First Quarter Commentary: When Will We Ever Learn?

Posted Apr 12, 2010 | Calvin Brown

Several years ago, a delightful little book entitled All I Ever Really Need to Know I Learned in Kindergarten was published. Its author, Robert Fulghum, had put together a “rulebook” for life that was made up of principles we had all learned as small children. The upshot of the book was this: we all know the rules by which we should live our lives—we have known them since we were five! We simply need to revisit and relearn these guiding principles in order to stay on track.

As I think back over the past couple of years and reflect on the Great Recession that we have all painfully endured, I am reminded of several lessons that we as investors need to revisit and relearn. All of us were already aware of these basic tenets of investing, but in difficult times we seem to easily forget them. While this list of lessons is by no means exhaustive, I do think it focuses on some basics worthy of revisiting.

First, markets overreact—both positively and negatively. This is irrefutable, inarguable and, plainly and simply, a fact! I use that statement intentionally and for dramatic effect. I do so because I know someone reading this will roll out the Efficient Market Theory to argue otherwise. While markets might behave rationally from time to time, there is no question that they can act irrationally on occasion and remain so for extended periods. As I stated, markets overreact in both directions. Dot-com bubble, anyone? In the late nineties we witnessed a company whose mascot was a sock puppet reach stratospheric valuations without ever earning one red cent, only to crash to earth and disappear into the history books. But many otherwise sane investors participated in the insanity. By the same token, in the early days of the Great Recession, we saw solid, blue-chip companies lose billions in market value in a few short weeks (or was it days?). And yet again, rational investors became irrational, which leads us to the second lesson we would be wise to relearn….

Panic selling is never a sound investment strategy. The very words “panic selling” implies irrational behavior, yet that is exactly what we witnessed, particularly in the waning days of 2008 and the first quarter of 2009. Almost everyone was gripped by the fear that the “R” was quickly morphing into a “D.” Pundits and talking heads were no longer talking recession; they were predicting Great Depression Two.

I distinctly remember visiting Duluth, Minnesota for a wedding during that time period. As I sat in my hotel room overlooking Lake Superior, I was being told by one of television’s most popular and recognizable financial “experts” that all of us should at least consider moving in with our parents or other family members if at all possible. I am being serious—that was his professional advice. I remember reacting viscerally to such an irresponsible comment—how could someone so respected and widely followed make a reckless comment almost certain to induce unmitigated fear among an already panicked investment community? I hope he cringes when he remembers that comment in retrospect.

But that irrational sentiment characterized the economic landscape in those days. Panic selling continued into the market lows of March 2009. One of the most difficult things to do as an investment professional is counsel a frightened client to stay the course and maintain their stock positions as the financial world is apparently crumbling around them. However, that is what we did, silently praying that we were giving sound advice. We know that the market pendulum swings between fear and greed, and it had swung completely and unequivocally to the fear side of the meter. Those that gave in to the fear and sold locked in historic losses. However, those that kept their heads while all around them were losing theirs (my apologies to Rudyard Kipling) enjoyed a resurgent market over the ensuing months that restored their portfolios to at least respectable levels. Those that refused to give in to the panic were rewarded, which leads us to the third and final lesson I want to revisit …

Owning high-quality businesses in a well-diversified portfolio remains the best way to accumulate wealth over the long term. Despite the Great Recession, despite the Lost Decade, which we discussed in last quarter’s commentary, despite wars, depressions and other horrific events that come our way, stocks continue to reward those who commit to long term investing. In fact, the Ibbotson Yearbook, which quantifies historical market results, has just been released for 2010 and it verifies that thesis. Equities have returned, on average, 9.8% to 11.9% per year from 1926 through 2009. That is a lesson well worth remembering during difficult times.

The three basic lessons briefly described here are lessons we already knew. While we might not have learned them in kindergarten, we learned them a long time ago. We simply need to be reminded of them from time to time. Adhering to these fundamental tenets will help us avoid following the crowd and making irrational decisions in good times or bad. Fortunately, we have emerged from the Great Recession, battered and bruised, yet resilient. The economy is clearly on the mend and the markets are responding favorably. Let’s vow to make a concerted effort to stay focused on the fundamentals and avoid being caught up in the inevitable extremes of euphoria or despair.

As has been my habit, I want to leave you with a quote that I believe illustrates both the hubris and dire pessimism that can grip investors:

“You are never closer to your greatest failure than when you are at the moment of your greatest success.”
—Craig Winn, one-time Dot-com billionaire