Monday, February 25, 2013

Focusing on Long-Term Returns

Depending on who you ask, the massive spending cuts that the looming federal government sequester will entail this Friday either spells economic disaster or be a non-event.

Judging from most polls, most people really aren't paying too much attention.  The constant partisan bickering in Washington has left most of us weary, and we have largely tuned out.

The stock market continues to climb, apparently sharing the public's general sense of ennui with the latest partisan bickering.

In previous Washington showdowns - such as the near-default on government obligations in the summer of 2011 - the market recoiled from the possible economic implications of a disfunctional government.

This time, however, investors are more focused on corporate fundamentals (which continue to slowly improve) rather than political battles.

As a good article in Saturday's New York Times suggests that the market may have it right.  Investors who have sold over the past few years in anticipation of economic downturns have largely regretted those decisions, as the market as continued to grind higher.

In fact, as the article pointed out, there have been 78 different occasions (as compiled by the investment management firm of Bel Air Investment Advisors) when the consensus opinion was that stocks were not advisable investments - yet selling stocks, or avoiding new investments, was not the correct decision.

Here's an excerpt:

THERE are always reasons not to buy stocks. Investors may think the Dow Jones industrial average is too high, as was the case in 1954 when the index topped 360. In 1941, there was Pearl Harbor. In 1962, the Cuban missile crisis. In 1997, the Asian financial crisis.

The list, adding up to 78 for each of the years from 1934 to 2012, was compiled by Bel Air Investment Advisors. 

But the punch line to this list was that stocks went up by an annual compounded rate of 10.59 percent over those 78 years, with occasional plateaus, and that $1 million invested in 1934 was worth $2.4 billion in 2012. 

In 1951, after graduating from Columbia Business School, Warren Buffett asked his professor Benjamin Graham if he could join him in his investment management business.

The story goes that not only did Graham turn Buffett down, but he also advised him to not get into the investment business at all.  

Graham pointed out to his former student that the Dow Jones Average - which had just broken the 200 mark - was due for a tumble, since it was far ahead of the fundamentals, according to Graham.

Interestingly, Buffett's father Howard - who was a stockbroker back in Omaha - agreed with Graham, and suggested that his son purse another line of work, since the market was doubtlessly poised for a "correction".

Buffett later would cite this advice as perhaps the worst advice he ever received, and subsequent history would of course confirm this assessment.

Here's an excerpt from a Fortune article written about Buffett's start reprinted in the book Tap-Dancing to Work: Warren Buffett on Practically Everything 1966-2012 written by Carol Loomis:
I had two mentors: my dad, Howard Buffett, and Ben Graham. Here were these two guys who I revered and who over the years gave me tons of good advice. But when I think about what they said to me, the truth is, the first thing that comes to mind is bad advice.

I was not quite 21 when this happened, in 1951, and just getting out of business school at Columbia. I had just taken Ben’s class there — and I was the most interested student you ever saw. I wanted to work for Ben at Graham-Newman Corp., and I had famously gone to him and offered to work for nothing. He said no.

But I still was determined to go into the securities business, and that’s where Ben and my dad gave me the bad advice. They both thought it was a bad time to start. One thing on their minds was that the Dow Jones industrials had been above 200 all year, and yet there had never been a year when it didn’t sell below 200. So they both said, “You’ll do fine, but this is not a good time to start.”

Now there’s one thing that may have influenced my dad, and maybe Ben too. I was so immature. I was not only young-looking, I was young-acting. I was skinny. My hair looked awful. Maybe their advice was their polite way of saying that before I started selling stocks, I needed to mature a little, or I wasn’t going to be successful. But they didn’t say that to me; they said the other. Anyway, I didn’t pay any attention. I went back to Omaha and started selling securities at my dad’s firm, Buffett Falk.