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A New Year’s Resolution… early

December 5, 2011

It isn’t year-end yet and here I am already making my New Year’s resolution. Why? For one thing, boredom. I’m not finding many new investment opportunities, and most of the blogs I read are in semi-hibernation or have simply disappeared (where are you Shadow Stock?). Are these two connected? Most likely. It was certainly a sign when Greenbackd stopped posting almost a year ago. In any case, the overall market continues to be range bound, with the S&P 500 between 1,100 and 1,350, weighted down by the European sovereign debt problem. More frustrating yet, most equities seem to move in near lockstep. What few potentially interesting opportunities there have been, like JEF (due to the MF Global debacle), are unfortunately outside of my area of competence, and so, off-limits. So I have to content myself with reviewing my existing positions, which still seem to be among the best opportunities out there, and, where appropriate, adding to them little by little.

In these doldrums does danger lurk! The cardinal sin of value investing is swinging at a pitch that isn’t in your sweet spot. So, how to keep our little hands happy while we wait? I often go back and re-read some key value investing texts which I then use to re-evaluate my current strategy and investment choices. A week or so ago I was rereading Howard Mark’s comments from last May (which now seem propitious). They were written just after the most recent market top and Marks was commenting on (or lamenting) the return to a less risk-averse investor attitude compared to the rampant panic widespread during financial crisis of 2008/09. How quickly we forget, seems to be the repeated chorus. Well, he was right. Three months later and investors discovered the European problem; until recently we were in risk-off mode again, the market trending down as investors shifted out of ‘risky’ equities. There was a generally negative investment atmosphere, even a whiff of recession in the air. Things looked bad and there was (and perhaps still is) the possibility of a catastrophic outcome with the disintegration of the euro zone. The result: I began to feel comfortable again. But of course we don’t know whether, after our latest little rally, sentiment will get more negative, how much more negative or how long it might stay negative. I’m a bit sorry that my cash position is not just a tad higher; I’m sensing that there could be some opportunities coming up. Which leads back to my New Year’s resolution. It has to do with discipline, Buffett’s 20-punch card and having enough cash to take advantage of opportunities.

My resolution is simple: only invest when the opportunity is an exceptional one, otherwise keep your shirt on and the cash in the bank. I was rereading some of Klarman’s examples in Margin of Safety, and my own holdings seem to pale in comparison; hardly any are the slam-dunks he described. Perhaps my investment criteria are too lenient. Perhaps I’m not scouring the universe with enough fervor? More likely, it’s simply because I am not waiting for the really fat pitch, and then when I do swing, it’s without enough follow through (i.e. the position I take isn’t large enough). So, my resolution: more cash on hand and less compromise when evaluating a potential investment. To some degree this is my take away from Klarman’s Margin of Safety. He emphasizes absolute return rather than relative return. It’s a lesson I soon forget, so I keep a copy of his book on my netbook to reread on trains, planes and automobiles. To drive the lesson home I contemplate what my portfolio (and investing results) might have looked like had I followed Klarman’s definition of value investing more assiduously during the period around the financial crisis of 2008/09. In fact, I often contemplate whether my strategy shouldn’t be simply to remain in cash except during periods of severe economic upheaval (like the 2008/09 liquidity crisis) when funds would be invested, then slowly liquidated over the ensuing recovery. That kind of strategy, however, comes directly from the most recent market experience, and we know that the markets rarely repeat, though they often ‘rhyme’. What if we were in 1960? How many years might one be ‘waiting’ in cash and missing the market advance? Would we have the temperament to stay in cash for 5 years while the markets advanced strongly? I sincerely doubt I it. That requires exceptional staying power even without clients yelling at you from the other end of a phone. So, while this kind of strategy seems intellectually appealing due to our two most recent market experiences (the late 90’s tech boom and the subprime mortgage crisis), I don’t really believe it is implementable for mere mortals like me. Still, more cash and less trash is my leitmotiv for the new year.

  1. Lib permalink

    Excellent post. Your thought process mirrors mine in many ways. There are a couple of things I really like that are cheap right now, but I still need to remind myself not to swing too much at merely ‘good’ pitches. Thanks for sharing your travails!

  2. Justin permalink

    I suspect that being able to wait five years for the fat pitches might also have a lot to do with whether or not you are “eating what you kill.” In other words, if you’re living off of your nest egg. I bet if not, it’s easier to sit out the bull markets. But if your entire income is dependent on your investment portfolio (obviously, cash included), missing those moves must be very stressful.

    I’ve always thought the best way to stay disciplined (if I were in fact only managing my portfolio and didn’t have an income, which I do) would be to keep about five years’ worth of living expenses in cash at all times, ready to be spent. Wouldn’t make it “easy” to miss the runs, but, might make it easier.

    In any event — thanks for the great post and your great blog.

  3. I don’t think you really need to stay in cash if you don’t find great opportunities. You do need to be willing to sell good ideas if you encounter a great idea though, and that can sometimes be hard.

  4. Ted K permalink

    Dear blog host,
    I like this post a lot. Not highly technical (and good posts needn’t be) but I think a lot of investors suffered this same situation and had similar thoughts currently. I don’t know what decisions you made or your portfolio make-up, but my guess is your choices of individual stocks “were not wanting” in proper valuation or “Margin of Safety”. But rather, whatever probs you had were more generally related to market valuations. I think you have a good mindset now though, and if you can hold to your discipline, you’ll do better than most the next year. Wish you the best.

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