Monday, January 04, 2010

New Year’s Resolution: Think For Yourself

It was a cool Florida evening one year ago next month when your editor joined a distinguished investment strategist, familiar from near-constant CNBC exposure, and a third market observer on a makeshift stage in the dining room of a country club to discuss the economy and the prospects for the stock market—such as they were, in those gloomy days—before a solemn group of Chartered Financial Analysts from the local financial community.

The crowd had reason to be solemn.

The news was horrible and getting worse. Indeed, the financial crisis then gathering steam outside the tree-shaded windows of the club would not reach a peak for another four weeks before finally culminating in that apocalyptic March, 2009 print of “666” on the S&P 500.

The lessons of Warren Buffett—whose high-profile, crisis-defying investments in Goldman Sachs and GE were looking pretty stupid—seemed quaint, old-school and positively out-dated as we faced the crowd.

Who wanted to “put all your eggs in one basket and watch that basket,” as Buffett liked to say, when Buffett acolytes such as Bill Miller—his so-called “Value Trust” fund had lost a third of its value in the previous ten years—were watching their concentrated portfolios getting crushed in the financial collapse?

And so it came as no surprise that your editor was figuratively elbowed aside when the Famous Strategist took control of the discussion, delivering in a loud and booming voice a vision of the future that no doubt made the hot coffee turn to ice in the throats of the gathered host.

Your editor kept only a few notes of the session, being seated on a stage next to the Famous Strategist and being more concerned with addressing the questions at hand, as opposed to writing down what the Famous Strategist was advising the CFAs in attendance, but we did jot down enough to preserve the gist.

And it was not pretty.

“The economy is gonna be an underachiever for several years…the consumer has adjusted to a new reality,” was one line. So far, nothing shocking here: both statements are quite reasonable, even for stock-market optimists.

“There’s another trillion dollars in losses that are gonna be taken by the banks.”
Now, pessimists would argue that the verdict on this statement isn’t in yet—that the Alt-A mortgage time bomb has yet to explode, for one thing.

But by our Bloomberg, the combined trailing-12-month losses of the 21 institutions that comprise JP Morgan, Citigroup, BB&T, Bank of America and the whole rotten crew of banks described by our Famous Strategist, amount to not-losses at all, but profits.

Specifically, they amount to operating profits of $10 billion and net income of $5 billion for the twelve months encompassing the worst of the crisis—from fourth quarter 2008 through the first three quarters of 2009.

Of course, JP Morgan alone has taken $30 billion in loan loss provisions during that time, and the rest of the bunch has likewise been taking losses along the way on their Bubble-Era loan books. So, “another trillion dollars” of loan loss provisions, as predicted by the Famous Strategist, may well be the final tally when the cycle is concluded.

But, thus far, those losses have been more than made up for by profits.

As for investment advice, our Famous Strategist couldn’t have been clearer: “The financials are a graveyard of bad investment, and they’re illiquid, most of the large ones…” he warned the audience. “The government can say what they want, but they’re gonna have to nationalize these institutions—treat ‘em like Fannie and Freddie, which is the walking dead.”

Since those words were spoken, however, the “walking dead” have acted more like sprinters: BankAmerica was trading around $5 that dark night, and can’t be had for less than $15 as we write this. So too JP Morgan, a share of which cost $25 then, but now fetches more than $40. Wells Fargo, which was $17, is now $27.

Only Citigroup, among the big banks, and was trading at $3.50 at the time, costs less today. And not one has been nationalized.

Hard to imagine a better batch of investments than the large financials in the last twelve months.

But it was, perhaps, the career advice our Famous Strategist gave to the CFAs that resonated most loudly, and most threateningly, that dark night: “We live in an era of reduced expectations,” he said, and that included equities.

Pointing out the lousy ten-year history of the S&P 500 (which made the papers during the last few weeks of 2009, the concluding year of the stock market’s first-ever negative decade), he suggested the CFAs focus on fixed income and safety for their clients. “Get used to it,” he said. “It’s going to last for years.”

Now, the real lesson here is not, to be clear, that a Famous Strategist could be dead wrong—like, 99% wrong—and that Warren Buffett, who would eventually turn a profit on his Goldman Sachs investment, is usually, eventually, right.

Hey, Buffett actually sold puts on the markets near their all-time highs. Yes, they’re “European” puts and don’t get exercised for another decade, and yes, he’ll probably make money on them. But the fact is the best investor who ever lived actually sold insurance on world markets at their all-time peaks.

Nor is the point here that the Financial Crisis was a short-term blip whose after-effects will be smoothed over by the subsequent near-doubling in the S&P 500 from its 666 low in 2009, and great things to come in 2010.

If anything, the Crash of 2008 appeared to us to mark the end of US economic supremacy, much as the Crash of 1929 marked the end of Great Britain’s, and our displacement by China is something we will be dealing with for decades.

The lesson is something all investors eventually learn, and it is this: think for yourself.

Those CFAs who took the Famous Strategist’s advice that dark February night and dumped their financials and stashed the proceeds in safe Treasuries are certainly wishing they had.

Jeff Matthews
I Am Not Making This Up

© 2009 NotMakingThisUp, LLC
The content contained in this blog represents only the opinions of Mr. Matthews, who also acts as an advisor: clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author


lotusboy said...

Sometimes it doesn't matter how smart you are. Fear is fear.

Anonymous said...

Without names, i think you made this whole thing up. :)

Hal Hoeft said...

Without question I agree that one must think for ones self. However, at the time these comments were made by the unnamed market strategist the FED had not engaged on a QE strategy nor had BB demonstrated any inkling that he was even capable of getting "ahead" of the issues plaguing the credit markets. Nor had FAS 166/167 been deferred for a year. Did this strategist change his/her position as additional information became available?

Anonymous said...

And if you're unwilling or unable to think for yourself, buy low cost index funds and don't touch them until you need the funds in retirement. It's better than 90% of the advice you'll receive and you never know which 10% you should listen to.

American Bandersnatch

John said...

Jeff... You might have spoken a few days to early when you said China will displace us.. Senator Dodd decided not to run again.

Anonymous said...

I was there. Buffett also said that some companies looked very cheap (mentioning Wells Fargo and AMEX, I believe).
Let's be fair.
He was right on the specifics.

ForMyOwnAccount said...


Excellent comment! You urge your readers to think for themselves, and you do so by citing a very specific instance in which listening to someone else, no matter how respected, is no substitute for thinking for oneself.

Since you state that so well, it may also be useful to point your readers, all of whom are surely learned people, to read a short essay written several hundred years ago by a tiny man with a huge brain named Immanuel Kant. His essay is entitled "What is Enlightenment?" The first paragraph alone is worth the time and effort. Kant's message is essentially the same as yours: think for yourself.

I have in the past left a comment that could have maybe, perhaps, just possibly been construed as other-than-constructive-criticism. I am now forced by the sheer quality and subtlety of your writing to eat my words. The usefulness of your blog for all investors is undeniable. I hope your readers appreciate how hard it is to write like you do. As Hemingway once said when he was asked why he was on revision 34 of some small paragraph of something he was writing, "I had to get the words right."

You not only get the words right; you also impart a lesson that, if heeded, will make us all better investors and better -- nay freer -- human beings.

Anonymous said...

Professor Jeff:

I'd like to add two corrolaries to your axiom of thinking for one's self:

A) Have the courage of your conviction when developing your own investment position of philosophy after doing your own thinking. It is just as important to stick with what you you believe no matter how loud the siren song if dissent may be to your own opinion. Just ask anyone who's shorted a stock...

B) At the same time, be open minded enough to change your conviction when the story changes. It is dangerous to be dogmatic in your belief when circumstances changes and random events occur. Having an open mind is the perfect balance to continuing to think for yourself.

By the way, I wonder whether that "market strategist" was none other than Peter Schiff? Just wondering, and I know, you can't name names to protect the innocent...

Jeff Matthews said...

Aaron, thanks for your thoughts. As for whether it was Peter Schiff, the answer is no.

I'm not trying to be cute here by not naming names, but the point is not about the person, it's about the message, and how wrong that message turned out to be.

So I'll leave it at that.



Anonymous said...

in addition to selling puts at the dead high, buffett sold the dead low in implied volatility. and then claimed that there is no point in purchasing options for the purpose of subsequently trading stock against them. hardly market commentary worthy of such a knowledgeable and experienced investor. as is your point, my point is that his followers are better served by a mea culpa, not some cockamamie excuse served up in a holier than thou ignorance laced statement.
i'd like to like buffett. but it kills me when he says things like that.