Monday, February 27, 2012

Where Are the Bulls?

I was on vacation last week - the skiing was surprisingly good in Maine, by the way - so I spent the weekend trying to get caught up.

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Warren Buffett's annual letter to shareholders was released on Saturday.  The press already reported some of the highlights - most notably, that he has appointed a successor but not yet released their name - but I urge you to read the whole letter.

http://www.berkshirehathaway.com/letters/2011ltr.pdf

One of the great parts of reading Buffett's letters is that he has a way of framing complex investment decisions in a clear, concise fashion that make it easy for most readers to follow.

For example, many of us (including me, unfortunately) tend to equate rising stock prices with investment success. 

However, Buffett argues that a true investor - someone with a long-term time horizon - should actually hope that the prices of stocks declines, so that attractive businesses can be purchased at lower costs:

The logic is simple:  If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rises.  You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those that will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who after the price of gas increases, simply because his tank contains a day's supply.

Buffett goes on to urge readers to go back to the basics, through a re-reading of Benjamin Graham's investment classic The Intelligent Investor.

I first read Graham 30 years ago, but I picked up the book again yesterday, after reading Buffett.  I had forgotten what a terrific read it is, and so I have decided to take the Oracle's advice, and will begin studying Buffett's former professor's book again.

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Another part of what makes reading Buffett so refreshing is that he is upbeat and generally optimistic.

This is in stark contrast to most of the investment community, that seems to almost hoping for the markets to collapse so that their dire view of the world can be vindicated.

Jeremy Grantham of the investment firm GMO, for example, is someone who I have long admired and respected for his work.

But his most recent quarterly letter is so dire and unhappy that I fear for his health.  He finds little of investment anywhere, but leaves the question of what anyone who is trying to invest for retirement left unanswered.

http://www.gmo.com/websitecontent/JGLetter_LongestLetterEver_4Q11.pdf

Grantham is positively sunny, however, when compared to noted bond specialist Jeffrey Gundlach of DoubleLine Capital LP.

Gundlach - whose investment results in the fixed income arena are near the top of his competitive universe - now compares the United States to the last days of the Roman Empire, and foresees a similar fate for our country.  Unfortunately I could not post his company's exhibits on this site for copyright issues, but if you want to become truly depressed please feel free to do a quick Google search.

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What's interesting about the plethora of bearish commentators that I read this weekend their underlying assumption that everyone else is so bullish.

Other than Buffett, however, I found little evidence of any euphoria, or even good spirits, in my weekend reading.

Moreover, it seems that the public doesn't believe the most recent market rise either.

For example, according to Merrill Lynch, domestic equity mutual funds just experienced their largest outflows in 10 weeks.  Most of this money is flowing right back into bond mutual funds, despite the fact most bond yields are now below inflation rates.

Moreover, according to Bloomberg, stocks are now near their cheapest level ever compared to bonds:
 
Earnings in the S&P 500 have more than doubled to $96.58 since 2009 and are projected to reach a record $104.28 this year, more than 11,000 analyst estimates compiled by Bloomberg show. The earnings yield, or annual profits divided by price, climbed to 7.1 percent, 5 percentage points more than the rate on 10-year Treasuries. That’s wider than in 97 percent of months in 50 years of Bloomberg data. 

I will be posting more thoughts this week, but for now I see no need to change my essentially bullish stance on stocks.