Lessons From The Bear Market
Lessons From The Bear Market
From a research perspective, the past 12 months have been the most difficult in The Intelligent Investor’s 10-year history. The Growth Portfolio fell 37% in the year to 30 June, the Income Portfolio fell 26%, and the last Buy recommendation to show a positive return was ARB Corporation in August 2006. There have been 15 since, of which three – Timbercorp, RHG and Platinum Asset Management – have more than halved.
That would be concerning in itself, but it’s been all the more frustrating because this bear market was supposed to be fun. We spent an exasperating few years standing on the sidelines refusing to get dragged into the bull market euphoria. We first lamented the lack of bargains way back in September 2003 when Making the case for cash. We made The case for more cash in July 2004 and then sounded a series of increasingly dire warnings: Profits won’t defy gravity forever in May 2005; Easy money signals tough times ahead in April 2006; Rise and fall on RBA’s call in June 2006; Dear Glenn, you have a problem in January 2007; Hangover will follow global binge in June 2007; Expensive lessons from cheap credit in August 2007; Scylla, Charybdis and Bernanke in September 2007; and Strong arms ready to crush weak hands in January 2008.
And on top of the worrying global picture, we warned about particular sectors with articles such as Is your bank going broke? in April 2007, Danger lurks in the banking sector in January 2008, and countless warnings on the listed property sector, such as Property trusts don’t add up from June 2006 and last year’s special report Are your property investments safe as houses?. We rang the warning bell on MFS and ABC Learning and, at 30 June last year, the ratio of sells to buys was five to one. People were leaving The Intelligent Investor because they were sick of the pessimism.
Not our finest hour
Yet here we are somewhere between the start and the end of the bear market we had to have – what was supposed to be our finest hour – and our Growth Portfolio is suffering more than the overall market. How did we get here?
It’s not that we’ve bought a bunch of dud stocks. Despite share price retractions that might make you think otherwise, many of the businesses we’ve recommended are progressing as expected. Albeit hindered by the high Aussie dollar, ARB and Cochlear are working out nicely, Flight Centre has well and truly exceeded expectations and Infomedia is still churning out dividends in the face of a gale force currency headwind.
Even where we think we’ve initially overestimated the value on offer – as with Timbercorp, RHG, Platinum Asset Management, Sigma Pharmaceuticals and Mortgage Choice – the extent of the error is a fraction of the share price fall. No, the problem is that because of our investments in stocks such as these, we’re now passive participants in a market that offers extraordinary value.
Given the excesses and problems we accurately foresaw, it would have been reasonable to expect more patience. Instead, we shot our bolt too early, despite expecting better value to emerge. We thought we’d be able to switch from our original selections into that better value as it emerged – but that clever trick doesn’t work if the value continues to emerge in the stocks you’ve already picked. It has been a salutary experience for everyone and we owe it to ourselves – and to you – to try to take something from it.
Psychological shortcomings
As humans we’re all psychologically wired to be poor investors. We’re wired to follow the crowd, to extrapolate the recent past, and to cling to our prior decisions in spite of confuting evidence. These psychological shortcomings are exacerbated for us by the fact that we provide our research to some 9,000 subscribers and face constant pressure to provide buy recommendations.
Over the years we’ve handled these pressures reasonably well, but the main lesson from the past year is that we aren’t immune. The experience itself has taught us a lot (C.S. Lewis called experience ‘that most brutal of teachers’, but ‘you learn’ he said, ‘my God do you learn’) but we’ve also decided to add some extra rigour to the way we reach our stock recommendations.
Senior analyst Gareth Brown recently handed me an article published in The New Yorker in December last year. Centre stage in the story is Peter Provonost, a critical-care specialist at Johns Hopkins Hospital in the US. In 2001, in an attempt to counter line infections at the hospital, he introduced a simple five-step checklist for doctors to follow. As the article explains:
Doctors are supposed to (1) wash their hands with soap, (2) clean the patient’s skin with chlorhexidine antiseptic, (3) put sterile drapes over the entire patient, (4) wear a sterile mask, hat, gown, and gloves, and (5) put a sterile dressing over the catheter site once the line is in. Check, check, check, check, check. These steps are no-brainers; they have been known and taught for years. So it seemed silly to make a checklist just for them. Still, Provonost asked the nurses in his [intensive care unit] to observe the doctors for a month as they put lines into patients, and record how often they completed each step. In more than a third of patients, they skipped at least one.
During the next two years, they calculated that this simple checklist ‘prevented forty-three infections and eight deaths, and saved two million dollars in costs.’ The article goes on to ask, if something so simple can transform intensive care, what else can it do? Well, for one, it can improve the analytical process at The Intelligent Investor.
Redressing the balance
I feel we need to define the process we use for selecting stocks more clearly. So for starters we’ll be instituting a simple, written checklist that forces us to address certain issues that our psychology might otherwise encourage us to gloss over. We’re also going to redress the balance between the time we spend running the business and the time we spend researching stocks – we all feel there’s too much of the former and not enough of the latter – and we need to apportion our time better between genuine searching for opportunities and simply regurgitating news. So you can expect to see more in-depth stock research – especially from Greg and myself.
Finally, I’d like to reiterate the sentiments in Greg’s Confessions from the research desk. I’m proud of the service The Intelligent Investor has provided over the past decade and, while we’ll have our ups and downs, now is certainly not the time to panic and make wholesale changes. The Growth Portfolio has risen 3% in July while the index fell 6%. Given the portfolio of extraordinarily cheap stocks it contains, that’s a trend we expect to continue. So amid all the pessimism, we see reasons for optimism.
It would be wonderful to relive the past 12 months knowing what we know now, but unfortunately life isn’t like that. It is at the times we are most challenged that we learn our most valuable lessons. For the analysts at The Intelligent Investor, now is such a time.
I trust that the lessons we learn now will have a greatly beneficial impact on the performance of our recommendations in coming years, and that we will restore the excellent performance our portfolios have shown in the past.
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Comments
I know you guy poo-poo any form of technical analysis, but its most basic tenet is "the trend is your friend". Incorporating this aspect into your recommendations may have stopped you from shooting your bolt too early and would likely have improved your performance over the last year.
You may be correct when you identify Stock X as being undervalued, but until the market agrees with you and arrests the declining price it will still be a poor investment decision. Without market sentiment on your side (or at least not totally against you) you wil always lose.
I think the combination of insightful valuation (which you do - very well) and basic technical analysis (which you don't) would greatly improve your performance and appeal.
Kind regards.
Steve/II team, I have over the last year been closely observing the perspectives presented on the companies covered and reasoning behind your recommendations.
My focus has been on weighing up how to balance my allocation of money between stocks, cash, property or paying down debt. Despite Buy recommendations on certain stocks and your growth portfolio inclusions (which as a stock market focused organisation your must have), I have actually felt a fair bit of bearishness in your general views to the extent that I opted to stay out of the share market altogether until early July 08 at which point I felt some strong bullishness return in your outlook and was moved into making my first of a series of meaningful investments which started with MOC at 85.5c. I feel your organisation has done a great job of identifying the advantages of one stock over another through the whole period. However in times like those we have just seen where the entire market seemed overpriced, I think the investor themselves needs to make a call on whether to be in the stock market or not. I am thankful for the views provided from your organisation which have helped keep me out of the market until the last month.
I think T.I.I. team has been the victim of Anchoring bias, anchoring to the period in which value stocks were hard to find.
Are you going to publish your checklist, Steve? As a T.I.I subscriber, I'm interested. A checklist relevant to stock research at T.I.I. should be equally relevant to any investors.
By the way, I think this piece by Zweig http://online.wsj.com/article/SB121700939198285307.html is of interest to you. "You cannot even pretend to be protected against loss while [the valuations] are still crumbling."
Hi Steve,
I want all the guys at The Intelligent Investor know that there are people who appreciate what you do. I've been a subscriber for a few years, and your publication is glimpse of light in the darkness for me. I believe what you do is right, your hard job will be paid back, and everyone who have enough patience to follow you will be rewarded. Thank you.
Enjoy your research very much. Unbiased, unflattering and cynical. Best I have found.
And while I am please to see your humble attitude to your growth portfolio's performance at this juncture, I do expect the portfolio will do better than the market going forward.
I too would be interested to see both your investment checklist (John's post) and technical views of all your recommendations (Paul's post).
G’Day Steve,
I have been a subscriber for about four years and I have waited patiently for an opportunity to follow the sensible value investing principles. Unfortunately Australia has had a mighty boom and it has been a long wait. Like you, I too, after such a long wait, jumped on the first value I saw recently only to see it become more and more a bargain! Oops!! CS Lewis is right - experience teaches painful but unforgettable lessons.
I agree that after such a long wait it was kind of natural to react so impatiently, but more and more I believe that patience is going to be vital in the future for Aussie value investors. I am starting to believe that we will have perhaps another 20% drop in the market to bring p/e’s back into 10 yr historical ranges– after all we really still haven’t seen any of the significant problems we have been alerted to [i.e. real estate values about 30% overvalued – demographia.com says world average house prices are about 4 times gross average wage but we have about seven to eight times, banks yet to suffer from this Aussie prob rather than overseas probs, people still overspending –esp credit card use - anticipating pay increases businesses are no longer capable of giving, personal debt levels higher than in the Great Depression, monetary policy levers no longer working, Government fiddling while ‘Broome’ burns, etc, etc]. All of this will take perhaps another year to work through, as denial is not just a river in Egypt.
Besides commiserating with you, I am writing to perhaps offer some feedback, that while I don’t mean it to, might sting a little. Please don’t get me wrong, I appreciate all the team’s efforts but I offer this as just my humble opinion so that we may both become just a little better in the future. After all I am far from perfect and need all the help I can get. I would like to be given more of the analyst’s reasons, calculations and analysis for why the companies are buys etc so I can decide if I agree…as often I don’t. I don’t need too much by way of updates on news items as I can get these with a Google search unless they are related back to the actual analyst’s calculations. I would like you to assume I am sceptical and to try to convince me as if I was your recalcitrant brother and you want to save him from the biggest mistake of his life – whether that is to buy or to sell. I am sure it would help the analysts to be even more rigorous than they already are, because if they can’t find the facts to be able to convince then that should be a warning not to recommend and to state that in their reviews. I’m sure you’d agree that it is better to miss some opportunities than to encourage trusting people of limited experience and means to invest.
Now I say these things frankly to you because one of the reasons I believe in value investing and in particular you guys is your willingness to speak the truth and be objective. I respect you for it. It is a great strength in these times of political and economic obfuscation. Investors need that now more than ever. Please keep up the good work and don’t lose faith – this is a particularly nasty and difficult-to-understand slump, which without doubt will eventually turn and then there will be opportunities that we will tell our grandchildren about!!
All the best,
Ben O’Grady
www.imagi-natives.com
Hi just read the above comments and suggest that I hope the day never comes that the Intelligent Investor utilises technical analysis to cloud its judgement of value. I would hate to think that good value propositions fail to be published becuase technical indicators are negative. I see your role to point out value and our role is to decide wether to act on that now, later or never. I don't think pointing out value early is a problem. For example a quality company like Westfield very rarely offer value but if the share price is offering us 5% below the value estimate then I want to know about it because that may be as good as it gets and I would more than likely buy at such a discount and hold them for the next 20 years. On the other hand a poorer quality company I would still like to know when it offers value but I will chose to wait until the value becomes large and if I miss out there will likely be another 20 opportunities in such lesser companies. To finish off just keep pointing out value and let us decide when to buy.
Have read above comments but it is the original comment by Paul that I feel indicates the problem. There is more BS on technical analysis than you can point a stick at. However one fact stands out, "dont try to catch a falling knife". Your value analysis seems to be quite good BUT if the share price is clearly falling it is better to wait rather than jump in. A basic fact is that a SP cant increase before it at least stops falling, and it will be better value when it does fall. This simple rule has saved me heaps over the years, and cost me when I ignored it. It is by no means perfect but it does increase chance of success.
Good post from Ben O'Grady. I don't think we are likely to get the details of the analysis that you are asking about though. That would involve publishing II's estimate of value, something II has clearly and somewhat unfortunately is not wanting to do. Just because II prefers to be 'approximately right' rather than 'precisely wrong' shouldn't prevent puting an estimate of value on a stock. If II is not happy to even estimate the value, I have to wonder about their whole valuation process and what it involves. That is the one issue I am really concerned about more than anything else.
Mistakes are merely experience that awaits assimilation.
I've not really had any tragedies with my picks of your selections (missed Flight Center tho') and have a few flutters on the side so I'm waiting for the dividend season to replenish the ammunition. All the disasters are my own doing.
II remains pragmatic, well-informed and open when it passes on their take on market possibilities. Don't be down hearted. I thought I was clever selling out the whole portfolio in August '87. High interest rates and everyone getting greedy. Felt the same way 20 years later but lazily said it all came good for those who stayed in the market so why not ride it out. I could have been rubbing my hands with a portfolio of cash. I'm not, I'm wringing them. At any rate I probably would have swung back into purchasing too early so it's not your fault. However if there are improvements in your crystal balls - bring them on.
Hi Steve,
I have been a subscriber of your for about 2 - 3 years now, and I am more than happy with the service you provide. It is brutally honest (extremely hard to find in this business) and offers fantastic research and analysis. If I am not mistaken, your company's job is to simply report your analysis and your research in a digestible manner so that we can use your research with our personal investment techniques and strategies (including Technical Analysis for those that are that way inclined). So in my case you and your company have done your job brilliantly and have far exceeded my expectations. You have pointed out numerous stocks well below value, pointed out numerous stocks well above value, (I escaped MFS just in time thanks to your research) and even though the value is getting greater now on many recommendations, I feel it is all the more better for us as investors. It is not your job to time your recommendations, it is our job as investors to time our purchases based on your analysis, and our investment goals and strategies.
So I would personally like to thank you and your team for your fantastic easy to read articles, I have learnt an absolute tonne from them, so please keep them coming.
Kind Regards,
Dale Cameron
I have been subscribing to your service on a 6 months trial and I'm going to renew, not because I agree with all your recent buy recommendations, because I don't, but because if I had been subscribing to you 12 to 18 months ago and acted on your warnings, I'd be smiling right now.
I've lost track but I believe I have been a subscriber for about 5 years now. I agree that the main thing that would enhance the recommendations from my point of view would be to provide the estimate of value. As with the qualitative analysis it is up to us the subscribers to decide how much we agree with it or not. You have done it for a number of stocks such as TIM, RHG, Soul Pattinson, etc. So when it is not there it suggests either a complete lack of confidence in the number you have arrived at or that you haven't bothered to come up with one at all.
Despite this I have been very happy with my subscription - sometimes I have agreed and followed to early and sometimes I have waited which can mean a better opportunity or a missed opportunity. To those supporting technical analysis I can only say that in my experience anyone who tells you they can pick the bottom or top consisitently before it happens should share their drugs, not their stock picks.
I have been a subscriber for over 4 years. I stood on the sidelines and missed the last bottom (when you were recommending to buy). Since then I have purchased stocks recommended by II that have fallen a long way from the height of the boom (ROC, SGN and others). This has been disappointing. Although I was following recommendation there was a element in my decision making which was the "fear of missing out". What's done is done, and from here on all I can do is invest my remaining money better.
The above article is interesting reading and provides largely a qualitative response on why errors may have been made. I personally would like a follow up article with a more quantitative response, i.e. the check list, estimates of intrinsic value of stocks currently on the buy list (a range would be fine; and I agree target prices are silly) so I can compare against my purchase price.
I remember watching the Warren Buffet DVD you supplied once with your subscription and Warren said was after buying a stock at a reasonable price, not necessarily cheap. He did not want to cheat the previous owners, if I remember correctly. I don't think he tried to pick the bottom, he was after value and a moat around the business. If my stock has not lost any value or it's moat then my concerns are few but if value has been lost or I overpaid for my stock then I am concerned.
Thanks
As a subscriber for a few years to I.I. I've been happy with the approach and learned a great deal. One point you've made before and is a favourite of all the obvious Value Investing guru's - don't over react to the markets moves! As you say, we just need to learn from it and keep looking for value. One suggestion I have is for your reports to contain a LITTLE more detail of your analysis.
PLEASE keep focusing on value invetsing approaches and ignore any calls for Technical Analysis, if a subscriber wants technical analysis they can easily find that elsewhere and combine it with your thoughts. As value investors I.I should stick to what it knows!
Top Article.
Always amazes me how well technical analysis works after the event.
There are many listed companies ie Argo in Australia and Buffet in the usa which have done okay value investing (long track records).
I haven't managed to find any similar companies that use technical analysis.
This is just part of the cycle. Obviously a Macro driven market.
The key to getting through this market in my view is holding quality and raising/ holding cash. If your fully invested now your options are limited but if your holding cash you should make much more from that money than any losses you have sustained in this bear market
Hi Steve,
I am a subscriber of 1 year and I bought my first shares ever about 10 months ago. I jumped in pretty quickly on your recommendations and now my shares are down. Mr. Market is depressed.
I read quite a lot about share investing in the years leading up to buying shares and I was and am convinced that you guys are on the right track. I believe that the money I put in is better invested where it is than anywhere else I could have put it unless I knew where the bottom was and held cash. I didn't expect that you would know where the bottom was.
I think that if you start trying to pick the market rather than the value of the company you will join the experts on the TV news which I do not watch.
If you are looking for suggestions, I would like to see some comment on the long term rate of return that you use from time to time to estimate fair value of a company and more specific comment on the price that you think is reasonable over the long term. The generalised recommendation categories can get a bit confusing when I am following a chain of reviews.
Thanks for the good work.
Steve and co,
Please, please, please do not wallow in self pity.
A key lesson I have learnt through investing in many fields of wealth management over the years is that an investor ultilmately must take ownership of their own performances and learn from them. If your subscribers are disappointed with your performance recommendations as a result of the performances of their own stock then they should reconsider whether they should be investing at all. One of the many lessons I have learned from your unique offering is that once I have learned of an opportunity from II that I should then follow through with more detailed research using my own methods and checklists. Once I am personally satisfied with my own choices then I proceed. I then measure and learn from my choices. With that approach I am thankfully only down 7% this calendar year based on buying a number of your recommendations at my timing. Stock such as FLT, MOC and IFM would never have come across my radar had it not been for your insight. After many years I still believe my best investment to be my annual II subscription. Cheers Michael
I have had my fingers well and truly burnt on ROC, TIM, SIP, RHG, PTM, so I agree I am doing something wrong. In future I will be waiting a long time after a share is recommended to see if it will continue falling. I figure it is OK to buy a rising stock anyway if I wait too long. The same applies when a share is moved to "sell" such as QBE and JBH in the past.(more finger burns) I wish I had hung onto those and ignored the advice, at least for some time.
Technical analysis might be useful for predicting when to buy, rather than selecting what stocks to buy.
Anyway, I accept that all of these decisions were my own, and that in the long term, the "value" should begin to show through.
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