The Days of Buy and Hold Are Over

Rarely will an investor seek to paraphrase Richard Nixon. However, when Nixon observed in 1971 that "we are all Keynesians now," he established the framework which allows me to comment on the current state of investing. Given the turmoil in markets, large bear market declines, and majestic rallies, we are all traders now.

For months in my weekly newsletter EPIC Insights, I have declared that the era of buy-and-hold investing is over. People who followed prudent approaches, saved, and invested for the long haul are left with losses and frustration. While defenders of buy and hold will cite studies and academic research to justify their approach, they need only look toward their most talented, well-respected practitioner to see its weaknesses.

Warren Buffett famously studied under Ben Graham, the father of value investing, and built an enviable record. Preferring a holding period of "forever," Buffett buys the stock of excellent companies at a discount to fair value, allows the businesses to operate, and enjoys the increasing wealth that usually comes from this approach. As markets headed higher, Buffett's astute stock picking allowed investors in his holding company, Berkshire Hathaway (BRK.A), to prosper.

However, times have changed. Using the marketable securities table displayed in Berkshire's 2008 annual report and adjusting the core holdings to current market prices, Berkshire's $35 billion portfolio shows a gain of 12%. Assuming the average life of these holdings is 12 to 15 years, Buffett has performed in line with the Dow while badly lagging what a risk-free investor would have received in short-term Treasuries. If the greatest buy-and-hold investor cannot outperform, how will other long-term investors fare?

Yes, some positions may work out exactly as planned, but to be successful overall we must evolve with the markets. Such a view leads me to keep a short leash on every position I take. For example, two weeks ago, I purchased XTO Energy (XTO) and ConocoPhillips (COP). Believing the stocks were cheap and oil was set to push higher, solid reasoning supported each action. Over the last two weeks, XTO and COP have resulted in gains of 8% and 10%, respectively. Although I am pleased with the gains, the markets are changing and so must I.

When I entered the trade, the oil market was in contango. Contango is a bearish feature as it indicates excess supply is on the market. While I would rather not go long a market showing contango, the direction of the future curve supported me. Having seen the one-month spread narrow from $4.46 to $0.79, it appeared the contango would disappear, the oil market term structure would become more bullish, and a long position in energy companies would deliver great returns.

Despite an increase in the spot oil price, the one-month spread has widened to $1.78. Even though the fundamentals remain bullish, I see no reason to take the risk of the contango widening further, oil dropping in price, and our hard-earned gains turning to losses. Recognizing we are all traders now, I recommend selling XTO and COP as this week's fundamental trade.

Comments

[y3115y:]

When most people go to timing, it is the bottom - according to Hulbert.

Mar 31 08:52 AM

[YoYoMama:]

What does "buy and hold" mean anyway? Buy and hold for 2 days? Two weeks? Two years? Two decades? If you can't - or won't - define how long the "hold" is in "buy and hold", how can you say it's "dead"?

Mar 31 09:12 AM

[berated:]

Sean is correct. While 'buy and hold' may not be dead, it's been on holiday for awhile and may not come back soon. According to what I've heard from Wall Street for the last 20 years, the traditional 'buy and hold' phrase translated into the long term (eg, ~10 or more years and I suspect most folks have the same definition). That strategy doesn't seem appropriate for current market conditions, does it?

Mar 31 09:44 AM

[dcb:]

The reason buy nd hold doesn't work anymore is becuase the big players don't do that. qquant funds do the most trading, and for them there is no such thing as a market top or bottom. only relativity. hedge funds don't do it, and the past experience is likely to increase that. So, the market does what it wants, you have to adapt to the market. the shame, it that buy and hold is based on what is still being told at the retail

Mar 31 10:51 AM

[Conan the B...:]

Of course "Buy and Hold" works.

The Manipulators just go in and out, they do not change the fundamentals or value.

If you want to lump Buffett into the Day Trading crowd, hey its your perogative.

The stocks you list weren't purchased to be sold the next day, that's not Buffett"s style. 35 years of Buy/Hold are reflected in BRK's price. $100 in the mid-seventies, don't you wish you had bought and held?

I've been buying recently, haven't sold a thing. Some aren't meant to be sold, ever. Income, at yields which I thought were gone forever are now available.

Buy and Hold is the cure for this Market.

IMO

Mar 31 11:53 AM

[Larry House:]

I will go a bit further and say the day of profitably investing in stocks and bonds may be over, considering the state of the world economy, the insane actions of the Obama administration, and the promise of rising inflation.

Mar 31 11:56 AM

[WayneS:]

If it is not buy and hold, it is not investing, but profiteering.

Mar 31 12:07 PM

[Phil Trupp:]

Doug Kass made exactly the same case against buy and hold this morning in his column for STREET TALK. He also used BRK as an example. In Mr. Hannon's BRK breakdown we are shown a 12 percent overall gain--not bad for one of the worst markets ever. And this gain is all in buy and hold positions. More to the point: Commentators tend to ape each other, playing on the same sentiments and themes, the same opinions; the analysis de jour works just fine until it's time to switch to a new tack and the chorus begins to strike up yet a new line of harmony. Clearly buy and hold doesn't work in current market conditions. This doesn't mean it won't work next month or next year or at some other time in the future. Circumstances change, markets change. Change is our only certainty.

Mar 31 12:28 PM

[Conan the B...:]

Larry, define profitably?

I deem an annual yield of 20% ex-stock volatility to be profitable, ditto a Monthly 10% Tax free. If you mean expecting triple digit annual gains, that's there too. I'm already up 50-60% in a couple and expect 100% this year in them.

ALJ and LINCY but go ahead, stick to your guns. Don't look at what is available, follow the crowd.

IMO

Mar 31 12:32 PM

[carey_jim:]

Your article reminds me of a toast:

Though confidence is very fine,
And makes the future sunny;
I want no confidence in mine,
I'd rather have the money.

Mar 31 12:51 PM

[Vox Rationalis:]

"Assuming the average life of these holdings is 12 to 15 years, "Buffett has performed in line with the Dow while badly lagging what a risk-free investor would have received in short-term Treasuries. If the greatest buy-and-hold investor cannot outperform, how will other long-term investors fare?"

You're making a few fundamental errors with this "analysis."

1. Assigning a strict buy-and-hold rule to Buffett. Certainly, Buffett's said his preferred holding period is forever. Does this mean he never sells anything? Of course not! Case in point - Petrochina, which Berkshire held for about 5 years. The company reached a valuation that Buffett and Munger felt was rich, so they sold - for a 700% gain.

2. Disregarding returns on assets no longer held (such as Petrochina) and wholly-owned businesses. Leaving out realized capital gains underestimates the performance of the equity portfolio. Leaving out the rest of Berkshire's businesses and investments provides an incomplete picture of Berkshire's returns.

Disregarding the rest of Berkshire's business is like judging a woman's beauty from afar; your initial assessment may be right, but would you decide to chat her up before you saw her up close? Of the investments held in Berkshire's insurance businesses, the equity portfolio made up less than half at year-end (down substantially year-over-year). In addition, Berkshire has dozens of smaller subsidiaries whose results have to be included in complete assessment of Buffett's returns.

3. Using Berkshire's share price to measure returns. The market's valuation of Berkshire's shares (often boosted by a so-called "Buffett premium") may or may not be related to the company's returns, but it certainly is not a direct metric. Growth of tangible book value is a much better yardstick.

So I ran a screen. In my screener, the longest investment period I can define is 10 years. From year-end 1998 to year-end 2008 (the same period for which the mutual fund returns are calculated), Berkshire's tangible book value increased 96.4%. There are 24,655 funds in my screener, including equity funds, fixed income funds, and tax-exempt fixed income funds; 5,902 have a 10-year history. Of these, the ones that had returns higher than Berkshire over this period:

4.4% (261/5902) of all funds
0.87% (24/2761) of all fixed-income funds
0.0% (0/1820) of all funds in categories related to Treasurys

Not so bad. Not so bad at all.

Mar 31 01:24 PM

[Conan the B...:]

VOX: you tell them, there have to be more stats than just those, hit them with a poleaxe or two.

Using just a 2 year timeframe for BRK is simply ridiculous.

My turn, If Buy/Hold is a thing of the past, why are Gold investors buying and holding?

Mar 31 01:49 PM

[Steve in Gr...:]

Thanks, Mr. Hannon, for the useful article. I think you are making an empirical argument, right? By observing Berkshire's short term returns, you conclude buy and hold is dead.

You might have made a different, a priori argument. Buy and hold is dead, because we are all Keynesians now. The governments intervene wildly and continuously. Unless you know where the government is going to go next with respect to a specific stock or industry, investing is folly.

Example: Lehman is allowed to go bankrupt, but Citi is bailed out.
Example: GM is first bailed out and now it looks like it will be forced into receivership.
Example: Card-check.
Example: Nationalized healthcare.
Example: PPIP

Unless you are one of the apparatchiks with inside information about the governments next stupidity, don't bet on a specific equity.

Mar 31 05:07 PM

[Moresby:]

Why don't you just call this what it is - CASINO.

Mar 31 09:48 PM