Backs Turned Looking Down the Path

Now that I am no longer operating full time in “crisis management” mode, I thought it might be instructional to look back and reflect on this things I did during the last nine months, which, in case anyone might wonder, has been the most challenging period in my career. This exercise will represent a debriefing, if you will -- an attempt to look back objectively at what happened, how I responded to what happened and what I might have learned from the experience.

Let me start by explaining what I did not do:

1) I did not sell stocks in October 2007, which turned out to be the peak of the market. At that time, the market did not exhibit any of the excesses we generally associate with market peaks. The excesses were located squarely in the housing and credit markets. I had no specific information showing how leveraged the banks and brokers were, nor how this leverage would spill over into the stock market and the general economy. Past bubbles had burst without threatening the entire global financial system. It was not obvious that bursting this one would have that impact.

2) I did not sell stocks to hold cash at any time during this period. I am not a market timer, and I don’t think anyone can do this successfully over time.

3) I did not abandon my long-held personal investment philosophy. It has worked for many decades and I suspect it will work for more decades to come.

4) I did not panic.


Here are a few things I did that I think served me well:

1) By October, I recognized that the situation had quickly deteriorated and that the markets had stopped functioning in a normal fashion. Once the VIX (CBOE Volatility Index) broke the 40 level (which had for years been its peak), I felt that the market could become very volatile. When Lehman Brothers fell and the credit markets seized up, the real trouble began. Still, I had personally experienced the Crash of 1987 and the Long-Term Capital Crisis of 1998, and so I truly felt that we could ride through this one as well. I kept analyzing companies and tried my best to assess the value of stocks – this is my training; this is what I do. Sitting around worrying about what might happen is never a productive activity.

2) By November, I was buying stocks. One of the downsides of being a value investor is that you rarely ever own the stocks everyone loves to talk about – the new and shiny ones with great stories and sex appeal. It’s kind of like driving a Ford Focus when everyone else is driving BMWs. However, starting in November many of the BMWs were going for prices usually associated with Fords. So, compelled by the value I was seeing, I began to nibble at not just the beat-up value stocks, but many of the growth names I had never owned before. The valuations were more compelling that the uncertainty about the future.

3) By early March, I was stubbornly holding my ground. By this time, every single “doom and gloomer” was in full froth mode, telling anyone who would listen (everyone in media, it seems) that the world was truly ending. The January through March decline was very hard for me – the reasons for the decline were even harder for me to understand – the VIX was down and the capital markets were once again working. Why was the market still going down? Was it mostly driven by retail selling? Mutual fund redemptions? Hedge Fund deleveraging? Maybe someday someone will write a book with definitive answers. I did not know that March 9th was the bottom, but I did feel that retail investor panic was peaking that week.

4) I kept working. Go back and read my blogs from February and March. In them you can see that I was closely following the events of the day and trying my hardest to make sense of it all. The best paragraph (in my humble opinion) of the month was this one from my March 9th post:

“Unless ‘this time is different’ (still the four most dangerous words in the investment business, in my view), the stock market will begin climbing the proverbial wall of worry, long before the talking heads will be able to tell us that the recovery has begun.”

Crises, panics and manias are always hard to deal with, but they are absolutely the natural product of open capital markets. No amount of legislation can prevent them. The best way to deal with them, in my opinion, is to 1) understand the risks associated with the markets, 2) understand your investment time horizon and 3) develop a personal investment philosophy that can support and sustain you during the hard times. The last nine months have been a huge challenge, and lots of people have lost a great deal of wealth. But, I firmly believe the only pathway leading to any hope of recovering that wealth will take us directly through the middle of the stock market. Once again.