Two-way markets are generally the safest, because most investors become aware of both the future upside and downside. For those of us who were privileged to attend the New Jersey Symphony Orchestra's Lunar New Year Concert Celebration, not only did they hear great music but they were also introduced to the year of the Pig. According to the Chinese horoscope, the year of the pig favors wealth, good fortune, and dedication to hard work. I am earnestly in favor of those sentiments for all our friends and subscribers. We can all use good fortune and a little bit of wealth and I will continue to be dedicated to hard work for our clients and family. For many investors the road to wealth is participating successfully in the primary direction of the markets. I am hard at work trying to fathom the primary direction of the markets, particularly the global stock markets. Currently, there are signals that point in both directions.
The near-term economic trend-rate of growth is slowing. Evidence of this emanates out of China and its pivot away from exports toward a more service-oriented economy. Signs of this are also evident in Europe, Asia, Africa, Latin America, and North America. The political picture reflects this slowdown. Markets have responded with frequent changes in direction. Underneath this increase in volatility there is a sense that we have entered into a new market.
This week's Barron's highlights two investment managers who announced their retirements after an incredibly successful career. Both very recently produced way below career average rates of return as the structure of the market changed. Few stock and bond investors have not heard of Bill Gross, formerly of PIMCO and more recently Janus Henderson, who for a while was acclaimed "The Bond King." Part of Bill's skill was his insightful short-term trading of mortgages and his ability to identify cyclical changes. His techniques are now are copied by many smart competitors. The other retiree is Steve Mandel, the portfolio manager of the hedge fund Lone Pine Capital. His long-term record of gaining 14.4% since 1998 vs. 6.6% for the S&P 500 makes him one of the best hedge fund managers. He was a successful retail analyst at Goldman Sachs (NYSE:GS) and moved to Tiger Management, the home of many very successful hedge fund managers. The retail market is going through a series of rapid structural changes. One of the warnings for poker players is, if you can't identify the "chump" or likely loser, it's likely to be you. Thus, it's time to retire from the game as quickly as possible. These two well-known names are not alone, a bunch of "value" focused managers who have not performed well are also in the process of considering retirement.
Worth noting in the latest week's ranking of the top 25 performing mutual funds, 8 were growth funds and 6 were science & tech funds. Most of these were small or mid-cap funds with a likelihood of common holdings. These appear to me to be more the result of trading decisions than the decisions of long-term investors.
For some time the large and growing global retirement capital deficit has been both a concern and potentially an expanded source of new funding for investment markets. Although both political parties are aware of the problem in the US, I don't believe discussions in the House Ways & Means Committee will produce large results.
A significant number of US corporations are raising their quarterly dividend, desiring to keep their dividend payout ratios reasonably stable. Many of their existing shareholders bought into these companies years ago and now have a cost basis that is way below the current price. While not a popular measure, the new dividend relative to the initial purchase price is producing a current yield at mouth-watering levels. If the step-up basis at time of death remains in place, the yield at cost will in most cases tend to prevent their sale. As the market structure rotates into a new phase of favoring good but not cheap companies, many of these will be like the companies that attracted Charlie Munger and Warren Buffett as discussed below.
We may have entered a "Munger" Market Phase
Charlie Munger is the long-time partner of Warren Buffett. Before they joined up, Warren concentrated on buying securities that were cheaper than others. In effect, buying the discounted vehicle in an intellectual capital arbitrage. Charlie taught Warren to buy good companies at a fair price. This switch can be seen in Berkshire Hathaway's (NYSE:BRK.A) (NYSE:BRK.B) record of successes in buying both whole companies and stock positions, which in part is the reason we own the shares both personally and in our private financial services fund.
The recognition of a "good" company is in the eyes of the beholder. There is a coterie of portfolio managers who believe that they own and buy high-quality companies in various markets and sizes. All have found their own high-quality companies. A recognized common characteristic of quality companies is their owners reluctance to sell. Often, the only time they become available in the market is when a principal owners' estate is selling them or when an owner is desperate for cash. Unfortunately, during periods of economic turmoil more of these jewels come into the market. We may have entered such a period.
When I look at a quality company candidate the last thing I look at is price, either in absolute or relative terms. The single most important element I look for when evaluating a company are its people. It is worthwhile remembering that the concept of an organized company comes from military organizations and groups of professionals e.g. weavers and goldsmiths. Companies were organized based on skill levels, discipline, and respect. Respect for other members of the company, critical clients, and others. Integrity within the company resulted in the reputation generated.
The same approach should be used in selecting partners in private relationships. As the sole owner of a private company who made a few acquisitions, including some that really worked and others that didn't, I know what I am looking for in new partners who can share the enhanced value from our working together. Being smart is important, but smart is not necessarily brilliant. Smart people have a good idea of what they know and have the intellectual integrity to know what they don't. It is the second trait that makes them good partners and different from those that are brilliant. Too often, those that are brilliant claim it is based on solving problems completely by themselves. In looking at people I find that this kind of brilliance is a sometime thing. In periods between bouts of creativity, brilliant people are often frustrated, frustrating, and difficult. Smart people, when they are wrong recognize it and seek help in new directions.
Another key characteristic to look for is high physical and intellectual energy. Often the most creative time for developing useful ideas is not during regular work time and rarely during committee meetings. The real test of a manager or management is how they work their way through problems. One will only know how good someone is when you know how they handle surprises and mistakes. Years after dealing with a crisis, some public companies are still benefitting from their recoveries, e.g. American Express (NYSE:AXP) (salad oil), IBM (360), JPMorgan (NYSE:JPM) (whale), and Johnson & Johnson (NYSE:JNJ) (Tylenol).
Most of the time owners of good assets are loath to part with them. We may have entered a period when more of these high-quality assets can be bought at "fair prices," but not necessarily on the cheap. We should watch Berkshire Hathaway and other high-quality acquirers who take advantage of these opportunities. History suggests that these periods don't last long.
A particularly difficult task in selecting companies or people is separating current popularity from long-term value creation, i.e. Hula-hoops vs. home equipment for exercising. A related concern is gauging the probability of solving future concerns.
The list of desired attributes is both long and difficult to determine and capture. Thus the strong likelihood that when they are found their price will not be cheap. If we have entered the "Munger" market, the odds may have improved.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.