Reply to thread

So from Oaktree:

Before I close, just a word on market bottoms.  Some of the most interesting questions in investing are especially appropriate today: “Since you expect more bad news and feel the markets may fall further, isn’t it premature to do any buying?  Shouldn’t you wait for the bottom?”  

To me, the answer clearly is “no.”  As mentioned earlier, we never know when we’re at the bottom.  A bottom can only be recognized in retrospect: it was the day before the market started to go up.  By definition, we can’t know today whether it’s been reached, since that’s a function of what will happen tomorrow.  Thus, “I’m going to wait for the bottom” is an irrational statement. 

If you want, you might choose to say, “I’m going to wait until the bottom has been passed and the market has started upward.”  That’s more rational.  However, number one, you’re saying you’re willing to miss the bottom.  And number two, one of the reasons for a market to start to rise is that the sellers’ sense of urgency has abated, and along with it the selling pressure.  That, in turn, means (a) the supply for sale shrinks and (b) the buyers’ very buying forces the market upward, as it’s now they who are highly motivated.  These are the things that make markets rise.  So if investors want to buy, they should buy on the way down.  That’s when the sellers are feeling the most urgency and the buyers’ buying won’t arrest the downward cascade of security prices.

Back in 2008, on the heels of Lehman Brothers’ September 15 bankruptcy filing, Bruce Karsh and his team embarked on an unprecedented program to buy the debt of companies in distress.  They invested an average of roughly $450 million per week over the last 15 weeks of the year, for a total of nearly $7 billion.  Debt prices collapsed throughout that period, and they continued to fall in the first quarter of 2009 (along with the stock market).  But because the hedge funds facing withdrawals had been gated – and because the leveraged, securitized vehicles that would melt down had all been liquidated – large amounts ceased to be for sale after year-end.  In short, if we hadn’t bought in the fourth quarter, we would have missed our chance.

The old saying goes, “The perfect is the enemy of the good.”  Likewise, waiting for the bottom can keep investors from making good purchases.  The investor’s goal should be to make a large number of good buys, not just a few perfect ones.  Think about your normal behavior.  Before every purchase, do you insist on being sure the thing in question will never be available lower?  That is, that you’re buying at the bottom?  I doubt it.  You probably buy because you think you’re getting a good asset at an attractive price.  Isn’t that enough?  And I trust you sell because you think the selling price is adequate or more, not because you’re convinced the price can never go higher.  To insist on buying only at bottoms and selling only at tops would be paralyzing.  

On the contrary, I gave this memo the title Calibrating because of my view that a portfolio’s positioning should change over time in response to what’s going on in the environment.  As the environment becomes more precarious (with prices high, risk aversion low and fear lacking), a portfolio’s defensiveness should be increased.  And as the environment becomes more propitious (with prices low, risk aversion high and fear prevalent), its aggressiveness should be ramped up.  Clearly, this process is one of gradual readjustment, not a matter of all-or-nothing.  It shouldn’t be the goal to do this only at bottoms and tops.

So it’s my view that waiting for the bottom is folly.  What, then, should be the investor’s criteria?  The answer’s simple: if something’s cheap – based on the relationship between price and intrinsic value – you should buy, and if it cheapens further, you should buy more. 

I don’t want to give the impression that it’s easy to buy while prices are tumbling.  It isn’t, and in 2008, Bruce and I spent a lot of time supporting each other and debating whether we were buying too fast (or too slow).  The news was terrible, and for a good while it seemed as if the vicious circle of financial institution meltdowns would continue unchecked.  Terrible news makes it hard to buy and causes many people to say, “I’m not going to try to catch a falling knife.”  But it’s also what pushes prices to absurdly low levels.  That’s why I so like the headline from Doug Kass that I referred to above: “When the Time Comes to Buy, You Won’t Want To.”  It’s not easy to buy when the news is terrible, prices are collapsing and it’s impossible to have an idea where the bottom lies.  But doing so should be the investor’s greatest aspiration.

As for the current episode, here’s some data from Gavekal Research’s Monthly Strategy piece for April, bearing on the question of whether the bottom was passed in March:

. . . markets rarely clear after one massive decline.  In 15 bear markets since 1950, only one did not see the initial major low tested within three months . . .  In all other cases, the bottom has been tested once or twice.  Since news-flow in this crisis will likely worsen before it improves, a repeat seems likely.

And here’s some data from my son Andrew regarding the movements of the S&P 500 index around the time of the last two big crises.  The first and second declines were followed by substantial rallies . . . which then gave way to even bigger declines:

And a chart for you to ponder:

[ATTACH=full]102149[/ATTACH] 

jog on

duc