For example, modern value investors are buying things like Visa and Costco because they are wonderful businesses with moats.

I certainly agree that, on the surface, Visa and Costco have incredible moats. Visa controls a significant portion of the global payment system and it’s unlikely that a competitor can disrupt that. Costco controls an ever increasing portion of America’s retail spending habits and maintains that by maintaining low prices and locking in consumers with memberships.

Neither of these businesses can be acquired at the kind of “fair” prices that Buffett acquired companies like See’s and Coca-Cola.

Look at the current EV/EBIT multiples of these wonderful businesses:

Coca-Cola – 24.14

Costco – 19.91

Visa – 23.42

Additionally, Buffett didn’t buy Coke and See’s at crazy, or even slightly high, prices. They were incredible bargains!

As mentioned earlier, for Coke, Buffett bought it at a P/E of 14 and 12. The enterprise multiple was likely much lower than that raw P/E suggests. See’s was purchased for $25 million. Sales were $30 million the year that he bought it. Profits were $4.2 million.

Buying a company for less than its annual sales and at a P/E of 5.95 is nothing like buying today’s compounders at EV/EBIT multiples over 20.

Yes, See’s wasn’t a net-net, but it was hardly a situation where Buffett and Munger threw caution to the wind and paid a sky high valuation for a great business that compounded over time.

Do I Trade Too Much?

Let’s return full circle to the question I asked at the beginning. Do I trade too much?

I don’t buy wonderful businesses and hold them for all the reasons described above. I buy cheap stocks and then get out when the fundamentals deteriorate or they get close to intrinsic value. I certainly trade more than the Buffett-style compounding value investors, who would waive a ruler at me like a nun in Catholic school for betraying the faith.

I went to Catholic school and this was a frequent occurrence.

I trade even more frequently than Graham’s rules recommend.

Not only do I sell at intrinsic value, I often sell at mere 52-week highs. I’ll also sell if I notice a deterioration in the performance of the business, often relatively quickly after I buy them.

A major reason I sell so quickly is because I know I’m not necessarily buying wonderful businesses. I’m buying businesses at what looks like a bargain price regardless of its underlying quality. I get out when I see signs of a deterioration in the business, which helps me avoid value traps.

I’d argue that the approach works, even though I’ve lagged the S&P 500.

As with all things, I like to look at the evidence and not the dogma.

Here is a comparison of stocks I’ve sold, comparing my sale price to the current market price.

price1

2

sells

selling

I’m not following the Buffett scriptures, but it seems to me like I’ve made some pretty decent sell decisions.

I think I will continue to follow my own path instead of sticking to an investing religion dogmatically.

Summary

  • Buffett believes in long term holding periods. Graham recommending shorter periods. I agree with Graham.
  • Wonderful businesses with moats are extraordinarily hard to find. It’s also hard to find in any quantitative sense.
  • There isn’t any empirical evidence that proves that wonderful businesses outperform over long periods of time. In fact, the opposite is true.
  • I get criticism for trading too much, but it seems to be working out for me. I’m going to chart my own path and not stick to an investing dogma like it’s a religion.
  • You do you. There isn’t any one true faith in investing.

Random

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Quick Note

TAIL

I bought TAIL yesterday. I basically bought this as a hedge against the stocks that I still own that I can’t bring myself to sell. This helps me stay somewhat market neutral during this bear market.

I’m not taking an outright short position on the market. Yet, anyway. Still struggling with whether I want to actually do that.

Deep Value

The good news is that the deep value universe of stocks in the Russell 3K with an EV/EBIT multiple under 5 is now over 200 stocks, which is the best environment we have seen since the financial crisis.

Under normal circumstances, I would be a buyer. I just don’t think markets bottom when a recession is only just beginning.

deepvalue

Market Valuations

Other good news, after yesterday’s decline, market cap/GDP is now down to 110%. This isn’t cheap, but better than where we were. There are a range of outcomes from here depending on where valuations are 10 years from now:

Market cap/GDP = 40% = -6.3% CAGR

80% = 1.7%

120% = 6.7%

The outcome is largely unknowable. Future valuations strongly depend on what interest rates are 10 years from now.

I think you could make a strong case for both outcomes: interest rates will be lower as we emulate the Japan example, which suggests valuations can be higher.

It’s also possible interest rates will be higher. I think that’s the likely outcome, as our demographic situation is different than Japan and I think money velocity will likely pick up as Millennials enter their peak earnings years. It’s also quite possible that, thanks to quarantines, we’ll have a baby boom in 9 months which is also bullish for the long term prospects of the economy.

In any case, we have to look at the range of outcomes. The base case is 1.7%, which isn’t really too exciting compared to the risk of owning equities.

Recession

Markets don’t bottom at the beginning of a recession when unemployment is low.

Of course, there isn’t anything normal about what’s going on right now. This was a violent move down, and for all I know the market could make an equally violent move up when this is all resolved.

I turn to valuations and history for guidance. In the last two recessionary drawdowns, market cap/GDP got down to 75% in 2003 and 57% in 2009. That means this likely really isn’t over until we get down to at least 80%.

The yield curve is currently un-inverted. That’s good news. I’m unusual among cranky market bears in that I want the Fed to ease and try to stop this recession aggressively and think they’re doing the right thing by throwing the kitchen sink at this. I also think that the federal government needs to pursue hardcore fiscal stimulus to end this.

yield

Markets don’t bottom when the yield curve just starts to un-invert. They bottom when we have a large spread between the 3-month and 10-year. That’s a pretty good indicator that an economic boom and turnaround is in our future. We aren’t there yet.

Buuuut . . . at least we’re starting to get there and are headed in the right direction.

More good news is that the vaccine is being tested. Let’s make sure this works and roll it out and defeat this thing.

Stay safe and healthy. Hug your people. Well, those you’re safely quarantined with. 🙂

Random

Electric Youth is great.

 

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

I’m out

dark

Selling

I sold a lot of stocks this week. I sold most of my stocks this week. I’m now up to 79.5% cash and bonds in this portfolio. This is obviously a wildly bearish perspective for markets and the economy.

One perspective on this: I’m panic selling and I’m not taking a long term perspective.

People of this persuasion would probably say: value investors should buy when there is blood in the streets! Isn’t there blood in the streets right now?

I don’t think so. I think we are only at the beginning of a truly horrific period for the markets and the economy and I am accumulating cash to take advantage of the bottom, which we are nowhere near.

I don’t think we’re anywhere close to the end of this. This is not capitulation. My Twitter feed is still full of people talking about buying the dip. The BTFD mantra isn’t slowing down.

That is not the mentality you see at the bottom of the market.

With all of this said, yes, I’m timing the market. Yes, I know you’re not supposed to time the market. Yes, I know you’re not supposed to pay attention to macro.

Yes, this is speculation. But you know what? Picking individual stocks is speculation. I created this account for active bets. I have other accounts for my balanced asset allocations. This account is for active bets. Right now, I’m making an active bet that this is only the beginning of a massive drawdown and value stocks are not going to be a place to hide.

I’m also nearly certain I’m right about this and I’m acting accordingly. This is only the beginning of the horror show that is about to unfold. I even sold my “cash equivalent” ETF because I’m concerned about the corporate debt market, which that ETF has exposure to.

I might look like a fool for doing this by the time all is said and done, but I think this is a prudent course of action based on where we are.

Recession

Back in December 2018, I was bullish. The reason was pretty simple: I knew we were not going to have a recession and there were a lot of cheap stocks.

Going into this year, I was bearish. The yield curve had already inverted, which reliably predicts recessions 1-2 years out. The world economy was already showing signs of slowing down, and manufacturing was already in a recession.

In the recession, my expectation was that stocks would fall 50%. I thought that my 30% cash allocation would give me a decent cushion when that happened. I also assumed that throughout 2020, I would have the opportunity to gradually exit positions and build up that cash position. There was nothing gradual about this decline.

While everyone loves the buy-and-hold mantra and Warren Buffett also extols it, I think it’s a common mantra at the end of a bull market that is typically bad advice.

Buffett has a quote which people like to repeat: “Be fearful when others are greedy, and greedy when others are fearful.”

Well, to be fearful when others are greedy, you actually need to sell. To be greedy when others are fearful, you actually need to have cash on hand to take advantage of the bargains. This advice is incompatible with buy-and-hold.

The reaction to the Coronavirus is going to make a recession that was already underway even worse. This isn’t going to be a standard recession. This is going to be much worse than recent experiences. This is unlike anything we’ve experienced since the Depression.

Around me, closures are being announced all over. Malls are closed. Sports are cancelled. Airports are dead. Even among the places that aren’t closed, people are avoiding them.

Think about what is going on right now. Global trade and global supply chains are slowing. People are beginning to quarantine themselves. That means they’re not going to restaurants and bars. What happens to the people who depend on tip income at restaurants and bars, for instance? What happens to the businesses where they spend money? How about people who work at airports? Movie theaters? Daycares?

Right now, we are suspending large chunks of the economic machine.

Now, think about all of the leveraged firms that are out there. How are they going to handle the slightest hiccup in their cash flows? Will they be able to keep making payments on their debt? Or will this force them over the edge? Now, what happens to all of the people who worked for those leveraged firms? Where do those people spend money? How about the partners that these firms had? Everyone’s spending is someone else’s income.

In 2008, the peak to trough decline in GDP was only 2.24%. Think about the impact that a 2.24% reduction in GDP had on markets and the economy. With the situation that’s currently unfolding, I’m betting the decline in GDP is going to be a hell of a lot worse than 2.24%.

Valuation

The thing about valuation: it doesn’t matter until something goes wrong.

Think about your typical highly valued stock. It has an absurd expectations embedded into it. As long as it continues to meet those expectations, then valuation doesn’t matter.

Of course, as a rule of nature, s*** happens. Eventually, there will be a hiccup or whiff of bad news. The stock craters. It is a phenomenon that repeats over and over again. It surprises market participants again and again.

The entire US stock market is the equivalent of a richly valued stock right now.

We’ve been lucky for the last 10 years. No s*** has happened. No recession. We had a near default in 2011, but it didn’t happen and we didn’t have a recession. We had an oil decline in 2015, which was bad for the oil industry, but good for everyone else. No recession. This is why valuations haven’t mattered and bears have become a punchline among the investing commentary class.

Now, we’re going into a storm. The s*** is hitting the fan. And we’re going into this at absolutely absurd valuations.

Recently, on a market cap/GDP perspective, we exceeded the highs of the tech bubble. The stock market was valued at 150% of GDP.  We were at 140% in 2000. We’re at 125% now.

To put this into perspective, at the lows in the early 2000’s bear market, we got down to 75% of GDP. That is 40% down from here.

And what happened during the recession of the early 2000s? Unemployment peaked at only 6%. To put this into perspective: unemployment was 6% in 2014 when we felt like the economy was booming. In the early 2000’s, we barely had a decline in GDP. The overvaluation in the market meant that an extremely mild recession was enough to send markets into a 45% peak-to-trough decline.

In 2008, the market was not as expensive. We were at 110% of GDP. The valuation fell to 57% of GDP. If we fell to this level from here, it means markets fall by another 54%. Hello, S&P 1,250.

2008 was an intense recession. However, as I mentioned earlier, that was only a 2.24% decline in GDP. Unemployment peaked at 10%. The fact that the market wasn’t as expensive as it was in 2000 probably cushioned that drawdown.

The extent of a serious drawdown is a combination of the overvaluation of the market and the severity of the recession. We were lucky that the early 2000’s recession was a mild one. I’ll bet that if we went into the 2008 recession at 2000 valuations, we would have seen a 60-80% decline in the market.

This time, we went into this drawdown already ahead of the 2000 era valuations. Meanwhile, we are likely going to get a recession that is even worse than 2008. This is a recipe for a horrific decline in the markets.

Value’s Place in This

I own a bunch of stocks with a margin of safety, right? If I already own stocks with margin of safety, then why should I care about the broader market? Why sell when I know the stock is worth more than that?

Well, the fact of the matter is that value almost always goes down with the broader market, sometimes by more. When markets drawdown, they bring everything else down with it. Serious drawdowns happen during recessions.

red

In every big drawdown, the US stock market has managed to drag small value down with it. This even happened in the early 2000’s. Value did well over this period, but in the middle of it, it still experienced a 31.28% drawdown.

Margins of safety don’t offer protection in recession. The margins of safety get bigger as the bear markets grind on.

Another part of the problem is that my margin of safety is based on EBIT and earnings. One of the drawbacks of this approach is that EBIT evaporates into a poof of smoke during a serious recession. Goodbye, margin of safety.

Looking Forward

Eventually, of course, I think this market will bottom. There will be fiscal stimulus. There will be monetary stimulus. There will be pent up demand from months of quarantines.

This will eventually be a stock picking bonanza, just like 1974 or 2009.

I just don’t think we’re there yet.

What if I’m wrong?

Well, that’s why I own a passive account that’s balanced between asset classes that should do well in multiple economic environments (this portfolio has 40% in treasuries and gold) and it is where I don’t try to predict the future.

If I’m wrong, I’ll have too much cash and I’ll continue lagging the S&P 500. No news there.

If I’m wrong, you can all laugh at how stupid I was to sell good businesses at bargain prices.

Frankly, I hope that happens, because I don’t want a recession or decline of this magnitude to happen. It’s going to be bad news for a lot of people who don’t deserve this. I’ll take absolutely zero pleasure in seeing this happen.

But . . . every fiber of my being tells me that I’m not wrong. I haven’t decided if I want to make an outright bearish bet on something like SH, but don’t be surprised if you see that trade soon.

I am positioning myself accordingly and trusting my instincts and my analysis.

Random

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Trades

I sold 16 shares of OSK @ $56.0236.

Sold 31 shares of NUE @ $32.59.

Sold 83 shares of MOV @ $11.70.

Sold 37 shares of PFG @ $33.

Sold 221 shares of NEAR (because I’m worried about the corporate debt market) @ $49.38.

In short, I think we’re headed for a horrific recession and there will be no place to hide. I think the market has another 30-60% downside.

When it’s all over – I want to have the cash to take advantage of the bargains.

We’ll have to wait and see if I’m right.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.