Rational Advisor

“If you wait for the robins, spring will be over,” - Waren Buffett, NYT Oct 2008

When the stock market goes up one day, and then goes down for the next five, then up again, and then down again, in no discernible pattern, that’s what you call stock market volatility. , and it’s usage causes people to panic and refrain from sticking to their well thought out plans. They want to “wait” till “IT “recovers.

Most first time investors perceive the stock market to be more volatile because of its typical sharp, sudden price swings. That perception is often reinforced by a simple but often overlooked mathematical relationship. The higher the Dow Jones Industrial Average (DJIA)is, the same percentage change in the index today reflects a much greater move in terms of points. For example, with the DJIA at 800, a 2% change reflects a move of only sixteen points (not very newsworthy). But with the Dow at around 11,000, the same percentage change represents 220 points, and the media focuses on the 220 point drop, not on the percentage.

Irrational Investors due to their emotions, get caught up in these swings and panic waiting for things to improve before they will invest. Always waiting as if there will be some green signal that identifies the bottom of a market.

And in so doing, they miss out on great opportunities. Recently Warren Buffett in a note in the New York Times said “If you wait for the robins, spring will be over,” He’s trying to say that if you’re looking for signs of improvement to invest, it may be too late. “Bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.” That’s the crux of his investing strategy. To take advantage of bad news and fright in the markets. And this is just the opposite of what our emotions want us to do. When we feel fright, our caveman emotions want us to run away from it. When in fact, it’s better to understand the reasoning and then to take advantage of it.

In our discussions with sound and rational investment managers there are three investing principles that came to mind:

1. Ignore the stock market. The stock market is just providing a price on businesses based on the mass psychology of the investing public, and usually is not a good indicator in the short term of the businesses true value. If you plan on having an investment program for a number of years, what happens in the market on a day-to-day basis is pretty much irrelevant.

2. Don’t worry about the economy. Stop discussing and debating whether the economy is poised for growth, or tilting toward a recession. Wise investors like Buffett and David Dreman dedicate almost no time or energy to analyzing the economy. Instead they focus on the underlying businesses that they are investing in and their revenue and cash flow.

3. Most good rational investment managers are buying businesses, and not the stock. They look for consistent operating history and favorable long-term prospects. What about its management? Is it rational, candid with shareholders, and able to avoid the herd mentality? Look at the financials, focusing on return on equity, not on earnings per share. These managers seeks out companies that generate cash in excess of their needs and companies with high profit margins, which reflect not only a strong business but a management with a tenacious spirit for controlling costs. Other financials to look at: retained earnings, estimated cash flows, and the value of a business. Once they have determined the value of a business, the next step is to look at the stock price. Most of these managers rule is to buy the business only when the stock price is at a significant discount to its value. Note that only at this final step do they look at the stock’s price.

Savvy investors don’t follow the herd: they have a game plan. And that’s exactly why they’re successful.

Stock market volatility will always be a part of investing, but a focused strategy will help weather the more stressful periods when the market is more volatile, since you’ll be focusing on the bigger picture. Success in the market does not depend on predicting the future. Volatility is more dependent on mass hysteria—fear and greed—than on underlying economic or financial events. Those are not reliable emotions on which to base long-term investment decisions.

And remember, don’t wait for the Robins to indicate that Spring has arrived.

“The most common cause of low prices is pessimism – sometimes pervasive, sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It’s optimism that is the enemy of the rational buyer.”- Warren Buffett, 1990 Chairman’s Letter to Shareholders

Just another normal week in the equity markets – now that the new normal features wild and sudden price swings and more than the usual dollop of odd trading behaviour. That’s what happens when hope mingles with panic and bargain chasers run headlong into fleeing mutual fund investors and hedge funds are hit by a wave of margin calls and withdrawals ($31-billion U.S. alone in the third quarter).

Here’s the drama check: There was historic intervention as governments injected billions into banks around the globe. There were violent flip-flops, The VIX volatility index wailed to a recent record above 81.

Crude has plummeted 51% from the all-time high it set in July.

The months-long oil collapse has largely been triggered by the demise of investment banks, said Fadel Gheit, a senior oil analyst with Oppenheimer & Co. Banks have drastically curtailed their highly-leveraged businesses, such as commodities trading, due to “the tightening credit, the diminishing appetite for risk and tougher government regulation,” he said.

Reduced speculative activity could keep oil prices closer in line with supply and demand for months to come. When the global economy stabilizes, “there’ll be a base for oil prices, but definitely lower than the current level,” Mr. Gheit said.

To be sure, these global government work outs take time and none of the emergency funding that was talked about will find its way into the financial system for a few weeks yet.

The question, of course, is whether a market that has already surrendered all its bull-market gains has sufficiently discounted the coming gloom. Here, it helps that investor sentiment is shot. The expectations bar is set pretty low when your benchmark is the Great Depression. In fact, a Merrill Lynch survey of 172 global money managers conducted just before Oct. 9 showed that 69% believed the world is in recession, up from 24% in August. A record 87% see company margins slipping and 43% now say stocks are undervalued — the highest in more than a decade.

It also helps that banks last week were charging marginally less to lend to each other, and a world suddenly on “Libor watch” makes credit shocks less likely.

In recoveries from past market plunges, trading has remained volatile even after the major indexes reached their lows, so it is widely expected that Wall Street will ratchet higher and lower for some time.

Despite the dizzying swings, the market has started building a base, which is the first step on the road to a genuine recovery. And if history is any guide, this will occur months before the economy gets up off its sickbed.

Similar sentiments were evident in a column in last Friday’s New York Times by renowned investor Warren Buffett, who recommended buying U.S. stocks. The billionaire said that his entire personal fortune may soon be invested in the domestic market in anticipation of an economic recovery.

“If you wait for the robins, spring will be over,” wrote Mr. Buffett. “Bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.”

In his article, Buffett tells the world why he is buying U.S. stocks now. A simple rule dictates his buying: Be fearful when others are greedy and be greedy when others are fearful. When Buffett speaks, we should all probably listen.

Warren Buffett has been moving his personal investments from safe U.S. treasury bonds into U.S. stocks, he wrote in an opinion piece in Friday’s New York Times.

“If prices keep looking attractive, my non-Berkshire net worth will soon be 100 per cent in United States equities,” he wrote.

“To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions,” he wrote. “But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records five, 10 and 20 years from now.”

“Let me be clear on one point: I can’t predict the short-term movements of the stock market,” he wrote. “I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.”

Warren Buffett and other savvy investors are, as of right now, positioning themselves to take advantage of the current fire sale in the stock market. They’re certainly analyzing financial data, looking for sound businesses whose stocks are battered by the current bear market but whose businesses are sound, strong and profitable, making them excellent candidates for strong long-term growth.

Let’s start off with the recent quotes and what they mean

Recent wise words (2008)

1. “A crisis always feels bottomless, and it usually isn’t,” - John Dorfman, US Value Manager - Bloomberg Oct, 2008

John Dorfman, here is saying that almost always crisis, when you are going through them feel like they have no end. “This sub-prime thing is going to end capitalism as we know it”, “Banks will fail and never come back”, “it’s the end of the US”. Almost through every crisis we get similar views, and yet the world tends to manage through it quite successfully. When you look at any chart of the markets, you’ll notice that the crisis are mere blips in the uptrend.. These blips look like major crevices, and scare the bee-jeezus out of investors. However every successful investor has taken advantage of these dips to add to their long term plans.

2. “Be fearful when others are greedy and be greedy when others are fearful.” - Warren Buffett, NYT Oct 2008

This is the crux of Warren Buffett’s investment program. And in this he’s really taking advantage of mass stupidity, and lemming like behaviour. Most people are not wealthy, and this is because they follow what “most” people do - which is read the paper and listen to the news on TV. The rich tend to do the opposite of the masses, this is why they are rich. if they did what the masses did, they would be like the masses. So, when the masses are fearful like now, this is when rational heads like Warren Buffett, David Dreman and others get into action. Yet, when the masses are excited like at the peaks is when these investors shy away.

3. “If you wait for the robins, spring will be over,” - Warren Buffett, NYT Oct 2008

Another great quote from Warren about not trying to time when the crisis is over. Too many times we look for some sort of magic signal, some green light that it’s okay to invest. there is no starting flag to say when the markets will recover. Its best to not try to time it.

4. “Bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.” - Warren Buffett, NYT Oct 2008

This is really point number 2, explained better. By taking advantage of people’s fears about certain companies and the investment arena, rational investors get to purchase those investments at a reduced price.

5. “The most common cause of low prices is pessimism – sometimes pervasive, sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It’s optimism that is the enemy of the rational buyer.”- Warren Buffett, 1990 Chairman’s Letter to Shareholders

Similar to points 2 and 4. But this was written in 1990, at the height of the S&L crisis. When investors thought it was the end of the banking world, when Orange Country in the US declared near bankruptcy. The point discusses that sometimes the pessimism is pervasive - everywhere, and almost everyo9ne is shouting doom, the end is nigh. And yet that’s the exact environment that allows attractive purchases. It’s Optimism by the masses that are the enemy of rational investors, not pessimism by the masses - that’s our friend.

Not so recent wise words (551 BC - 479 BC)

Confucius says -

1. Everything has its beauty but not everyone sees it.

Some people because of all the turmoil in the markets are not seeing the beauty in the attractive prices around us. They are not seeing the purchase of continuous revenue streams at cheaper prices. There are many businesses that even in these tougher times have continued to pay out their dividends, that have continued to increase their revenues - and we get to purchase these revenues at cheaper prices. And I’m glad that not everyone can see the beauty, because if they did, we would not get such attractive prices.

2. Our greatest glory is not in never falling, but in getting up every time we do.

We make a mistake if we don’t learn from our mistakes. We make a mistake when we refuse to do something just because we fell from it. We are bound to make mistakes, its human nature. And the most awful thing you can do is refuse to learn from it, and instead blame the whole system. The markets have come down, and many have panicked out of it, running to the safe harbor of cash. But, cash won’t help them retire at above inflation rate returns. Only businesses that grow their revenues and provided dividends at a greater than inflation rate can do that. So, pick yourself up, and return to the battle field.

3. The superior man, when resting in safety, does not forget that danger may come. When in a state of security he does not forget the possibility of ruin. When all is orderly, he does not forget that disorder may come. Thus his person is not endangered, and his States and all their clans are preserved.

It’s always wise to prepare for discomfort, when you feel the most comfort. What hurts is the surprises, and the fact that we did not realize it. this is what causes is to flee sound investments. In actuality, surprises will always happen, and sometimes the magnitude will be greater than what you expected. However, preparing for these and taking advantage fo them is probably our greatest tool to achieving financial success. Be prepared for disorder, and realize it is a normal and par for the course.

4. Study the past if you would define the future.

Probably the most important quote - it doesn’t mean look to past returns to predict future results. What it means is understand past risks. Past Risks have been very good predictors of future risks. So, when picking an investment get an idea of it’s volatility by studying its past volatility. Do not look at the past return as if it will predict the future return.

Rational