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  • Chris Mayer

A Preview of What's Coming

“A falling stock market seems to clarify and stimulate thought. When it is rising, nobody cares to know why or how, but when it falls everyone is very eager to know all about it.”


~ Albert Jay Nock (1870-1945), journal entry dated October 18, 1932, from Informed Common Sense: The Journals of Albert Jay Nock (with an introduction by yours truly).


I don’t know if you’ve been paying attention to what’s going on in European stock markets, but they have been hit harder than the S&P500 has. The virus had a head start there. And I can’t help but think they are giving us a preview of what to expect in the US.


The Italian stock market (as represented by the FTSE MIB), for example, is down 25% year-to-date. It’s down 30% from its high on February 19. The whole country is in lockdown. Exor, one of my favorite stocks, trades on the Milan exchange. Despite a war chest full of cash and one of the best young capital allocators in the game, it is down about as much as the broader market. (Disclosure, we own it in my fund).


The FTSE, to add another example, is down 21% year-to-date, as I write. The UK is a few steps behind Italy. The Bank of England just made an “emergency rate cut.” And the virus continues to spread. The number of infections is still on the rise.


My fund was heavy in European stocks before this mess began and it remains so. I have not sold anything because of the virus and – no surprise – I plan to wait it out. In fact, I have added a bit to some of my European positions. My time horizon extends well beyond this virus.


Therefore, I believe very good buys exist in the European markets – if you share such a longer-term view. In this case, I don’t think you’ll have to wait that long.


My guess is we have a strong recovery in the second half of the year. But even if that is not the case, at some point, the virus and its effects will be behind us.

I do think it could get worse before then, even if just in the next few weeks as countries take more and more measures to slow the spread of the virus. In the US, we’re just getting started.


I live in Maryland in the suburbs of Washington DC. The virus is spreading here. My son’s University is switching to online classes only. Spring break starts next week and the University is telling its students not to plan on coming back until at least April 10.


My middle brother has been exposed to the virus and is in quarantine, working from home. (He is not showing signs of sickness yet).


Already, conferences in New York have been cancelled or postponed. The Amtrak service I use to get to NYC has been halted because of lack of demand.


My travel plans are all in doubt. Will Warren and Charlie hold their annual meeting in Omaha this year? Tens of thousands of people from all over the world would cram together in an arena in Omaha and pack into restaurants and hotels. Should two elderly legends expose themselves to this kind of risk? It seems unlikely to me that the show will go on…


This is just the view from my little corner of the world.


Anyway, the point is it feels like we’re still in the early stages of containment here. I wouldn’t bet on “investors” doing the rational thing and looking past it. (As the old saying goes, “No one ever went broke underestimating the intelligence of the American people.”) People will panic, as they usually do.


So, it would not surprise me at all if the path of the S&P500 starts to end up a lot like the one Italy or the UK just traversed. As I write, the S&P500 is down about 15% year-to-date. As investment advisor Nick Murray wrote, “If you can’t endure a 15% decline every year and an average decline of about one third one year in five, you just flat-out can never be an equity investor.”


In the grand context of market movements in history, this one is barely worth talking about. But it might yet be.


I am just guessing. I am not a market timer or trader. I buy businesses with the idea that I want to own them for a long time – again, no surprise if you’ve been reading this blog or read my books.


But, not every business should be held for a long time…


Thomas Phelps, the author of classic 100 to 1 in the Stock Market (which inspired me to write my own book, 100 Baggers, updating his idea), summed up his approach with the phrase “buy right and sit tight.”


I notice some people tend forget the first part. Not every stock is worth holding. There are lots of bad businesses and plenty of bad stocks. They are for traders and speculators. You wouldn’t want to sock them away in your coffee can.


If you’ve done the work and invested in good businesses with strong finances and talented people at the helm, then time is your friend. To sell now is like pulling up your plants before they bear fruit.


If you accept the theory that a business is worth all the cash it will generate for its owners discounted back to the present, then you should realize that cash flows over the next year don’t matter much.


One of my favorite pieces on this point is by James Montier, “The Road to Revulsion and the Creation of Value,” reprinted in his book Value Investing. He constructs a simple discounted cash flow model to show the proportion of value contributed by timeframe.


As he writes (page 331): “The first three years contribute a mere 10% to the total value. The next five years are slightly more important, representing some 15% of total value. However the long-term proved far and away the greatest contribution to value, accounting for some 75% of the total… This simple exercise shows the relative unimportance of the next few years – even if they see earnings halve – to the long-term investor.”


Even though determining what that value is exactly is impossible, the theory is sound. You can jigger the numbers in different ways and still get at the same general conclusion. (Valuation is another factor, but not as critical as you might think over a long time horizon. You can be a little wrong on valuation and still wind up in fine shape if you are right on the quality of the business.)


I hope some of the above may help you as the market goes lower and your portfolio goes with it. Stay in the game and be of good cheer - because you're planting the seeds today for a great harvest in the future.


Finally, I leave you with the words of John Maynard Keynes, a very fine investor himself:


“I feel no shame at being found still owning a share when the bottom of the market comes. I do not think it is the business, far less the duty, of an institutional or any other serious investor to be constantly considering whether he should cut and run on a falling market, or to feel himself open to blame if shares depreciate in his hands. I would go much further than that. I should say it is from time to time the duty of a serious investor to accept the depreciation of his holdings with equanimity and without reproaching himself.”


Thank you for reading.


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Published February 28, 2020

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