Losses hurt more than the elation from similarly sized gains, so it’s no wonder that most of us drop into lessons-learned mode immediately after downdrafts. Shareholders demand to know what went wrong, why, and what their fund managers are changing–now!–to address the most recent cataclysm. Fair enough. That’s what happened at the end of 2008. But few of us do much soul-searching after a big rally like the one that started in March 2009.
“After the market meltdown of 2008, the most frequently asked question we received was, ‘What have you learned?'” wrote Mason Hawkins and Staley Cates of Longleaf Partners (LLPFX) in a recent shareholder letter. “Interestingly, we have not been asked about the ‘lessons of 2009.’ “
That’s too bad, because many of the same factors that lead to severe, near-term downturns, such as market overreactions to recent news, also power rebounds. Long-term investors shouldn’t upend their investment processes because of one year, good or bad. As Howard Marks of Oaktree Capital notes: “Investment performance in a single year should matter principally only to people who are going to liquidate their portfolios at the end of that year.”
The best investors may use vastly differing strategies, but they all share one trait: They regularly challenge their own assumptions and common doctrine. Great managers don’t completely overhaul their processes in an effort to win the previous battle. They stay true to their roots and make small, incremental adjustments that steadily enhance their processes. Some respected managers, such as bottom-up value managers John Rogers and Richard Pzena, are wary of predictions of a “new normal” and see parallels to past economic and market cycles, while others, such as hedge fund manager David Einhorn and more-thematic investors such as Janus Contrarian’s (JCNAX) David Decker, , contend that a degree of flexibility is warranted. “The range of possibilities for the next decade appears terribly wide,” Einhorn says.
Those who fail to learn from rallies as well as downdrafts risk being unprepared for whatever comes next.
Rogers has kept his Ariel (ARGFX) fully invested and still sees opportunity even after a nearly 95% one-year gain through April 5, 2010. He thinks 2009's lesson is the same as 2008's: Don't put too much credence on the recent past or try to predict the future. 'To us, the concept of a 'new normal' is another take on the often-stated 'this time is different' rationalization.'
Einhorn of Greenlight Capital believes adaptability is crucial. 'In reflecting on how much has changed this last decade, we have come to realise that many things that appear unthinkable can easily occur within a 10-year time frame.'
Richard Pzena of JHancock Classic Value (PZFVX) sees parallels now to every prior cycle in which value stocks fell ahead of the recession and then came out stronger. 'While market pundits are counseling 'de-risking' as their advice du jour, equities in general and value spreads in particular remain attractive despite the sharp runup of the last seven months. History suggests we are still in the early innings of this value cycle...'
Samuel Stewart, founder and president of Wasatch Advisors, is leery of blanket assumptions based on fixed time periods. The 'lost decade' was an anomaly resulting from the '90s bull market and two major shocks this decade--the 2001 terrorist attacks and the 2008 financial crisis, he says. 'We continue to believe that equities will be rewarding long-term investments.' Similarly, Wally Weitz of Weitz Partners Value (WPVLX) says, 'Historically, every time we have seen this type of 'lost decade' for stocks, the subsequent 10-year period has produced very strong equity returns.'
Janus Contrarian's Decker views the world as constantly changing and tries to roll with it. 'A year after witnessing a financial crisis so severe that it threatened to send the global economy spiraling into a severe recession (or possibly worse), we find ourselves facing a substantially improved and less chaotic situation. Last year the question was 'How bad can this get?' This year the question is 'How long will the recovery take?''
Harry Burn, John DeGulis, and T. Gibbs Kane Jr., the managers of Sound Shore (SSHFX), which finished both 2008 and 2009 ahead of its typical category peer and the S&P 500, recently commented that, 'The markets of 2009 and 2008 reinforced our view on the futility of market-timing and top-down theme investing, and also re-proved to us that times of heightened uncertainty, properly used, can produce above-average returns.'
Aston/Montag & Caldwell Growth (MCGFX) manager Ron Canakaris, who favours high-quality growth stocks, says 2009 showed that momentum-fuelled, speculative markets can go much further and faster than you think, but it's a mistake to chase what's been working. 'You don't want your clients holding the bag (when momentum reverses),' he says.
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